PrecisionLender Webinar - Preparing for SOFR: Changing the Playbook

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Goodbye LIBOR
• 2012: CFTC fined several major Wall Street banks ~$3.5
billion for rate-fixing scandals involving LIBOR
• 2013: Regulators increasingly expressed concerns over the
scarcity of underlying transactions in the unsecured
lending markets
• 2014: the NY Fed Alternative Reference Rates Committee
(ARRC) was formed to identify an alternative to LIBOR and
encourage voluntary adoption
• 2017: the UK Financial Conduct Authority announced that
it would no longer compel banks to submit LIBOR quotes
after 2021
Average Daily Trading Volumes

Hello SOFR
• In 2017, ARRC selected the Secured Overnight
Financing Rate (SOFR) as the proposed
alternative to LIBOR
• SOFR is an overnight transaction-based rate
based on tri-party repo data
• Tri-party General Collateral Repo - data from
BNYM
• Tri-party GCF Repo – data from Fixed Income
Clearing Corporation (FICC)
• Cleared Bilateral Treasury Repo
• Transaction volume underlying SOFR expected
to be $700bn+ / day
• NY Fed began daily publishing SOFR on April 3,
2018
• On BBG: “SOFRRATE Index”
• SOFR does not currently have forward term
fixings
SOFR Median with 1st and 99th Percentile Funding Rates
Quarter
Ends

To Summarize…
• Unsecured
• Includes a credit risk component
• Term fixings
• Ubiquitous
• Long Series of Historical Data
• Rate settings are subject to human judgment
LIBOR SOFR
• Collateralized with Treasury Securities
• Nearly Risk Free
• No Term fixings Currently
• New rate that will need to be studied
• Short Series of Historical Data
• Rate settings are a function of supply and
demand in large liquid markets

Why is Term Structure Important
1 1302928
LIBOR
SOFR
Rate reset known and payment calculated
Payments exchanged
Final rate reset known and payment calculated
Payments exchanged
Key issues:
(1) Operations: Queuing up payments and distributing payment notices on short
notice
(2) Cash/Liquidity Planning: Uncertainty about payment amounts until just
before payment
1 1302928

SOFR Building Momentum
• May 7 – Exchange traded SOFR Futures began
trading on the CME. Since then:
• $155B in notional open interest (40k contracts)
• $1t in cumulative notional volume (402k
contracts)
• ADV reached 7.5k contract/day in October
• Over 70 global participants
• Term structure extends out over 3 years
• S&P Global Ratings designated SOFR as an
“anchor money market reference rate” and SOFR
based debt continues to grow
• First half 2020 to Second Half 2021 – Discounting
Curve and PAI of cleared transactions transitions
to SOFR
SOFR Futures (3m) Contract Table

SOFR Debt Markets are Developing
FNMA Issued in August
FHLB Issued in November
SOFR Debt Issuance Table

How to Monitor SOFR on ChathamDirect
• Daily SOFR Curve: The daily SOFR curve
captures the convexity adjusted average
implied forward rate, which includes market
derived estimates of the likelihood for jumps
related to expected changes in the fed funds
target rate during the futures contract
reference dates.
• Monthly SOFR Curve: The monthly SOFR
forward curve is constructed using the
average of the daily forward rates. For
example, the SOFR monthly forward rate on
June 1, 2018 is equal to the average of the
daily SOFR forward rates for the month of
June.
• Quarterly SOFR Curve: The quarterly SOFR
forward curve is constructed by
compounding the daily forward rates. The
SOFR quarterly forward rate on June 1, 2018
is calculated by compounding the daily SOFR
forward rates from the months of June, July
and August 2018.
Futures derived
term fixings!!

