Chatham executes first Freddie Mac SOFR interest rate cap

Chatham is pleased to announce its part in the execution of the first SOFR-indexed interest rate cap in conjunction with a Freddie Mac financing. This financing, originated by Freddie Optigo lender CBRE, was the first Freddie multifamily SOFR-indexed loan. While pricing on the cap structure was slightly higher than a commensurate LIBOR cap, it was well within the borrower's underwriting constraints, and consequently served as proof of concept that these structures are available for Agency borrowers at pricing that does not unduly influence overall deal economics. Being on the leading edge of the debt and derivatives markets, Chatham brings deep and broad market perspective and expertise, guiding our clients to the optimal outcome even in unprecedented situations such as this first SOFR-indexed cap.

Throughout the COVID-19 pandemic, many market participants have questioned the reality and timing of a transition away from LIBOR, a legacy index linked to floating-rate real estate contracts for decades. While many thought the timing of the 2021 phase out would be extended, both Freddie Mac and Fannie Mae have led the charge in the lending market on the transition to SOFR. Beginning with their announcements in February of 2020, the Agencies have held firm in their position on transition timing and are now pioneering the new SOFR-based lending market.

Both Freddie Optigo lenders and Fannie DUS lenders are now issuing SOFR-based term sheets. Like the LIBOR-based floating-rate loans with which many market participants are familiar, the newly minted SOFR loan agreements include a requirement to hedge the borrower’s floating rate exposure. Freddie is initially allowing borrowers the ability to hedge their exposure to SOFR using either a SOFR- or LIBOR-based cap (see FAQ: USD LIBOR transition to SOFR for greater detail), while Fannie has mirrored their LIBOR-based structured ARM requirement of an initial 5-year cap for SOFR loans. This new reality will be felt across the spectrum of Agency borrowers as neither Freddie nor Fannie will accept LIBOR-based loan applications after September 30.

As the largest independent hedging advisor in the commercial real estate market, Chatham’s reputation and extensive market presence put us in a unique position to begin advising clients, Agencies, law firms, and cap providers on the critical considerations of these new requirements from the onset of the announcements. We have had numerous conversations centered on helping these stakeholders understand the differences between SOFR and LIBOR, the basis risk between the two indices, the new escrow mechanics, the cap pricing differences between the two indices, and (in the case of Freddie Mac financings), the pros and cons of hedging a SOFR-based loan with a LIBOR-based cap. Because the SOFR derivatives market is in its infancy compared to LIBOR, SOFR-based caps can cost more given the reduced liquidity in the SOFR cap market, as evidenced by the indicative pricing below. However, documentation terms that Freddie currently requires on LIBOR caps for SOFR loans may impact their cost, making SOFR caps the more affordable option.