New covered bonds and securitisation deals face basis and transition risks due to the end of LIBOR in 2021, says a new report from Moody’s Investors Service.
While efforts around addressing risks on the cessation of LIBOR are broadly positive, the transition process could lead to credit negative impacts on some new deals, including those involving securitisation and covered bonds, says a new report by Moody’s Investors Service.
The report entitled “LIBOR transition continues to create risks for new transactions” lays out how the LIBOR transition efforts are focused on existing transactions but have yet to eliminate risks in new transactions. Structured finance market participants and regulators have made some progress in addressing transition risks but continue to face “significant uncertainty and complexities.”
Efforts around changing documentation and associated language as a result of the anticipated end of LIBOR are broadly credit positive, says Moody’s. Most securitisation sponsors have yet to adopt alternative benchmarks but have adjusted contract language that govern how bond coupons that are currently based on LIBOR can be set in the future.
Basis risk arising from the cessation of LIBOR and the adoption of fallbacks, however, remains a real possibility, Moody’s said.
“Even when exposures on different levels of deals rely on the same indices in their new benchmarks, adjustments to those rates or differing transition timing could create at least modestly credit negative results.”
There may be unexpected legal costs in deals due to the ambiguity in contracts and swap-specific issues. The financial strength of obligors or deal parties may be weakened as a result of increased borrowing costs.
Lastly, the general incentive among securitisation sponsors and covered bond issuers is likely to act as a main source of mitigation against transition risk. The implications of changes in deal cash flows under many scenarios could be marginally credit negative or even credit positive, Moody’s says.
The report is available to Moody’s subscribers here.