September 22, 2020 - We have seen (well, we’ve read about) the first Syndicated Loan Hardwired Fallbacks, courtesy of Covenant Review. We discuss the background and recommendations for Loan Hardwired Fallbacks in general and details on this particular deal below.

First, recall that in May the ARRC recommended that the U.S. Syndicated Loan Market begin using hardwired fallbacks by September 30, 2020. But – and this is key – there was little expectation from the ARRC or engaged market participants that there would be widespread usage of hardwireds before this date. Why? The initial 2019 Loan Fallback language published by the ARRC included both an “Amendment” Approach and a Hardwired Approach that pointed to SOFR Compounded in Arrears as the ”fallback” rate if Forward Looking Term SOFR were not available.  However, over the past year, the ARRC’s Business Loans Working Group determined that SOFR Compounded in Arrears could be challenging for loans because they can be prepaid frequently and they trade without accrued interest. Since Compounded SOFR could be challenging for loans, there was reluctance to hardwire it in. In contrast, Daily Simple SOFR – which operationalizes like Prime or Daily LIBOR – was a much more workable solution.

But to replace Compounded SOFR with Daily Simple SOFR, the ARRC needed to update the fallback language (which it did in the Revised Fallbacks published in June 2020) and banks needed time to implement the revised fallback language (which they have been doing since June) before the Hardwired Fallback Language for Syndicated Loans was widely adopted. Thus, while we might have liked to have gotten here faster, we actually are where we thought we would be.

Now, on to that groundbreaking Hardwired Fallback loan! According to Covenant Review’s analysis, the deal is led by JPM Morgan and is a private multicurrency term loan and revolving facility for an industrial borrower. The fallback language says that if LIBOR ceases or is determined to be unrepresentative, the loan will fall back to Forward Looking Term SOFR. If that rate does not exist, the loan will fall back to Daily Simple SOFR. While Daily Simple SOFR exists today, if by some chance it does not exist at LIBOR cessation, the loan would use an amendment approach. In addition, the fallback includes an “Early Opt-In Trigger”, which states that if at least five loans contain a SOFR-based rate, then the agent and borrower can elect to transition this loan to SOFR prior to LIBOR cessation.

The deal’s fallback generally follows the ARRC Hardwired Fallback language, but with several modifications.  First, if Term SOFR is introduced after LIBOR cessation, this loan can “climb the waterfall” from Daily Simple SOFR to Term SOFR. (This provision is often seen in CLO Fallback language.) Second, it also contemplates an “amendment” fallback in other currencies, which is necessary as hardwired fallbacks do not yet exist in other currencies. Finally, it lays out necessary language around conforming changes at LIBOR transition.

Covenant Review concludes by i) hoping to see more hardwired fallbacks and ii) reiterating that the inclusion of hardwired fallbacks and early opt-in elections “are two critically important tools for market participants seeking to de-risk the LIBOR transition.”