May 21, 2019 / 7:56 PM / 5 months ago

'Zombie' LIBOR seen besetting U.S. mortgage industry

NEW YORK, May 21 (Reuters) - The U.S. mortgage industry may have to grapple with a “zombie” version of the London interbank offered rate even after the rate benchmark is expected to be phased out after 2021, industry officials said on Tuesday.

LIBOR is a rate reference for $200 trillion of U.S. financial products, mainly in interest rate derivatives. There are some $1 trillion worth of adjustable-rate home loans which are reset against it.

“It feels Y2K-ish,” said Timothy Kitt, senior vice president of single family pricing and execution at Freddie Mac, referring to the Year 2000 computer flaw. “People are starting to feel the burn.”

The Alternative Reference Rates Committee (ARRC), a financial industry group backed by the Federal Reserve and other government agencies, has put forth guidelines for participants to adopt the use of another reference rate in a bid to move away from LIBOR.

ARRC has encouraged a transition to the Secured Overnight Financing Rate (SOFR) from LIBOR, but the acceptance of SOFR among banks, corporate borrowers and asset managers has been slow.

Smaller banks are one to two years behind large financial institutions in their transition away from LIBOR, said Trent Reasons, associate director at Boston Consulting.

Reasons and Kitt were part of a panel at the Mortgage Bankers Association’s National Secondary Market conference in New York.

Some of the market reluctance to adopt SOFR is that it is an overnight risk-free rate in contrast with LIBOR which gauges borrowing costs between banks.

Another factor that has hindered SOFR’s acceptance is the lack of a term market right now, in which participants could reference loans and other products as far out as 30 years, analysts said.

Another issue that mortgage executives raised on Tuesday was what reference rate they would use for outstanding LIBOR-based loans after 2021.

ARRC has begun issuing recommendations on the contingency or “fallback” language about using a comparable index instead of LIBOR for existing products after 2021.

Another panelist Renee Schultz, Fannie Mae’s senior vice president of capital markets, voiced concerns about managing legacy LIBOR-based loans and products after 2021 especially if a comparable index does not exist by then.

If this were to happen, a “zombie” LIBOR may exist to support these legacy products even though it may no longer be an accurate measure of borrowing costs, according to Schultz and Kitt. (Reporting by Richard Leong Editing by Susan Thomas)

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