Fitch Ratings is calling the newly recommended adjustable-rate mortgage (ARM) fallback language a “postive development” as it moves toward becoming the market standard for Residential Mortgage-Backed Securities (RMBS) backed by such mortgages.
According to Fitch, the newly recommended ARM index U.S. dollar LIBOR fallback language, released by the Alternative Reference Rates Committee (ARRC), includes a “replacement event” trigger, detailed provisions for selecting a replacement index, and allowance for a change in loan margin. The language is 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.
“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,” Fitch states.
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 Q1 2020. Originators will be given sufficient time to implement the new instruments but this should be completed well before YE 2021.