SOFR – What does the Curve Represent
1.1
3.6 3.7 3.8 4.2
16.3
17.0
20.3
21.8
22.4
0
5
10
15
20
25
1 Yr 2 Yr 3 Yr 4 Yr 5 Yr
Basis Market Snapshot
(Centrally Cleared - LCH)
SOFR OIS / FF-OIS 1mL / SOFR-OIS
• SOFR scopes out the value of bank credit,
but does consider the market’s estimate
for the future value of Treasury collateral.
• Simply, SOFR can represent the cost
of holding off balance sheet
Treasuries, with a few caveats.
• In an era of monetary policy tightening it
makes intuitive sense for there to be a
positive slope to the basis between the
SOFR curve (secured) and Fed Funds
(unsecured)

SOFR – What does the Curve Represent
1 Yr 2 Yr 3 Yr 4 Yr 5 yr
Cash Treasuries 2.66% 2.83% 2.86% 2.89% 2.90%
SOFR OIS Swap 2.61% 2.74% 2.75% 2.75% 2.75%
FF OIS Swap 2.59% 2.70% 2.71% 2.71% 2.72%
2.50%
2.55%
2.60%
2.65%
2.70%
2.75%
2.80%
2.85%
2.90%
2.95%
Cash Treasuries SOFR OIS Swap FF OIS Swap
Yield Curve Comparison
Cash Treasuries / SOFR / Fed Funds
Observations In the current environment…
• The cost of holding Treasuries on balance
sheet, as well as regulatory
considerations, factor into the yield
spread between cash products and
related derivatives.
• The impact of the Fed’s large scale QE
programs has skewed the relative
amount of cash available in the system,
which factors into the basis between Fed
Funds referencing OIS and SOFR
referencing OIS

Transition Process: Loans
• Overview
• The Fed estimates that ~$1 trillion in outstanding
commercial mortgages are linked to USD LIBOR; ~80% will
mature prior to 2021
• Various working groups have been commissioned to address
LIBOR transition dealing with a wide variety of cash
instruments (e.g., CREFC, SIFMA, SFIG, LSTA, etc.).
• Challenges
• Dealing with legacy contracts that reference LIBOR that
don’t have economically appropriate fallbacks will be a
challenge
• Recommendation
• Inclusion of broad language in new documentation that
gives the bank discretion in selecting an alternative or
fallback rate in the event LIBOR is actually or substantively
discontinued
• Include provisions for basis difference between LIBOR
and fallback

Transition Process: Derivatives
• Overview
• ~$190 trillion in outstanding contracts referencing LIBOR
• Current ISDA LIBOR definitions have a fallback to polling banks for
quotes; not sufficiently robust.
• Most market participants believe that banks would be unlikely to
provide quotes if LIBOR discontinued.
• ISDA is leading an initiative to determine fallbacks if LIBOR
discontinued.
• Transition Plan
• ISDA is considering mechanisms, like a Protocol, to allow market
participants to incorporate new fallbacks into legacy contracts.
• Protocol would be automatically incorporated into legacy and new
trades through revised ISDA definitions.
• Triggered by objective factors (e.g., public statement by LIBOR
administrator).
• Challenge to minimize value transfer
• Key challenge is identifying the method for adjusting for the
difference between LIBOR and SOFR by determining the
appropriate method for calculating a spread or other adjustments
to compensate for differences between LIBOR and SOFR (primarily
bank credit risk and term structure)

Transition Process: Minimizing Value Transfer
 Adjusted Risk-Free-Rates – Before any spread adjustments are incorporated, risk-free-rates
(RFRs) need to be adjusted to reflect the difference between the tenor of the existing LIBOR
index and an overnight rate.
 Spot Overnight Rate
 Convexity Adjusted Overnight rate
 Compounded (arrears)
 Compounded (advance)
 Spread Adjustment Methodology
 Forward Approach
 Historical Mean/Median Approach
 Spot Spread Approach
ISDA put forward a consultation with various proposals on how fallback rates may be calculated
– each with its own set of pros/cons.
The consultation is specific in excluding USD LIBOR from the scope of the document. The analysis and commentary are meant to be
illustrative of the potential impact these methods may have if applied to USD LIBOR transactions. Author’s calculations.
The Simpsons

Fallback Logic – Adjusted Risk Free Rates

Spot Overnight
Rate
Convexity Adjusted
Overnight Rate
Average 2.01% 2.03%
Minimum 0.01% 0.01%
Maximum 6.60% 6.71%
Standard Deviation 2.10% 2.13%
Current 1.91% 1.92%

 Compounded (In arrears)
 Compounded (In advance)
Spot Overnight
Rate
Compounded
In Arrears
Compounded
In Advance
Average 2.01% 1.95% 1.93%
Minimum 0.01% 0.02% 0.02%
Maximum 6.60% 6.45% 6.45%
Std. Dev. 2.10% 2.10% 2.09%

Fallback Logic – Forward Approach
The forward curve was bootstrapped using
convexity adjusted SOFR futures. As liquidity
develops in SOFR swaps, our proprietary curve
building methodology will adapt to incorporate
the new information.

