LIBOR Floors in Leveraged Loans
66 Pages Posted: 21 Nov 2017 Last revised: 11 Jan 2018
Date Written: January 10, 2018
The use of LIBOR floors in U.S. leveraged (syndicated) loans is examined. These options, rare prior to 2008, provide a minimum interest rate on these otherwise floating rate loans. This contract design is consistent with theory that suggests lenders prefer more fixed rate assets while interest rates are low in order to cover their fixed costs. On average, banks that participated in floor-adjusted credit lines had noninterest expense rates 10-20 bps higher than did banks in purely floating rate facilities. Demand for floors appears to originate from the supply of credit as borrowers seeking to extend loans between 2005 and 2016 were able to attract 33% more principal from lenders if a floor was added. Consistent with their theoretically higher interest rate sensitivity, loans that embed floors are more likely to include call protection, in the form of cancellation and upfront fees. Finally, I document that LIBOR floors represent a significant component of loan pricing, contributing three to five times as much as upfront fees to total lender compensation.
Keywords: LIBOR Floors, Leveraged Loan, Syndicated Loan, Loan Pricing
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