In recent weeks, companies including Oryx Midstream, WellPet, Viagogo and CommScope have been receptive to lenders’ protests after launching loan deals with CSAs that were lower than the Alternative Reference Rates Committee recommends.

But some other borrowers — Gainwell and StandardAero being two recent examples — have attempted, and in some cases succeeded, with SOFR amendments that do not follow ARRC recommendations for the CSA.

The ARRC recommendations are advisory, as opposed to mandatory. Nevertheless, some buyside firms are seeking legal counsel to address the growing issue of sub-optimal CSAs in the loan market, sources said.

Awareness of the issue is becoming more widespread. Eagle Point Credit Management, which invests in CLO equity, recently hosted a conference call with around 70 market participants; the firm encouraged its peers to pressure CLO managers to push back on non-ARRC amendments.

“We need to make sure we’re not getting hosed on what is essentially a regulatory issue, when PE sponsors are getting a nice windfall,” one such investor told 9fin this week.

“We are asking CLO managers for a report card for every CSA amendment, asking ‘what’s your action and what was the result’. To the extent they are not voting against these and not pushing back, that will have repercussions and maybe we don’t trust them to do their fiduciary duty.”

It’s understandable that CLO equity holders are aggrieved: the impact of a small reduction in the overall spread of a loan portfolio is magnified for them, because of the leverage in CLO structures.

ARRC of the covenants

Last year, a consensus appeared to be emerging that investors would push for a 10bps CSA to when transitioning to SOFR — if they were given the opportunity to object in the first place.

Now, in more and more instances, they are demanding CSAs in line with the ARRC recommendations: 11bps for the one-month rate, 26bps for the three-month rate, and 43bps for the six-month rate.

Oryx Midstream is one recent example. The company initially offered a 10bps CSA to existing lenders in connection with its recent $300m add-on loan deal, which funded a dividend to the company’s private equity sponsors.

After investor pushback, the company boosted the CSA to 11.448bp, 26.161bp and 42.826bp for one, three and six month SOFR. It did, however, manage to tighten the OID for the add-on, which was was placed at 99.25 from price talk of 98-98.5.

One reason the ARRC recommendations have become popular is that they provide adjustments across the SOFR curve. This is helpful, because it’s becoming more common for borrowers to switch between different SOFR tenors in response to fluctuations in benchmark interest rates.

“Over the last year or so, issuers have had the ability to change interest frequency,” said one buysider. “They can pick one, three or six months, and a lot of issuers chose one month because it was lower.”

For CLOs, this also increases the risk of an asset-liability mismatch between the spread on the loans versus what the collateral manager is paying to investors on the bonds.

“We have told collateral managers that 10bps is not enough of a CSA,” said the CLO equity investor. “We need the full ARRC of 26bps, otherwise we will have a large mismatch and that is coming out of our excess spread.”

Call your lawyer

Two sources told 9fin that lenders have been seeking legal advice, to determine whether they have any recourse in situations where borrowers have pushed through loan amendments with suboptimal compensation.

There is a question mark, however, over whether there is any realistic path to legal action.

In many SOFR amendments, only negative consent is required — meaning that lenders have to actively object to the proposal, otherwise they are presumed to have consented. In some other situations, credit agreements allow the revolver lender to make the rate transition without consulting term loan holders.

“If you gave up your vote to the revolver lender, what are you gonna do?” said one CLO manager. “Equity wants to push back, because the impact is big, and people are objecting to low CSAs, but I don’t know what your legal action could really be.”

Some sources suggested that potential legal challenges could hinge on how credit agreements require the CSA to be calculated, as this language can be vague.

“Some amendments have gone through where the issuer or agent has taken the stance that, based on the way the language reads, the CSAs for the loan is based on ‘prevailing market rates’,” said the CLO equity investor.

“But who sets 10bps as the prevailing rate and who can verify that? We will likely see potential legal battles from that.”

If these battles do materialize, it could add another layer of drama to a market that’s already dealing with a lot: the NAIC’s proposed rule changes on CLOs, a pending case on whether loans are securities, and just last week, the resurrection of an old Dodd-Frank rule that could present challenges for CLO managers.