The Federal Reserve-backed group guiding the implementation of the Secured Overnight Financing Rate has given securitized debt issuers a map that could speed up a transition away from Libor.
While other corners of the bond market have already made progress in retiring the London interbank offered rate as a benchmark it sells debt against, structured credit has lagged far behind. This week the Alternative Reference Rates Committee (ARRC) gave the market a way to close the gap by publishing a white paper outlining a specific approach for using the 30-day average of SOFR.
Freddie Mac has utilized the SOFR alternative-benchmark in multifamily apartment securitizations while JPMorgan Chase & Co. has used it for a handful of AAA tranches in its series of prime residential mortgage-backed bonds starting in October though vast portions of the structured finance markets have stuck with Libor. ARRC’s recommendations can be used for calculating payments on asset-backed securities as well as residential and commercial mortgage-backed securities.
ARRC suggested the monthly interest rate would reset in advance of each interest accrual period as opposed to the end of each period to better align with how underlying consumer loans, residential and commercial mortgages reset. The paper doesn’t address Libor transition issues for collateralized loan obligations.
Loans underpinning ABS and MBS “reset in advance, regardless of the interest rate used, in order for borrowers to know in advance what they will owe on the related payment date, thus permitting the related borrowers to manage household budgets or monthly cash flows,” the committee wrote. The group “recognized the importance of this timing for borrowers. Resetting the ABS ‘in arrears’ would introduce basis risk where the underlying assets reset in advance.”
While the retirement of Libor was given an extension to mid-2023, ARRC has insisted that cessation of Libor products should start as soon as possible.
“The ARRC has adamantly stressed that now is the time for market participants to stop issuing new Libor-based products, including securitized products,” said Tom Wipf, ARRC chairman and vice chairman of institutional securities at Morgan Stanley, in a statement.
Although ARRC has work underway to develop a forward-looking term rate based on SOFR (known as term SOFR), the authors said “there is no guarantee when or if the ARRC will recommend the use of term SOFR, whether for securitized products or otherwise. It is also not certain whether any recommendation would apply to all securitized products, and may be limited to use in legacy securitized products solely in connection with a transition from Libor.”
Therefore, it’s important not to wait until those forward-looking rates become available, ARRC said. Hence, 30-day average SOFR could be used.
Freddie Mac employed the SOFR benchmark on some of its multifamily CMBS starting in December 2019. The stockholder-owned corporation chartered by Congress in 1970 to create a continuous flow of funds to mortgage lenders, has issued 25 floating-rate CMBS containing SOFR bond classes with a total outstanding balance of over $23 billion through Jan. 31, according to ARRC data.
While the initial four transactions referenced a calendar month average of SOFR set in advance, all SOFR bond classes and underlying SOFR loans thereafter have incorporated the published 30-day average SOFR, also set in advance, ARRC said.
“Though this paper sets forth one option for how ABS, MBS, and CMBS products could use 30-day average SOFR, market participants may select appropriate adjustments to the methodologies,” ARRC said in the paper.
Relative Value: RMBS, CMBS
- Canyon Partners has found relative value in select smaller, more esoteric securitizations, George Jikovski, a partner and portfolio manager at the firm, said in an interview this week
- Examples include fix-and-flip and mortgage-insurance credit risk transfer deals (private-label deals, not Fannie/Freddie CRT transactions). In this sector, BBB rated risk is clearing around 250 basis points to 275 basis points over Libor, Jikovski said
- Canyon has also added Freddie-K C tranches recently from the GSE’s multifamily CMBS series of deals, and has generally preferred floating-rate over fixed-rate securities
“The robust performance in online consumer lending that persisted throughout 2020 has picked up substantial steam in 2021,” according to a recent analysis of online lending from dv01, a data company that tracks loans underlying securitized debt. “Aided by two rounds of fiscal stimulus, performance received a massive boost courtesy of a second government stimulus at the beginning of the year and has continued through March 2021. Impairments continue to decline, modified borrowers are returning to full payments, and prepayments and total payment rates are surging past previous highs.”
ABS deals in the queue for next week include Ford (prime revolving auto loans), GM Financial (prime auto loans), Finch Investment Group (tax liens), Kubota Credit Corporation (equipment) and Purchasing Power (consumer installments).
–By Adam Tempkin