Lenders need ability to opt out of base rate loans, LSTA says

By Angela McDaniels

Tacoma, Wash., Oct. 14 - The Loan Syndications and Trading Association, Inc. said lenders need to consider incorporating provisions in their credit agreements that would allow them to select the higher of Libor and their base rate for calculating interest.

That was one suggestion made by LSTA in response to queries from members about the credit agreement provision known as the "eurodollar disaster clause" that allows lenders to convert Libor loans to base rate loans, according to an association news release, which summarized comments made by Rick Gray, partner of Milbank Tweed Hadley & McCloy, in a conference call discussion with LSTA members.

LSTA said the clause protects lenders against certain types of events or "disasters" in the Libor market that result in lenders not being able to obtain quotes adequately reflecting their cost of making the loan.

"Ironically, in the current environment, with Libor rates almost matching base bates, it may be less expensive for many borrowers to select base rate loans rather than borrow off eurodollar rates. Most credit agreements do not contemplate the possibility that the base rate would not adequately cover their cost of funding and do not offer lenders the option to opt out of base rate loans," LSTA said in its release.

"This outcome is exacerbated by the fact that the interest margin for base rate loans is generally about 100 basis less than the interest margin for Libor loans."

Issue 'still too current'

Under a typical eurodollar disaster clause, lending off Libor can be suspended if the administrative agent determines that "adequate and reasonable" means do not exist for ascertaining Libor or if the lenders find that Libor will not adequately and fairly reflect their cost of making the loans, according to the release.

If the clause is invoked, and the credit agreement provides for both base rate and Libor pricing, then any loans priced according to Libor will be calculated according to the U.S. base rate.

LSTA said there are several different ways to tackle this issue, the first being to ensure that quotes are accurate.

Other ways that lenders are considering addressing the issue is by incorporating other provisions in their credit agreements, for example, including a Libor floor, increasing or supplementing the applicable margin, providing for the interest rate to be the higher of Libor or another rate basis or shortening the interest period, the release stated.

"The issue is still too current to tell how the market will settle down and want to address this," the association said in the release.

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