Covering Your Cost of Funds in a Syndicated Deal
In the past year, we’ve seen many changes in how interest rates are calculated. Volatility in the quoted rates for LIBOR created problems for several lenders, who suddenly found that the interest rates they were earning on some of their outstanding loans didn’t cover their cost of funds.
There are many possible ways to remedy this problem, most of which I’m sure you’re all familiar with by now. For example:
- You can set a rate floor for both LIBOR and base rate loans, to protect against significant decreases in the quoted rates.
- You can require that the interest rate be based on “the higher of” LIBOR or the base rate.
- You can use the rates quoted to a few carefully chosen reference banks as the basis for calculating LIBOR, rather than the typical published rates.
- You can require one-month LIBOR rather than offering longer interest periods.
- For larger companies, you can calculate the margin based on the credit default swap rate for that company – or you can use a credit default swap index rate.
There are deals out there containing all of these and more. And these approaches work equally well in single-lender deals as in syndicated deals.
However, in a syndicated loan, there is additional tension between the need for each of the lenders to have its own cost of funds covered, and the problem that would be created for the borrower (and perhaps other lenders) if a situation affecting only one member of the bank group could be used to drive the interest rate up on the entire credit facility. The “market disruption” clauses in a few older deals are not entirely clear on this point, but the current standard is to provide for some consensus that the problem affects many of the lenders in the group before taking action.
One fairly common way to address this issue is to include a provision like the following, which appears in the Alliance Data Systems Corporation credit agreement. This provision requires a majority of the lenders to share the problem before triggering a switch from LIBOR to the base rate.
Alternate Rate of Interest. If before the beginning of any Interest Period for a Eurodollar Borrowing:
(i) the Administrative Agent determines (which determination shall be conclusive absent manifest error) that adequate and reasonable means do not exist for ascertaining the Adjusted LIBO Rate for such Interest Period; or
(ii) Lenders having 50% or more of the aggregate principal amount of the Loans to be included in such Borrowing advise the Administrative Agent that the Adjusted LIBO Rate for such Interest Period will not adequately and fairly reflect the cost to such Lenders of making or maintaining such Loans for such Interest Period;
the Administrative Agent shall promptly give notice thereof to the Borrower and the Lenders, and, until the Administrative Agent notifies the Borrower that the circumstances giving rise to such suspension no longer exist, (a) the obligations of the Lenders to make Eurodollar Loans, or to continue to convert outstanding Loans as or into Eurodollar Loans shall be suspended and (b) each outstanding Eurodollar Loan shall be converted into a Base Rate Loan on the last day of the then current Interest Period applicable thereto. Unless the Borrower notifies the Administrative Agent at least three Business Days before the date of any affected Borrowing for which a Notice of Borrowing has previously been given that it elects not to borrow on such date, such Borrowing shall instead be made as a Base Rate Borrowing.
The Alliance Data Systems agreement is from May of 2009; another recent example with similar provisions is the Tyson Foods credit agreement from the first quarter of 2009 (and there are many more). It can be helpful to include a provision like this in a syndicated loan agreement, so that the lenders in the bank group are protected from receiving yields below their cost of funds, in a way that makes sense for the entire group.
