What’s Market: 2021 Year-End Trends in Large Cap and Middle Market Loans

This article examines significant trends and developments seen in the US loan market in 2021, including key issues seen in loan negotiations and documentation, as well as the growing importance of private credit and direct lending, the record growth of sustainable financing and developments in LIBOR transition.

Direct Lending

In the contemporary sense, direct lenders are the disrupters of the US loan market. The explosive growth of direct lending or private credit is a central part of the story of the US loan market in 2021.

With its perceived advantages of speed of execution, simpler deal structures and greater certainty of terms without exposure to market flex in the syndication process, direct lending has become increasingly attractive to sponsors and large cap borrowers. Direct lending began with non-bank lenders providing financing for mostly smaller middle market acquisitions. Even as recently as two or three years ago direct loans rarely exceeded $500 million and were often much smaller. However, deal sizes of direct loans have continued to increase steadily and now occupy territory that was once the sole purview of the broadly syndicated market, such as the $2.6 billion direct loan to Thoma Bravo in July 2021 to finance its buyout of Stamps.com.

While direct lending transactions are widely considered to take a less borrower-favorable approach compared to broadly syndicated deals, practitioners report that direct lenders are increasingly prepared to agree to looser covenant packages, which erodes this distinction between direct loans and broadly syndicated loans.

The increasing popularity of direct lending and the growth in the deal sizes of direct loans has also seen the execution of unitranche facilities that are significantly larger than traditional unitranche facilities, in some cases multi-billion-dollar facilities. For example, in October 2021, Galway Insurance Holdings secured a $2.6 billion unitranche loan to refinance existing debt and finance add on capacity for acquisitions.

Sustainable Financing: The Continued Evolution of Sustainability-Linked Loans

Growing enthusiasm by many corporate borrowers for socially responsible lending and investment has resulted in the development of a suite of credit and capital markets financial instruments that are designed to incentivize and promote sustainable investments and help companies meet their environmental, social, and governance (ESG) goals. These include green loans, sustainability-linked loans (SLLs), social loans, social impact bonds, green bonds, social bonds, and sustainability-linked bonds. As an increasing number of US companies looked for ways to incorporate more ESG metrics and targets into their loan documents, SLLs, in particular, have become increasingly popular because of their flexibility and the financial incentives they offer. SLLs market share grew exponentially in 2021 as a result.

At $1.6 trillion, the global sustainability financing volume in 2021 increased 116% year-over-year. More specifically, the volume of SLLs in the US topped $218 billion in 2021, compared to the $5 billion recorded in 2020.

SLL's share of the sustainable lending market has increased because of their availability to all types of companies, the diversity in the terms they offer, and the greater flexibility these loans provide for use of proceeds. Unlike other sustainable financing products, SLLs can be used for any purpose. They are also performance-based with pricing terms (typically an ESG-linked interest rate margin) that adjusts up or down depending on the borrower's ability to meet pre-determined sustainability performance targets (SPTs) as measured by pre-defined key performance indicators (KPIs). The KPIs that must be met are varied and range from environmental targets to increasing diversity in the borrower's board of directors. For a more detailed discussion of SLLs, see Practice Note, Understanding Sustainability-Linked Loans.

• Noteworthy developments relating to SLLs in 2021 include:
• Updates to the Sustainability-Linked Loan Principles (SLLP).
• Changes to SLL loan terms.
• Execution of the largest SLL financing transactions to date.

Updating the SLLP

The Loan Syndications and Trading Association (LSTA), together with the Loan Market Association and the Asia Pacific Loan Market Association have published several documents relating to principles and guidance for sustainable financing. In May 2021, the SLLP, originally published in 2019, and the accompanying Guidance on Sustainability-Linked Loan Principles (Guidance) were revised in response to the steep increase in the volume of SLLs, which had started to raise concerns that the SPTs being included in SLL credit agreements were not sufficiently ambitious or robust. It would risk undermining the integrity of the market if it was too easy for borrowers to achieve their targets and gain the financial and reputational benefits of entering into these loans without meaningfully changing their business operations. The updated SLLP and related Guidance have made several changes designed to emphasize the importance of setting proper targets and establishing clear methods of verifying that these targets are met to improve the integrity of these products and minimize sustainability-washing.

