Freddie Mac Sells First SOFR-Indexed Commercial Mortgage Bond
While Secured Overnight Financing Rate is the widely favored substitute for Libor in the U.S., it is not yet a definite choice.
(Bloomberg) -- Freddie Mac has priced the first commercial-mortgage securitization to contain a class of bonds indexed to the Secured Overnight Financing Rate, or SOFR, the heir presumptive to the beleaguered Libor benchmark.
The approximately $765.6 million transaction, which priced on Dec. 12 and is scheduled to close on Dec. 20, is part of the government sponsored enterprise’s ongoing series of CMBS bonds known as “K” deals that are backed by multifamily properties.
The transaction is significant because the securitized-credit markets have been the slowest within fixed income to begin adopting the proposed new benchmark, which is the preferred replacement for Libor after it is phased out at the end of 2021. The corporate-credit and commercial paper markets, meanwhile, have been further along, with banks such as Citigroup Inc. and JPMorgan Chase & Co. taking part as issuers. The Federal Home Loan Banks, Fannie Mae and Freddie Mac have been offering SOFR-referenced floating-rate debt since July 2018.
“Freddie’s goal was to provide support to the fledgling SOFR bond market, create liquidity, and provide proof of concept with a test-case for multifamily securities tied to SOFR,” said Robert Koontz, senior vice president of multifamily capital markets at Freddie Mac in a telephone interview. “We thought it was a good opportunity to lead the path and take on some of the basis risk, as investors were interested in seeing SOFR work and the mechanics behind it for multifamily securitizations.”
Koontz also said that Freddie wanted to test out a multifamily SOFR-indexed bond to get ahead of the potential for a SOFR-based commercial mortgage loan, which is currently in development. Both Freddie Mac and Fannie Mae are also working on a SOFR-linked residential adjustable-rate mortgage product.
While SOFR is the widely favored substitute for Libor in the U.S., it is not yet a definite choice. Part of the reason that securitized markets have been further behind in adopting SOFR is that unlike Libor it is an overnight rate and lacks a forward-looking term curve. This could cause structured finance investors to lose money in the transition from Libor to SOFR if there is not an adjustment calculation used to preserve value between Libor and the new SOFR rate.
“There isn’t term SOFR that exists today,” Koontz said. “It’s still in the lab.”
In its test-case deal, therefore, Freddie Mac solved this problem: the GSE provides investors a guarantee on the SOFR-linked bonds that will cover any basis mismatch in the event SOFR exceeds Libor.
Only one $200 million senior tranche of the floating-rate CMBS transaction was priced off of SOFR, while another $565.6 million senior slice was priced off of Libor, which is the traditional benchmark for a floating-rate multifamily securitization.
The underlying multifamily loans collateralizing the SOFR-linked tranche are currently Libor-based with 10-year terms. All Libor-based loans and Libor-based bonds will convert to an alternative index, which may be SOFR, when Libor ceases to be published.
The Federal Reserve Bank of New York, in conjunction with the Treasury Department’s Office of Financial Research, is proposing to publish compounded averages for SOFR in early 2020 that will create benchmarks at 30, 90 and 180 days. The bank extended its comment period for the compounded averages to Jan. 10.
Until the New York Fed publishes its calculator for determining the SOFR forward-looking averages, Freddie Mac will publish the averages using the methodology currently published by the New York Fed and the Alternative Reference Rates Committee (ARRC).
“Based on the strong demand for this transaction, you’ll see more SOFR-indexed floating-rate multifamily CMBS going forward,” Koontz said.
--With assistance from Alexandra Harris.
To contact the reporter on this story: Adam Tempkin in New York at atempkin2@bloomberg.net
To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Christopher Maloney, Christopher DeReza
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