Freddie Mac’s Latest K-Deal Includes SOFR Loans

Even as the financial community reluctantly lets go of LIBOR as the world’s long-standing benchmark rate, Freddie Mac is ploughing forward with its own efforts to adopt the Secured Overnight Financing Rate, or SOFR, the rate banks use to price US dollar-denominated derivatives and loans. This is one of the main replacements for LIBOR.

The government-sponsored enterprise just rolled out its latest offering of K-Certificates and it includes classes of floating rate bonds indexed to SOFR and backed by underlying mortgages that are also indexed to SOFR. The $991.5 million in K Certificates are expected to price on or about December 8, 2020.

The offering is the first of its kind as previous SOFR-based K-Deal floating rate bonds were backed by LIBOR-based underlying mortgages. The offering also includes classes of floating-rate bonds indexed to LIBOR and backed by underlying mortgages that are indexed to LIBOR.

Freddie Mac multifamily began purchasing SOFR based floating rate mortgages in October 2020 and is set to stop all LIBOR-indexed loan purchases by the end of the year. Once the LIBOR-indexed loans purchased by year-end 2020 have been securitized, floating rate K Certificates will include only SOFR-indexed bond classes.

In the past year there have been more than 20 K-Deals that included bonds indexed to SOFR. The collateral for those offerings was LIBOR-based with Freddie Mac covering the basis mismatch. With purchases of SOFR-indexed loans gaining momentum, it was ready to launch the first tranche of SOFR bonds backed by SOFR collateral.

Shifting Strategies

As agencies shift to using SOFR loans, commercial real estate investors will have to adjust strategies and portfolios, according to a Walker & Dunlop podcast on the subject.

“All existing loans with maturities after 2021 will transition to SOFR,” said Blake Lanford, managing director and co-head of Walker & Dunlop’s trading desk in the podcast. “Regulators are trying to minimize the value transfer of transaction by implementing a spread adjustment based on the perception of fairness. But there are likely to be some winners and losers.”

What can companies do now to prepare for the transition? Walker & Dunlop suggests four ways to begin.

First, inventory current LIBOR exposure under existing loans and derivatives with a focus on those expiring after 2021. Second, assess fallback language and determine the fallback rate for current debt. Third, evaluate models and system impacts to determine what adjustments may be required with the shift to SOFR. Finally, understand the anticipated financing schedule for both refinancing existing debt and adding new debt.

While there are certain factors beyond some firms’ control, Walker & Dunlop is expecting the transition to play out on the timetable that has been set it all along by regulators.

“Does the actual transition for LIBOR set at the end of 2021 mean it is going to go away altogether as of that date or will it continue to exist in some form or fashion beyond that?” Lanford pondered. “Regulators would tell you it is going to go away altogether but there are certain factors, what they call ‘tough Legacy’.”

Lanford said it is challenging to amend from LIBOR to anything else in light of the fact that 100% shareholder consent is needed to do so.

“What we have seen is what I would describe as shifts in interim deadlines but we haven’t heard anything definitive from regulators that they expect there to be a significant way of transition specifically,” he explains. “There are extensions but nothing definitive in terms of a delay to the broader timeline at the end of 2021. But it definitely signals that there’s flexibility, should market conditions demand.”