“The idea that the loan market could trade the floors that exist today for additional spread is pure fantasy.” – Beth MacLean, bank portfolio manager, PIMCO.

It’s March 2008. The Fed has dropped rates precipitously to forestall a liquidity crisis. One-month Libor craters to 2.8% from 5% only three months before. Libor spreads for single-B issuers, which had bottomed out at 225 bps in 2007, rise to over 380 bps. Thus did the leverage loan market flip from sell-side to buy-side, and Libor floors took hold.

As the crisis deepened, debt investors demanded a minimum Libor rate, effectively a subsidy boosting their all-in returns. The further Libor dropped below the floor, the more of a premium was earned over the spread itself. By the time Lehman collapsed in September 2009, Libor was near zero. Floors, which had opened as high as 350 bps, settled down to (and have remained) around 100 bps.

Fast forward to today: the Fed’s intention to increase rates later this year has investors concerned that issuers will press to eliminate floors altogether. Who needs a subsidy (goes the argument) when actual Libor will soon rise above the floors?