LIBOR Update: CREFC Survey on Fixed-Rate CMBS Benchmarking
November 15, 2021
On November 10, CREFC launched a survey regarding the impact on the pricing and quoting of fixed-rate CMBS as a result of the transition away from LIBOR. By way of background, federal banking regulators have said that banks must stop originating LIBOR products after December 31, 2021. The recommended replacement rate for LIBOR is the Secured Overnight Financing Rate (SOFR), a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.
Please Respond to CREFC’s Survey to Assist in Gauging the Market’s Preference for Benchmarking Conventions for New-Issue and Legacy Fixed-Rate CMBS
CREFC’s survey asks respondents to rank their preferred benchmarks and provide feedback. Your attention to the survey would be greatly appreciated. Please click here to access the survey (and if your firm does not allow access to the survey website, please click here for a Word version which can be returned to Raj Aidasani). Submissions are requested by December 3, 2021.
While the transition will bring significant changes to floating-rate CRE securitizations, primarily SASB CMBS and CRE CLOs, the impact to fixed-rate securitizations – both new issue and legacy – will be transformative as well. Currently, fixed-rate CMBS bonds are priced and quoted off a swap rate curve (e.g., “S + 200”) that incorporates a snapshot of the forward expectations for LIBOR for the floating-rate leg. For example, a typical 10-year CMBS bond prices off a 10-year swap rate, based on a forward curve derived from LIBOR futures contracts. In addition, a significant number of fixed-rate CMBS investors hedge their positions immediately upon pricing using LIBOR swaps.
Banks may be wary of continuing to use the LIBOR swap curve for quoting new-issue CMBS transactions after year-end 2021 in light of supervisory guidance and their internal policies regarding the transition. In addition, as the market broadly moves away from LIBOR to SOFR, LIBOR swap quotes may not be as reliable given the lack of underlying hedging activity in the market. SOFR swap volumes have grown throughout the year, and liquidity in SOFR futures contracts is high, with some reports that certain SOFR futures contracts are more liquid than their equivalent LIBOR contracts.
Based on our discussions with members, two options are under consideration for pricing and quoting fixed-rate CMBS in place of the LIBOR swap curve: 1) SOFR Swap Curve or 2) Treasury Securities.
SOFR Swap Curve
The SOFR swap curve is the market’s replacement for the LIBOR swap curve with forward expectations of SOFR replacing LIBOR for the floating-rate leg. As with the LIBOR forward curve, it reflects future expectations of Fed policy and market conditions. As a result of SOFR First, an initiative launched under the CFTC’s Market Risk Advisory Committee (MRAC), interdealer broker screens no longer reference LIBOR swaps and, per ClarusFT, approximately 80% of the interdealer market is now SOFR-based.
Treasury Securities
Before mid-1998, CMBS was priced off Treasuries, similar to the fixed-rate unsecured corporate bond market (which continues to price over Treasuries). Soon after the Russian financial and Long Term Capital Management liquidity crises of 1998, CMBS began pricing off the LIBOR swap curve due to the use of swaps in hedging by originators during the collateral accumulation process and the better liquidity in swap rates at the time. Currently, all new issue investment-grade CMBS tranches (except IOs) are priced versus comparable average life swap rates.