Asset-backed traders and bankers felt the shake of Year 2000 last Wednesday as the three-month Libor got the millennium bug, jumping 57 basis points overnight.
"I don't think many people looked at it [Tuesday]," said Dan Nigro of Chase Asset management. "But it kind of hit everybody [on Wednesday]."
According to Jeff Salmon, director of ABS research at Barclays Capital, the jump was the result of the three-month Libor's maturity date extending beyond the first of the year.
"That level of jump, I think, was completely [the result of] pricing that risk of having securities that are going to reset over the end of the year," said Salmon. "We'll probably see something similar when we see one-month Libor too."
Consequently, for issuers, getting investors to play into that range is suddenly more costly, according to Nigro.
"Anything off three-month Libor basically changes significantly in terms of pricing," said Nigro. "But more important is the impact for fixed-rate investors, which effects everybody. Swap spreads are out four basis points on two-years and two to four basis points on three-years."
As Nigro explained, initial payments are based on these new rates, which must be factored into pricing. The new pricing disproportionately affects shorter swap maturities, because this initial payment becomes a higher proportion of the overall payment made.
In terms of the secondary market, the increased rate will affect investors already holding securities at least until the next reset date.
"Let's say I bought the security at par, three-month Libor plus 20," explained Salmon. "Last month it paid me the coupon at roughly 550 plus 20, so my coupon was 570. Now with the dramatic jump, at the next reset, obviously the value of the thing is going to be much less. Probably down to 98 or 99. So actually I'm going to lose in the pricing of that bond."
However Salmon contends that the effects of this jump, as well as what can be expected with the rise in the one-month Libor next month, are short-term. "Markets move quickly into equilibrium," said Salmon.
