The Alternative Reference Rates Committee (ARRC), an organization co-convened by the Federal Reserve Bank of New York to find a new rate index after weaknesses in the London Interbank Offered Rate (LIBOR) were exposed, announced late last month that it it is now formally recommending forward-looking Secured Overnight Financing Rate (SOFR) term rates following the completion of a key change in interdealer trading conventions in July.
While the news on its own does not have a direct effect on the trajectory of the reverse mortgage industry, it could provide for a valuable forward step when it comes to the ultimate adoption of term SOFR rates for the industry dealing with Home Equity Conversion Mortgages (HECMs). The primary necessity for wider adoption of term SOFR rates specifically for the reverse mortgage industry depends on whether or not the Federal Housing Administration (FHA) adopts similar measures based on the recommendations of the ARRC and the Government National Mortgage Association (GNMA, or “Ginnie Mae”).
The ARRC announcement
The announcement of the recommendation for term SOFR rates on the part of the ARRC is seen as a demonstrable forward step in accelerating the ultimate retirement and dissolution of the LIBOR index for the wider market, the ARRC said in its announcement.
“The ARRC’s formal recommendation of SOFR Term Rates is a major milestone in the transition away from U.S. dollar (USD) LIBOR, providing market participants with an essential transition tool and marking the completion of the Paced Transition Plan that the ARRC outlined in 2017 and has been working toward since,” ARRC said in the announcement of its decision at the end of July. “The successful SOFR First convention change, along with the continued growth in SOFR cash and derivatives markets, has allowed the ARRC to recommend SOFR Term Rates, consistent with the principles and indicators it established to do so.”
The endorsement of adopting SOFR term rates marks a potential milestone in hastening the discontinuation of the USD LIBOR index according to Tom Wipf, ARRC chairman and vice chairman of institutional securities at Morgan Stanley.
“This formal recommendation of SOFR Term Rates is an achievement for the USD LIBOR transition specifically and for financial stability overall. This concludes the ARRC’s Paced Transition Plan and market participants now have all the tools they need as we enter the transition’s homestretch,” Wipf said. “With just five months until no new LIBOR, significant work remains and I urge everyone with LIBOR exposures to immediately take action and base their new contracts on forms of SOFR.”
Additionally, since the end of 2021 is quickly approaching and with it no new LIBOR indices, firms are strongly encouraged to take as much action as they can right now to build a strong foundation on SOFR, according to John C. Williams, president of the Federal Reserve Bank of
New York and co-chair of the Financial Stability Board’s official sector steering group.
“We are seeing great momentum in the transition toward SOFR and today’s recommendation will undoubtedly accelerate that progress,” Williams said.
Fed warns Judge about discontinuing LIBOR too quickly
However, in a lawsuit seeking to immediately end the use of the LIBOR index, the Federal Reserve told a judge that scrapping the LIBOR index too quickly could result in catastrophic results for financial markets. This is according to a filing in San Francisco federal court by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York said in a filing Friday in federal court in San Francisco, as reported by Bloomberg.
“Without an orderly transition away from LIBOR, there would undoubtedly be confusion and uncertainty in all markets that currently rely on LIBOR on a day-to-day basis,” the Fed said in the filing based on the reporting.
Some of the nation’s largest financial institutions unsuccessfully argued to try and have the case deciding the immediate fate of LIBOR moved from San Francisco to New York, in concert with previous decisions which have been made at that venue regarding issues of concern to financial institutions. That request was denied, however, according to the reporting at Bloomberg.
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 first convened ARRC to identify best practices for alternative rates, and to develop an implementation plan.
The last major development in the phasing out of LIBOR for the reverse mortgage industry occurred this past March, when the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced it will cease publication of the one-week and two-month LIBOR indices after December 31, 2021 and for all remaining LIBOR contracts after June 30, 2023.
However, the reverse mortgage industry requires the action of FHA when it comes to the full migration to a new index. In May, industry participants updated reverse mortgage stakeholders about the progress being made at the National Reverse Mortgage Lenders Association (NRMLA) Virtual Policy Conference.
In March, HUD and the Federal Housing Administration (FHA) published Mortgagee Letter 2021-08, which officially announced that the HECM program is moving on from the LIBOR index for adjustable-rate HECMs, and will instead adopt the SOFR. The letter constituted long-awaited guidance from the federal government, and “removes approval for use of the LIBOR index for adjustable interest rate HECMs,” approving the industry’s preferred index of SOFR while providing a timeline for how and when the changes will be implemented.
NRMLA has been active in the process of transitioning the reverse mortgage industry away from the LIBOR index, having separately formed a working group of subject matter experts across several of its own committees to discuss courses of action the industry can take and is in consultation with FHA and Ginnie Mae on the matter.