In an important step for the syndicated loan market in transitioning to SOFR and away from LIBOR as a benchmark interest rate, the Loan Syndications and Trading Association (“LSTA”) recently published what it deems a “concept” credit agreement (we’ll call it the “Concept SOFR Agreement” here) that references daily simple SOFR or daily compounded SOFR. The Concept SOFR Agreement can be found on the LSTA’s website, along with a blackline against the LSTA’s form term loan agreement referencing LIBOR (available to LSTA members at www.lsta.org).
A CONCEPT SOFR LOAN AGREEMENT ARRIVES
Following this summer’s ARRC recommendation of using “Daily Simple SOFR” in arrears as the preferred** fallback rate in the waterfall of replacement rates, rather than “Daily Compounded Rate” (**until a forward looking term SOFR Rate develops; see below for news on that rate), the Concept SOFR Agreement provides for a loan in which interest accrues based on SOFR for each day of the interest period, with a lookback of a negotiated amount of days. The lookback period allows the administrative agent and borrower to determine the rate of interest for the interest period before the period ends and the interest is due, giving time for the administrative agent to get an invoice out, and for the borrower to pay. A five-day “lookback” for a June 1 loan with a 30 day interest period, for example, would apply the May 25 SOFR rate to the June 1 balance, and so on throughout the interest period, so that by June 23, the administrative agent will know the daily rates through the end of the 30 day interest period. McGuireWoods’ LIBOR Transition Blog previously posted a summary of the ARRC’s recommendation of Daily Simple SOFR.
The Concept SOFR Agreement includes alternative language to provide for Daily Compounded SOFR (compounding the balance) instead of Daily Simple SOFR, although the LSTA has previously: (1) expressed that Daily Simple SOFR is anticipated to be much easier to implement operationally by banks and other participants due, in part, to the complexities of compounding interest in prepayable loans that trade and (2) observed that there is little difference in the economics between Daily Compounded SOFR and Daily Simple SOFR.
As another (and optimistic) alternative, the Concept SOFR Agreement provides language to transition to a forward-looking Term SOFR in the event an accepted rate and methodology comes into existence. If such Term SOFR develops, the Concept SOFR Agreement provides flexibility to transition to that rate via an amendment between the administrative agent and borrower, in much the same way as many current agreements provide for a potential amendment to incorporate SOFR upon certain trigger events indicating LIBOR will cease. As a reminder, Daily Compounded SOFR and Daily Simple SOFR are not set in advance like LIBOR, but are calculated daily in arrears during the interest period; in contrast, Term SOFR would operate akin to the current LIBOR structure and would be easier for lenders to institute. The lack of a robust SOFR derivatives market to derive forward-looking SOFR term rates is one of the impediments to Term SOFR.
Note that although the LSTA calls this agreement a “concept document” and notes it does represent standard market practice, the publication of such a form agreement by the LSTA will surely help spur market practice and be a leading reference when parties negotiate loan agreements based on SOFR.
TERM SOFR—ONE OF THESE DAYS…
The LSTA recently issued an update regarding Term SOFR. The LSTA noted that the ARRC has recently issued a Request for Proposal for a forward looking term SOFR rate with aspirations to publish the rate in 2021 if there is sufficient liquidity in the SOFR derivatives market. As noted above, since the rate is more analogous to LIBOR and because the rate would be known in advance of the interest period, market participants have expressed a clear preference for Term SOFR.