Answer to LIBOR Question Written in Reverse Mortgage Notes

When British banking authorities in July announced the eventual death of LIBOR, the reverse mortgage industry was faced with the long-term task of replacing the backbone benchmark for adjustable-rate Home Equity Conversion Mortgages. While much can change between now and LIBOR’s planned trip out to pasture in 2021, the solution to one problem might be easier than expected.

Dan Hultquist, director of learning and development at the ReverseVision software firm, told RMD that he was initially concerned about what would happen to existing HECMs at the time of the switch, since there might not be a contingency plan for swapping out benchmarks on extant mortgages. So he dug into the text of a model adjustable rate note from the Department of Housing and Urban development, and to his surprise, found that HUD had planned for this exact eventuality.

Right there in section 5, titled “Interest Rate Changes,” subsection B stipulates that at the time of a specified “change date,” the interest rate will be based on a given index “chosen by the Borrower.”

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The next paragraph explains what happens should that index disappear.

“If the Index is no longer available, Lender will use as a new Index any index prescribed by the Secretary,” the document continues — essentially saying that the lender can simply switch to the already-approved Constant Maturity Treasury rate, which remains HUD-certified for use.

Of course, the HUD secretary — either current department chief Ben Carson or his potential future successor — could approve a new standard between now and then. But Hultquist emphasized that if the LIBOR went away tomorrow, the solution could be as simple as putting letters in the mail notifying borrowers of the change.

“That’s amazing to me, that HUD actually had the foresight to say: ‘What happens if an index goes away? And maybe we should put that into a note,’” Hultquist said.

Meanwhile, since this article was originally published, several authorities have weighed on the viability of a LIBOR replacement, including this take from Mark Gilbert at Bloomberg Businessweek. In a column that veers from serious to tongue-in-cheek, Gilbert argues that the Financial Conduct Authority, the British agency that oversees LIBOR, can simply revamp the benchmark instead of abandoning it entirely.

To combat the authority’s assertion that there isn’t enough inter-bank lending to provide an accurate backbone for LIBOR, Gilbert suggests that the FCA use corporate bonds, the commercial paper market, and other existing metrics to calculate the benchmark.

“Instead of ditching LIBOR and making lawyers rich amid a scramble to rewrite the gazillion contracts that are tied to the benchmark, maybe just changing the composition and calculation of LIBOR makes more sense,” Gilbert writes.

Then, for his flippant conclusion, Gilbert also makes a last-ditch recommendation should all other efforts fail.

“Send the body that calculates the benchmark down to its local sports store, buy 16 sets of dartboards and darts, set up an interest-rate wall in the chimpanzee enclosure at London Zoo, and let the apes set the levels,” Gilbert writes.

Written by Alex Spanko

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  • Let us say we can make the borrowers comfortable with the idea of the CMT (or whatever other index might be selected by the Secretary) replacing LIBOR. How will the market react? Will premiums be lower during the period that this unknown exists? Everything should be fully operational before LIBOR ends but it could be an interesting ride in between.

  • Unfortunately I don’t think many seniors read that clause. If a new index is used and the interest rates go higher than the Libor at the time it can certainly give the appearance of a bait and switch in the seniors mind. We certainly don’t need anymore negative press but we will have to wait and see.

    • Great point, and something that I hope is heard loud and clear. If the new index is higher than the LIBOR at the time of the switch, their will be negative press and a lot of upset customers that will sell against the product. We need to be very careful here.

    • I’ve thought about that, but if you do, you cannot answer their follow up question. That will be, what is the next index going to be? Or will the index be higher than the LIBOR? I think we have to trust the industry is going to handle this responsibly and not create uncertainty with potential customers. Many of them are already wary of a variable rate as it is. Even with historical data that is readily available for them to review.

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