The Shield – Transitioning From LIBOR: A Year With SOFR

A little over a year ago, the transition from the London Interbank Offered Rate (“LIBOR”) to the Secured Overnight Financing Rate (“SOFR”) occurred. This transition had been in the works for several years and officially concluded in June of 2023. Below, we summarize some important milestones that have transpired since the transition.

There has been widespread adoption of SOFR. An excess of $2 trillion of new financial instruments including loans, bonds, and derivatives have been issued and are currently outstanding.
In the past 12 months there has been a significant increase of nearly 50% in trading volumes and liquidity in SOFR-based products.
The development and adoption of SOFR term rates, which provide forward-looking term structures similar to those of LIBOR, have gained traction.

Financial institutions have had to upgrade their systems and processes to accommodate SOFR, including risk management, valuation models, and accounting systems.

Regulators have provided guidance and support to facilitate the transition, including the endorsement of SOFR by the Federal Reserve.

Market participants have developed new hedging strategies to manage exposure to SOFR. This includes SOFR futures and options, Eris swap futures, and various over-the-counter derivatives.

Credit spread adjustments have been widely used to bridge the gap between SOFR and LIBOR, ensuring that the overall interest rate remains comparable.

Financial models have been recalibrated to price SOFR-based instruments accurately. This includes adjustments to yield curves and discounting methodologies.

One such remaining challenge has been the adoption of the Bloomberg Short-Term Bank Yield Index (“BSBY”). This index was created to provide an alternative successor rate to LIBOR besides SOFR, though the market did not significantly adopt BSBY. As a result, BSBY is scheduled to cease publication on November 15th, 2024. Unlike LIBOR transition, however, there isn’t currently a published regulator-produced fallback protocol for BSBY. Should you have exposure to BSBY, proactive steps should be taken over the coming months to transition this exposure.

Overall, the transition from LIBOR to SOFR represented a major shift in the financial markets, necessitating widespread adjustments across various facets of the industry. While there have been hiccups with the transition and challenges remain, the progress over the past year indicates a strong commitment by market participants and regulators alike moving forward. If you would like to further understand this topic or are looking for assistance in transitioning from BSBY, reach out to your Blue Rose advisor today.

Comparable Issues Commentary

Shown below are the results of two higher education financings from Blue Rose clients in Michigan that priced earlier this summer. On May 30th, Central Michigan University (“CMU”) priced its tax-exempt Series 2024A General Revenue Refunding Bonds. Less than two weeks later, on June 11th, Michigan State University (“MSU”) priced its tax-exempt Series 2024A General Revenue Bonds. CMU’s transaction was issued solely to refinance its outstanding Series 2008A and Series 2014 Bonds. MSU’s financing was a dual-purpose issuance that refunded ~$32 million of the University’s outstanding commercial paper notes and also provided funding for several major capital projects. Both universities’ financings were negotiated transactions.

CMU’s bonds carried an A1 rating from Moody’s and an A+ rating from S&P Global Ratings, while MSU’s bonds carried higher ratings of Aa2 and AA from the same two rating agencies, respectively. MSU’s transaction was the larger of the two, coming in at roughly $361.6 million. CMU’s transaction was smaller, with just over $52.5 million in total par amount. Both schools’ bonds feature a standard 10-year call provision in 2034. The structures of the two deals were slightly different: CMU’s Series 2024A was fully serialized from 2025-2039 with no term bonds, while MSU’s Series 2024A was serialized from 2025-2044 and featured three term bonds in 2046, 2049, and 2054. All overlapping maturities between the two transactions featured 5% coupons. MSU also used three 5.25% coupons on its 2043 serial maturity and the term bonds maturing in 2046 and 2054.

From mid-May leading up to CMU’s pricing on the 30th, the MMD benchmark declined by 19-39 bps across the curve. All tenors from the 3-year to the 12-year point saw 30+ bps decreases. On the 30th, rates moved higher by 1 bp in 2029-2035, remaining unchanged for all other maturities. CMU was ultimately able to achieve credit spreads ranging from 12 to 43 bps on its serial maturities. Leading up to MSU’s pricing, over the next 11 days MMD decreased further by 16-21 bps across the yield curve. On MSU’s pricing day, MMD was unchanged across the curve. Michigan State was ultimately able to achieve spreads of 6-30 bps on its serial maturities and spreads of 29, 35, and 34 bps on its three term bonds, respectively.

Interest Rates

Meet the Author:

Brandon Lippold | [email protected] | 952-476-6054

In his role of Vice President, Brandon Lippold is focused on growing client management responsibilities, in particular ensuring that our clients’ transactions run smoothly through closing. He has significant expertise in direct purchase bonds and derivative products and is experienced with the pricing and execution of fixed rate bond transactions and reinvestment products. Mr. Lippold is closely involved in every step of the financing process for clients, from initial capital planning stages all the way through closing. He joined Blue Rose in 2018 as a Quantitative Analyst.

Prior to Blue Rose, Mr. Lippold worked at HedgeStar (formerly DerivActiv) where he most recently held the title of Senior Quantitative Analyst and Valuations Team Lead. His professional experience also includes time in the fields of mergers and acquisitions and private equity. Mr. Lippold has also held the position of Co-President for the national volunteer organization Students Today Leaders Forever.

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