Fed Group Proposes Adjustable-Rate Mortgages Using Libor Replacement
July 11 2019 - 1:36PM
Dow Jones News
By Daniel Kruger
A financial industry group is proposing to use a new benchmark
designed by the Federal Reserve for adjustable-rate mortgages,
replacing the troubled London interbank offered rate.
The proposal, released Thursday in a paper written by a group
overseen by the New York Fed, marks another step in efforts to
replace Libor, the interest-rate benchmark that underpins trillions
of dollars in financial contracts including credit cards, corporate
loans and derivatives. Libor was slated for replacement in 2021
after a manipulation scandal.
The paper is the latest in a series of presentations by
regulators and banks including Goldman Sachs Group Inc., Morgan
Stanley and MetLife Inc. intended to push markets and companies to
replace Libor. The group, known as the Alternative Reference Rates
Committee, or ARRC, in 2017 designated the secured overnight
financing rate, or SOFR, as its preferred benchmark.
Finding a replacement for Libor is a key challenge for banks,
companies and investors because each wants a reference rate that
reflects risks from short-term lending and is supported by a liquid
market that behaves in a predictable manner. Properly setting the
rates on such loans can determine whether the loans are affordable
for borrowers and profitable for lenders.
About $1.2 trillion of U.S. mortgage debt is linked to the Libor
rate, according to the New York Fed, making it the largest segment
of consumer debt affected by the transition. Fannie Mae and Freddie
Mac, the federal housing-finance giants, are planning to buy the
new mortgages and to package them as debt securities as soon as
possible before the planned cessation of Libor at the end of 2021,
ARRC officials said.
Companies have sold $148 billion of shorter-term floating-rate
debt linked to SOFR since the first offering by Fannie Mae last
July, according to the CME Group. Almost one-quarter of that amount
was issued in June, the largest monthly total to date. That is a
fraction of the amount of Libor-linked debt sold during the
period.
Members of the group say SOFR is more reliable than Libor
because it is derived from the rate to borrow cash overnight using
U.S. government securities as collateral. These trades are known as
overnight repurchase agreements, or repos. Libor is set by a group
of banks in London that provide estimates of the rate at which they
could lend to other banks over various periods. Those estimates
take into account the risk the borrowers won't repay the debt.
The push to bring the new adjustable-rate mortgages to market
also could force other participants in the housing market to
address the expected end of Libor, ARRC officials said. People from
mortgage brokers to call-center employees will have to be educated
about the mortgages, while banks, investors and servicing companies
will need to revise their bookkeeping infrastructure to accommodate
the new debt. Those changes could take between 12 and 18
months.
The new mortgages are the latest step by ARRC members to
encourage companies to begin using SOFR as a reference rate.
In April, the Fed released a paper written by two central-bank
economists describing a method to calculate longer-term SOFR rates
using prices from futures contracts. Analysts have said this kind
of term structure could make selling floating-rate debt linked to
SOFR more attractive to companies. However, ARRC members have said
that the longer-term SOFR rates won't be ready until late 2021, and
are urging companies to use the overnight rate to speed the
adoption of the new rate.
Write to Daniel Kruger at Daniel.Kruger@wsj.com
(END) Dow Jones Newswires
July 11, 2019 14:21 ET (18:21 GMT)
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