The Latest on the LIBOR Transition with MBA’s Andrew Foster and Dan Fichtler
MBA NewsLink interviewed Mortgage Bankers Association Associate Vice President of Housing Finance Policy Dan Fichtler and Associate Vice President of Commercial/Multifamily Andrew Foster about the transition away from the London Interbank Offered Rate to a successor index for floating-rate loans.
MBA NEWSLINK: There’s been quite a bit of activity on the transition away from LIBOR in recent months. Can you give us the latest on where this effort stands as it relates to the mortgage industry?
ANDREW FOSTER: Preparations for a post-LIBOR market are ramping up, as we are now less than two years from the expected discontinuation of LIBOR. The good news is that many critical decisions are being made by regulators and other bodies, which is giving mortgage industry participants more information with which to plan their LIBOR “exit strategies.”
Last year, the Alternative Reference Rates Committee–the group tasked with facilitating the transition–proposed a new type of single-family, adjustable-rate mortgage that is indexed to a new benchmark known as the Secured Overnight Financing Rate. In February, the Federal Housing Finance Agency announced that Fannie Mae and Freddie Mac will stop accepting LIBOR-indexed single-family and multifamily loans later this year and will begin accepting SOFR-indexed loans, presumably with features very similar to those described by the ARRC.
In recent months, the ARRC has also recommended improved contract language for single-family loans, proposed a spread adjustment to minimize changes in value when loans switch from LIBOR to SOFR and finalized the calculations necessary to support SOFR-indexed ARMs. Lastly, in March, the ARRC released a proposal for New York State legislation, which is intended to minimize legal uncertainty and adverse economic impacts associated with the LIBOR transition.
NEWSLINK: So does this mean the market is ready for SOFR-indexed mortgages? What about other benchmarks?
DAN FICHTLER: We’re getting there, but some more important decisions need to be made before we’ll see widespread use of SOFR-indexed ARMs. For example, while the GSEs will begin accepting SOFR-indexed ARMs later this year, the industry is still awaiting important details related to changes in eligibility, underwriting, pricing and delivery requirements. We expect those details to be released shortly.
As far as other benchmarks, regulators are focused on ensuring that mortgage originators use benchmarks that meet the standards set forth by IOSCO, an international body of securities regulators. Foremost among these standards is that benchmarks should be based on underlying markets with robust, observable transactions. Various organizations have been exploring new benchmarks beyond SOFR, some of which are meant to more closely reflect the features embedded in LIBOR.
For instance, in February, officials from several mid-sized American banks sent comments to federal regulators noting their concerns with the use of reference rates that do not reflect bank credit risk. This development underscores the challenges in preparing for and executing the transition away from LIBOR. It is also significant that, at some point next year, the GSEs will no longer accept ARMs indexed to Constant Maturity Treasury (CMT) rates.
NEWSLINK: The New York Department of Financial Services recently requested LIBOR transition plans from its regulated institutions. More broadly, what role are regulators playing in this transition?
FICHTLER: That’s right, the New York Department of Financial Services has requested that all the institutions it oversees provide it with plans documenting risk management practices, assessment of alternative benchmarks, processes for communication with consumers and counterparties, operational readiness and governance frameworks. While this request only applies to institutions overseen by the New York Department of Financial Services, I would be surprised if other state regulators do not follow suit. Similarly, we hear increasing reports of examiners at both the federal and state levels actively reviewing financial institutions’ LIBOR transition plans.
Here in the United States, the LIBOR transition has been a focus for all the major financial regulators. The Financial Stability Oversight Council, chaired by Treasury Secretary Steven Mnuchin, has detailed the risks associated with the transition for several years. Many senior Federal Reserve officials, including Chairman Jay Powell, have called on institutions to reduce their LIBOR exposures as quickly as they prudently can do so. FHFA continues to oversee the transition-related activities of the GSEs, while the Department of Housing and Urban Development and the Department of Veterans Affairs do the same for the housing finance programs they operate. Meanwhile, regulators in other jurisdictions around the world are addressing the transitions from LIBOR benchmarks in currencies other than the U.S. dollar.
NEWSLINK: Are there any particular transition challenges or concerns for commercial and multifamily real estate finance markets you would highlight?
FOSTER: The size of commercial and multifamily floating-rate debt–the product type which is priced off of LIBOR–is small compared to the overall size of different markets and asset classes involved in the transition, which is generally a true statement for all loans and cash products. This can be problematic as issues arise with the rightful focus on making sure things run smoothly in derivatives markets. For instance, there exists the potential for basis mismatch if spread adjustment calculations are not managed similarly across derivatives and cash markets. This could prove challenging for the ability to hedge effectively.
What stands out as challenging for a business-to-business industry like commercial real estate finance and its legacy LIBOR-indexed loans is that mortgage loan documents are not homogeneous. These contracts are negotiated by lenders and borrowers on a deal-by-deal basis, so not only is there a lack of standardization across different lenders, but there can be some lack of uniformity within each lender’s own book of business. Additionally, loan sizes can be quite high as compared to single-family mortgages, which obviously increases the stakes in terms of dollar volume when moving to a new rate structure.
Lastly, different capital sources have different models, so how the transition is managed and impacts businesses may be different in a variety of ways depending on whether an institution is a bank balance sheet lender, an agency lender, an insurance company or a commercial mortgage-backed securities (CMBS) shop.
NEWSLINK: What has MBA been doing to help its members prepare?
FICHTLER/FOSTER: Our main objectives are to first, advocate for the industry’s views and recommendations before policymakers and other officials charged with leading the transition; and second, ensure that our members are well-informed and have access to the resources they need to promote a smooth transition.
On the first point, we are active participants in the ARRC discussions that focus on mortgage lending and servicing. As with all of our policy priorities, we know how important it is to be in the room and at the table when key decisions are being made. We also speak regularly with administration officials and legislators on various elements of the transition. These discussions typically focus on the efforts that our industry is undertaking to facilitate the transition, as well as ways in which policy decisions can remove obstacles or minimize the chances of market disruptions.
On the second point, MBA has developed a wide range of materials to help our members. Our single-family and commercial/multifamily working groups serve as venues for discussions and questions on all elements of the transition. We have offered webinars on topics such as commercial real estate transition impacts, preparations for commercial servicing systems, and improvements in contractual fallback language. Our single-family consumer disclosure template for new LIBOR-indexed ARMs allows our members to keep potential borrowers informed, while our commercial market primer provides a checklist of key considerations for our CREF members. And of course, we continue to provide research and data that closely track industry preparedness.
NEWSLINK: what should we expect next in this process?
FICHTLER/FOSTER: As we noted earlier, we do expect several developments from the GSEs in 2020 that will allow lenders to begin delivering SOFR-indexed ARMs. We also expect finalization of a recommended spread adjustment from the ARRC, which should facilitate the transition from legacy LIBOR-indexed loans to SOFR. Derivatives markets tied to SOFR will continue to grow and become more liquid, which will provide support for changes in consumer lending markets.
As referenced above, the request from New York Department of Financial Services for its regulated entities to provide transition plans is likely the beginning of various regulators, examiners and other market participants focusing more on operational risks and potential mitigants with respect to the LIBOR transition.
MBA looks forward to continuing its role as a strong resource and advocate for its members, the real estate finance industry and all stakeholders seeking a smooth transition away from LIBOR.