Life after Libor language puts banks in control

Goldman Sachs imagines Libor substitute: itself

International Finance Review 2203 30 September to 6 October 2017

By:  Shankar Ramakrishnan and Eleanor Duncan

Goldman Sachs raised eyebrows last week with language in a bond deal that outlined how the debt would be valued after the discontinuation of Libor.

But in a surprising twist, the bank said a “calculation agent” would decide what to use in Libor’s place - and named itself the agent.

“Investors have to be mindful about an issuer-friendly provision like this,” said Alexander Diaz-Matos, an analyst at securities research firm Covenant Review.

“It is definitely not the right way forward.”

The bank’s new eight-year non-call seven bond transitions from fixed-rate to floating if the security is not called.

But Libor is going to be scrapped by 2021, and market players have been scratching their heads to find an alternative benchmark for floating-rate debt.

With no clear alternative as of yet, issuers of floating-rate bonds have been inserting vague language in their bond prospectuses.

BOLD STEP

Goldman Sachs, however, took the bold step of saying that by itself it would “determine whether to use a substitute or successor rate that it has determined is comparable”.

That did not seem to hamper the self-led deal - the US$2.5bn bond cleared at 120bp over Treasuries on a US$5.6bn order book, or some 20bp inside initial price talk.

The final level implied a new issue concession of just 2bp compared with the nearest comparable, and the new bond was quoting some 6bp tighter the day after pricing.

“At this point, investors don’t trade on the basis that Libor will be discontinued, because no one really thinks it is going to happen in, say, even 10 years,” said one credit strategist.

Still, the move got the attention of more than a few in the market.

“I have definitely heard from some investors that have reservations around Goldman being its own calculation agent instead of a third party,” said James Strecker, a fixed income analyst at Wells Fargo.

“The language about having ‘sole discretion’ to decide whether to use a successor or substitute base rate, and if an industry accepted replacement has been established, is disconcerting.”

One banker said Goldman may have decided to act on its own because third-parties might be wary - at least for now - of signing off on language that pointed to an unclear outcome.

So, while he thought the move could be considered “a bit cheeky”, the wording might also get replicated in bond documents by other banks in upcoming deals.

“It is better than nothing,” he said. “It is never easy to come up with solutions in a vacuum.”

Life after Libor language puts banks in control

International Financial Review 2206 21 October to 27 October 2017 

By:  Natalie Harrison, Shankar Ramakrishnan, Eleanor Duncan and Kristen Haunss

Who would you trust to decide the precise levels of coupon payments you receive on your debt holdings after Libor is discontinued?

If your answer is “the banks that have issued or arranged those deals”, you’re in luck.

A series of bond and loan deals in recent weeks have come with “life after Libor” language, allowing banks to appoint themselves or affiliates as the calculation agent to decide on a substitute when the benchmark is phased out.

The head of the UK’s financial markets regulator, Andrew Bailey, said in July that a Libor substitute must be in place by the end of 2021.

And the markets have started to respond by adding provisions to deal documents to ensure there is flexibility to allow for new benchmarks at that point.

Last week Goldman Sachs sold a perpetual non-call five fixed-to-floating bond for which it alone will determine what will be used in place of Libor. Two weeks previously Goldman had started the trend when it sold an eight-year non-call seven bond with exactly the same language.

Other banks that have issued bonds with similar provisions include JP Morgan (which raised US$1.26bn from a perpetual non-call five bond on October 13) and Bank of Nova Scotia (which raised US$1.25bn from a perpetual non-call five bond on October 6). The deal from JP Morgan included a clause that said it could appoint itself or an affiliate as the calculation agent and therefore determine what benchmark would be used to replace Libor.

BNS appointed a third party to make that decision, but could appoint itself if the third party resigned and a replacement couldn’t be found.

“There are probably better alternatives for bondholders, but for now banks seem to be using this language which makes them the calculation agent,” said Alexander Diaz-Matos, an analyst at research firm Covenant Review.

