Others may follow the GSEs’ early move on Libor exit

The government-sponsored enterprises’ plan to cease accepting loans pegged to the London interbank offered rate a year ahead of its scheduled expiration is expected to hasten action in securitized markets.

“The short timeline is positive for U.S. securitizations because it will likely help encourage market participants across U.S. residential mortgage-backed securities, U.S. commercial mortgage-backed securities and other asset classes to accelerate their own responses to the benchmark’s anticipated cessation after 2021, lowering Libor-transition uncertainty and certain cash flow risks for deals,” Moody’s said in a recent report.

Fannie Mae and Freddie Mac plan to disallow the use of Libor in single-family and multifamily loan applications on or before Sept. 30, and stop acquiring adjustable-rate mortgages pegged to Libor in both markets by Dec. 31, according to the Federal Housing Finance Agency.

The two GSEs also will require new language for all single-family uniform adjustable-rate mortgage instruments closed on or after June 1. There are plans to eventually retire ARMs indexed to the constant maturity Treasury index as well as those that are indexed to Libor. Roughly 5%-10% of loans originated in the single-family market over the past year have been ARMs, according to mortgage technology provider Ellie Mae.

Both Fannie and Freddie are members of the Alternative Reference Rates Committee that has been working to come up with a Libor alternative since 2014. The secured overnight financing rate that ARRC has recommended as Libor’s successor is based on transactions in the Treasury repurchase market. In addition, both GSEs have issued securities indexed to SOFR. Other possible replacements to Libor include the American interbank offered rate.

One challenge securitized markets may face in replacing Libor could be obtaining investor consent. Generally, at least third-thirds of bond holders must approve a change in transaction terms outside that stipulated in the original documents, and some contracts may not cover such a contingency.

Mortgage companies in the primary market also have been working on language they will use to notify borrowers if their ARMs switch to a different index.

Libor is being phased out because it has been based on a shrinking amount of bank activity involving wholesale deposits and short-term commercial paper notes, and has been subject to manipulation.