Commercial Loans and Fun Blog

What is the SOFR?

Posted by George Blackburne on Thu, Jan 18, 2024

I saw an advertisement on LinkedIn this week where a lender was tying his interest rate to SOFR.  Look in the lower left-hand quadrant of the Stabilis ad below.  Do you see where it says, "Starting Rate SOFR + 5.49%?"

 

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What on Earth is SOFR?

SOFR stands for the Secured Overnight Financing Rate.  It may sound like a complex financial term, but it is actually a significant development in the world of interest rates. In simple terms, SOFR is a benchmark rate that is used to determine the cost of borrowing cash overnight, collateralized by Treasury securities.

Unlike the traditional benchmark rate, LIBOR (the London Interbank Offered Rate), which relies on the expert judgment of panel banks, SOFR is based on data from actual transactions in the marketplace. This shift from subjective judgment to objective data is aimed at increasing transparency and reducing the risk of manipulation.

SOFR is replacing LIBOR because LIBOR broke down about ten years ago.  During the global financial crisis in 2008, European banks became so worried about their own and each other's solvency that they refused to lend to each other, even on an overnight basis.

 

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What Went Wrong With LIBOR?

The London Interbank Offered Rate, or LIBOR, had been the go-to benchmark rate for commercial real estate lenders for decades. However, the global financial crisis in 2008 led to a breakdown in trust and a severe lack of liquidity in the interbank lending market.  

This lack of lending activity caused a significant problem for LIBOR, which is calculated based on the borrowing rates submitted by a panel of banks. With banks being hesitant to lend, the data used to determine LIBOR became unreliable and subjective.

The crisis revealed that LIBOR was vulnerable to manipulation and lacked transparency. The rates submitted by the panel banks were based on their own judgment and could be influenced by various factors, including their own financial health or even market pressures.

 

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In response to the crisis, regulators and financial institutions recognized the need for a more robust and objective benchmark rate. This led to the development of the Secured Overnight Financing Rate (SOFR), which is based on actual transactions in the marketplace.

Unlike LIBOR, which relied on the subjective judgment of panel banks, SOFR is calculated using data from observable transactions in the repo market. These transactions involve borrowing cash overnight and using Treasury securities as collateral. By using real transaction data, SOFR provides a more accurate reflection of the cost of borrowing cash overnight.

Note:  The data doesn't come primarily from interbank lending, so if the banks freeze up and interbank lending dries up, the regulators can still compute SOFR.

 

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When To Use Blackburne & Sons:

Blackburne & Sons Realty Capital Corporation is a 44-year-old commercial hard money lender based out of Sacramento, California.  Unlike other hard money shops, which only make bridge loans, we make 15-year loans with a 30-year amortization.  There is no prepayment penalty, so our loans are perfect for your bridge loan needs; But... your client will never have a balloon come due during a bad recession.

Our specialty is making small hard money loans on junky little commercial properties in the Boonies.  

We will also finance politically-incorrect properties, such as cannabis properties and gentlemen's clubs.  We once financed the World's Largest Female Mudwrestling Palace in Los Angeles.  The loan paid like clockwork.  This month we are working on a drag show bar.  

 

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The next great regression is well past due.  Maybe a bitcoin blowoff?  Look around.  All of those hard money mortgage funds with whom you work?  Over 90% of them will be out of business within months of the next crash because they charge their investors only 1% for loan servicing.  It will take a management fee or servicing fee of 3% to 4% for them to survive.

The S&L Crisis wiped out 90% (100%?) of all hard money funds.  A new generation of funds arose, but the Dot-Com Meltdown wiped out 90% (100%?) of them.  Another generation of hard money funds arose, but the Great Recession wiped out 90% (100%?) of them.

In contrast, Blackburne & Sons instantly puts together a new syndicate of private investors to fund each deal, so we are not reliant on the health of some fund.  Blackburne & Sons is the only hard money shop that can boast that it was in the market every day of all three great recessions.

You need to develop a relationship with Alicia Gandy, our Loan Goddess, or with George IV, my oldest son.  Success in commercial mortgage brokerage is all about relationships.

 

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Topics: SOFR

SOFR - The New Commercial Loan Index That is Replacing LIBOR

Posted by George Blackburne on Tue, Nov 24, 2020

SwapsLast week I blogged on the problems associated with LIBOR.  It is abundantly clear that something needs to be done to replace the LIBOR index as a measure of market interest rates.

 

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I also pointed out that $350 trillion in financial instruments worldwide are currently tied to LIBOR.  Regardless of which index the authorities end up using to replace LIBOR, the switchover is going to be tricky.  I can see in my mind's eye some greedy attorney affixing a bib and rubbing his hands together in glee.  Yum.

The index that will be replacing LIBOR, at least here in the U.S., is the secured overnight financing rate (SOFR).  The secured overnight financing rate is a benchmark interest rate for dollar-denominated derivatives and loans.  The 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.

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

 

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Benchmark rates, such as the secured overnight financing rate (SOFR), are essential in the trading of derivatives—particularly interest-rate swaps, which corporations and other parties use to manage interest-rate risk and to speculate on changes in borrowing costs.

Interest-rate swaps are agreements in which the parties exchange fixed-rate interest payments for floating-rate interest payments. In a “vanilla” 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)—the rate may be higher or lower than SOFR, based on the party’s credit rating and interest-rate conditions.

In my earlier blog article, I pointed out that LIBOR had become the rate at which banks do not lend to each other because most banks are up to their gills in liquidity.  LIBOR had become nothing more than a guesstimate.  SOFR is therefore preferable to LIBOR since it is based on data from observable transactions.

 

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Unlike LIBOR, there’s extensive trading in the Treasury repo market—roughly 1,500 times that of interbank loans as of 2018—theoretically making it a more accurate indicator of borrowing costs.

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

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.

 

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Time will tell whether SOFR is a suitable replacement for LIBOR.  The difference between the two indices was that LIBOR was based on unsecured 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.

What is going to happen if a Chinese destroyer trades missiles with an American destroyer?  Talk about "living in a powder keg and giving off sparks."  Such an event could easily trigger World War III.

Suddenly the investment world goes into a risk-off mode.  Corporate bonds and stocks would likely plummet, while Treasuries and gold would likely soar.  Because SOFR is based on well-secured, inter-bank loans, SOFR might not increase that much.

 

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

What damage will be done to the U.S. financial system because SOFR materially understates real interest rates in the system?  Remember, over $80 trillion in financial instruments are already tied to SOFR.  I dunno; but it can't be good.

My own company, Blackburne & Sons, will always be in the market - even during war time - to make commercial real estate loans.  

 

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That being said, the Company is moving more into the syndication business.  We are putting together syndicates to buy income-producing properties for all cash.  In other words, there will be zero debt.  That is where everyone should be if war does break out - trophy properties that are owned free and clear.

If you are an accredited investor, and you like the idea of owning trophy commercial properties free and clear, please contact Angela Vannucci at 916-338-3232 x 302.  If you decide to email her, please write in the Subject line, "Free and Clear Property."

Blackburne & Sons Will Soon Be Moving:

After 25 years in the same location, we have no choice but to make the leap.  Homeless people are sleeping right outside our windows.  We are finding used needles on the ground almost every day.  We move in about a month and a half.

 

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Topics: SOFR