Key Takeaways
- We received official notices, executed supplemental indentures, notification through the DTCC platform, and/or confirmation from trustees and collateral managers for the entire S&P Global Ratings-rated LIBOR-based CLO universe.
- All of the S&P Global Ratings-rated CLO transactions have transitioned (or will transition) to the same rate, CME term SOFR, and with similar CSAs of 0.26%.
- To date, there has been no rating impact driven solely by the transition away from LIBOR.
It has now been six years since the U.K. Financial Conduct Authority (FCA) announced that LIBOR would no longer be available after 2021, before extending the deadline until June 30, 2023, for dollar settings. Two months have now passed since the official LIBOR cessation date, and we thought it would be a good point at which to take stock of the transition for the universe of S&P Global Ratings-rated collateralized loan obligation (CLO) transactions. Earlier this year, there were close to 1,000 S&P Global Ratings-rated CLO transactions (and roughly 5,000 tranches) that had to transition away from LIBOR. Significant progress has been made since then. Below, we recap what happened to these CLOs during the transition period.
The indenture provisions for these CLOs contained numerous types of contractual LIBOR transition language, ranging from no fallback at all to very specific, Alternative Reference Rate Committee (ARRC)-like, fallback language. The transition provisions varied by CLO vintage, deal type, and manager. We inventoried all the fallback languages in our rated U.S. CLO transaction universe ahead of the June 30th transition date and performed stress tests to gauge the potential rating impact of the transition (see "Scenario Analysis: LIBOR Transition, Excess Spread, And U.S. CLO Ratings," published June 30, 2022).
Recap Of The Transition
Jan. 1, 2022, saw the end of LIBOR for new issue U.S. CLO transactions, and they began indexing to the secured overnight financing rate (SOFR). The loan market followed a similar timeline, with newly issued floating-rate loans (almost entirely) using SOFR as their benchmark. Similarly, existing loans being refinanced and extended also transitioned to SOFR.
The ARRC-recommended language for CLO fallback language incorporated "asset replacement triggers" in an effort to facilitate a smooth transition process and timing, with the idea being that when the majority of the loans within a given CLO were no longer indexed to LIBOR, the notes issued by the CLO would automatically follow. This seemed likely to produce a process in which the LIBOR transition would take place over many months, if not quarters. Unfortunately, economic conditions in 2022 led to very little corporate loan refinancing activity and little new issuance supply as well, leaving a majority of corporate loans indexed to LIBOR well into 2023. This reduced the use of the asset replacement triggers in CLO transaction documents, as most CLOs didn't hit their 50% threshold until the second quarter of 2023. Market conditions also brought a near halt to the number of CLOs being refinanced or reset, closing off another avenue that would have seen CLOs transition away from LIBOR over the course of the last year or so.
The transition away from LIBOR for corporate loans accelerated in May-July 2023. To date, at the time of this publication, roughly 80% of the corporate loans have transitioned away from LIBOR (the remaining 20% are expected to transition in the coming months).
The credit spread adjustments (CSAs) among loans tied to SOFR haven't been as uniform as the CSAs used on the CLO side. CSAs for corporate loans varied from zero to 26 basis points (bps). In some cases, CSAs for corporate loans were included in the overall spread margin, making the specific CSA harder to deduce. In contrast, all of the CLO transitions we have observed have used a CSA of 26 bps.
In May and June, CLO transition activity picked up significantly
As the number of CLO tranches that transitioned away from LIBOR was low during most of the transition period, the count of LIBOR-based deals in second-quarter 2023 remained high even in the face of the fast-approaching June 30, 2023, deadline. However, during June, we saw a significant pick up in the pace of CLO supplemental indentures and notices proposing to transition deals to SOFR. In the course of our CLO surveillance activity, we received and reviewed thousands of proposed indentures, executed indentures and notices, as well as data from the Depository Trust & Clearing Corp. (DTCC) platform.
All of the CLO transitions we have observed used CME term SOFR with a CSA of 26 bps under a variety of CLO indenture provisions, including:
- LIBOR Act: CLOs with no fallback language or LIBOR-based fallback language (i.e., fixed at the last quoted LIBOR rate) had the ability to transition to the ARRC-recommended index and CSA through the Adjustable Interest Rate Act of 2022 (LIBOR Act). This mostly applied to older transactions (2017 and prior vintages) with indenture language from before the announcement of the LIBOR cessation.
- Manager discretion: CLOs with limited manager discretion allowed the manager to pick a replacement index that was deemed to be standard in either the loan or CLO market. This was not necessarily hardcoded to CME term SOFR, and the CSA to be applied was not necessarily specifically defined.
- ARRC language: This quickly became the "norm" in more recent vintages of CLOs. The fallback language was hardcoded in the CLO indenture to CME term SOFR + 0.26161 as the CSA. The transition would be automatic following a benchmark transition event.
The Entire S&P Global Ratings-Rated LIBOR-Based U.S. CLO Universe Has Been Accounted For
For our universe of rated U.S. CLOs, we have completed a review and received notice of transition (or intent to transition) in a variety of forms, including:
- Official notices;
- Executed versions of supplemental indentures;
- Notification through the DTCC platform; and/or
- Confirmation of LIBOR transition.
The S&P Global Ratings-rated CLO tranches have, or will, transition to the same rate, CME term SOFR, and with CSAs of 0.26%.
We will continue to monitor the transitions as typical CLO transactions "freeze" the benchmark and its value to be used at the beginning of the accrual period (to be used on the subsequent payment date). For a CLO following the most commonly found payment cycle (January -> April -> July -> October), the first SOFR interest determination date would occur in July and would be used in the subsequent payment date (in October).
To date, we have taken no CLO rating actions based primarily on the transition away from LIBOR, and anticipate this will continue to be the case.
Related Research
This report does not constitute a rating action.
| Primary Credit Analysts: | Yann Marty, Paris + 1 (212) 438 3601; yann.marty@spglobal.com |
| Catherine G Rautenkranz, Englewood + 1 (303) 721 4713; c.rautenkranz@spglobal.com | |
| Stephen A Anderberg, New York + (212) 438-8991; stephen.anderberg@spglobal.com |
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