Changes to SLL Loan Terms

SLLs are typically investment grade loans. However, in 2021, practitioners noted that ESG-linked pricing began to find its way into leveraged loan facilities and not just in the energy sector. Market participants also commented that although the drafting of SLLs is still deal-specific, some market precedent is beginning to form.

While early SLLs featured a one-way pricing adjustment that resulted in a discount, in 2021 more SLL deals included a two-way pricing adjustment. They establish a discount on the margin if the borrower meets the relevant target and impose a premium on the margin if the target is missed. US deals that include the two-way margin adjustment include:

• South32, which entered into a $1.4 billion facility with an interest rate reduction or increase based on emissions and improving energy and water use efficiency.
• Eastman Chemical Company, which refinanced its $1.5 billion facility with an interest rate reduction or increase based on reduction in greenhouse gas (GHG) emissions, plastic waste recycling, and increased percentage of women in professional or managerial roles.

Some market watchers are skeptical whether interest rate adjustments of this magnitude are sufficient to incentivize meaningful changes to borrowers' operations. While some may argue that an increase of, for example 2.5 basis points (bps) is not meaningful, imposing excessive penalties may cause borrowers to shy away from the SLL market, jeopardizing the growth of this market and the benefits of promoting sustainable financing. Moreover, borrowers are generally unwilling to risk their reputations or the damage to their lending relationships that failure to abide by their commitments may cause.

As the sustainable financing market matures in the US and overseas, market participants note the market must confront certain issues and challenges, including:

• Whether to tie the sustainability-linked margin ratchet to performance against specific KPIs or to the borrower's ESG rating, or a combination of both.
• Use of static versus dynamic and cumulative SPTs and adjustments to KPI targets and methodology.
• Lack of reliable corporate ESG disclosure, standardization of reporting, and, in some cases, verification of disclosed information.

Examples of 2021 SLL Transactions

Some of the largest US SLLs executed in 2021 include:

• In February, Anheuser-Busch InBev entered into a $10.1 billion credit facility that ties the margin on its loans to improving water efficiency, increasing certain recycled content, sourcing purchased electricity from certain renewable sources and reducing GHG emissions.
• In June, Crown Castle International Corp. amended its $6.2 billion credit facility to, among other things, tie the margin on its loans to achieving sustainability goals regarding LED lighting systems and electricity generated from an eligible renewable source.
• In September, Ford Motor Company amended its $15.5 billion credit facility to, among other things, tie the margin on its loans to achieving certain GHG emissions, renewable electricity, and tailpipe emissions sustainability goals.

For more information on sustainable financing, including social loans, green loans, and SLLs, see Practice Notes, Understanding Green Loans, Understanding Sustainability-Linked Loans, Understanding Social Loans, What's Market: Green Loans, and What's Market: Sustainability-Linked Loans.

Loan Negotiation and Documentation Trends

As the spirited recovery of the loan market that began in the latter part of 2020 continued throughout 2021, borrower favorable terms were available to many companies. Borrowers and sponsors continued to prioritize negotiating permissive covenant packages, flexible default provisions, and generous accommodations in the calculation of financial ratios, including EBITDA adjustments and carve-outs to the debt component of the leverage ratio. For their part, lenders continued with some success in 2021 to push for protections from collateral releases and other actions by the borrower that could weaken the borrower's creditworthiness.

Incremental Debt Permissions

Incremental loan provisions continued to be an important topic in the negotiations between many borrowers and lenders during 2021. Borrowers, on the one hand, typically seek expansive incremental debt permissions to enable them to obtain sizable amounts of additional financing. Meanwhile, lenders are keen to bolster pricing protection for their initial loans by relying on most favored nations (MFN) provisions.

