In not hurrying to move away from the LIBOR benchmark and adopt alternative rates for new issuances, the asset securitization market risks endangering the sufficient liquidity and capital efficiencies, say market observers.
Yet the U.S. collateralized loan obligation (CLO) market, however, might be able to sidestep some of those ill effects, especially if managers follow the lead of the closely related U.S. syndicated loan market, according to FitchRatings.
New issuances of CLOs continue to reference the USD LIBOR benchmark, according to Fitch, and if CLOs go the way of syndicated loans, as expected, managers might only begin reining in their use of LIBOR at the end of 2021, the regulatory deadline for LIBOR use in new products.
Issuers of leveraged loans appear ready to use the Secured Overnight Financing Rate, or SOFR, the popular alternative to LIBOR. That puts leverages loans a step ahead of the rest of the market in using SOFR, because the Alternative Reference Rates Committee (ARRC) was expected to recommend that benchmark by mid-2021. At this point that recommendation looks more likely before yearend, according to Fitch.
Newly issued CLO transaction documents contain ARRC fall-back provisions referencing term or daily SOFR.
For other fixed-rate asset classes and liabilities, the transition away from LIBOR is less important. Fitch has not observed much new issuance referencing alternative rates, but the RMBS sector is the furthest along in moving away from LIBOR. Some recent RMBS deals have pulled back from the LIBOR reference, such as the Citigroup Mortgage Loan Trust 2021-RP4 and the RATE Mortgage Trust 2021-J1. Most U.S. mortgage originators have shifted to SOFR, Fitch said, and a few have moved to Treasury rates for their non-fixed-rate loans.
Fitch says it expects to see hybrid SOFR adjustable-rate mortgages in nonqualified mortgage programs. RMBS issuance backed by new loans in that subsector, however, has been slow.
In the case of FFELP student loan asset-backed securities, Fitch says a smooth transition away from LIBOR and consistency through other deals afterward might require federal legislative action. This intervention is critical for FFELP notes, because few trusts have been able to make the switch through full investor consent.
A switch away from LIBOR is also important to FFELP student loan ABS deals in light of the possibilities for positive excess spread to support performance and the lower levels of credit enhancement relative to other structured-finance asset classes.
