couple discussing on SORA vs SIBOR mortgage peg

What Is SORA & How Does It Work?

SORA stands for Singapore Overnight Rate Average.  It’s important for us to understand SORA as MAS (Monetary Authority of Singapore) had endorsed the recommendations put forth by the various financial industry committees from ABS (Association of Banks in Singapore) to SC-STS (Steering Committee for SOR & SIBOR Transition to SORA), who had collectively announced the timeline for SORA to replace SIBOR as a loan peg for mortgages in Singapore back in Dec 2020.  There will be a 4-year transition period from 2021 to 2024 by which time SORA will become the only market-based (instead of BOARD-based) peg for pricing home loans in Singapore after end-2024 when SIBOR will be discontinued.

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 SORA will become the only market-based (instead of BOARD-based) peg for pricing home loans in Singapore after end-2024.

MAS actually provides a detailed documentation of SORA and how compounded SORA is derived, which it publishes on its website daily.

However, my guess is this 14-page documentation would be too daunting for the average homeowner to read through much less comprehend.  It is hence the purpose of this article to extract, interpret and present what we think are the key concepts of SORA and what’s important to understand as a homeowner with a mortgage that’s pegged to compounded SORA. DBS home loans, OCBC home loans and UOB home loans now include SORA in their packages even for commercial property loans. At least one foreign bank have also started offering SORA home loans and more are expected to follow suit.

Even existing homeowners on SIBOR-based home loans will transition to SORA-based home loans (after their lock-in expire) within the next four years as various banks start to announce their plans for this migration. It is thus high time for us here at MortgageWise to explain what is SOR and how it works.

1. What Is SORA?

SORA is a volume-weighted overnight lending rate in the money market that market participants like financial institutions charge when they lend to one another.  If it is an overnight lending rate which means its value fluctuates daily, how do you get a 1-month or 3-month SORA?

If we plot the actual SORA values (daily rates) where the earliest available data starts from July 2005 until July 2020 (15-year period), you will see the volatility issue involved in using it as a loan peg:

Here, we use the value of SORA on the 1st business day of the month to plot the graph.  Imagine if your mortgage interest is pegged to actual daily SORA, your interest rate can fluctuate greatly depending on which day in the month your interest rate is reset.

In order for SORA to be used as a loan peg, an average reading of SORA needs to be established.  According to MAS, instead of simply taking simple averages (adding up all the daily readings divided by no of days in the period), compounding average over a period better reflects the economic costs of borrowing overnight over a specified period.  It also better reflects time value of money more accurately.

Even existing homeowners on SIBOR-based home loans will transition to SORA-based home loans (after their lock-in expire) within the next four years as various banks start to announce their plans for this migration.

2. How Do You Calculate Compounded SORA?

(F) calculating mortgage interests

Compounded SORA for any period can be calculated using the formula given by MAS:

Fret not.  We are not about to launch into a mathematics session next to explain all the notations used (found in the MAS documentation for those who are keen).  Thankfully, the smart people at our central bank has figured out an easier way to do this via a SORA Index.  

First, the value of SORA on a starting point defined as the 1st business day of 2020 (SORA value published on 3 Jan 2020) will be set to 1.0000000000 (up to 10 decimal places) as an index.  MAS then simply calculates how much is the “interest earned” on this index the following business day by compounding it daily (or more days for weekends).  Think of it like a bank deposit with daily rest where an interest rate of 1.50% (annualized) for example means your deposits grow by 0.0041% (1.50% divide 365 days) each day as it is compounded with interest added and recalculated daily.  In other words, you can take SORA Index like you deposit $1 on 3 January 2020 and watch how this grows over time with daily compounded interest except that this daily interest added is not constant but varies as it’s an overnight market rate.

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With this SORA Index (base date 3 Jan 2020 where it equals 1) published daily, compounded interest can now be calculated easily by inputting the SORA Index value on the start and end date for any period like a rolling past 1-month, 3-month or 6-month, using the formula (extract from MAS documentation):

SORA Index computation formula

Still confused? I think the most important takeaway from this article is to at least understand the  meaning of compounded SORA for 1-month, 3-month and 6-month which is – the compounded average interest rate you “earn” from overnight interbank rates on a rolling past 30-day, 90-day or 180 days respectively (loosely speaking as there are some technical interpretations on business days in the MAS document).  Except here it’s not deposit rates you earn but lending rates which will be used to price your mortgages.  The concept of how it’s derived is similar though.

Compounded SORA for 1-month, 3-month and 6-month is the compounded average interest rate you “earn” from overnight interbank rates on a rolling past 30-day, 90-day or 180 days respectively.

MAS is the administrator for SORA, SORA Index and compounded SORA for 1-month, 3-month and 6-month, which collectively are referred to as SORA Averages.  It calculates and publishes on MAS website the full set of SORA Averages by around 9 a.m on the next business day. Also understand that in this blog we will simplify the terminology used for compounded SORA for ease of use. When we talk about 1-month SORA or 3-month SORA, we are actually referring to the 1-month compounded SORA or the 3-month compounded SORA respectively.

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3. How Does It Compare To SIBOR and Is It Good As A Mortgage Peg?

By now you might have realized the biggest difference between pricing your home loans on the two mortgage loan pegs is that while SIBOR is forward-looking (based on SIBOR value in the future on the next rate-setting date), compounded SORA is backward-looking (based on past rolling historical data of SORA).  What’s the implication for that?

As we are now at a historical low point in the interest rate cycle where the only direction for interest rate is to move up, this makes SORA a good peg at least in theory.  Any hikes or upward movement will be dampened especially with the 3-month averaging effect compared to pricing in SIBOR where your loan will be repriced straightaway at the higher rate.

However, over the months we have also observed that compounded SORA can be quite volatile just like the underlying SORA where it averages.  Has the compounding effect smoothen out the kinks we seen in the earlier 15-year SORA chart?  We have to observe this over time as MAS only started publishing compounded SORA from Aug 2020 so we only have a short 9-month horizon which looks like this:

It would seem that even compounded SORA can still be slightly more volatile.  3-month SIBOR (red line) has moved up only by a small margin in recent months from 0.40 to 0.44 but 3-month SORA (orange line) has increased from 0.08 to 0.22 or more than double the increase in SIBOR.  Because of the small range of data, we are still unable to draw meaningful conclusions but it’s reasonable to expect daily interbank borrowing rates to be more volatile than borrowing over longer periods like 3-month.

The use of backward-looking data in a way negates the slightly elevated volatility of employing overnight rate as a benchmark for mortgages (Forward-looking rates are more exposed to market factors on a single day’s fixing, such as quarter or year-end volatility). At the very least you know the interest rate movements over the past months and have the option of switching to fixed rate home loan earlier if you like. The tradeoff here is that SORA, though slightly more volatile, will be less susceptible to market inefficiencies or manipulations as the underlying overnight unsecured market is the most actively traded SGF funding market. In other words, SORA is a more robust benchmark over the long term.

We can only hope that the compounding effect will somehow smoothen out more of this volatility in SORA as we look at this correlation chart (until 2024 when SIBOR is discontinued) going forward. There’s really no other alternative for a market-based mortgage loan peg after 2024.

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