Private Loans Find Their Level During LIBOR’s Last Hurrah

By: John Czapla

Estimated reading time: 2 minutes

The article in brief:

  • SOFR has emerged as the successor to LIBOR in the private loan market, and most market participants have ceased using LIBOR in favor of SOFR in newly originated loans altogether
  • As the June 30, 2023, LIBOR cessation date approaches, most deals, notably newly originated deals, do not have a credit spread adjustment (CSA), as these deals are building any SOFR/LIBOR difference into the credit spread
  • Some, however, are still using spread adjustments on LIBOR-to-SOFR amended loans, and adjustments in recent months may suggest that lenders have the upper hand in setting terms for private loan deals

LIBOR officially disappears at the end of June, and most private credit market participants, who have been preparing for this day for more than a year, have already definitively turned the page and stopped considering the longtime short-term benchmark rate entirely for new loans.

But in what may be seen as a barometer for the tone of private credit markets, those lenders who are still incorporating credit spread adjustments (CSAs) on top of the borrower’s own credit spread in a nod to syncing the lower SOFR to LIBOR, have been squeezing all the juice they can out of their deals by pushing for the spread recommended by the Alternative Reference Rates Committee (ARRC),  a group of private-market participants convened by the Federal Reserve Board and the New York Fed. The ARRC-prescribed CSAs are 11 basis points for one month; 26 basis points for three months, and 43 basis points for six months.ARRC Deals Done at CSA in LIBORs Last Months 2023

For three-month interest-pay loans, the CSAs negotiated between many lenders and borrowers/equity sponsors over the last year or so have generally been in the 10 to 15 basis point range versus 26 basis points for the ARRC recommended rate. Those lower rates appear to have been justified based on the difference in three-month SOFR and LIBOR spot rates and swap rates, which are in the 10 to 15 basis points zip code.

As the chart shows, about two-thirds of the new private deals originated in the first six weeks of 2023 had no CSA. Implicitly, market participants are  embedding a single straightforward spread over SOFR to capture both the borrower’s credit risk and the fact that SOFR is typically lower than LIBOR since it is considered a risk-free rate. The percentage of deals with no CSA can be expected to grow in the run-up to LIBOR’s June demise, especially with the increasing availability of forward SOFR rates as the benchmark becomes more widely embraced.

But for those loans still incorporating a CSA, there was a discernible increase in deals referencing the higher ARRC rates in the first part of 2023 versus the lower flat 10 to 15 basis point CSAs common last year. This trend likely reflects tighter credit conditions in the private market, where lenders have had a stronger position in setting the terms in recent months.