Given the expected cessation date for LIBOR in 2021, new-issue CLOs have generally been including the hard-wired fallback language published by the Alternative Reference Rates Committee of the Federal Reserve Bank of New York (“ARRC”) into their Indentures. However, equity investors and portfolio managers have been concerned with the potential for a mismatch between the base rates used to determine the interest on the assets in the underlying portfolio of a CLO and the base rate used to determine interest on the CLO notes (i.e., if the majority of the underlying collateral obligations of a CLO use a base rate other than Term SOFR, and such CLO uses Term SOFR as its base rate).
To avoid the possibility of a mismatch between the rates on assets and the rates on CLO notes, some new-issue CLOs have included the optionality to implement a base rate on the CLO notes that is utilized by at least 50% of such CLO’s floating rate collateral obligations as another fallback rate. Recently, we have seen a number of CLOs utilize a variation to this approach. These CLOs only permit an alternative base rate to be adopted for determining interest payable on the CLO notes if at least 50% of (i) the underlying floating rate loan assets, or (ii) the floating rate notes priced or closed in the new issue CLO market and/or that have amended their base rate in the last 3 months, also utilize such alternative base rate. The fallback options for such CLOs include the usual base rates (i.e., Term SOFR, Compound SOFR, etc.), but also the rate that satisfies one of the prongs set forth above. This approach is essentially an attempt to ensure that the LIBOR replacement rate for the notes of such CLOs is consistent with the base rate used to determine interest by a majority of the assets in such CLO’s underlying portfolio or by a majority of transactions in the CLO market.
If you would like further information about this or any other matter, or would like to discuss further, please feel free to contact Greg B. Cioffi, Andrew Robertson, Abhijit Kurup, or any other member of the CLO practice group.