{"id":885,"date":"2020-11-24T14:21:02","date_gmt":"2020-11-24T20:21:02","guid":{"rendered":"http:\/\/agcus.net\/?p=885"},"modified":"2026-02-04T19:16:46","modified_gmt":"2026-02-05T01:16:46","slug":"sofr-the-new-commercial-loan-index-that-is-replacing-libor","status":"publish","type":"post","link":"http:\/\/streamapse.com\/TAR\/?p=885","title":{"rendered":"SOFR – The New Commercial Loan Index That Is Replacing LIBOR"},"content":{"rendered":"

Last week I blogged on the problems associated with LIBOR<\/a>. \u00a0It is abundantly clear that something needs to be done to replace the LIBOR index as a measure of market interest rates.<\/p>\n

I pointed out that $350 trillion in financial instruments worldwide are currently tied to LIBOR. \u00a0Regardless of which index the authorities end up using to replace LIBOR, the switchover is going to be tricky. \u00a0I can see in my mind’s eye some greedy attorney affixing a bib and rubbing his hands together in glee. \u00a0Yum.<\/p>\n

The index that will be replacing LIBOR, at least here in the U.S., is the secured overnight financing rate<\/strong><\/em> (SOFR). \u00a0The secured overnight financing rate\u00a0is a benchmark interest rate for dollar-denominated derivatives and loans. \u00a0The Federal Reserve Bank of New York began publishing the secured overnight financing rate (SOFR) in April 2018 as part of an effort to replace LIBOR.<\/p>\n

The daily secured overnight financing rate (SOFR) is based on actual transactions<\/em> in the Treasury repurchase market, where investors offer banks overnight loans backed by their bond assets.<\/p>\n

\"\"<\/a>
Photo by Andrea Piacquadio from Pexels<\/figcaption><\/figure>\n

Benchmark rates, such as the secured overnight financing rate (SOFR), are essential in the trading of derivatives\u2014particularly\u00a0interest-rate swaps, which corporations and other parties use to manage interest-rate risk and to speculate on changes in borrowing costs.<\/p>\n

Interest-rate swaps are agreements in which the parties exchange fixed-rate interest payments for floating-rate interest payments. In a \u201cvanilla\u201d swap, one party agrees to pay a fixed interest rate, and, in exchange, the receiving party agrees to pay a floating interest rate based on the secured overnight financing rate (SOFR)\u2014the rate may be higher or lower than SOFR, based on the party\u2019s credit rating and interest-rate conditions.<\/p>\n

In my earlier blog article, I pointed out that LIBOR had become the rate at which banks do\u00a0not<\/strong><\/em> lend to each other because most banks are up to their gills in liquidity. \u00a0LIBOR had become nothing more than a guesstimate. \u00a0SOFR is therefore preferable to LIBOR since it is based on data from observable transactions.<\/p>\n

Unlike LIBOR, there\u2019s extensive trading in the Treasury repo market\u2014roughly 1,500 times that of interbank loans as of 2018\u2014theoretically making it a more accurate indicator of borrowing costs.<\/p>\n

Interest rate swaps on more than $80 trillion in notional debt switched to the SOFR in October 2020. \u00a0This transition is expected to increase long-term liquidity, but it also may result in substantial short-term trading volatility in derivatives.<\/p>\n

While SOFR is becoming the benchmark rate for dollar-denominated derivatives and loans, other countries have sought their own alternative rates, such as SONIA and EONIA.<\/p>\n

Time will tell whether SOFR is a suitable replacement for LIBOR. \u00a0The difference between the two indices was that LIBOR was based on unsecured<\/strong><\/em> loans between banks, whereas SOFR was the rate that banks would loan to each other, but only if such loans were backed by rock-solid collateral.<\/p>\n

What is going to happen if a Chinese destroyer trades missiles with an American destroyer? \u00a0Talk about “living in a powder keg and giving off sparks.” \u00a0Such an event could easily trigger World War III.<\/p>\n

Suddenly the investment world goes into a risk-off mode. \u00a0Corporate bonds and stocks would likely plummet, while Treasuries and gold would likely soar. \u00a0Because SOFR is based on well-secured<\/strong><\/em>, inter-bank loans, SOFR might not increase that much.<\/p>\n

At the same time, the demand for non-US-government debt will almost certainly plummet. \u00a0Yields on investment grade bonds could soar to over 20% in a matter of 48 hours.<\/p>\n

What damage will be done to the U.S. financial system because SOFR materially understates real interest rates in the system?<\/strong> \u00a0Remember, over $80 trillion in financial instruments are already tied to SOFR. \u00a0I dunno; but it can’t be good.<\/p>\n

My own company, Blackburne & Sons, will always be in the market – even during war time – to make commercial real estate loans.<\/p>\n

That being said, the Company is moving more into the syndication business. \u00a0We are putting together syndicates to buy income-producing properties for all cash<\/strong><\/em>. \u00a0In other words, there will be zero debt. \u00a0That is where everyone should be if war does break out – trophy properties that are owned free and clear.<\/p>\n

By George Blackburne<\/p>\n","protected":false},"excerpt":{"rendered":"

Last week I blogged on the problems associated with LIBOR. \u00a0It is abundantly clear that something needs to be done…<\/p>\n","protected":false},"author":1,"featured_media":886,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[15,1],"tags":[5,69,70,71],"class_list":["post-885","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-financial-insights","category-latest-news","tag-commercial","tag-index","tag-libor","tag-replacing","entry","double"],"_links":{"self":[{"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/posts\/885","targetHints":{"allow":["GET"]}}],"collection":[{"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=885"}],"version-history":[{"count":1,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/posts\/885\/revisions"}],"predecessor-version":[{"id":17715,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/posts\/885\/revisions\/17715"}],"wp:featuredmedia":[{"embeddable":true,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/media\/886"}],"wp:attachment":[{"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=885"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=885"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=885"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}