On July 12, the SEC staff published a statement that encourages public companies and other market participants to proactively manage their transition away from LIBOR (short for London interbank offered rate) and identifies many of the key issues that warrant increased attention in a timely manner. See “SEC Staff Publishes Statement Highlighting Risks for Market Participants to Consider as They Transition Away from LIBOR” and related Staff Statement on LIBOR Transition at https://www.sec.gov/news/press-release/2019-129.
For many years, borrowers were given the option of choosing an interest rate based on either the prime rate (plus a spread) or LIBOR (plus a slightly greater spread). For many (and probably most) borrowers, the LIBOR option yielded a far more favorable effective rate. Many loan documents, particularly those issued by larger financial institutions and/or issued in larger debt financings) included fallback language to address the possibility of LIBOR being temporarily unavailable, but (a) often the language was simply to allow the lender or agent to select an alternate reference rate (which the borrower might not find to be as favorable as LIBOR -- and of course the spread over that alternate rate would need to be discussed), and (b) the language clearly addressed the temporary (not permanent) unavailability of LIBOR, which could generate questions of contractual intent (and an implied obligation to establish a replacement in good faith) if LIBOR is permanently discontinued.
While the fallback language may have been modified somewhat in more recent loan agreements, the language still tends to be somewhat vague and open-ended. And, while borrowers may have never needed to resort to the fallback, there was always the daunting possibility (from the borrower's standpoint) of having only the prime rate option available.
This is what borrowers are now facing, particularly if their loan agreements do not contain any fallback language. Even if their agreements do contain fallback language, the borrowers will want to work with their lenders to come up with an alternate reference rate (and related spread) that they are mutually comfortable with (such as SOFR, or secured overnight financing rate), rather than leave it to chance or the last minute and be stuck without any effective interest rate option (and possibly have their borrowing costs increase dramatically) and with limited or no refinancing prospects. This is the primary risk and potential chaos that the SEC is rightly warning against.
The SEC – although perhaps suspecting that resolutions will ultimately come down to the last minute as more information, insight and market practice are established – is nonetheless attuned to the risks associated with the discontinuance of LIBOR after 2021, if ignored by public companies and their counterparties. As a result, this issue will now need to be addressed in the “Risk Factors” section of a public company’s SEC periodic reports and registration statements to the extent they have exposure under existing loan transactions.
This disclosure would seem hard to quantify in most cases, but clearly could be material to some companies depending on their relative leverage and the state of their loan documents and lending relationships.
This post was written with assistance from Shahe Sinanian, a former colleague of the author.
PartnerArmed with more than three decades of capital market experience, Spencer represents smaller publicly traded companies, and often underwriters and investment funds, in public and private securities offerings. He focuses ...