Preparing For Life After LIBOR

Preparing For Life After LIBOR

LENDERS ARE MULLING POSSIBLE REPLACEMENTS FOR THE INDUSTRY’S STANDARD INDEX

By JOEL BERG

Your customers this year might need more information about how the interest rate is being calculated on their reverse mortgage, a calculation that is typically an afterthought.

A closely watched and long-running process has been remaking one of the key factors for adjusting the interest rate on a variable-rate HECM, the most common kind of reverse mortgage. While the process is highly technical, there is a clear bottom line: The end result will affect the amount that borrowers stand to receive after their HECMs close, as well as the profits that lenders earn.

The factor in question is the underlying rate, or index rate, used to calculate changes in the variable rate. About 90 percent of HECMs are variable-rate loans, which let borrowers take out more of their equity than they would under a fixed rate. Until late last year, HECM rates rose and fell according to an index based on the London Inter-Bank Offered Rate, better known as LIBOR. Published daily, LIBOR represents the average interest rate that major banks expect to pay each other for short-term loans. It lost favor with regulators, however, after a 2012 scandal in which banks were discovered to be manipulating LIBOR to their advantage.

LIBOR is slated to go away for all lenders at the end of 2021. But, thanks to a surprise move by Ginnie Mae, the index is already on the way out for HECM lenders. Ginnie Mae announced that starting on December 1, 2020, it would no longer buy loans tied to LIBOR. The move stemmed from a concern over the reliability of LIBOR going forward.

In the place of LIBOR, HMBS issuers have turned to the Constant Maturity Treasury index, or CMT, which was used for HECMs until 2007. The CMT, published by the Federal Reserve Board, is based on the monthly average yield of a basket of Treasury securities such as government bonds.

Based on how HECMs are securitized and sold on the secondary market, Ginnie Mae’s decision essentially meant that lenders had to switch to CMT by the end of November 2020, says Steve Irwin, president of NRMLA, which was fighting for more time.

Industry leaders see Ginnie Mae’s move as a step back. Use of the CMT index, for example, is likely to narrow the number of investors purchasing bonds backed by HECMs, relegating them to a niche product, Irwin warns.

“We think that given the demographic trends in the country and around the world, the HECM marketplace should be part of the mainstream,” Irwin says.

That mainstream is turning slowly toward indexes based on the Secured Overnight Funding Rate, or SOFR. Like LIBOR, SOFR is based on lending between banks, but it is culled from actual rates, not estimates.

However, the other lending products that use LIBOR—such as business loans and adjustablerate home mortgages—still have the rest of the year to find a replacement, which has been an arduous task, given the trillions of dollars in transactions that reference the index.

For reverse mortgage industry leaders, work continues to try to make SOFR the default for HECMs.

IMPACT ON BORROWERS

The final decision rests with the Federal Housing Administration, says Irwin, who has been focusing on transition issues alongside NRMLA board members Joe DeMarkey and Tim Isgro of Reverse Mortgage Funding and Michael McCully of New View Advisors. They are part of a larger group known as the Alternative Reference Rates Committee, created by the Federal Reserve Board and the New York Fed to help smooth the transition away from LIBOR.

Even though a shift from CMT to SOFR could be disruptive because it would be yet another change, Irwin says, it would lead to a more robust secondary market for HECMs over the long term.

Among borrowers, the ongoing index changes are likely to spur questions about the impact. The questions are not limited to reverse mortgages, nor are they unwarranted. If lenders and regulators are not careful, a new index could deliver a windfall to lenders or a bonus to borrowers depending on whether or how the new index diverges from the old.

“SOFR is not a one-for-one replacement for LIBOR,” says John Button, CEO of technology provider ReverseVision, which is based in San Diego. “For new loans, you can manage that. But for existing loans, that’s a bit of a problem.”

Borrowers could end up paying more under a new index than they would have under LIBOR—or they could end up paying less. The rate for borrowers is basically the index plus a fixed number referred to as the margin. If the margin is two, the borrower’s rate is two points higher than the index rate. For example, an index rate of 1.5 percent would translate into a rate of 3.5 percent for the borrower—and an expected amount of profit for the lender.

The end goal of the index transition is what stakeholders call minimizing value transfer.

NRMLA would like regulators to offer consumers an explanation of the index changes and why they are happening, Irwin says. It was regulators, after all, that prompted the change.

“We hope that senior borrowers have access to independent, third-party information that clearly in plain language explains the situation,” Irwin says. “We don’t need to create confusion for the senior borrower.”

Button adds: “I think it’s going to be important not only what that message is but who’s delivering that message, and that’s why I think it’s important that HUD play a role in communicating with the consumer.”

Editor’s note: This article originally appeared in the January/February 2021 issue of Reverse Mortgage Magazine.