MFN protection has weakened in recent years in the increasingly borrower-friendly loan markets by including MFN thresholds, imposing sunset periods after which MFN protection no longer applies, and by excluding certain categories of incremental debt from MFN protection entirely.

MFN thresholds and sunsets remained similar in 2021 to pre-pandemic levels. An MFN threshold of 50 bps is standard for most deals, although in some large cap and sponsored deals in 2021 MFN thresholds were set at 75 bps. In deals that included MFN sunsets in 2021, these typically fell within a range of 12 to 24 months.

For an example of an incremental debt provision with:

• A 50 bps MFN with no sunset for one tranche and a 12-month sunset for the other tranche, see What's Market, Gray Television, Inc. credit agreement summary.
• A 75 bps MFN with a six-month sunset, see What's Market, Dotdash Meredith, Inc. credit agreement summary.
• A 75 bps MFN with a 12-month sunset for certain term loans secured on a pari passu basis, maturing within two years of existing loan, and above a certain threshold, among other carve-outs, see What's Market, CCC Intelligent Solutions Inc. credit agreement summary.
• A 100 bps MFN with a six-month sunset for certain dollar-denominated broadly syndicated floating rate incremental term B loans, see What's Market, Ping Identity Corporation credit agreement summary.

For further discussion of trends in MFN provisions, see Article, Current Trends in MFN Provisions.

Incremental debt capacity in 2021 loan deals typically continued to be made up of:

• A fixed dollar basket, commonly referred to as a free and clear or freebie basket, that is usually set at one turn of closing date EBITDA and sometimes includes an EBITDA builder component that allows the basket to grow in step with increases in the borrower's earnings.
• An unlimited amount of incremental borrowing capacity up to a maximum leverage limit, typically set at the borrower's closing date leverage.
• A prepayment basket comprised of the amount of any voluntary prepayments of principal of the initial loans and any previous incremental loans.

For an example of an incremental provision with a freebie basket that includes an EBITDA builder, a ratio-based basket and a prepayment basket, see What's Market, Digi International Inc. credit agreement summary and What's Market, Jazz Pharmaceuticals, Inc. credit agreement summary.

Particularly in sponsored transactions, the ratio-based basket sometimes includes a no worse than prong for permitted acquisitions and investments. This allows the borrower to incur incremental debt if the borrower's leverage ratio after giving effect to the incurrence of the new debt and the pro forma addition of the target company's EBITDA is no higher than it was before the borrower incurred the debt. For an example of a ratio basket permitting first lien incremental debt provided after the incurrence the first lien ratio is no higher than the first lien leverage ratio as of the last day of the quarter, see What's Market, CCC Intelligent Solutions Inc. credit agreement summary.

Reclassification and reallocation of incremental loans among different baskets continued to be a theme in the negotiations of incremental loan capacity in 2021, particularly for stronger borrowers and sponsors. This often involves:

• Reclassification between the freebie basket and the unlimited ratio-based basket. This allows the borrower to reclassify incremental debt that it incurred using its free and clear basket to its ratio-based basket if it satisfies the applicable ratio. This effectively allows the borrower to recharge the free and clear basket which it can subsequently use for additional incremental loans at a time when it can no longer satisfy the applicable ratio condition. See What's Market, Dotdash Meredith, Inc. and What's Market, Ping Identity Corporation credit agreement summaries.
• Reallocation of debt capacity under the borrower's general debt basket to its incremental free and clear basket that boosts the size of its free and clear incremental permission.

Practitioners note that it is an aggressive negotiating position for a borrower to seek to reclassify and reallocate debt incurred under other baskets. In other deals the focus shifts instead to EBITDA adjustments. If these are more generous to the borrower, one effect may be that the borrower has greater incremental debt capacity.

