The commercial real estate capital markets are close to saying goodbye to LIBOR – and working through some situations in which there is ambiguity – as the historical benchmark for pricing floating-rate loans edges closer to its June 30 expiration.
While the commercial real estate market has had a mostly orderly approach to adopting the Secured Overnight Financing Rate (SOFR) as its new floating-rate benchmark, commercial real estate sponsors and lenders are looking at the language around transitioning derivatives contracts tied to the benchmark, said Rob Mangrelli, a managing director at Chatham Financial.
The Kennett Square, Pennsylvania-based advisory and technology firm is also working with sponsors on situations in which the fallback language in loan documents for benchmark changes is causing a reversion to the Prime Rate, rather than Term SOFR. Term SOFR is a forward-looking index rate published by CME Group that is used for pricing floating-rate loans and notes and should reflect average daily SOFR rates on a one-, three-, six- and 12-month tenor.
“The challenge with Prime is, first and foremost, is that it traditionally is around 300 basis points over the upper end of the Federal Reserve’s target rate,” Mangrelli said. As of June 21, the Prime Rate was at 8.25 percent, while Term SOFR is at 5.05 percent and the Federal Reserve’s target rate is in the range of 5-5.25 percent. “In those situations where the loan language falls back to the Prime Rate, borrowers are speaking to lenders to see if it is possible to make amendments after June 30.”
Another area of concern is that there are some restrictions around broker-dealers using Term SOFR for hedging. “The result of those restrictions in that end users like commercial real estate borrowers who are transitioning to Term SOFR tend to have some level of economic charge. The issue there is that there is not great transparency over the cost of Term SOFR. For some firms, that charge could mean some borrowers are caught by surprise,” he said.
Still, Mangrelli believes the transition has largely been smooth. “We have had a decent timeline toward a change and companies have had the time to get familiar with their products but there are still some outliers or situations where there is ambiguity or uncertainty,” he said.