Fallback Logic – Static Historical Spread
Year SOFR 1mL
Avg.
Spread St Dev
Running
Average (to
Present)
1998 5.31% 5.56% 0.25% 0.25% 0.22%
1999 4.92% 5.24% 0.32% 0.31% 0.21%
2000 6.15% 6.41% 0.27% 0.14% 0.21%
2001 3.85% 3.89% 0.05% 0.21% 0.20%
2002 1.66% 1.77% 0.11% 0.07% 0.21%
2003 1.09% 1.21% 0.12% 0.07% 0.22%
2004 1.30% 1.50% 0.19% 0.09% 0.23%
2005 3.13% 3.38% 0.25% 0.09% 0.23%
2006 4.90% 5.10% 0.19% 0.11% 0.23%
2007 4.85% 5.25% 0.40% 0.50% 0.23%
2008 1.68% 2.68% 1.00% 0.99% 0.22%
2009 0.16% 0.33% 0.18% 0.08% 0.14%
2010 0.18% 0.27% 0.09% 0.05% 0.13%
2011 0.08% 0.23% 0.15% 0.05% 0.14%
2012 0.17% 0.24% 0.07% 0.06% 0.14%
2013 0.07% 0.19% 0.12% 0.04% 0.15%
2014 0.06% 0.16% 0.09% 0.03% 0.15%
2015 0.12% 0.20% 0.08% 0.03% 0.17%
2016 0.35% 0.50% 0.15% 0.08% 0.20%
2017 0.90% 1.11% 0.22% 0.06% 0.22%
2018 1.65% 1.86% 0.22% 0.07% 0.22%
Total 0.22% 0.16%
Pricing logic for floating rate products, and
risk transfer pricing in general, is in transition
and should contemplate the bank’s cost of
incremental liquidity above the volume
weighted mean of overnight financing
transactions for Treasuries.

 Adjusted Risk-Free-Rates – Before any spread adjustments are incorporated, risk-free-rates (RFRs)
need to be adjusted to reflect the difference between the tenor of the existing index and an
overnight rate.
Valuation Example
Tenor Index Coupon Spread Dv01
(100mm)
Value
5yr 1ML 2.75 0 bps $46,359 $0
5yr SOFR-OIS 2.75 20.3 bps $46,458 $0
Solve For

 Adjusted Risk-Free-Rates – Before any spread adjustments are incorporated, risk-free-rates (RFRs)
need to be adjusted to reflect the difference between the tenor of the existing index and an
overnight rate.
Valuation Example
Tenor Index Coupon Spread Dv01
(100mm)
Value
5yr 1ML 2.75 0 bps $46,359 $0
5yr SOFR-OIS 2.75 14 bps $46,532 $250k
Solve For

Averages can be misleading
SOFR 1mL SOFR + 22 Difference
1998 5.31% 5.56% 5.53% 0.03%
1999 4.92% 5.24% 5.13% 0.11%
2000 6.15% 6.41% 6.36% 0.05%
2001 3.85% 3.89% 4.06% -0.17%
2002 1.66% 1.77% 1.88% -0.11%
2003 1.09% 1.21% 1.31% -0.10%
2004 1.30% 1.50% 1.52% -0.02%
2005 3.13% 3.38% 3.35% 0.04%
2006 4.90% 5.10% 5.12% -0.02%
2007 4.85% 5.25% 5.07% 0.18%
2008 1.68% 2.68% 1.89% 0.78%
2009 0.16% 0.33% 0.37% -0.04%
2010 0.18% 0.27% 0.39% -0.12%
2011 0.08% 0.23% 0.30% -0.06%
2012 0.17% 0.24% 0.38% -0.14%
2013 0.07% 0.19% 0.29% -0.10%
2014 0.06% 0.16% 0.28% -0.12%
2015 0.12% 0.20% 0.33% -0.13%
2016 0.35% 0.50% 0.56% -0.06%
2017 0.90% 1.11% 1.11% 0.00%
2018 1.65% 1.86% 1.86% 0.00%
2.24% 2.24% 0.00%

