With new guidance and model documents issued by Fannie Mae and Freddie Mac, the mortgage industry is several steps closer to operating without LIBOR.
The industry has been grappling with the eventual demise of LIBOR since 2017. The key body developing a coordinated approach has been the Alternative Reference Rates Committee (ARRC). The GSEs have worked closely with the ARRC and they are now putting the ARRC’s recommendations into practice. The ARRC recommended a transition from U.S. dollar (USD) LIBOR to the Secured Overnight Financing Rate (SOFR), which will be published by the Federal Reserve Bank of New York. On November 15, 2019, the ARRC also published recommended “fallback language” for use in adjustable rate mortgage (ARM) notes that would replace the LIBOR benchmark with a replacement rate and a spread adjustment that would align the replacement rate with the prior benchmark.
Fannie Mae and Freddie Mac recently announced details of their plans for a successful transition from LIBOR-indexed ARMs to SOFR-based ARMs and have provided updated form instruments for immediate use.
In Lender Letter LL-2020-01 and Bulletin 2020-1 Fannie Mae and Freddie Mac, respectively, address the following key issues:
- Updated Form ARM Notes and Riders: both GSEs updated and published new standard ARM notes and riders to incorporate the “fallback language” suggested by the ARRC for newly-originated products.
- Retirement of LIBOR ARMs: Fannie Mae will retire all LIBOR-indexed ARM plans later in 2020 and will no longer acquire loans indexed to LIBOR by the end of this year. Similarly, Freddie Mac will not purchase LIBOR-indexed ARMS with application received dates on or after October 1, 2020 and will no longer purchase any LIBOR-indexed ARMS on or on or after January 2, 2021.
- SOFR ARMs: Fannie Mae and Freddie Mac both plan to accept delivery of SOFR ARMs during the second half of 2020. ARMs using an index based on a 30-day average of SOFR will be eligible for sale to the GSEs. Further details are promised in future bulletins.
- Future Retirement of CMT ARMs: At “some point in 2021,” Fannie Mae and Freddie Mac will no longer acquire ARM loans that use an index based on constant maturity Treasury securities (CMT) and will retire all CMT ARM plans. No specific dates have been established but sellers are cautioned not to increase their CMT-indexed ARM deliveries.
While the GSE guidance and revised forms provide some clarity to the mortgage industry for newly originated ARMs, many questions about the cessation of LIBOR remain. Sources estimate there are still 2.8 million LIBOR-based ARMs with a collective value of $1 trillion that do not have the AARC “fallback language.”
Several legal and operational questions remain about how loan servicers will transition those loans from LIBOR to SOFR while avoiding borrower harm and confusion (as well as litigation). We will address those key topics and others in upcoming articles as the mortgage industry and LIBOR part ways.