What is a CAS?

CAS stands for Credit Adjustment Spread. This is a concept from loan land that becomes relevant when the interest rate benchmark on a floating rate loan is changed.

For their interest rates, floating rate loans usually refer to a benchmark plus a margin.

Here are some of the most common benchmarks: EURIBOR, NIBOR, STIBOR, HIBOR and formerly also US$ LIBOR, which was finally set on June 30, 2023. All of these are referred to as term rates or IBORs. SONIA, SOFR, €STR and SARON, which are referred to as risk free rates. For risk free rates, we further distinguish between simple and compounded risk free rates.

Today, among other things, because of the fallout from the LIBOR scandal, loan documents include provisions that allow switching from one benchmark to another.

Note that benchmarks often trade at a spread, which is the case due to some important differences in what the rates represent (e.g., over-night rate vs 1-month or 3-month rates; secured vs unsecured rates etc.).

For example, see here the spread between EURIBOR and €STR.

 Also, see here the spread between SOFR and 3-months US$ LIBOR.

This is where the CAS comes into play. When an interest rate is switched, investors want to receive the same floating rate yield as before the switch. This means it will not be sufficient to refer to the new benchmark but there must be an additional component in the interest rate calculation that addresses the spread between the benchmarks. Such is the purpose of the CAS! It ensures economic equivalence after having changed the benchmark.

So, for example, if you switched your benchmark from EURIBOR to €STR, the facility agreement would provide that a so called Rate Switch CAS applies. Such Rate Switch CAS is then added to the €STR to reflect the difference (or spread) between EURIBOR and €STR following the rate switch. Whether a Rate Switch CAS is included in the facility agreement, depends on the negotiating power of the borrower. If the borrower is a large corporate or backed by a powerful sponsor, the CAS may not necessarily be included in the documentation and banks my have to live without the adjustment, which essentially means that a rate switch puts the banks’ yield at risk.

If the loans are compounded risk free rate loans from the outset, strictly speaking, a CAS is not required because the margin could be adjusted to reflect a different benchmark. The LMA facility agreement form, however, provides for a Baseline CAS—the driver being pricing transparency. In practice, however, the Baseline CAS is rarely used.