By Vipal Monga and Daniel Kruger 

A benchmark lending rate that regulators and investors hope can replace the scandal-plagued Libor as the foundation for trillions of dollars of debt from credit cards to business loans easily passed a key test.

Mortgage finance giant Fannie Mae sold $6 billion of adjustable-rate securities in the first major trial run of the new index Thursday. The sale marked a milestone for borrowers, investors and bankers as Libor, the London interbank offered rate, begins its planned wind-down from ubiquitous metric to expiration at the end of 2021.

Once obscure, Libor eventually became the foundation for trillions of dollars of derivatives and other financial contracts. More recently, it was discredited after evidence emerged that bank traders were manipulating it to boost trading profits. Banks were fined billions of dollars, and several traders were sent to prison. Since 2012, Libor has been under the supervision of U.K. regulators.

On Thursday, investor demand for the Libor-replacement proved strong enough that it could inspire other borrowers to use the new benchmark, analysts said. Known as the secured overnight financing rate, or SOFR, the new index was developed by a panel of banks and investors overseen by the Federal Reserve, as part of an effort to move contracts away from Libor.

The new product is one of several that aims to address a major challenge for the financial markets. Libor-based contracts cover many borrowings including floating-rate home mortgages, business loans and complex financial instruments.

"There is a massive amount of work to do to move all that risk from Libor to another index," said Michael Cloherty, head of interest-rate strategy at RBC Capital Markets. "It's a long, long path."

Fannie Mae is part of a group of financial industry associations and banks convened by the Fed in 2014 to address replacing Libor. Last year, the group approved the new rate as an alternative to U.S.-dollar-based Libor.

Libor has been calculated by asking banks how much it theoretically would cost them to borrow money from other banks, making it possible to manipulate. The new SOFR rate is averaged from more than $750 billion of short-term loans made every day, known as repurchase agreements or "repo" trades, backed by Treasury securities as collateral. Analysts expect it to be resistant to attempts at manipulation.

As of Wednesday, the SOFR rate was 1.87%, based on $753 billion worth of transactions, according the Federal Reserve Bank of New York. Fannie Mae's bonds were priced in three segments, maturing in six, 12 and 18 months, carrying rates that exceeded SOFR by 0.08, 0.12 and 0.16 percentage points, respectively.

The rate is "more robust" than Libor because it's based on actual market trades that reflect the price at which banks and other financial institutions can borrow, said Greg Moore, head of U.S. fixed income currencies and commodities at TD Securities USA, which was one of the lead managers on Fannie Mae's offering, along with Barclays Capital Inc. and Nomura Securities International lnc.

Supporting the Libor replacement has been a pressing priority for regulators and market participants as the old benchmark moves closer to disappearing. Fed Vice Chairman for Supervision Randal Quarles last week revealed data showing the dearth of transactions that reference Libor each day, and said banks are "justifiably uncomfortable" with how thin the underlying markets for Libor have become.

Still, Mr. Quarles said the transition toward the replacement rate was proceeding "ahead of schedule."

While Libor's history has been troubled, the rate will likely continue to be widely used for some time to come, said Moti Jungreis, head of global markets at TD. In part, that is because the rate is still used in trillions of dollars worth of contracts that were signed before the index fell out of favor.

Write to Vipal Monga at vipal.monga@wsj.com and Daniel Kruger at Daniel.Kruger@wsj.com

 

(END) Dow Jones Newswires

July 26, 2018 17:33 ET (21:33 GMT)

Copyright (c) 2018 Dow Jones & Company, Inc.
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