The London Interbank Offered Rate is set to expire at the end of this 2021, and U.S. lenders are still unclear on what short-term interest rate benchmark they will transition to.
LIBOR, dubbed the world’s most important number, is a scandal-plagued benchmark that undergirds about $350 trillion in loans. LIBOR is a common benchmark for determining short-term interest rates. Adjustable rate mortgages, for example, are often linked to LIBOR.
When borrowers take out on ARM on their home, they lock in a lower interest rate for a set period of time, typically about five years. After that, the interest rate will fluctuate depending on an index like LIBOR.
HousingWire Magazine’s February 2019 cover story details the challenges with LIBOR, and what its end will mean for mortgage servicers. Click here to read more about that [subscription required].
But as the end of the benchmark rate nears, U.S. lenders are no closer to a replacement rate, according to a group of trustees from Fitch Ratings’ U.S. RMBS Trustee Roundtable held earlier this month. The group explained that investor consent poses a meaningful logistical challenge to the phase-out of LIBOR.
While the trustees await explicit guidance from external parties for LIBOR replacement, it's currently unclear that this guidance will be forthcoming in a timely manner. The trustees highlighted a need for greater awareness of key bondholder communication challenges. They believe that the most significant concerns exist for legacy RMBS containing poorer index transition language in governing documents.
New options are being presented as replacements. Some think the Federal Reserve Bank of New York’s Secured Overnight Finance Rate may have the best bet of becoming its replacement. But SOFR is an overnight rate, and therefore much more volatile than LIBOR, leading experts to think a new, forward-looking SOFR would be the best replacement.
Fannie Mae and Freddie Mac recently announced they are building non-LIBOR adjustable-rate mortgages based on SOFR. Officials at the GSEs who spoke on background with HousingWire said they are laying the groundwork to have a non-LIBOR product in place well before the end of LIBOR.
But Fitch pointed out that while the GSEs have publicly signaled their support for SOFR, no formal announcement has been made for the replacement index for legacy loans and securities.
“Even if there is a universal determination of a LIBOR-replacement index, the mechanics of changing the older deal documents are daunting,” Fitch explained.
Fitch explained that while there will likely be enough time to input a replacement for LIBOR before the benchmark ends, especially given the recent GSE announcements and progress of governmental working groups.
“It is likely that there will be sufficient time for an effective transition away from LIBOR to take place by the end of 2021,” Fitch said. “However, the LIBOR transition could present logistical challenges especially for legacy transactions that represent a significant portion of outstanding issuance. As such, the investor consent aspect raised by the trustees remains a key concern.”