February 22, 2021
What Does It Mean and What Should I Do?
If your loan is fixed using an interest rate swap, it is likely that the swap contract is based upon Libor as a benchmark. You may have heard that Libor is being discontinued and the anticipated replacement is called SOFR (Secured Overnight Financing Rate).
Most lenders are seeking to alter or amend existing loan agreements with what has been coined “adherence” language. This specifies the new index to be used and any adjustment that may be required in converting to the new index.
Here is the important part.
Your loan documents, which are different from your swap documents, also contain swap replacement language. If the replacement language in the loan documents is exactly the same as the change in the swap documents, you will be fine. However, these are separate adjustments and not normally controlled by the same people within the bank. This misalignment could be costly. How costly? As an example, a difference of only 8/100ths of a percent on a $20 MM non-amortizing 10-year loan could amount to more than $1.5 MM in additional interest expense.
There are 3 Steps You Should Be Taking Before Signing Anything
1. Compare the Libor replacement language in your loan documents with the Libor replacement language in your swap documents and the adherence language. If the replacement language in the documents is not aligned, go to step 2.
2. Quantify the estimated exposure by multiplying the estimated basis point differential by the present value of each basis point.
3. Negotiate a better alignment of the Libor replacement language between the swap and loan documents to reduce exposure.
CMAC is performing the initial analysis (steps 1 and 2) at no cost for its clients and for CPOMP Members.