"About a third of outstanding Moody's-rated structured finance tranches are tied to LIBOR, with much higher shares in several major securitization sectors," says Moody's analyst, Jody Shenn. "Furthermore, many deals are backed by assets with floating rates pegged to LIBOR or contain interest rate swaps tied to the benchmarks. But while the links to LIBOR in the securitization market are clearly meaningful, the credit impacts of the planned phase-out on affected sectors remains uncertain."
Sectors with a significant percentage of tranches pegged to LIBOR include US collateralized loan obligations (CLOs), representing more than $300 billion of LIBOR-tied tranches, US subprime residential-mortgage securities (RMBS), with more than $100 billion and UK RMBS, with more than GBP80 billion, Shenn says. Transactions with collateral or swap links to LIBOR overlap significantly with deals with LIBOR-linked tranches. Not all transactions with LIBOR-linked tranches have collateral or swaps tied to LIBOR, however, and such links also exist in deals with tranches that are not tied to LIBOR.
Credit impacts could stem from a number of factors. If securitization liabilities, collateral and/or swaps do not all shift at the same time to the same replacements, the available excess spread in deals could rise or fall, or interest shortfalls could arise. At the same time, the credit quality of securitization obligors could be bolstered if the payments required on their borrowing fall as a result of a LIBOR replacement with lower rates than LIBOR, or vice versa.
Assessing the effects of the LIBOR phase-out will require consideration of issues including the likelihood of tranches remaining outstanding through the disappearance of LIBOR. A further consideration for transaction parties is how they will address a lack of specific guidance on the LIBOR phase-out in securitization documents, or a scenario in which documentation calls for approaches that appear unviable. To the degree that the methods proposed are insufficient, deal documents may need to be amended, though in some cases this would require approval of all noteholders.
Finally, the ultimate timeline and success of the initiative to discontinue LIBOR remains unclear. Market participants and/or policy makers could decide to slow down the process, while banks could continue to work to produce LIBOR of their own volition, though the Financial Conduct Authority has said LIBOR's survival couldn't be guaranteed without its support.
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