As lenders start to prepare for the transition from LIBOR to SOFR (or perhaps another rate like AMERIBOR), practical concerns of how to implement the change are coming to the forefront. Many sources have highlighted the need for due diligence on the loans in a lender's portfolio, but not many have focused on the actual scope of review that is needed.
It's a potentially daunting task—every single agreement that might bear interest or fees based on LIBOR has to be identified. Depending on the lender, this may be hundreds or thousands or hundreds of thousands of documents. They may be scattered across different offices covering different business units on different computer systems that often do not communicate with each other. The LIBOR terms in a loan may be contained in several different documents that originated from different templates, from standard LaserPro forms to highly negotiated 200-page agreements. Simply assembling the loans in a way that they can be reviewed efficiently can be a challenge.
In a perfect world, the best practices are easy to determine. A deep-dive review of every loan agreement should be done to see exactly what LIBOR terms are used, exactly where they are used and exactly what the LIBOR provisions say. Does the loan agreement call it LIBOR, LIBO Rate, Adjusted LIBO Rate or perhaps Eurocurrency Rate? Is the LIBOR provision in Section 2.3(d) or was it moved to an entirely different section in a particular loan? Hopefully the LIBOR provisions aren't scattered throughout a variety of different sections covering different features of LIBOR. Whatever the situation is, ideally all of these terms and provisions would be cataloged in a database that can be evaluated in further detail.
If all of this sounds expensive and time consuming, it is. On the one hand, human reviewers may be relatively cheap, but it can take months to complete a large review. On the other hand, once it is properly trained (not a simple task), artificial intelligence can review hundreds of thousands of contracts quickly. However, the setup costs alone can be prohibitive. Regardless of whether human review or AI is used, some errors are bound to occur. We explore in another recent Alert whether borrowers will be willing to pay such costs, or whether lenders will be forced to absorb them.
These shortcomings call into question the true value of detailed LIBOR due diligence. If the portfolio is not already organized in an easily accessed, centralized database containing searchable copies of the main loan documents and certain key information about each loan?such as the names of the loan parties, the dates of the agreements and the amount of the LIBOR margin?there is definitely value in organizing the loans. Beyond that, it is not clear that detailed information about the exact LIBOR terms used and their exact location and wording is really necessary. If LIBOR transition is accomplished successfully, LIBOR will disappear permanently. In that context, a LIBOR due diligence database is a collection of all the terms and provisions that won't matter anymore. What's the point of having it?
The obvious answer is that the information can be useful in preparing the amendments that will transition from LIBOR to SOFR or another rate. This is a pretty good reason to have the information, but the question then becomes whether the full detail on each and every loan agreement is really necessary. For many lenders, the vast majority of loan agreements in their portfolios are likely based on one or more templates. On smaller loans, these templates often do not get negotiated much, and the LIBOR provisions in particular are often not open to negotiation since they deal with the fixed operational mechanics used by the lender to determine the interest rate. A focused review of a representative sample of each type of loan agreement should pick up most of the LIBOR terms and provisions used across most of the portfolio and give some indication of the variances from that. In any particular loan agreement, there can be great variability from the template, but there is little variability in the end result—LIBOR is going away and being replaced with a new rate template.
A traditional amendment relies heavily on knowing the exact terms and provisions that are to be amended. If that approach is followed, then a full due diligence review of each and every loan agreement is necessary. Each loan agreement with any sort of variation from the form will need its own customized amendment, since an amendment that does not identify and properly address each variation will not work.
Can an amendment be drafted that deletes LIBOR and replaces it with a new rate without having performed due diligence regarding the specific details and variations of each underlying loan agreement? We consider that in our next Alert.
About Duane Morris
As the end of LIBOR draws closer, Duane Morris' LIBOR Transition Team will continue to monitor developments and issue additional Alerts.
For More Information
If you have any questions about this Alert, please contact Roger S. Chari, Joel N. Ephross, Amelia (Amy) H. Huskins, Phuong (Michelle) Ngo, Han Wang, any of the attorneys in our Banking and Finance Group or the attorney in the firm with whom you are regularly in contact.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.