SOFR bond issuance up despite shortcomings

IFR 2378 - 10 Apr 2021 - 16 Apr 2021
5 min read
Americas, EMEA
William Hoffman

Issuance of US dollar floating-rate bonds is on the rise in 2021 as financial and corporate borrowers alike accept that the Secured Overnight Financing Rate is probably here to stay, even as problems persist and alternatives attempt to get in the game.

Borrowers have already priced in excess of US$20bn of SOFR floating-rate paper this year, more than the US$15.1bn issued during the whole of 2020, according to IFR data. When including fixed-to-float bonds that are often used by banks and other financial institutions using SOFR as the reference rate in the back-end, issuance is up to US$48.2bn this year, more than double the US$21.3bn issued over the same period a year ago, according to Refinitiv data.

There are a few reasons for the increase in SOFR supply starting with strong demand from the buyside for floating-rate paper in the current rising rate environment, according to one senior US banker.

"With front-end yields as low as they are the investor base feels there is limited downside and potential upside in floaters as opposed to fixed-rate paper given the direction of yields we’ve seen so far this year," the banker said. "There’s a natural scarcity driven by the fact that we’ve seen such little floating rate issuance in recent years."

Indeed, floating-rate US dollar bond issuance so far this year makes up around 5% of total supply, up from 2.3% last year but still down from 5.7% in 2019 and 14% in 2018, according to IFR data. Just last week six issuers raised US$3bn of floating-rate paper – all in SOFR.

Seven borrowers have raised US$5.25bn of Libor floating-rate notes this year, but such deals are increasingly hard to price because portfolio managers do not want to add Libor exposure into their investment profiles, the banker added.

"We’ve done a couple of Libor deals early in 2021 and they were tough," the banker said. "The investor base is kind of saying 'No more'."

Corporate issuers are stepping into the space that has typically been reserved for financial issuers. Natural gas company Enbridge issued the first corporate SOFR floater in late February and since then nine borrowers have followed: CenterPoint Energy, Roche Holdings, Siemens, Atmos Energy, One Gas, Verizon, NextEra Energy Capital, AT&T and BMW.

Despite that growth in bonds, the response to SOFR has been tepid in other parts of the market.

For example, SOFR-linked derivatives remain relatively low and the pool of total Libor securities has grown since 2018 to US$225trn rather than shrink, said Mark Cabana, rates strategist for Bank of America.

"It is certainly the case that there has been a bit more SOFR activity, but it’s not the natural snowballing activity one would hope for especially given that we’re eight months away from when new US dollar Libor is slated to stop," Cabana said.

Obstacles to adoption

Two factors are holding SOFR back from wider adoption, researchers said: the failure to develop a term SOFR rate and the lack of a credit component.

To the first point, the Alternative Reference Rate Committee at the end of March said a term SOFR rate would not be established by the middle of this year and furthermore may not be established by year end.

"It’s disappointing for the market," Cabana said. "The establishment of term SOFR was something the ARRC had long said was part of their transition plan, however, actions taken by them do raise questions as to how much they wanted to see a term SOFR at all?"

Second, banks have argued that because SOFR rates do not react to credit prices the transition away from Libor may make banks appear riskier during periods of stress as their liabilities increase in value but their assets do not, BMO wrote in a recent report.

These lingering problems create an opening for other credit-sensitive alternatives to overtake SOFR in certain corners of the market.

The Bloomberg Short-Term Bank Yield Index has gained momentum since it was officially introduced in January having met the International Organization of Securities Commissions' Principles for Financial Benchmarks last week. Intercontinental Exchange has its own alternative called the Bank Yield Index and the American Financial Exchange has promoted its Ameribor rate for several years.

Although the ARRC went out of its way to say it will not punish issuers that use these alternatives, it is not endorsing them either, and that is a problem for issuers and the financial institutions that underwrite the bonds.

"We’re not hearing from issuers or buyers of floating-rate notes that there is a credible alternative to SOFR right now," a second banker said. "It’s much more of a consideration on the asset side as banks look at loans on their own books, but the bond market isn’t considering anything beyond what ARRC has recommended."