U.S. banks won’t be allowed to issue new debt tied to the benchmark in 2022, leaving some firms struggling to decide how to proceed
Wall Street’s shift away from the London interbank offered rate takes effect at the start of the new year. Some companies are more prepared for it than others.
Starting Jan. 1, U.S. banks won’t be allowed to issue new debt tied to Libor, the global benchmark underpinning trillions of dollars in financial contracts.
Financial authorities began to phase out Libor in 2017 after it was discovered that traders at large banks manipulated the rate by submitting false data.
Large U.S. financial institutions have been readying themselves for the transition for years. Many of them replaced Libor with alternative reference rates, notably the Secured Overnight Financing Rate — Wall Street’s preferred choice — for some of their assets, including interest-rate swaps and mortgage-backed securities.
Meanwhile, non-financial companies and smaller institutions such as regional banks are in varying stages of picking a replacement rate and updating their systems to handle the switch, analysts say.
Some firms have been clinging to Libor, closing out one more new deal before year-end since debt sold before the deadline can keep referencing the rate through June 2023.
Executives, lawyers, and investors expect these companies to make further progress transitioning away from Libor in early 2022.
But for some nonfinancial companies, the preparation could result in distractions from their core business, and worse, the lack of preparation can raise questions from financial regulators about their ability to manage the transition, said Venetia Woo, global lead Libor adviser at consulting firm Accenture.
“These changes might seem very minor from the outside, but they have big ripple effects,” Ms. Woo said.
Many products, including currency swaps and floating-rate notes, have been switched over from Libor, said Michael Gibson, director of the Federal Reserve’s division of supervision and regulation, at a Financial Stability Oversight Council meeting earlier this month.
All new mortgage-backed securities issued by Fannie Mae and Freddie Mac are now tied to SOFR, he said, and around 90% of recently issued floating-rate notes.
The value of interest-rate swaps referencing SOFR has grown from under $1 trillion in September 2020 to over $7 trillion through November 2021, said Mr. Gibson.
Cross-currency swaps, by which one party borrows currency from another and lends another currency in return, between the U.S. dollar and other currencies have almost completely transitioned to SOFR or other reference rates, he added.
But for business loans, the transition has been slower.
Of $598.59 billion worth of junk-rated corporate loans sold this year through Dec. 27, just 2.6% referenced SOFR, according to Leveraged Commentary & Data.
So-called leveraged loans are typically issued by companies with large amounts of debt relative to earnings and used by private-equity firms to help finance corporate buyouts.
Earlier last month, WideOpenWest Inc., an Englewood, Colorado-based cable operator, launched a $730 million loan due 2028 to refinance an existing credit line.
The company chose SOFR over other replacement rates because it is based on observable transactions and large volumes, chief financial officer John Rego said.
“We believe the key characteristics of SOFR underpin its strong presence and acceptance in the market, and will be the leading benchmark in a post-Libor era,” Mr. Rego said.
Also last month, medical-device maker ICU Medical Inc. sold an $850 million leveraged loan to help fund its pending $2.35 billion acquisition of the medical division of Smiths Group PLC, an engineering firm.
The San Clemente, California-based company’s executives selected SOFR given that their lenders told them it was the most accepted replacement rate in the leveraged-loan market, said CFO Brian Bonnell.
ICU Medical didn’t consider credit-sensitive alternatives, Mr. Bonnell said.
“We weren’t looking to do something exotic for the sake of being unique,” he said.