Investors caught out by vanishing spread adjustments

Sayed Kadiri

Editor

Lenders are being warned to stay on top of loan amendments or risk US loans switching benchmark from Libor to Sofr without an accompanying credit spread adjustment (CSA).

Market sources tell Creditflux that a flurry of these amendments took place in the past two months, catching out investors who did not block the proposals — and even costing some that were alert to the situation.

‘Negative consent triggers’ are widespread in the Libor succession language of US loan docs. These stipulate that a proposed switch to Sofr is effective unless a majority of lenders object within five business days.

It is customary for a CSA to be included as part of a migration from Libor to Sofr, but sources say that recent loan amendments have disregarded this practice.

Software company Infoblox is one borrower said to have attempted such an amendment.

Furthermore, one loan investor says private equity sponsors have sought to catch loan investors out by filing loan amendment notices at 5.30pm on Fridays in late August, so these are viewed by as limited an audience as possible.

“Lenders could suffer a drop in yield”

Charles Tricomi, Head of leveraged loan research | Xtract Research

Those defending loan amendments without CSAs might point to the loan primary market, where deals frequently do not come with a spread adjustment. But Charles Tricomi, head of leveraged loan research at Xtract Research, says there is a good reason for this.

“The spread adjustment has largely disappeared from recent originations because the margin takes it into account,” he says. “But lenders should ensure that, before they give their consent (if required) to a new index in older loans, there is provision for an adjustment, or they will suffer a drop in yield.”

Ropes & Gray partner Alexander Zeltser concurs. “It seems that whether there is a CSA at this point will be dependent on the language in the existing documentation governing such amendments, and the relevant agent and borrower’s interpretation of those provisions.”

The disparate nature of the loan investor base makes achieving the consent of 50%-plus a difficult task, particularly within five days. One loan investor says his firm held upwards of 10% of a company’s loans and yet was unable to rally enough support to block a CSA-less amendment.

There are accusations that some lenders were negligent in not staying on top of loan amendments over the summer. “Unless you have a deep bench of meticulous analysts you could lose out,” says a loan fund manager.

The fund manager adds that some lenders might be in a sticky situation as they try to manage private equity sponsor and investment banking relationships. “You don’t want to be seen blocking something other lenders are willing to do. That could cost you next time the sponsor comes to market with a loan.”

The transition from Libor to Sofr has been complicated this year by volatility in both benchmarks, with Sofr trending higher than Libor in certain periods. As Creditflux goes to press, three-month Sofr is 355 basis points; three-month Libor is at 364bp.

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Global credit funds & CLO's

October 2022 | Issue 249

Published in London & New York.