THE END IS NEAR

Before Goldman introduced the new language, most bond clauses dictated that bonds would be valued until maturity off Libor’s last quoted level.

“This is going to continue to be an issue until there is greater clarity around a new benchmark,” said one senior banker.

Having the issuer itself as the calculation agent “is not a good option to grant and, as a credit investor, makes me uncomfortable”, David Knutson, co-leader of industry group The Credit Roundtable and head of Americas credit research at Schroders, told IFR after the BNS trade.

“Giving the issuer the ability to change the calculation agent only adds to the uncertainty associated with Libor’s future.”

Libor is currently referenced in roughly US$300trn of contracts globally, according to the US Federal Reserve.

The Fed in August requested public comment on proposed plans for the Federal Reserve Bank of New York and the Office of Financial Research to publish three new reference rates intended as Libor alternatives.

The Credit Roundtable has formed a working group in the past few weeks to address some of these issues before the Fed comment period closes on October 30.

“There are three main problems,” said Knutson. “What will replace Libor, what language should be put into current bond documents, and what do we do with all the debt that has been issued in the past and matures after December 2021?”

SIMILAR IN LOAN LAND

It is a similar story in the loan market, where JDA Software, Surgery Partners and LPL Financial are among the companies that have recently added language to their leveraged loan credit agreements that allows the agent bank and the borrower to decide on a Libor alternative.

The provisions have come under scrutiny, however, as investors are concerned some terms do not allow them to have input on a feature that could impact their interest payments.

For many loans, provisions give a majority of lenders the ability to object or consent to the change within a set period if no new, widely accepted alternative has been adopted by the market, according to Jenny Warshafsky, a covenant analyst at Xtract Research.

But JDA, the software company that received an equity injection last year from the Blackstone Group and New Mountain Capital, added language to its recent US$1.24bn term loan that allows it to change the benchmark with just the approval of the loan’s agent, JP Morgan, bankers said.

The language was later tweaked to say that JDA and JP Morgan would give consideration to the “generally accepted” market standard before choosing a replacement. It also said the all-in applicable rate would not change.

Surgery Partners, a healthcare services provider, included a provision in its US$1.29bn term loan that stipulates that if a new rate is not in place, the administrative agent, Jefferies, “from time to time” in consultation with the borrower, may select a new one, according to a regulatory filing.

CLO OPTION

The US CLO market was quicker than other sectors to respond to Bailey’s comments.

The language to deal with a post-Libor world in CLOs has varied, but an early iteration said an alternative rate could be chosen as long as holders of the controlling class agreed to the change and rating agencies confirmed it would not affect existing ratings. A popular option now is to include language that stipulates the new benchmark is the one identified by the US loan trade group, the Loan Syndications and Trading Association.

Invesco is marketing a CLO that stipulates an option for the designated reference rate is the one recognised as the industry standard by the LSTA or the Alternative Reference Rates Committee, another banker said.

This option has not shown up in loan agreements, but some investors said it should be considered.

“Given that we have time to sort this out, some parties are closing deals with the same language that we have always had,” said Jacob Schtevie, a partner at law firm Winston & Strawn in Chicago.

“Other market participants are trying to set a roadmap in their loan agreements for how to fix this issue when it actually arises. It will be interesting to see where the market ends up.”

PRICING IMPACT?

Still, any concern about the language is not obviously impacting pricing or appetite for the deals in question.

“Not sure we’d make too much of it,” said a credit strategist at a US bank.

The first bond deal to include such language - Goldman’s US$2.5bn transaction on September 26 - cleared at 120bp over Treasuries on a US$5.6bn order book, or around 20bp inside initial price talk. The follow-up last Wednesday was a US$1.5bn perpetual non-call five priced at 5%, or 25bp inside initial price thoughts, on books of US$3.45bn.

Bank of Nova Scotia’s US$1.25bn perpetual non-call five had orders of US$7bn and priced 35bp inside initial price thoughts, while JP Morgan’s US$1,257.5m perp non-call five was launched 12.5bp tighter than IPTs.