September 19, 2019 - While the daily SOFR spike grabbed the headlines this week, other LIBOR coverage should be noted as well. First, LIBOR’s end is trending. In an American Banker Bankshot podcast, the LSTA’s Meredith Coffey discussed exactly why LIBOR is going away, what the replacement rate likely would be, and why this is important to bankers and borrowers (and students and homeowners!). But that wasn’t the only LIBOR article relevant to the loan and CLO market. Risk.net observed that CLO investors are finding a silver lining in LIBOR’s demise. Specifically, CLO equity investors historically have lamented the basis risk between CLO assets (leveraged loans) and liabilities (the CLO notes). In 2018, the LIBOR curve steepened, with one-month LIBOR sitting more than 40 bps below three-month LIBOR. Corporate borrowers increasingly borrowed using one-month LIBOR, while CLO notes pay three-month LIBOR. That 40 bps differential between assets and liabilities materially impacted CLO equity distributions for a period of time. In contrast, a SOFR curve should be flatter. Moreover, if all asset classes ultimately adopt “SOFR Compounded in Arrears”, a three-month SOFR contract will just be a continuation of a one-month SOFR contract. This should minimize basis risk for CLO equity investors – and this is at least one silver lining.
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