Research report

It’s complicated: Leveraged loans and the LIBOR transition

A deep dive into challenges facing the loan market as SOFR’s incorporation gains momentum.

Lara Rhame
March 23, 2021 | 12 minute read

A series co-authored by Lara Rhame, Chief U.S. Economist at FS Investments, and Tal Reback, Principal at KKR

The global transition away from LIBOR is progressing, but while some market segments have already embraced SOFR, other markets remain behind. In this note, we cover two topics: First, we discuss the implications of the recent USD LIBOR extension. Second, we focus on leveraged loans, a critical area which has so far been slower to address the fact that global markets are leaving LIBOR.

Business loans are an integral part of the U.S. economy and impact a significant group of small and medium-sized issuers who, unlike large corporations, may not have direct access to the capital markets. Bloomberg estimates that $4.7 trillion worth of business loans are tied to LIBOR. This includes $3.4 trillion in loans for revolving credit facilities and term loans to investment-grade (“IG”) companies, most of which are held on bank balance sheets.1 Here, we will focus on the sub-IG part of the syndicated loan market, commonly referred to as leveraged loans, which has become an important asset class for many fixed income investors. The leveraged loan market came onto the scene in the mid-1980s and helped fuel the leveraged buyout boom that swept Wall Street during that period. Since then, the market has grown to ~$1.2 trillion and in the last 10 years has averaged ~10.5% annual growth.2

Nearly all leveraged loans pay a floating rate coupon tied to LIBOR, putting the asset class particularly top of mind in the transition away from LIBOR. With a keen focus on a smooth and orderly transition for the financial system and capital markets, regulators announced on November 30, 2020, that they would consult on extending the cessation date of USD LIBOR only to provide the legacy cash market additional time to naturally roll down exposure and navigate an extremely complex process. Meanwhile, the industry deadline for banks to stop using LIBOR in new loans continues to draw nearer, and the market has yet to see new SOFR loan issuance.

Total leveraged loans outstanding

Source: S&P Market Intelligence, as of February 28, 2021.

Key takeaways
  • USD LIBOR was granted an 18-month extension to ensure markets have ample time to incorporate robust fallback language into existing financial contracts, such as loans.
  • Regulators have made it clear that while USD LIBOR will be quoted until June 2023, the rate should not be utilized in any new contracts after 2021.
  • While issuance of SOFR-linked debt by GSEs and banks continues to grow, the leveraged loan market has been slower to embrace the rate.
  • A “trigger event” on March 5 marked the official beginning of the end for LIBOR, providing clarity and a sense of urgency for the loan market. 

  • Bloomberg Finance, L.P.

  • S&P/LSTA Leveraged Loan Index.

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.

Lara Rhame

Chief U.S. Economist + Managing Director

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