Calculating Compliance with Financial Ratios

Given the importance of financial covenants and negative covenant exceptions that incorporate financial ratios and their component definitions, borrowers and lenders continued to pay close attention to them in loan agreement negotiations in 2021.

Leverage Levels and Equity Contributions in LBOs

Total leverage levels in LBO deals continued to inch slightly higher in 2021. In large corporate LBO transactions, the average total leverage was 7.0x, up from 6.9x in 2020. 81% of LBOs in 2021 had leverage six times EBITDA or above, while in 2020 and 2019, 79% and 74% of LBOs, respectively, were levered at this level. LBOs levered at seven times EBITDA or higher increased from 55% in 2020 to 59% in 2021. According to Refinitiv LPC, the average LBO equity contribution in 2021 was 44% for large corporates.

EBITDA Adjustments

Much of the focus in loan agreement negotiations about financial covenants concerns adjustments to EBITDA using cost-savings and synergies add-backs. As with many points arising from loan agreement negotiations, EBITDA adjustments are most borrower-favorable in large cap loans to the most creditworthy borrowers and portfolio companies of top-tier sponsors. In middle market deals, EBITDA adjustments are typically subject to a cap in a range of 20% to 30% and may only apply for a limited period in which the actions giving rise to the cost-savings or synergies must be taken and the effects realized. Some of the terms sought by borrowers and sponsors in negotiations about EBITDA add-backs include:

• Uncapped EBITDA adjustments for cost savings expected to be realized at any time in the future. This is the most aggressive position and resisted by the market except for the strongest borrowers in the most heavily subscribed deals.
• Longer look-forward periods. The typical range of periods during which EBITDA addbacks can be made is between 18 and 24 months. In the strongest credits borrowers sometimes seek longer periods up to about 36 months (see What's Market, Dotdash Meredith, Inc. credit agreement summary).
• Revenue -based adjustments to EBITDA. If included, these adjustments allow the borrower to add to its current EBITDA an amount of projected revenue from an expansion of its business, such as an acquisition. Anecdotally, practitioners report that these adjustments were more commonly negotiated in transactions during 2021. Sponsors argue with some success that their business model depends on acquiring companies and they should be able to add revenue-based adjustments to EBITDA. However, these requests often meet firm resistance from lenders.

For an example of a credit agreement with extensive adjustments to EBITDA, see What's Market, Milan Laser Holdings LLC credit agreement summary (with EBITDA adjustments including a run-rate cost savings add-back with a 24 month look forward and revenue-based adjustments).

For further discussion of EBITDA adjustments, see Article, Current Trends in EBITDA Cost-Savings Add-Backs.

Carve-Outs to Debt

In 2021, as in recent years, borrowers continued to request carve-outs to what constitutes debt for purposes of covenant compliance, which impacts leverage calculations for financial maintenance covenants and incurrence tests.

A common lender concern is that extensive carve-outs to a borrower's calculation of debt undermine the loan agreement's ability to accurately assess the borrower's financial health. In 2021, debt calculations commonly excluded unrestricted cash and cash equivalents of the borrower, enabling it to subtract these items from the total amount of debt for purposes of covenant compliance. A growing trend in 2021, according to some practitioners, is to allow debt proceeds that are not promptly applied to be considered as unrestricted cash or cash equivalents and netted out of the calculation of the borrower's debt.

Negative Covenants and Covenant Flexibility

During 2021 borrowers and sponsors continued to pressure lenders to agree to generous covenant exceptions across the board. In particular, borrowers have sought to achieve greater operational flexibility by being able to reclassify basket capacity under particular negative covenant exceptions and to reallocate basket capacity across different covenants.

For an example of a credit agreement permitting the borrower to reclassify its investment basket capacity, see What's Market, Dotdash Meredith, Inc. credit agreement summary.

For examples of credit agreements allowing borrowers to reallocate investment, restricted payment and restricted debt payment baskets, see What's Market, BigBear.ai Holdings, Inc. and The Hillman Group credit agreement summaries.