Average Daily Volume of 10-yr LIBOR Swaps (Still Trading in Size)
$-
$5.00
$10.00
$15.00
$20.00
$25.00
$30.00
$35.00
$40.00
$45.00
$50.00
Billions

Percentage of Fed Funds Referencing OIS Swaps Longer than 2 Years
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
2016 2017 YTD

Color from the Trading Desk
Source: Chatham executed transactions
Percentage of Chatham Executed Balance Sheet Trades
Referencing LIBOR vs Non LIBOR
0
10
20
30
40
50
60
70
80
90
100
LIBOR NON LIBOR
2017 2018

Appendix: Loan Language Examples
• Example 1:
• If USD LIBOR becomes unavailable during the term of this Note, the "Published LIBOR Rate" shall mean the
replacement benchmark rate (upon any future phasing out of USD LIBOR) as designated by the Alternative
Reference Rates Committee ("ARRC") appointed by the Federal Reserve Bank or such other index that
Lender selects in consultation with Borrower and which is generally recognized in the marketplace as the
replacement for USD LIBOR (adjusted to account for any differential in pricing). Borrower agrees that, upon
Lender’s written request, Borrower shall execute and deliver such amendments to this Note and the Swap
Transaction Documents as may be necessary or desirable to replace USD LIBOR with an alternative rate
which will yield Lender a comparable return on its investment.
• Example 2:
• Notwithstanding any other provision of this Note, if Lender shall reasonably determine (which
determination shall be conclusive and binding absent manifest error) that, (i) by reason of circumstances
affecting the relevant market, reasonable and adequate means do not exist for ascertaining the LIBOR rate
hereunder, (ii) the LIBOR rate hereunder does not adequately and fairly reflect the cost to Lender of funding
the loan evidenced by this Note, or (iii) it is unlawful for Lender to make or maintain the loan evidenced by
the Note as a LIBOR rate based loan as contemplated by this Note, or to obtain in the interbank Eurodollar
market the funds with which to make such LIBOR rate based loans, Lender shall give prompt written notice
thereof to Borrower and after the giving of such notice, Lender may designate a substitute index.

Appendix: Loan Language Examples
• Example 3:
• If the Lender determines in good faith (which determination shall be conclusive, absent manifest error) that
(A) by reason of circumstances affecting the London Interbank Eurodollar market, adequate and fair means
do not exist for ascertaining the One-Month LIBOR Rate, (B) the LIBOR Rate does not accurately reflect the
cost to the Lender of the Loan, or (C) a Regulatory Change (as hereinafter defined) shall, in the reasonable
determination of the Lender, make it unlawful for the Lender to maintain interest at the LIBOR Rate, for
purposes of determining the Interest Rate, the One-Month LIBOR Rate shall be replaced with a comparable
rate or index chosen by the Lender. “Regulatory Change” shall mean the introduction of, or any change in
any applicable law, treaty, rule, regulation or guideline or in the interpretation or administration thereof by
any governmental authority or any central bank or other fiscal, monetary or other authority having
jurisdiction over the Lender or its lending office.
• Example 4:
• If the LIBOR Rate becomes unavailable during the term of this Note, the “LIBOR Rate” shall mean the
replacement benchmark rate (upon any future phasing out of the LIBOR Rate) as designated by the
Alternative Reference Rates Committee (the “ARRC”) or such other index as is generally recognized in the
relevant marketplace as the replacement for LIBOR as determined in the Bank’s sole discretion.

PrecisionLender Webinar - Preparing for SOFR: Changing the Playbook

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