Fitch Rtgs: New ARM Note Positive Development for US RMBS LIBOR Transition

The newly recommended adjustable rate mortgage (ARM) index US dollar LIBOR (LIBOR) fallback language released by the Alternative Reference Rates Committee (ARRC) and supported by Fannie Mae and Freddie Mac is a positive development for US mortgages and is expected to become market standard for new loan originations, says Fitch Ratings.

The recommended fallback language provides greater clarity to consumers, and the market in general, about when and how the replacement index will be chosen; this is key as the industry looks ahead to the expiration of LIBOR at the end of 2021.

The immediate focus of the ARRC's recommended ARM note fallback language is on new mortgage loan originations, an important development despite the relatively low percentage of ARM loans being originated today. Fitch believes that certain elements of the recommended standard could ultimately be helpful in the consideration of approaches to existing ARM loans, notably legacy LIBOR product containing less clarity in terms of fallback detail. While current pathways remain uncertain, the recommended language might serve as a guide to selecting a replacement index for legacy LIBOR product once LIBOR is no longer available. LIBOR is used globally as a reference rate for pricing loans, debt and derivatives comprising more than $240 trillion in assets, including $1.2 trillion in adjustable rate mortgages and $178 billion backing US RMBS transactions.

US mortgage originators are expecting to transition to using updated 'uniform ARM instruments' incorporating the new fallback language once Fannie Mae and Freddie Mac establish the necessary timeline. Fannie Mae and Freddie Mac anticipate publishing the updated 'uniform ARM instruments' in first-quarter 2020. Originators will be given sufficient time to implement the new instruments but this should be completed well before YE 2021. As mortgages follow the ARRC template Fitch would expect the market to implement the ARRC provisions for securitization bonds in new RMBS backed by such mortgages.

The fallback language contained in the updated forms will include the following enhancements:

A 'Replacement Event' trigger, keying off of clearly identifiable situations where the existing (LIBOR) index is no longer available;

More detailed provisions for selecting a replacement index; specifically, a waterfall that obligates the noteholder to select a new index that has been selected or recommended by the Federal Reserve or a body convened or endorsed by the Federal Reserve, if available; and

Allowance for a change in loan margin, which should help to allay concerns about replacement index rates, an important consideration for ARM borrowers and investors.

The ARRC is convened by the US Federal Reserve Board and the New York Federal Reserve Bank to help ensure a successful transition from LIBOR to a more robust reference rate, its recommended alternative, the Secured Overnight Financing Rate (SOFR). While SOFR is not yet a common reference index in residential mortgages or RMBS, it is expected to be the new standard no later than when LIBOR is no longer available. The ARRC is comprised of a diverse set of private-sector entities that have an important presence in markets affected by LIBOR and a wide array of official-sector entities, including banking and financial sector regulators, as ex-officio members.

Contacts:

Roelof Slump

Managing Director, US RMBS

1 212 908-0705

Fitch Ratings, Inc.

Hearst Tower

300 W. 57th Street

New York, NY 10019

Andreas Wilgen

SF Group Credit Officer, Credit Policy Group

[phone]

Fitch Ratings Limited

30 North Colonnade, Canary Wharf

London E14 5GN

United Kingdom

Sarah Repucci

Senior Director, Fitch Wire

[phone]

Media Relations: Sandro Scenga, London, Tel: [phone], Email: [e-mail]

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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