Auto-Cure Provisions

Equity cure rights have long been a feature of many credit agreements, allowing sponsors, parent companies and other equity holders to cure a financial covenant breach by the borrower by injecting fresh capital into the borrower. More recently, stronger borrowers and sponsored borrowers have negotiated greater rights to cure defaults in what are sometimes described as auto-cure provisions.

An auto-cure provision (sometimes called a cure default provision) allows a borrower or a sponsor to remedy a covenant breach at any time if the lenders have not accelerated the loan. From a lender's perspective, auto-cure provisions give considerable power to borrowers and sponsors as they can cure a covenant breach at any time after the relevant cure period expires. This means that borrowers and sponsors can begin work-out discussions after the end of a cure period. If they cannot obtain desired concessions from the lenders, they can end the discussions at any time by curing the default.

Market participants report that in 2021 lenders were increasingly pressured to include auto-cure provisions in deals with top-tier borrowers and sponsors. In middle market transactions they are not common and where auto-cure provisions are included they are typically limited to covenants for the delivery of notices or financial statements.

For examples of credit agreements allowing auto-cure, see What's Market, Cheniere Energy, Inc. credit agreement summary (permits auto-cure if the triggering act or condition has been remedied, waived or ceases to exist) and The Hillman Group, Inc. credit agreement summary (permits auto-cure provided officer had no actual knowledge of the events, actions or conditions triggering such default).

Erroneous Payment Provisions

In the aftermath of the decision in In re Citibank August 11, 2020 Wire Transfers (see 520 F. Supp. 3d 390 (S.D.N.Y. 2021) (the Revlon case), many administrative agents favor incorporating protective erroneous payment provisions (EPPs) in their credit agreements. EPPs address the consequences of accidental payments made by agents to syndicate members. EPPs give the administrative agent the right to demand repayment of funds sent to syndicate members by mistake, with the latter having a contractual obligation to return mistakenly paid amounts.

While the market has not coalesced around a common set of provisions, EPPs in many deals include elements of the draft model provision published by the LSTA in March 2021 and updated in June. In the LSTA model EPP, lenders waive the discharge for value defense which was the common law defense relied upon by the lenders in the Revlon case. Anecdotal evidence generally supports the view that market participants regard the LSTA's model provisions as considered and comprehensive, but they may be too involved or complex for deals documented in a more streamlined fashion, including direct lending deals which have also begun to include EPPs. Some practitioners report that some lenders have resisted the inclusion in full of the LSTA's model EPPs on the basis that they are overly accommodating to the administrative agent if it determines it has made an erroneous payment. For a more detailed discussion of the LSTA's model EPPs, see Practice Note, What's Market: Erroneous Payment Provisions.

Key issues that are commonly addressed in EPP negotiations include:

Whether to include a claw-back cut-off date, after which time the administrative agent is no longer able to demand the return of any erroneously made payments. This is an important issue for many lenders. The LSTA's updated model EPPs includes a claw-back cut-off date, which is set at five business days (in brackets).

• The language relating to the payment of interest on the returned funds to be paid by the lender.
• Whether the determination by the agent that a mistake has been made must be either in the reasonable discretion or in the sole discretion of the agent.
• Any lender not willing to return the erroneous payment will be deemed to have assigned its loans (but not its commitment) with respect to which the erroneous payment was made to the agent (a deemed assignment). This creates complexities, including regarding unfunded commitments and in the secondary loan market.
• Set-off of the unreturned amount against amounts owed by the agent to the lender under the loan documents.

In some cases, lenders have sought to address the issue of erroneous payments by broadening the definition of a defaulting lender and expanding the administrative agent's rights to remove lenders, in each case to include lenders that do not return erroneously made payments. The effect of this is to give the administrative agent the ability to redirect sums that may otherwise have been payable to that lender and to deprive the lender of certain voting rights and rights to receive fees.

