The question is not nearly as existential as the question phrased by William Shakespeare, but it is a significant one in the lending world as the transition from LIBOR to SOFR ideally happens by the middle of next year. The official answer is easy—hardwired LIBOR transition language is recommended by the ARRC for syndicated loans and bilateral loans. For diligent lenders, adopting hardwired language is part of a proactive approach to addressing the LIBOR transition process. By setting the broad parameters of the new rate up front now, the ultimate details of implementing the new rate can be simplified with a notice to the borrower rather than negotiating an amendment in the future when time is short. Our prior Alert discusses the hardwired approach in more detail.
Still, for some lenders there are solid reasons to adopt a wait and see approach and possibly skip the hardwired language. These lenders are no less diligent in their desire to do the right thing, but the developments in the LIBOR/SOFR transition are starting to accelerate, with major details still unsettled at this point. Determining how the broad market will handle the transition and keeping a lender’s actions in line with the market without getting ahead of the developments may suggest a more cautious approach.
Legacy loans that either do not have LIBOR transition language (other than to base or prime rate), or that have some variation of the amendment approach language, will need to be amended to include a new SOFR interest rate. Separate work flow processes and documentation will need to be developed to implement the transition for each of these types of loans. Adopting the hardwired approach for new loans adds yet another work flow process to be developed and implemented. Existing loan forms need to be amended to add the hardwired approach language. The language needs to be vetted and understood by the business and legal teams and explained to and negotiated with borrowers. In the transition process, these new loans will need to be treated differently than the pre-hardwired approach loans. The SOFR amendment forms will need to be adapted into notices, with the same type of review and vetting described above. None of these actions is particularly difficult, but it takes time and effort, and they will likely apply to a limited subset of a lender’s loans—only loans originated in the next six to nine months (ideally). After that, lenders should only be originating SOFR loans.
One of the main benefits of going through the effort above is that sending a notice later on is easier that having to negotiate an amendment. But is it really that much easier? All the hardwired approach does is set forth a waterfall of rates to be used in place of LIBOR. Most of the details, including the mechanics of how the replacement rate will be calculated and used, the spread adjustment to make the new rate approximate LIBOR, and the conforming changes to such concepts as interest periods, interest payment dates and prepayment premiums, are left to the future. Many of these details are still being thought through by industry leaders—they should be coming out soon, but they’re not quite there yet. There is little or no definitive guidance, much less market practice. In this context, what is a borrower really agreeing to? If a lender believes that it can sign a loan agreement today with hardwired language and simply send a notice to the borrower next June with the SOFR details, it may find that some borrowers think differently.
Whether a lender chooses the amendment approach or the hardwired approach, the communication part of the LIBOR transition process should begin now and be a fluid one as the picture becomes clearer and a lender develops the details of its SOFR interest rate product. Waiting for the market to work out the details should not be an excuse to delay—LIBOR transition is coming and much work lies ahead. Communicating is part of that work, and it allows the borrower to be part of the process, evaluate the details and have its questions and comments addressed. Ultimately, these efforts can help make the SOFR interest rate option work more smoothly, as operational and practical issues in implementing SOFR are bound to arise for the foreseeable future. Importantly, involving borrowers in the process can get them more comfortable with the transition to SOFR. At that point, having them sign an amendment rather than giving them a notice may not be such a big difference.