(Editor's Note: We intend to update this article periodically as U.S. CLO transactions transition to SOFR.)
Key Takeaways
- U.S. CLOs are in a state of transitioning to a new benchmark rate before the June 30, 2023, Adjustment Interest Rate (LIBOR) Act deadline.
- SOFR adoption is slow, with new issuance and supplemental indenture driving the transition.
- "Alternative Reference Rates Committee-like" continues to be the preferred liability fallback language.
U.S. collateralized loan obligations (CLOs) are in a state of transitioning to a new benchmark rate before the June 30, 2023, Adjustment Interest Rate (LIBOR) Act deadline. The Federal Reserve Board, which Congress has granted limited authority to facilitate the transition, has endorsed a suggested rate of term secured overnight financing rate (SOFR) + a credit spread adjustment (CSA) of 26 basis points (bps). S&P Global Ratings is providing current information on the state of the LIBOR-to-SOFR transition for U.S. CLOs in this article, which will be updated periodically.
U.S. leveraged loans have also begun their benchmark transition. However, due to the current economic environment, the pace of corporate loan issuance and refinancing still remains slower than initially expected. Consequently, the transition of assets and liabilities to term SOFR from LIBOR in U.S. CLOs is occurring at a slower-than-expected rate.
SOFR Adoption Is Slow, With New Issuance And Supplemental Indenture Driving The Transition
With the June 30, 2023, LIBOR transition deadline fast approaching, we have seen only a small percentage of deal liabilities completely transition to CME Group's term SOFR. Since Jan. 1, 2022, new deal issuances have not been using LIBOR as a benchmark rate. As of June 15, 2023, approximately 40% of the S&P Global Ratings-rated U.S. CLOs are currently CME term SOFR based or proposed to transition, with the remaining 60% of the deals yet to make the switch (see chart 1).
Chart 1
The following is a breakdown of the approximately 40% S&P Global Ratings-rated U.S. CLOs benchmarked to term SOFR:
- 16% originated from new issuance. Since January 2022, we have not seen any new U.S. CLO transaction price with rates other than CME term SOFR as the reference rate for the liabilities.
- 20% transitioned or proposed to transition via supplemental indenture. Of the 20%, approximately 19% of deals are proposed to transition on or after June 30,2023. All the S&P Global Ratings-rated U.S. CLOs have transitioned using the Alternative Reference Rates Committee (ARRC)-recommended 26 bps CSA, though we have seen proposals that are less than the ARRC-recommended CSA.
- 3% transitioned via refinancing or reset, which notably has been extremely slow over the past year with current market condition uncertainties.
- Less than 1% transitioned via reaching the benchmark transition trigger (having more than 50% of the portfolio assets indexed to a rate other than LIBOR, namely CME term SOFR). As of today, we have only seen middle-market U.S. CLOs transition via reaching the benchmark transition trigger.
- As of June 15, 2023, the average U.S. broadly syndicated loan (BSL) CLO transaction has about 49% of its assets tied to term SOFR.
"ARRC-Like" Continues To Be The Preferred Liability Fallback Language
We reviewed S&P Global Ratings-rated U.S. CLO transaction documents to identify their liability fallback language. We believe U.S. CLO fallbacks can be classified across three broad categories:
- Alternative Reference Rate Committee (ARRC)-like language: These fallbacks are very similar to language recommended by the ARRC and are mostly seen with the U.S. CLOs issued since 2020.
- Manager-limited discretion language: In these documents, the fallback language gives the manager limited discretion to select a replacement rate, usually one widely used in the underlying loan market or CLO market. These are mostly seen with the U.S. CLOs issued in 2018 and 2019.
- Weaker or no fallback language: This category reflects a mix of legacy fallback language that wasn't necessarily designed for the permanent cessation of LIBOR. These are mostly seen with U.S. CLOs issued before 2018. Transactions with weaker or no fallback language will likely be able to rely on the Adjustable Interest Rate Act.
Chart 2
We have observed that when many pre-2020 vintage U.S. CLOs were refinanced or reset in 2021, their documents were updated via supplement indentures to incorporate robust fallback language (such as the ARCC-recommended language). Since 2022, U.S. CLO tranches have transitioned to SOFR using supplemental indentures and not through the breach of the benchmark transition event definition found in the ARCC language. U.S. CLO tranches are using the recommended ARRC language, which suggests a CSA over the new benchmark. Although the majority of U.S. CLOs have ARRC-like language, some amortizing legacy deals originally issued in 2017 or earlier still have weak or no fallback language.
Credit Spread Adjustments
Chart 3 shows the daily comparison between three-month LIBOR and three-month CME term SOFR rates starting from February 2022.
Chart 3
Related Research
- Credit FAQ: The Potential Impact Of LIBOR Transition On U.S. CLOs, Feb. 24, 2023
- U.S. Interest Rates In A Post-LIBOR World, Sept. 21, 2022
- Scenario Analysis: LIBOR Transition, Excess Spread, And U.S. CLO Ratings, June 30, 2022
- Scenario Analysis Report Outlines The Potential Effect Of LIBOR Transition On U.S. CLO Ratings, July 5, 2022
This report does not constitute a rating action.
| Primary Credit Analysts: | Patrick Anderson, Englewood + 1 (303) 721 4710; patrick.anderson@spglobal.com |
| Brian Lee, Englewood +1 3037214492; brian.lee@spglobal.com | |
| Vijesh MV, Pune; Vijesh.MV@spglobal.com |
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