The Federal Reserve on Monday announced that it was endorsing a statement encouraging banks to transition away from the U.S. dollar-based London Interbank Offered Rate (LIBOR) index “as soon as practicable,” according to an announcement the federal bank issued on Monday morning.
“Given consumer protection, litigation, and reputation risks, the agencies believe entering into new contracts that use USD LIBOR as a reference rate after December 31, 2021, would create safety and soundness risks and will examine bank practices accordingly,” the Fed announcement read. “Therefore, the agencies encourage banks to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021.”
New contracts entered into prior to December 31, 2021 are recommended to either utilize a different reference rate, or have “robust fallback language” that includes a clearly defined alternative reference rate for the time after LIBOR’s discontinuation, the statement said.
These actions are necessary to facilitate an orderly— and safe and sound— LIBOR transition,” the Fed statement said. “If the administrator of LIBOR extends the publication of USD LIBOR beyond December 31, 2021, the agencies recognize that there may be limited circumstances when it would be appropriate for a bank to enter into new USD LIBOR contracts after December 31, 2021[.]”
These circumstances include auction-related transactions in the case of a member default; market making in support of client activity related to pre-2022 LIBOR transactions; a bank trying to limit its exposure to LIBOR in the future; and novations of LIBOR transactions executed prior to January 1, 2022.
“Today’s plan ensures that the transition away from LIBOR will be orderly and fair for everyone – market participants, businesses, and consumers,” said Fed Governor Randal Quarles, the vice chair for supervision, in a statement to CNBC.
In September, the Government National Mortgage Association (GNMA, or “Ginnie Mae”) announced new restrictions on the eligibility of Home Equity Conversion Mortgage (HECM)-backed Securities (HMBS) for adjustable rate loans operating off of the LIBOR index, effective for all HMBS issuances dated on or after January 1, 2021, nearly a year ahead of the planned sunset of the index.
To facilitate the quick timetable, the reverse mortgage industry will be adjusting its index to the Constant Maturity Treasury (CMT) rate, though the industry preference is the likely replacement index for other financial institutions: the Secured Overnight Financing Rate (SOFR), according to New View Advisors Partner Michael McCully and the National Reverse Mortgage Lenders Association (NRMLA).
“We believe that moving to a niche index [like the CMT] for a niche product is the opposite direction [we want to be moving in] that we all are attempting to avoid,” McCully said at the NRMLA Virtual Annual Meeting & Expo in November. “We’re really working very hard to make our industry [the providers of] a more mainstream financial solution, and we don’t believe that remaining with CMT, for the long term, will have that intended effect.”
Read the announcement of the central bank’s position at the Federal Reserve website.