How the Death of LIBOR Will Affect Reverse Mortgages

British banking officials announced Thursday that the London interbank offered rate — better known as LIBOR — will be phased out by 2021, ending a banking era and raising questions about how the reverse mortgage industry will replace the standard.

LIBOR has served as the backbone of adjustable-rate Home Equity Conversion Mortgages for nearly a decade, forming the benchmark for expected rates and rate adjustments. And with ARMs now dominating the HECM space, the shift will eventually have a major effect on the way reverse lenders do business.

A decade of LIBOR

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The Department of Housing and Urban Development first opened the door to LIBOR-based loans in October 2007, and the standard soon overtook the previous benchmark, the Constant Maturity Treasury (CMT) rate.

“Nearly all HECM ARM business has been tied to the LIBOR indices over the last decade,” Dan Hultquist, director of learning and development at ReverseVision, told RMD in an e-mail.

But the standard has been fraught with controversy over recent years: Because LIBOR is based on self-reported interbank rates, the numbers were always susceptible to inaccuracies, and several participants were revealed to have been lying about their numbers to mask problems or gain an advantage.

Back in 2008, as Bloomberg points out in this detailed history of LIBOR, the Wall Street Journal reported that banks were purposely fudging the numbers to hide the coming financial crisis.

“Insiders knew that the market for interbank lending had dried up, meaning banks were essentially making up their figures each morning,” Bloomberg notes.

Since then, major banks — including Barclays — have paid a total of $9 billion in LIBOR-related fines, according to Bloomberg, and former UBS and Citigroup trader Tom Hayes was sentenced to 11 years in prison in 2015 for illegal LIBOR manipulation.

Uncertain future

The Financial Conduct Authority, which oversees LIBOR, didn’t draw a straight line between the recent chicanery and the benchmark’s 2021 death letter, according to a New York Times report, but chief Andrew Bailey did give an example in which rates for a specific type of deal were submitted daily — despite only 15 representative transactions of that type occurring in all of 2016.

“In our view, it is not only potentially unsustainable, but also undesirable, for market participants to rely indefinitely on reference rates that do not have active underlying markets to support them,” Bailey said, according to a transcript of his speech.

The Times posited that LIBOR will be replaced by a metric that relies more heavily on actual loan interest rates and not self-reported figures, floating the Sterling Overnight Index Average — or SONIA — as a potential understudy.

When asked how the reverse mortgage industry would react to LIBOR’s demise, Hultquist said he anticipates that lenders and HUD will eventually select a new benchmark, or simply use the CMT for new adjustable-rate HECMs and the 10-Year Treasury for the expected rate.

The National Reverse Mortgage Lenders Association emphasized that the industry and regulators still have a while to figure out a replacement plan.

“This benchmark will phase out by 2021, and we look forward to working with all appropriate stakeholders in ensuring that a meaningful benchmark is in place before these changes take place,” NRMLA executive vice president Steve Irwin said in a statement e-mailed to RMD.

Written by Alex Spanko

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  • If I remember correctly, a primary reason we switched from CMT to LIBOR is because the Secondary Market was familiar with LIBOR’s, and HECM’s were the only adjustable using CMT. We wanted a Secondary Market, so we migrated to LIBOR. When the LIBOR goes away, it’ll affect the Forward and Reverse Secondary Markets the same, and we’ll all migrate to a new Index the Investors are comfortable with … no worries.

  • Hi all,

    I am a counselor, so I know that I am going to get a question that I cannot answer without doing a lot of research. What happens to the current loans that are based on LIBOR when LIBOR phases out in four years? I have not read one of the mortgages in a while and I do not have one in my office to read now. Is there a contingency clause that allows the mortgage to be reformed to the new rate? Or will whatever the last LIBOR rate is in 2021 make it a fixed rate from that point on?

    As Raymond says, we will migrate to a new rate for the new loans, I am concerned about the past loans. I know that I will be getting questions about that.

    Frank J. Kautz, II
    Staff Attorney

    Community Service Network, Inc.
    52 Broadway
    Stoneham, MA 02180
    (781) 438-1977
    (781) 438-6037 fax
    FrankKautz@csninc.org

    • Not to worry. The Model Adjustable Rate Mortgage Note includes provisions in Section 5 for when an Index is no longer available – “Lender will use as a new Index any index prescribed by the Secretary.” Fortunately, the Secretary had already approved the use of the CMT index.

      • Thank you Dan. It has been a long while since I have read through one. I should probably get one and read it again.

  • It’ll be interesting to see what type of LIBOR price and volume volatility will occur as we approach 2021. And if our industry can (or is able) to switch to the new index (1-yr CMT?) prior to the LIBOR actually being shut down.

    • More interesting will be the volatility over the next two months as people rush to try to get a LIBOR loan because they are told that is better. I expect to be very busy doing counseling.

  • Hopefully the mortgage industry will not wait unit the libor index is phased out “BY 2021”. We have a habit of waiting until the “last minute” to do most things in the mortgage world. Maybe we can make an exception this time and migrate to a new index for new loans originated beginning say January 2019. The fewer outstanding notes and resulting servicing that require a change from a libor based rate to something else, and the reduction in potential consternation for both borrowers and investors, the better. I would expect the Forward world to take the lead on this issue, but HMBS investors and other HECM participants should get their oars in the water now. I would be in favor of HECM lenders/investors returning to the CMT early on if a consensus cannot be reached in short order.

  • Since HUD is composed of itself along with FHA and Ginnie Mae, Ginnie Mae should have a major voice in the selection and timing of that selection due to the investors in its issuance programs.With the intrinsic problems and casual oversight of its own internal controls one wonders how LIBOR has survived as a leading interest index for as long as it has.

    Delaying the selection of a new index brings uncertainty, something the investment community hates. Yet selection of a new index before the investment community has settled on what appears to be the new standard in indices seems risky. Running to the CMT should be delayed by HUD as long as possible.

    Perhaps a group like the G20 will establish a new index with sufficient acceptance that it will replace LIBOR’s use before 2021. The problem is not so much with alternative indices but rather with acceptable replacements for LIBOR indices. It is surprising that the major international banks have not already established a new index with more reliable internal controls and much better oversight of those controls.

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