Fed group charts path for securitized issuers to drop Libor

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The Federal Reserve-backed group that guides the implementation of the guaranteed overnight funding rate has given issuers of securitized debt a card that could accelerate the Libor transition.

While other segments of the bond market have already made headway in removing the London Interbank Offered Rate as a benchmark against which it sells debt, structured credit has lagged far behind. This week, the Alternative Reference Rates Committee (ARRC) gave the market a way to close the gap by issuing a white paper describing a specific approach for using the 30-day SOFR average.

Freddie Mac a used the SOFR alternative benchmark in multi-family apartment securitizations while JPMorgan Chase & Co. has used it for a handful of AAA tranches in its series of prime residential mortgage bonds starting in October, albeit large portions structured finance markets have remained loyal to Libor. ARRC recommendations can be used to calculate payments on asset-backed securities as well as residential and commercial mortgage-backed securities.

The ARRC suggested that the monthly interest rate would be reset before each interest accrual period rather than at the end of each period to better align with the resetting of consumer loans, residential mortgages. and underlying business. The paper does not address Libor transition issues for secured loan obligations.

Read more: Libor Kill Becomes Reality for Banks as Key Milestone Takes

The loans underlying the ABS and MBS “are reset in advance, regardless of the interest rate used, so that borrowers know in advance what they will owe on the corresponding payment date, thus allowing concerned borrowers to manage household budgets or monthly cash flows, ”the committee wrote. The group “recognized the importance of this calendar for borrowers. Resetting the “late” ABS would introduce basis risk when the underlying assets are reset in advance. “

While Libor’s retirement received a extension mid-2023The ARRC insisted that the discontinuation of Libor products should begin as soon as possible.

“The ARRC has strongly insisted that the time has come for market participants to stop issuing new Libor-based products, including securitized products,” said Tom Wipf, President of the ARRC and vice president of institutional securities at Morgan Stanley, in a statement.

Open questions

Although the ARRC has work in progress to develop a forward-looking forward rate based on SOFR (known as SOFR), the authors said, “There is no guarantee when or if the ARRC will recommend the future. use of the term SOFR, whether for securitized products or otherwise. . It is also uncertain whether a recommendation would apply to all securitized products and could be limited to use in traditional securitized products only as part of a Libor transition. “

Read more: Libor transition continues even with uncertain SOFR forward rate

Therefore, it is important not to wait for these forward-looking rates to become available, the ARRC said. Therefore, the 30-day average SOFR could be used.

Freddie Mac has used the SOFR benchmark on some of his multi-family CMBS from December 2019. The joint stock company owned by Congress in 1970 to create a continuous flow of funds to mortgage lenders, issued 25 CMBS at rate variable 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 referred to a monthly SOFR average set in advance, all SOFR bond classes and the underlying SOFR loans thereafter incorporated the published 30-day average SOFR, also set at advance, the ARRC said.

“While this document presents an option for how ABS, MBS and CMBS products could use the 30-day average SOFR, market participants can select the appropriate adjustments to the methodologies,” ARRC said in the document.

Relative value: RMBS, CMBS

  • Canyon Partners has found relative value in some smaller, more esoteric securitizations, said George Jikovski, partner and portfolio manager of the company, in an interview this week.
  • Examples include credit risk transfer contracts with credit insurance and mortgage loan insurance (private label contracts, not Fannie / Freddie CRT transactions). In this sector, BBB-rated risk is emerging from around 250 basis points to 275 basis points above Libor, Jikovski said.
  • Canyon has also recently added Freddie-K C tranches from GSE’s multi-family CMBS series of operations, and has generally preferred floating rate securities to fixed rate securities.

To quote

“The strong online consumer lending performance that persisted through 2020 accelerated significantly in 2021,” according to a recent online lending analysis from dv01, a data company that tracks underlying loans to securitized debt. “Thanks to two rounds of fiscal stimulus, performance was significantly boosted by a second government stimulus early in the year and continued until March 2021. Depreciations continue to decline, modified borrowers are coming back full payments, prepayments and total. payment rates exceed previous highs. “

And after

ABS deals in the queue for next week include Ford (senior revolving auto loans), GM Financial (senior auto loans), Finch Investment Group (tax liens), Kubota Credit Corporation (equipment) and power purchase (payments to consumers).

–By Adam Tempkin

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