JP Morgan first to issue SOFR-linked preferred stock

BofA, Goldman Sachs and others are also preparing for Libor’s end

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JP Morgan’s latest preferred stock issuance has a first-of-its-kind provision buried in the small print: the floating leg will pay a forward-looking term rate based on SOFR, the secured overnight financing rate.

The $2.25 billion offering, which settled on July 31, will pay a fixed rate of 5% until August 1, 2024 and then switch to a floating rate of three-month term SOFR, plus a spread of 3.38%.

Such a rate does not currently exist. The Alternative Reference Rate Committee (ARRC) convened by the Federal Reserve Bank of New York is working on creating a forward-looking term rate based on SOFR derivatives, which is expected to begin publishing by the end of 2021.

Preferred stock, which combines the features of debt and equity, has historically been linked to Libor – either the three-month Libor rate or the mid-market swap rate in the relevant currency – when the coupon moves from fixed to floating.

Regulators have urged banks to stop using Libor as a reference rate for new issues. In a speech on July 15, John Williams, president of the New York Fed, warned market participants there were only 901 days to go before UK’s Financial Conduct Authority gives up its power to compel banks to submit quotes for the benchmark.

The ARRC has created templates for fallback language for various cash instruments, including bilateral business loans, syndicated loans, floating rate notes and securitisations.

Banks are beginning to put in fallback provisions to specify an alternative reference rate if Libor ceases to exist. However, there is little consensus on what the fallback should be.

Bank of America (BofA) issued $1 billion of preferred stock in June (Series JJ) with a fixed rate of 5.125% until June 20, 2024, which will then convert to a floating rate of three-month US dollar Libor plus 3.292%.

The prospectus states that if Libor becomes unavailable, a “waterfall of alternative rates” will be used in its place. The first of these is a forward-looking term version of SOFR. If that is not available, a compounded average of daily SOFRs will be used. But, as the documentation notes, there is currently “no market convention with respect to the calculation of compounded SOFR” either.

The third option in the waterfall is a fallback rate designed by the International Swaps and Derivatives Association, which is expected to be finalised by the end of the year. If all else fails, BofA or its calculation agent “will determine the Benchmark Replacement that will apply to the Preferred Stock”.

In a warning to investors, the documentation states: “Uncertainty surrounding the establishment of market conventions related to the calculation of term SOFR and compounded SOFR and whether either alternative reference rate is a suitable replacement or successor for three-month US dollar Libor may adversely affect the value and return of the Preferred Stock and, therefore, your depositary shares.”

JP Morgan has included similar fallback language in other recent capital raises. The bank issued $2.5 billion of senior callable debt in May that will pay a fixed rate of 3.702% until May 6, 2029, when it will convert to a floating rate of three-month US dollar Libor plus 1.16%.

If Libor is discontinued, the floating rate will fall back to a forward-looking term version of SOFR. If that does not exist, the rate will be determined by “relevant authorities”, which could be the ARRC, Isda, or even JP Morgan itself.

Goldman Sachs has decided to avoid the beleaguered benchmark rate altogether.

The bank issued 500,000 shares of preferred stock in June that pays 5.5% until August 10, 2024. After that, it will be benchmarked to the five-year US Treasury rate plus 3.623%.

A spokesperson for the bank said the Libor transition was a factor in the decision.

Barclays has opted for a similar approach. The bank’s Tier 1 capital issuance in US dollars has historically been benchmarked to the mid-market US dollar swap rate, which is tied to Libor.

For its most recent subordinated contingent convertible securities issuance this year, Barclays switched to the five-year US Treasury rate for the floating leg. For UK-denominated debt, the floating reference rate has been changed to gilts.

Others are sticking with Libor-linked rates for now. BNP Paribas also used the mid-market US dollar swap rate for its Tier 1 debt issuances and stuck with that rate for its most recent issuance in March.

The bank said its decision was influenced by the fact that “an adjustment factor will be needed to account for the basis difference between SOFR (or any successor rate) and Libor.”

“There is no market-accepted adjustment factor as of the date of this prospectus,” the documentation reads.

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