Goldman Sachs issues debut SOFR trade with improvements

Credit: REUTERS/Brendan McDermid

Goldman Sachs came to market on Monday with its first bond to reference the Secured Overnight Financing Rate (SOFR) as the bank sought to better match derivative markets and further advance the new reference rate as a replacement for Libor.

By William Hoffman

NEW YORK, May 20 (IFR) - Goldman Sachs came to market on Monday with its first bond to reference the Secured Overnight Financing Rate (SOFR) as the bank sought to better match derivative markets and further advance the new reference rate as a replacement for Libor.

The US$1bn two-year non call one-year floater was upsized from the initial US$500m size after receiving strong investor demand that swelled order books to US$2.25bn.

Wells Fargo, JP Morgan and Citi are the only other banks to issue US-dollar bank SOFR notes, but they struggled to build sizable order books. For example, Citi's US$1bn debut in March garnered order books of just US$1.3bn.

This is not only Goldman's first bond of this kind, but it also attends to some of the changes being advanced by the Alternative Reference Rates Committee (ARRC), the organization created to ensure the transition to Libor.

Goldman's SOFR bond uses a compound interest rate calculation, rather than the simple average interest rate calculation used up until now by the other banks.

Simple average interest is operationally easier to calculate because it is the same mechanism in existing systems used in Libor transactions.

But compound interest is considered to be more accurate as it accounts for accumulated interest not yet paid, according to an April report from the Federal Reserve's Alternative Reference Rates Committee (ARRC).

The derivatives market uses compounding as well, so issuing SOFR notes in the same format will allow borrowers to more efficiently swap in the future, one banker close to the trade told IFR.

"We believe aligning financial conventions, such as compounded averaging, between cash and derivatives are crucial for the marketplace," Beth Hammack, global treasurer of Goldman Sachs, said in a statement.

"This issuance provides an investment alternative to Libor, as well as demonstrates our commitment and support to continue diversifying our funding sources in Alternative Risk-Free Rates."

While SOFR is a better measure of interest movements, issuers have expressed frustration with a rate that is difficult to calculate before payments are due.

There are a number of ways to deal with this problem, but Goldman has opted for a two-day "lookback" period, which means the bank uses the SOFR rate from two days prior when calculating payments for the life of the loan.

Interest payments for SOFR bonds are calculated on a daily basis, but Goldman's will use the SOFR rate from two-days prior.

By comparison the only other two borrowers that have used this structure, namely L-Bank and the European Investment Bank, have no delay but will suspend the rate for the days leading up to the interest payment, say bankers.

Goldman bond better accounts for daily rate volatility, helping propel demand for the issue and setting a precedent for other trades.

"The ARRC committee has blessed compounding as the way to go moving forward," the banker away from the deal told IFR.

"Goldman is trying to incorporate that now into new issuance instead of it just being something the committee has suggested."

(Reporting by William Hoffman; Editing by Paul Kilby and Jack Doran)

((william.hoffman@thomsonreuters.com; 646 223 6141;))

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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