September 5, 2019 - On September 3rd, we hit 850 days before the (earliest) potential end of LIBOR. So, what’s in your workflow for the next 850 days? To help you organize, we discuss fallbacks, new SOFR issuances and – critically – how lenders can learn exactly where things stand (and what is happening) with respect to the end of LIBOR.
For many markets, Step 1 in LIBOR transition has been developing broadly executable fallback language. Last month, Covenant Reviewed lauded the FRN market for getting in line with the Alternative Reference Rates Committee’s (ARRC’s) recommended hardwired LIBOR fallback language. Both Covenant Review and Practical Law Company might have been less laudatory on the loan fallback side, observing that there generally is loan fallback language but noting that it universally takes the form of amendment fallbacks. Splitting the difference is the CLO market, where most deals use amendment fallback language, but some have gone hardwired. Just last week, Fitch released a note observing that the ARRC related fallback language in five CLOs they analyzed reduces operational uncertainty. (Hardwired fallbacks should reduce the chances of legal traffic jams and market disruption upon LIBOR cessation.)
While fallback language is critical, replacing LIBOR with SOFR in new issuances ideally would obviate the fallback uncertainty. And the progress is accelerating there. According to CME, there has been over $230 billion of SOFR issuance, including $50 billion in August 2019 alone.
This is substantial progress, but what might really kick the SOFR market into gear is the government and the mortgage world switching to SOFR for floating rate issuances and adjustable rate mortgages (ARMs). That’s happening too. In July, both Fannie Mae and Freddie Mac said that they supported the ARRC’s white paper for using SOFR in ARMs, and would use it to create a SOFR Indexed ARM product for new mortgage originations. Meanwhile, as the WSJ reported, the Treasury Department also is considering issuing floating rate notes tied to SOFR. The Treasury Borrowing Advisory Committee (TBAC) had analyzed the potential of Treasury issuing SOFR FRNs and observed that they could likely price in line with or better than existing T-bill pricing. The TBAC agreed that a Treasury SOFR FRN could help expedite the transition from LIBOR – and should do so, particularly if it does not come at a cost to taxpayers.
However, systems must be able to operationalize SOFR before there can be widespread adoption of the rate for new issues. This has been acknowledged by Freddie (“our ARM products based on the SOFR index will be available once systems and processes have been put in place”), Fannie (“Fannie Mae expects to make an ARM product based on overnight SOFR available once systems and processes have been put in place to accommodate the new index”) and TBAC (“Treasury issuance of a SOFR-linked FRN was unlikely to be imminent given operational issues and design choices”). So how do we get there? The LSTA developed a series that walks market participants from where we are today (somewhat functional loan fallback language) to where we need to be (ability to do hardwired fallbacks and SOFR issuances). Both the LSTA Conference on October 30th in NYC and ABS East in Miami on September 22nd-24th will feature progressive tracks to help lenders leave LIBOR. We start with an overview on where LIBOR transition stands today, what the public sector is requiring and how private sector thought leaders are responding. We then move to understanding SOFR – how term SOFR, compounded SOFR and daily simple SOFR actually behave and who is likely to use each. Next up is next-gen documentation – both how LIBOR fallback language is developing but also how a SOFR document would look. Finally – and to the point made by Fannie, Freddie and Treasury – we will describe how SOFR could be operationalized. At the LSTA, we’ve run (some of) the ARRC committees and we have (some of) the LIBOR answers. We hope to see you in Miami and/or New York to exchange insights with you.