Recommended benchmarks or credit sensitive indices: the best way forward? | Arent Renard

General

In the United States, SOFR is the recommended benchmark but has not been widely adopted. In the UK, SONIA is the recommended benchmark and has been widely adopted.

What is best to use depends mainly on the combined debt and interest rate swap situation of the company and the bank.

Recommended references

The positive and negative attributes of using recommended references are listed below:

Positive

  • More likely to be stable in the event of market disruptions (e.g. March 2020 pandemic) although significant unexplained SOFR disruptions in September 2019
  • Objectively established rate

Negative

  • Newly developed benchmark with limited track record (compared to LIBOR)
  • SOFR not widely adopted by banks in the United States

Credit sensitive indices

The positive and negative attributes of using credit sensitive benchmarks are listed below:

Positive

  • Attempts to replicate the credit sensitive nature of LIBOR as opposed to SOFR
  • Less likely to be manipulated than LIBOR

Negative

  • More likely to be impacted by market disruptions
  • An even more limited track record than SOFR

Best hint to use – it depends

The use of recommended benchmarks against credit sensitive indices depends on the overall debt situation, in particular the use of interest rate swaps, for each type of entity, as is generally the case. summary below:

Companies

LIBOR based loans / limited swap exposure

For those types of companies with limited exposure to interest rate swaps, lower and more stable interest rates are preferred.

Answer: Recommended repositories

LIBOR Based Loans / Swap Extension

Since companies have large variable rate debt covered by interest rate swaps, these companies (counterintuitively) want higher interest rates. Higher interest rates reduce / eliminate the negative market value of corporate swaps.

It should be noted that if the bank counterparty continues to pay the variable rate due under the interest rate swaps, these companies continue to pay the fixed rate due under swaps. Therefore, higher interest rates do not affect the company’s bonds, but, as mentioned above, have a favorable impact on swap liabilities.

Answer: Credit sensitive indices

Banks

LIBOR based loans / limited swap exposure

For those types of banks with limited exposure to interest rate swaps, higher interest rates from borrowers are preferred.

Answer: Credit sensitive indices

LIBOR Based Loans / Swap Extension

Banks with a significant amount of interest rate swaps, like the largest international banks, these banks (counterintuitively) want lower interest rates. Falling interest rates increase the market value of swaps to bank counterparties (and, in parallel, as mentioned above, increase the negative market value for the firm’s counterparty).

Answer: Recommended repositories

Source link

Leave a Reply

Your email address will not be published. Required fields are marked *