Libor’s impending demise is starting to make a greater impact on the private-label U.S. residential mortgage-backed securities market.
This month, two new floating-rate transactions were launched in which issued notes were tethered to the Secured Overnight Financing Rate (SOFR) published by the New York Federal Reserve, instead of the longstanding London Interbank Offering Rate that banks and other financial services firms are being increasingly pressured to drop as a floating-rate benchmark, as its use will begin to phase out starting next year.
A PIMCO-managed private fund last week priced a $306 million securitization of first- and second-lien home equity loans (Bravo Residential Funding Trust 2021-HE1), while this week Arch Mortgage Insurance Co. and United Guaranty Residential Insurance Co. co-sponsored a mortgage-linked insurance premium securitization with issued notes tied to SOFR (Bellemeade Re 2021-1).
Ratings agency sources say they are the first respective HELOC and MLI deals to opt for SOFR-benchmarked bonds in the private MBS space.
The two deals joint a trio of offerings this year sponsored by JPMorgan’s mortgage unit and Flagstar Bank to utilize SOFR, which has also been introduced into in GSE credit-transfer risk securitizations. Freddie Mac issued its first CRT transaction
JPMorgan was the first to issue a private, SOFR-referenced prime loan pool
“We're excited to see more deals come to market and do expect it to pick up,” said Krisi Leo, president of the Structured Finance Association. “As you know, the regulators have been clear that they would like to see new [Libor-based] issuance stop by the end of this year.”
In the BRAVO deal that closed last week, four classes of notes were priced to SOFR with a spread, including a $200M Class A2 tranche.
Bellemeade's capital stack is made of insurance-linked notes that reference of pool of 131,501 conforming fixed- and variable-rate mortgages with a coverage level of $7.77 billion.
The BRAVO and the Bellemeade transactions are using a SOFR benchmark calculated by using compounded 30-day average of overnight trading activity, priced with a premium spread to approximate what the returns would be under one-month Libor.
The UK’s Financial Conduct Authority (FCA) has definitively committed to ending the publication of most Libor rate at the end of the year. On March 5, the FCA announced it will drop all Libor quotes for sterling, Euro, yen and Swiss franc settings, but would extend Libor settings for most U.S. dollar tenors (overnight, one-month, three-month, six-month and 12-month terms) for another 18 months through June 2023. Only 1-week and two-month U.S. Libor will permanently disappear after Dec. 31.
Under current methods, the FCA compiles daily quotes from a panel of global banks in order to publish rates for five currencies as well as across seven tenors.
The extension for U.S. dollar Libor rates allows asset-backed issuers to wind down legacy deals with current benchmarks, such as collateralized loan obligations that market notes commonly tied to three-month Libor. It also “allows for more time for primary markets to shift to alternative indices; for possible state or federal legislation to be enacted to reduce litigation and operational risk from legacy contracts, where amending fallback language remains difficult,” according to a March 10 report from Fitch Ratings.
U.S. regulators such as the Federal Reserve are pressuring banks to stop issuing Libor-based commercial loans, including leveraged loans that supply CLO deal collateral.
“Even on the asset side, at some point, loans are going to start to switch to SOFR this year, so you're going to issuers need to build liquidity on the liability side for match funding,” said Leo.
Most existing securitizations have incorporated “fallback” language into deal documentation that inserts a replacement rate – such as SOFR – in the event of no available Libor benchmark to price floating-rate coupons.