Although EPPs concern the relationship between the lenders in the syndicate and their administrative agent, borrowers have also voiced concerns. In discussions about EPPs counsel for borrowers have sometimes sought to:

• Clarify that the borrower and the other credit parties have no payment or other obligations regarding payments erroneously made by the administrative agent to any lenders.
• Clarify that advances of borrowings and any other payments made to the borrower, or any other credit party are deemed not to constitute erroneous payments.
• Limit the administrative agent's ability to assign the loans of any lenders that refuse to return erroneous payments so that loans cannot be assigned to parties that are not otherwise eligible to become lenders under the loan agreement, such as the borrower's competitors.
• Clarify that regardless of what transpires with erroneous payments, the commitments of the lenders under the loan agreement remain available to the borrower.

For a discussion of recent trends regarding EPPs, see Practice Note, What's Market: Erroneous Payment Provisions.

Lender Protections: Subordination Risk and Collateral Releases

During the last several years, certain high-profile cases have caused lenders to try to tighten covenant exceptions to protect their collateral and other credit support provided by the borrower and other credit parties. In the face of heavy competition from other lenders and in a negotiating environment that generally favors borrowers, in 2021 lenders had mixed success in obtaining these protections.

Reducing Subordination Risk

In recent years, so-called uptiering transactions, if they are not prohibited under the loan agreement, have caused concern among lenders. Uptiering transactions typically involve financially distressed borrowers and are used by a borrower to strengthen its liquidity position by amending its existing credit agreement to bring in new money from new lenders. The new lenders are senior to the existing lenders, which creates a super-senior tranche of debt in the borrower's capital structure and subordinates the existing lenders' liens behind those of the new lender.

In response, some lenders include anti-priming language in their loan agreements. This typically requires that all lenders must consent to any amendment that subordinates their liens to the liens of new lenders. The voting threshold is generally reduced to majority consent if all lenders have been offered the opportunity to participate in the new senior debt. (See What's Market, Owens & Minor Distribution, Inc. credit agreement.)

For more information on subordination risk and possible solutions, see Article, What's Market: 2020 Year-End Trends in Large Cap and Middle Market Loan Terms.

Preventing Asset Transfers

Ever since the high-profile dispute involving the retailer, J. Crew, lenders in the broadly syndicated and middle markets have focused on preventing borrowers from transferring material assets out of the collateral pool by means of what has become known as a drop-down financing. In the J. Crew case itself, the drop-down financing involved the borrower transferring significant intellectual property assets to an unrestricted subsidiary and thenusing those assets to support other financing. To prevent borrowers from transferring valuable collateral outside the credit group where it is out of reach of the lenders, many loan agreements include so-called J. Crew blockers. These provisions can take different forms, such as:

• Requiring lender consent for the borrower to designate a subsidiary as unrestricted.
• Restrictions on investments in unrestricted subsidiaries and limits on transfers of intellectual property or other material assets to unrestricted subsidiaries.

In 2021, not all lenders were still successful in negotiating for these types of restrictions and the market does not follow a common approach regarding provisions to limit asset transfers to unrestricted subsidiaries. Some lenders, particularly in middle market transactions, focus on limiting transfers to non-guarantor restricted subsidiaries, subject to agreed basket exceptions.

For examples of credit agreements with J.Crew like blocker provisions, see What's Market, Gray Television, Inc. credit agreement summary (limits transfers of material FCC licenses to unrestricted subsidiaries) and Ping Identity Corporation credit agreement summary (restricts transfers of material intellectual property to unrestricted subsidiaries).

LIBOR Transition

During 2021, the loan market continued to adapt to LIBOR's phaseout, and LIBOR transition remained a top priority for market participants.

In anticipation of LIBOR's cessation, US regulators encouraged banks to cease entering into new contracts that use LIBOR as a reference rate by December 31, 2021. New contracts entered into before that date should either use a reference rate other than LIBOR or have robust fallback language that includes a clearly defined alternative reference rate that applies after LIBOR's discontinuation. For a checklist of points of best practice for lenders and borrowers to help their transition from LIBOR to a replacement benchmark interest rate, see Loan Agreement LIBOR Fallback Checklist.

