Sometimes it takes a nudge to make a deadline feel real.
The mortgage industry got a reminder of the work ahead of it when Fannie Mae and Freddie Mac recently announced they’ll stop accepting adjustable-rate mortgages (ARM) tied to the London interbank offered rate (LIBOR) by the end of 2020. That’s a full year ahead of LIBOR’s official demise – and requires action sooner than most lenders had anticipated.
Addressing the Pain with Change
The ramifications of LIBOR for mortgage lenders aren’t as deep and confusing as they are for commercial lending, capital markets and derivatives. Those markets are far more complex than the heavily regulated mortgage industry. Additionally, the impact of LIBOR will ripple through all aspects of lending organizations. While the scope of the transition is limited – we estimate 3% to 5% of mortgages – it touches multiple functions, all of which require changes across several dimensions. These include:
- Governance. Key foundational differences exist between LIBOR and SOFR, the secured overnight financing rate that’s the preferred replacement rate. Margin, cap/floor and frequency of updates and publication methods will all need to be taken into account. It will be essential for stakeholders in originations, servicing and secondary marketing to collaborate.
- Policy and procedure. Process changes across operations will include customer communication, modeling and repapering key documents.
- Partners and third-party platforms. Lenders’ extensive use of third-party platforms and the wide circle of third-party providers means the number of application programming interfaces (API) to be accommodated is much higher than for capital markets. A single mortgage might require 20 or more APIs; half a dozen of these – such as document generation and links to Fannie Mae and Freddie Mac – potentially reference LIBOR and will require adaptation and validation.
- Technology. Transitioning to SOFR-based contracts requires new controls on point of sale and loan origination systems. Lenders can expect to make changes to loan origination documents, ARM setup and the rates they publish on their websites. They’ll need to update rate sheets and reconfigure key rate setup parameters and look-up tables.
- Core operations. Per our estimate, roughly 3% to 5% of existing servicing portfolios will require rate index adjustment, necessitating customer communication and putting an additional load on call centers. Lenders will need to understand and process language on fallback options in the existing contracts.
Getting Started Sooner Rather than Later
Sunsetting the LIBOR benchmark requires detailed planning that most lenders haven’t yet begun. But they need to.
Banks are typically further ahead in the transition than non-bank lenders because they have a broader range of products tied to LIBOR, including derivatives, commercial loans and capital market products. They have more work to do than non-bank lenders, which are often behind the curve on LIBOR because mortgages are their only product, and they remain focused on their core business.
Regardless of the type of financial institution, the common thread among lenders we work with has been to hold off on the LIBOR transition while awaiting guidance from Fannie Mae and Freddie Mac.
The LIBOR phase-out represents more than a simple rate replacement. With its impact across core systems, interfaces, operations and customer communication, it’s a deadline that’s real and just got closer.
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