Real estate businesses facing LIBOR crunch

By Bridging Loan Directory 16th April 2020

Real estate businesses are facing a LIBOR crunch, with over half of property businesses with borrowing yet to speak to lenders about alternative interest rate benchmarks, finds research from the law firm Collyer Bristow.

Collyer Bristow surveyed 60 real estate business in the UK and found:

70% are aware that LIBOR is being phased out.
52% have borrowings operating beyond 2021 that use LIBOR to calculate interest, with a further 22% unsure if their borrowing is linked to LIBOR.
52% have not yet spoken to their lenders to agree alternative benchmarks to calculate interest.
68% believe that if, as a result of the change, the amount of interest payable on borrowing was only known a few days in advance of it being paid it would have a detrimental impact on cash flow.
70% of property businesses said this is one of their top operational priorities, although it should be noted that this survey was conducted before the current coronavirus pandemic.
25% of property businesses with borrowing and who have spoken to lenders are broadly happy with proposed preference rates to replace LIBOR.

LIBOR, the benchmark reference rate used to calculate interest payments in variable loan rates, will cease to be used after the end of 2021, with lenders encouraged to use risk free rates, or RFRs, which are based on transaction data and less susceptible to manipulation.

The change will, says Collyer Bristow, result in real estate businesses not necessarily knowing the amount of interest to be paid on borrowing until just a day or two payment is due.

Janine Alexander, a partner at Collyer Bristow specialising in banking and financial disputes said:

“One of the primary differences between LIBOR and RFRs is that there are no forward-looking elements built in to account for expected movements in interest rates over the interest period for the borrowing. In practice, and dependent on exactly how the RFR is used to calculate interest, this is very likely to mean that borrowers will not know what interest is payable until a few days before those interest payments are due, and that may cause cash flow problems if rates are volatile.

So it is surprising that so few real estate businesses have yet to engage with lenders over current and future borrowing requirements despite the potential impact it will have on cash flow management. We are, however, encouraged that businesses recognise importance of taking action and would urge them to speak with lenders as soon as is possible.

It is also encouraging that where businesses are in discussions with lenders, they find alternative benchmarks to be commercially acceptable.”

Collyer Bristow offers this advice to real estate businesses with lending contracts that extend beyond 2021:

Check contractual positions on loans. Do they include a fallback provision specifying alternative benchmarks?
Consider whether that fallback position is commercially acceptable as a permanent basis for the loan.
Consider the potential ‘Zombie LIBOR’ scenario, where LIBOR continues to be published but because of the withdrawal of most banks’ submissions do not reflect interbank market pricing. Would this situation trigger a fallback provision or the right for a borrower to change to another rate?
Consider whether facility terms allow the lenders to amend the benchmark rate without a borrower’s permission? If not, review any requests from lenders carefully, particularly any amendments proposed which may give the lender the right to change the benchmark rate for interest payments without permission.
Consider interest rate hedges associated with a loan. Any mismatches in the benchmark used after 2021 between an interest rate swap and the underlying loan may lead to additional cost or exposure.

Janine Alexander adds:

“Real estate businesses face many challenges, not least of which rebuilding following the impact of COVID-19, and lending contracts post LIBOR may understandably fall down the list of priorities. That would be a mistake.

The FCA and the Bank of England have confirmed that LIBOR will cease to be used from the end of 2021, and letting this drift into 2021 risks being in a position where there is no time to consider alternatives if an appropriate solution cannot be agreed with current lenders.”