Chatham executes first Freddie Mac SOFR interest rate cap
- September 14, 2020
On Wednesday, September 9, Chatham executed the first SOFR-indexed interest rate cap on behalf of a commercial real estate (CRE) borrower in conjunction with the closing of a CBRE-originated Freddie Mac financing.
Chatham is pleased to announce its part in the execution of the first SOFR-indexed interest rate cap in conjunction with a Freddie Mac financing. This financing, originated by Freddie Optigo lender CBRE, was the first Freddie multifamily SOFR-indexed loan. While pricing on the cap structure was slightly higher than a commensurate LIBOR cap, it was well within the borrower's underwriting constraints, and consequently served as proof of concept that these structures are available for Agency borrowers at pricing that does not unduly influence overall deal economics. Being on the leading edge of the debt and derivatives markets, Chatham brings deep and broad market perspective and expertise, guiding our clients to the optimal outcome even in unprecedented situations such as this first SOFR-indexed cap.
Throughout the COVID-19 pandemic, many market participants have questioned the reality and timing of a transition away from LIBOR, a legacy index linked to floating-rate real estate contracts for decades. While many thought the timing of the 2021 phase out would be extended, both Freddie Mac and Fannie Mae have led the charge in the lending market on the transition to SOFR. Beginning with their announcements in February of 2020, the Agencies have held firm in their position on transition timing and are now pioneering the new SOFR-based lending market.
Both Freddie Optigo lenders and Fannie DUS lenders are now issuing SOFR-based term sheets. Like the LIBOR-based floating-rate loans with which many market participants are familiar, the newly minted SOFR loan agreements include a requirement to hedge the borrower’s floating rate exposure. Freddie is initially allowing borrowers the ability to hedge their exposure to SOFR using either a SOFR- or LIBOR-based cap (see FAQ: USD LIBOR transition to SOFR for greater detail), while Fannie has mirrored their LIBOR-based structured ARM requirement of an initial 5-year cap for SOFR loans. This new reality will be felt across the spectrum of Agency borrowers as neither Freddie nor Fannie will accept LIBOR-based loan applications after September 30.
As the largest independent hedging advisor in the commercial real estate market, Chatham’s reputation and extensive market presence put us in a unique position to begin advising clients, Agencies, law firms, and cap providers on the critical considerations of these new requirements from the onset of the announcements. We have had numerous conversations centered on helping these stakeholders understand the differences between SOFR and LIBOR, the basis risk between the two indices, the new escrow mechanics, the cap pricing differences between the two indices, and (in the case of Freddie Mac financings), the pros and cons of hedging a SOFR-based loan with a LIBOR-based cap. Because the SOFR derivatives market is in its infancy compared to LIBOR, SOFR-based caps can cost more given the reduced liquidity in the SOFR cap market, as evidenced by the indicative pricing below. However, documentation terms that Freddie currently requires on LIBOR caps for SOFR loans may impact their cost, making SOFR caps the more affordable option.
If contemplating a SOFR-indexed financing, please reach out to your Chatham contact to evaluate the merits of various cap structures based on your specific financing situation.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.20-0359
Our featured insights
The Agencies are on track to transition to SOFR as an index for floating-rate loans by EOY. Applications for SOFR indexed loans may be seen as early as this month. Liquidity of SOFR interest rate caps is limited but Chatham is optimistic that they will be available for closing these loans.
Despite the disruption caused by the COVID-19 pandemic, the UK Financial Conduct Authority is still advising all market participants to prepare for a discontinuation of LIBOR at the end of 2021.
This summarizes the impacts that COVID-19 has had on repo markets and SOFR, how market participants have responded, and the possible implications of the economic slowdown on the LIBOR-SOFR transition.
Why are LIBOR and swap rates not following the central bank rates down? What is the status with LIBOR transition and should I continue to prepare? Read this week's European real estate market update.
While the week prior was a big week for monetary policy, with the Fed taking wide ranging policy actions to strengthen liquidity in credit markets, this past week ended with a bang for fiscal policy.
JCRA, now part of Chatham Financial, the independent financial risk management advisory, is delighted to announce that it has been recognised as Risk Management Advisory Firm of the Year at the GlobalCapital Global Derivatives Awards 2019.
This white paper is intended to help treasurers prepare for the disappearance of the financial sector’s most important number.
Understanding the tactical steps involved in executing on an interest rate cap can help CRE investors plan and use their time efficiently prior to closing on a loan. Request your interest rate cap execution checklist here.
The Fed has adopted a “flexible form of average inflation targeting” that aims for inflation rate to average 2% over time. Under this framework, the Fed funds rate will likely stay low for longer. Also, there will be an elevated emphasis on the maximum employment objective of the dual mandate.
An interest rate forward curve for a market index is, at a discrete moment in time, a graphical representation of the market clearing forward rates for that index.
The interest rates on which CRE investors focus are comprised of real rates, inflation expectations, and credit spreads. Understanding how macroeconomic conditions impact these components and a good risk management policy provide a framework for managing interest rate risk.
In reviewing what has transpired in the commercial real estate (CRE) lending markets over the past six months, we found it helpful to re-read our market commentary as it was written at the end of each of the last three quarters.
After a record 20.4% monthly contraction in UK GDP in April, the expectation was that with some businesses able to reopen under strict conditions in May, there would have been a solid rebound in output.