Wednesday, August 5, 2009

LIBOR hitting record lows, forcing lenders to get creative

LIBOR continues to drift down, hitting new record lows. It's a positive sign as lower LIBOR is lowering banks' cost of funds. But this trend is also lowering interest income on assets, because a large portion of loans on banks' balance sheets tend to be LIBOR based.

USD 3-month LIBOR

A typical non-investment grade corporate loan may pay LIBOR + 2-3%. With the 3-month LIBOR at 47 bp, the current yield is under 4% (plus capital appreciation), making such asset a fairly unattractive investment. That is why on new corporate loans, the lenders now insist on an imbedded LIBOR floor.

From LPC (Loan Pricing Corporation):
Libor floors have taken hold among refinanced credits. The majority of Libor floors among leveraged credits have averaged 2%, although it remains to be seen whether this may be stepped up to 2.5% or even 3%.

For example, the CIT rescue loan has a 3% LIBOR floor. Going forward, it's going to be increasingly difficult to get floating rate financing without this feature.
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