Beginning in 2019, the loan market began transitioning away from LIBOR typically by including fallback language which could either follow the amendment approach or the hardwired approach, as described by the Alternative Reference Rates Committee (ARRC).

Under the hardwired approach, fallback language is included in the credit agreement that provides more certainty on the successor rate and spread adjustment and, in many cases removes the need for consent to an amendment. This differs from the amendment approach, under which, following a trigger event, the borrower and the administrative agent facilitate a streamlined amendment to replace LIBOR by selecting a successor rate and a spread adjustment.

In March 2021, the ARRC issued supplemental versions of its recommended hardwired fallback language for USD LIBOR syndicated and bilateral business loans. Although the supplemental versions are not meant to differ considerably from the ARRC's previous versions of hardwired language, they are intended to provide more simplified versions. In July 2021, the ARRC formally recommended the forward-looking Secured Overnight Financing Rate (SOFR) term rates produced by the CME Group, Inc., a key component of the ARRC's hardwired approach language.

Before the pandemic, the market had almost universally followed the amendment approach for fallback language. However, by the end of 2020 and through 2021, credit agreements and credit agreement amendments increasingly including hardwired fallback language. According to market observers most credit agreements executed in 2021 incorporated the hardwired fallback approach (often some version of the ARRC's recommended fallback language). For more information, see Practice Note, Hardwired LIBOR Fallbacks and Article, Current Trends in Hardwired LIBOR Fallback Language.

Negotiations between borrowers and lenders concerning LIBOR transition issues continued in 2021. Issues commonly negotiated included:

• The timing of transition. Lenders want to avoid a bottleneck of loan agreement amendments transitioning to a LIBOR replacement rate around mid-2023, however borrowers may prefer to delay amending their loan agreements to allow more time to get up to speed on the changes and to compare LIBOR with the alternative replacement rates.
• The spread adjustment. Legacy loans with ARRC hardwired language should apply certain ARRC-agreed spread adjustments, however, new loans have no pre-set spread adjustments. According to market practitioners, there has been pressure from strong borrowers to reduce or eliminate those adjustments.
• The amount of lender discretion. Some borrowers have pushed for a more consensual process relating to transition-related credit agreement changes that may be made by the lender. At a minimum, many borrowers have tried to temper the lender's discretion by requiring them to act reasonably and follow any accepted market practice.

For more information, see Article, Expert Q&A on LIBOR Transition: Issues for Borrowers to Consider.

In the direct lending market, practitioners noted that most direct lending credit agreements incorporated the hardwired fallback approach through the end of 2021 and into 2022, with direct lenders opting to select a replacement rate at a later time. Direct lenders are typically not subject to bank regulation and may continue to use LIBOR in 2022.

However, there may be increasing regulatory pressure on direct lenders to move away from LIBOR and market practitioners have noted that direct lenders are trending towards SOFR as a replacement rate. Use of SOFR by other market participants may also influence direct lenders towards SOFR. An example might be, if a direct lender wishes to participate in a loan involving a bank where the borrower wants a single rate across senior and junior tranches. Direct lenders may also increasingly encounter SOFR-based loans under their own leverage or subscription-based debt facilities with banks.

For additional information on LIBOR fallback language, see Loan Agreement LIBOR Fallback Language Toolkit.

SOFR and Credit Sensitive Rates

In 2021 market participants continued to evaluate appropriate reference rate alternatives to LIBOR, including SOFR-based rates and credit sensitive rates (CSRs) like the Bloomberg Short-Term Bank Yield Index rate (BSBY) and the American Interbank Offered Rate (Ameribor).

