IFR 03.7.2020

International Financing Review March 7 2020 71

LOANS LEVERAGED LOANS

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Investors push for Libor floors

„ US Libor has fallen sharply

US leveraged loan investors are pushing to set

a minimum return for lending to some of the

world’s most well-known companies as rates fall

amid global market volatility caused by concerns

about the fast-spreading coronavirus.

DUFF & PHELPS and KISSNER GROUP were

among companies that added a Libor floor, the

minimum rate a key lending benchmark can

be set at, to its financing packages last week to

ensure a base return for investors. Three-month

Libor, the rate companies often peg interest

payments to, has fallen 47% this year.

Libor fell sharply after the Federal Reserve

stepped in to cut interest rates by 50bp on

Tuesday to try and contain the fallout from the

virus. While a boon for borrowers that can lower

their interest payments, the drop can hurt lenders

who receive less compensation for their risk.

Introduced during the credit crisis as an

antidote to a plunging Libor, market participants

began to push for the removal of floors when

the benchmark started to bounce back and inch

closer to 1%, the level of many floors.

Three-month Libor dropped to about 100bp

last Wednesday following the Fed emergency

rate cut after starting the year at 190bp.

“While markets had widely anticipated that

cuts would be forthcoming, the timing of the cut,

just a couple of weeks before the Fed’s regularly

scheduled meeting, sent a strong message

that it views the risks as highly elevated – and

that it remains prepared to act if conditions

deteriorate,” Steven Oh, global head of credit

and fixed income at PineBridge Investments, said

in note posted to the firm’s website.

As Libor fell and volatility picked up investors

have sought more protections, including floors,

in exchange for providing credit.

More than 17% of loans issued in February

included a 1% Libor floor, up from 14.47% in

January, according to Refinitiv LPC data.

Salt supplier Kissner, corporate financial

adviser Duff & Phelps and pump and compressor

manufacturer Sundyne this week all added

1% Libor floors to debt packages to back their

acquisitions.

SQUEEZED CLOS

CLOs are the largest investors in the US

leveraged loan market, and in the aftermath

of the financial crisis, Libor floors helped boost

equity returns. When Libor sat around 25bp, 1%

floors contributed about 7.5 percentage points of

extra annual cash payments to the fund’s most

junior investors, Morgan Stanley previously said.

The funds pool loans of different credit quality

and sell slices of varying seniority, from Triple A

to B, to investors including insurance companies

and banks, which are paid a spread over Libor.

Equity holders, which own the most junior

portion of the CLO, are paid last with interest left

over after bondholders receive their distributions.

Falling Libor coupled with companies cutting

interest payments on more than US$151bn of

loans in the first two months of 2020, about 70%

of deal flow, ate into CLO distributions leaving

less for the equity.

“Equity holders are still feeling the pressure

of squeezed spreads and that is not going to be

alleviated through refinancings or resets until

spreads return to normal levels,” said Jason

Merrill, an investment specialist at Penn Mutual

Asset Management.

Welcoming conditions at the start of the year

prompted equity investors to take advantage of

the early 2020 loan repricing wave to refinance

CLO debt tranches and cut expenses, which

would increase their payouts. But with spreads

widening amid the market volatility, that option

is now off the table, he said.

Complicating the issue is that Libor is set to be

phased out at the end of next year.

Until the market transitions to a replacement,

investors say they will continue to push for Libor

floors on new deals.

“I expect floored loans to be in fashion this

spring,” a portfolio manager said.

Kristen Haunss

9 IFR Loans 2323 p 63 - 76 .indd 71 06 / 03 / 2020 19 : 19 : 51