May 10, 2022 | Stamford, CT — The commercial loan market is working through the messy details of how to reprice outstanding Libor-based loans into alternative base rates.
After the Libor scandal came to light in 2012, regulators announced that Libor would be phased out and replaced by new base rates by 2023. In Q2 2022, most banks will have moved away from originating new Libor-based loans, transitioning into alternatives such as SOFR or BSBY. These base rates represented 85% of all traditional Libor-based originations in Q1, with SOFR-based agreements dominating the bilateral market, according to data from the latest Greenwich Commercial Lending Market Insight.
“Despite this transition, a significant portion of legacy deals in floating-rate portfolios still carry Libor-based spreads,” says Erik Wnuck, Director at Coalition Greenwich. “The market is now wrestling with question of how to reprice these agreements upon renewal, and when to make the transition to SOFR.”
Rather than opening the thorny issue of repricing outstanding loans, many lenders are opting to wait and make the transition at renewal. Even that strategy could prove dicey, since the transition from one base rate to the other could initially appear to be a spread increase to the borrower.
Half of Loans Show Spread Increase When Switched to SOFR
More than half (54%) of the loans displayed a spread increase when transitioned from Libor to SOFR upon renewal. The spread difference within these renewals is about 17 bps, which falls between the 11 bps and 26 bps premium suggested by ARRC on a 30- and 90-day tenor. Only 13% of the loans displayed a credit downgrade upon renewal, suggesting the spread increase is most likely due to the CAS. In 36% of these renewal events, there was no change to the spread despite the transition, suggesting that no adjustment was applied.
Going forward, borrowers should expect more spread adjustments, as lenders are in the process of educating their sales forces on the necessity of reviewing pricing on legacy renewals, with an emphasis on base-rate transition.
“As we move into a period of market uncertainty driven by international events, inflation and rising interest rates, lenders and borrowers alike will be keen to analyze the rate changes between SOFR and Libor,” says Erik Wnuck.
The Q2 2022 edition of the Greenwich Commercial Lending Market Insight provides quarterly analysis of credit quality, loan utilization, volume, and pricing. It is based on data from the Greenwich Commercial Loan Analytics, which uses the Coalition Greenwich market-leading dataset of commercial loan transactions to help measure banks’ relative performance compared to independent, third-party metrics.