A key concern around transition is that SOFR, the rate preferred by the ARRC, is risk free, while LIBOR embeds a measure of bank credit risk. This means that SOFR is generally lower than LIBOR and in periods of market disruption, LIBOR is likely to widen, while SOFR is likely to remain flat or decline.

Even though the market is generally embracing Term SOFR, questions remain about how to originate new SOFR loans that are economically equivalent to LIBOR loans. For a discussion about this issue, see Article, In Search of "Fair" Spread Adjustments for New SOFR Loans.

The ARRC has recognized that market participants may choose a successor rate not based on SOFR. In 2021, there was increasing interest in CSRs, including BSBY and Ameribor, especially for certain large banks and in the regional bank and bilateral loan market. However, market participants are also cautious as these are relatively new rates. To avoid repeating the problems of the past, any possible LIBOR successor rate must be robust and should be carefully evaluated considering future regulatory and market changes. In June 2021 comments to the Financial Stability Oversight Council, SEC Chair Gary Gensler discussed the issues with CSRs and their risks to financial stability and market resiliency.

For additional information on SOFR versus CSRs, see Loan Agreement LIBOR Fallback Checklist.

In the second half of 2021, credit agreements tied to SOFR and other LIBOR-alternative reference rates began to appear more regularly in the loan market and credit agreements tied to LIBOR-alternative reference rates continued to grow in the fourth quarter of 2021. According to Practical Law's sample analysis, the proportion of deals using SOFR grew from 1% in Q3 to 32% in Q4 2021.

Practical Law Finance analyzed 100 credit agreements that were publicly filed with the SEC between October 1, 2021 and December 31, 2021. Of the 100 deals analyzed:

• 59 deals (59%) incorporated hardwired approach LIBOR fallback language:
  • 58 deals had a benchmark replacement rate tied to SOFR (for an example, see What's Market, Dollar General Corporation amended and restated credit agreement summary); and
  • one deal had a benchmark replacement rate tied to Ameribor (for an example, see What's Market, Landsea Homes Corporation credit agreement summary).
• 37 deals (37%) tied their interest rate to a LIBOR-alternative reference rate:
  • 32 deals identified a SOFR-based rate as the interest rate (for an example, see What's Market, The Boeing Company credit agreement summary); and
  • five deals identified BSBY as the interest rate (for an example, see What's Market, BJ's Restaurants, Inc. fourth amended and restated credit agreement summary).
• Four deals (4%) followed the amendment approach for LIBOR fallback language.

For more information on LIBOR transition, including developments in 2021, see Practice Note, What's Market: LIBOR Interest Rate Provisions, and LIBOR Replacement Toolkit.

Looking Forward

2021 was a record-breaking year for the US loan market and many market participants are optimistic that 2022 will also see a strong performance. However, the US loan market and the broader economy face significant headwinds. Stubborn inflation figures are an ongoing concern as are supply chain problems affecting many sectors of the economy, both of which could negatively impact loan market sentiment and performance. Widely expected interest rate increases by the US Federal Reserve may also play a role, along with international tensions and the impact of Russian sanctions.

Nevertheless, credit continues to be available to borrowers on favorable terms. Direct lending looks set for another strong year in 2022 and continued strong growth of ESG-linked financing seems likely. LIBOR cessation in June 2023 is sure to mean that efforts continue in 2022 to address LIBOR transition, including with respect to legacy LIBOR loans.

The market statistics cited in this article (unless otherwise stated) were provided by Refinitiv LPC, an LSEG business.

For a complete copy of this article published on the Practical Law website on February 28, 2022 which also includes links to recent examples of credit agreements and Expert Views from leading industry experts, see Practice Note, What's Market: 2021 Year-End Trends in Large Cap and Middle Market Loan Terms, Practical Law, at https://us.practicallaw.thomsonreuters.com/w-034-0874.

The market statistics cited in this article (unless otherwise stated) were provided by Refinitiv LPC, an LSEG business.

This article was prepared by the Business Law Section's Commercial Finance and Uniform Commercial Code Committees.