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SF Credit Brief: With LIBOR Transition Approaching In U.S. CLOs, Fallbacks Remove Some Uncertainty

The LIBOR transition may have been extended, but it's not going away. U.S. regulators have indicated that banks should stop using LIBOR in new issue contracts by December 2021. This means the leveraged loan and collateralized loan obligation (CLO) markets are expected to see significant changes in interest rates during 2021 as borrowers and lenders come to terms with new risk free rates, such as SOFR, together with spread adjustments, floor considerations, and related changes.

Legacy CLO transactions should have additional time to make the shift toward new rates based on the recent announcement from the Financial Conduct Authority that most dollar LIBOR settings will cease after June 2023. At year-end 2020, S&P Global Ratings had about 870 rated U.S. CLOs from 140 managers outstanding, with origination dates ranging from 2006 through Dec. 30, 2020. Within these CLO indentures, there are a variety of document provisions related to how a potential LIBOR transition should be handled.

We reviewed CLO indentures to assess the LIBOR fallback language governing a transaction's liabilities. We decided to bucket the different types of provisions into five categories that would allow us to compare CLOs to each other and to other structured finance asset classes (see "As The Deadline For The Transition From LIBOR Approaches, Work Remains For U.S. Structured Finance," published Oct. 6, 2020). To categorize CLOs by vintage, we used the latest of the CLO's initial closing date or most recent reset/refinancing date, since LIBOR provisions are often updated when these occur. A large majority of our rated CLO transactions closed between 2018 and 2020 (667 deals, or 76% of our rated U.S. CLO universe).

At a high level, we observed the following from our review and note a significant CLO vintage bias:

  • Alternative Reference Rates Committee (ARRC)-like fallback language can be found in 26% of the overall transactions, including 76% of the transactions that closed in 2020.
  • On the other end of the spectrum, there is a smaller number of U.S. CLOs (roughly 130 of our rated deals, by our count) that could theoretically become fixed-rate obligations post-transition; we expect this number to decline significantly in 2021 as large numbers of existing CLOs reset or refinance and update their LIBOR transition language.
  • In between the two opposites above, there are CLOs where the manager has the flexibility to select a replacement rate post-transition, with restrictions around what the new base rate can be. This concept was introduced in 2018 after the announcement of the LIBOR transition but before the ARRC-recommended language was developed, and most of the CLOs with this language in their documents were originated in either 2018 or 2019.
  • Finally, we see a handful of other approaches, including some relatively recent transactions with weaker replacement language. This can occur when a transaction is partially refinanced without amending the LIBOR fallback language for all LIBOR-linked liabilities.

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This report does not constitute a rating action.

Primary Credit Analysts:Yann Marty, Paris + 1 (212) 438 3601;
yann.marty@spglobal.com
John A Detweiler, CFA, New York + 1 (212) 438 7319;
john.detweiler@spglobal.com
Stephen A Anderberg, New York + (212) 438-8991;
stephen.anderberg@spglobal.com

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