By Richard Leong
NEWYORK (Reuters) – U.S. mortgage bankers are concerned about the coming phase-out of a global interest rate benchmark because, they said at a conference, the transition will entail costs and administrative burdens and the replacement rate is not an ideal substitute.
The London interbank offered rate (LIBOR), whose reputation was tarnished by scandals from trader manipulation, is a benchmark for $200 trillion (150 trillion pounds) in dollar-denominated financial products, mostly in interest rate swap contracts.
Roughly $1.2 trillion in mortgages and another $1 trillion in mortgage-backed securities are set against LIBOR, according to the Alternative Reference Rates Committee, a U.S. financial industry group.
A complicated move away from LIBOR could prove disruptive for the mortgage market. It could result in a jump in late mortgage payments due to confusion among homeowners because of the change in their interest rate resets.
“We could see a spike in delinquencies because customers don’t know what have been done,” said Dan Sullivan, a principal at PricewaterhouseCoopers.
Sullivan spoke on a panel about LIBOR at the MBA National Secondary Mortgage Market Conference on Tuesday.
Regulators set LIBOR to be phased out in 2021 and have encouraged alternatives to take its place.
The New York Federal Reserve, together with the Office of Financial Research, a government agency, developed the Secured Overnight Funding Rate (SOFR) as a LIBOR alternative.
One of SOFR’s shortcomings, critics say, is that it is not a measure of what banks charge each other to borrow dollars, which LIBOR does.
“It’s a great index but it’s a risk-free rate. There’s a mismatch there,” said Stephen Kudenholt, co-chair of capital markets at Dentons US LLP.
SOFR is derived from daily trades in the repurchase agreement market where traders use their Treasuries holdings as collateral to obtain overnight cash.
LIBOR is based on a survey of banks on what they charge each other for dollars.
This main difference makes it tough for end users such mortgage lenders and servicers to set prices on loans and related products, according to the panelists.
Moreover, the absence of a vibrant futures market for SOFR makes it tough for traders and lenders to extrapolate a longer-term rate to hedge their interest rate risks, they added.
After SOFR’s launch in April, futures contracts tied to it began trading earlier this month, albeit with low daily volumes.
Dan Fichtler, a MBA director of housing finance policy, said there are concerns about the costs for the industry to overhaul its computer and accounting systems and processes to accommodate the change from LIBOR.
Mortgage servicers also face the burden of notifying and explaining to borrowers about the reference change to their mortgage rates when their floating-rate loans reset in 2021, the panelists said.
Al Qureshi, managing director of analytics at Incenter said he prefers more tweaks to LIBOR rather than abandoning it for an imperfect alternative.
“It’s an apple-and-orange question,” Qureshi said of choosing between the two rate benchmarks.
Graphic: U.S. dollar LIBOR market footprint – http://reut.rs/2FiHaxy
(Reporting by Richard Leong; Editing by Daniel Bases)