Taking Comfort with the Transition to SOFR
With the financial markets’ transition away from London Inter-bank Offered Rate (LIBOR) to Secured Overnight Financing Rate (SOFR) underway, early adopters are raising questions and considerations about this new index as they head into their respective investment committees in an already challenging time. However, though a tentative transition timeline has been set and quoting new loans over a SOFR benchmark is underway, only now are borrowers focusing on how SOFR-indexed products tie in to their portfolios.
As the multifamily industry shifts to the new index, transparency is important for our Optigo® network of lenders, borrowers and investors. We’ve prepared a new report to help address the when, why and how of our transition from LIBOR, plus we share insights into new SOFR features from a pricing and capital markets perspective. Read the report about "Taking Comfort with the Transition to SOFR".
Historical SOFR Volatility
As many are aware, the repo market that’s used to derive overnight SOFR can be (and has been) volatile at times. Overnight SOFR volatility has led to instances of large spikes in the rate. The most extreme case was an over 282-basis-point (bps) increase in overnight SOFR on September 17, 2019, to 5.25%. It’s important to point out how quickly these spikes historically reversed themselves given the vast market size and large number of participants. In this extreme example, the SOFR rate fell back down by 270 bps the next day, reversing almost 100% of that dramatic increase.
Historical Relationship Between 30-Day Average SOFR and One-Month LIBOR
From a borrower’s perspective, since SOFR is based on fundings that are “secured” in the overnight Treasury market, whereas LIBOR tracks “unsecured” lending, SOFR should, in theory, be lower than LIBOR over longer periods. SOFR rates were first published in early 2018 and an indicative 30-day average SOFR figure was first published in May 2018. Exhibit 2 of the report shows the historical difference between the benchmarks, and conveys that SOFR has historically been a lower benchmark. Going back to May 2018, the historical difference between the two indices is 8 bps. By comparison, the current difference today is roughly 5 bps.
Demand for SOFR Bonds
As part of the LIBOR to SOFR transition, Freddie Mac began issuing SOFR bonds with our K-F73 floating-rate securitization in December 2019. Our floating-rate issuances with SOFR bonds now include 22 different transactions totaling more than $8.1 billion in multifamily SOFR bond issuance. This has given us the opportunity to build our investor base and optimize our back-end execution in preparation for the next steps of the transition. Exhibit 3 of the report details the size of our SOFR- and LIBOR-indexed bonds in our recent floating-rate K-Deals®.
Interest Rate Caps
The market for SOFR caps is still under development, although it is worth noting that some financial institutions are already quoting SOFR caps. Freddie Mac is working closely with these participants and we believe that, as more institutions offer SOFR caps, the cost difference between SOFR and LIBOR caps will compress.
For additional information, read the report about "Taking Comfort with the Transition to SOFR" or check out the online resources below.
- K-Deal SOFR Bonds Overview
- K-Deal SOFR Bonds Summary Chart
- LIBOR Transition Overview web page
- LIBOR Transition Playbook – describes key transition milestones and recommended actions for stakeholders to consider as they manage the upcoming transition from LIBOR
- FAQs – frequently asked questions related to the GSE’s transition away from LIBOR-Indexed products to SOFR-indexed products
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