The London Interbank Offered Rate (LIBOR) index is scheduled to be retired in 2021, and while the transition to a new index would likely be a positive development for the forward and reverse mortgage industries in time, the transition has the potential to create issues for both the servicing of existing loans, as well as the origination of new ones. This is according to an article authored by Washington, D.C.-based law firm Weiner Brodsky Kider PC.
After international investigations determined that LIBOR was vulnerable to widespread manipulation efforts identified between 2003 and 2012, global regulators started more actively advising financial institutions to move away from the LIBOR standard, preferably by 2021. In 2014, the Federal Reserve Bank of New York convened the Alternative Reference Rates Committee (ARRC) to identify best practices for alternative rates, and to develop an implementation plan.
After providing a robust background on foundational and recent developments related to the future transition — including recommended best practices being published by the ARRC, as well as the CFPB’s publication relating to LIBOR transition guidance — lawyers at the firm presented two possible issues that could stem from moving to a new rate index. The servicing of existing loans is one area where difficulties could emerge.
“For existing legacy LIBOR-indexed single-family closed-end ARM loans and open-end variable rate HELOCs, the contract language in the loan documents will control the relationship between the parties,” the firm writes. “On existing LIBOR-based single-family ARM loans, the contract typically states that if the reference rate is no longer available, the note holder has the right to choose a new, comparable index.”
An issue on top of this, though is that most adjustable-rate mortgage (ARM) loan contracts don’t specify a replacement index if the original is “not available.” They also don’t specify if the note holder can adjust the loan’s margin added to the reference rate when determining the interest rate.
There may also be issues with new originations, and lenders will need to determine what can be used in LIBOR’s stead once the rate is retired.
“Regarding originating new single-family ARM loans, lenders should consider using the revised GSE LIBOR-indexed single-family uniform ARM notes,” the firm writes. “[These] incorporate the ARRC’s recommended fallback language, for all new originations of GSE single-family ARM loans until the earlier of the remaining period of time during which LIBOR-based single-family ARM loans remain eligible for purchase by the GSEs, or the date on which Fannie Mae or Freddie Mac, as applicable, begins accepting delivery of SOFR-indexed ARM loans, and use the new GSE SOFR notes thereafter (the timelines for this process are discussed above). The timelines, however, are not applicable to non-agency ARM loans that will be held in portfolio, and for such loans, the decision of which index to use is generally a business decision.”
Read the article at Weiner Brodksy Kider.