Although the transition from LIBOR interest rates has been planned for quite some time now, Fannie Mae and Freddie Mac recently provided additional details of the necessary changes to outstanding adjustable rate mortgage loans that currently are linked to LIBOR indices. As expected, these changes largely mirror the changes mandated in the recently enacted LIBOR Act, described below, as well as current practice for new Fannie Mae and Freddie Mac loans. Consequently, loan servicers can now solidify plans for adjustments to the rate calculations this summer, but should take care to do so accurately.
By now the plan to abandon the use of LIBOR-based interest rates is well known. The end of the life of LIBOR means that a replacement for it is needed in existing loans that rely on it for the calculation of interest, including adjustable rate residential mortgage loans, among many other contracts. Fannie Mae and Freddie Mac (“GSEs”), and federal governmental authorities, have been planning for the transition away from LIBOR for a number of years, providing numerous timelines, guidance, and resources, and dedicated transition portals. Most recently, in January 2023, the GSEs updated their LIBOR Transition Playbook, originally published in May 2020.
In order to facilitate the benchmark replacement for all outstanding contracts currently relying on LIBOR but containing no, or inadequate, fallback (i.e., rate transition) provisions, including but not limited to mortgage loans, the Adjustable Interest Rate (LIBOR) Act (“LIBOR Act”) was signed into law on March 15, 2022 (discussed in our Legal Update, A Deeper Dive Into the US Adjustable Interest Rate (LIBOR) Act). Subsequently, on December 16, 2022, the Board of Governors of the Federal Reserve System (“Fed Board”) adopted the final version of the Regulation Implementing the Adjustable Interest Rate (LIBOR) Act (“LIBOR Act Regulations”) (discussed in our Legal Update, Fed Adopts Final Rule Implementing the Adjustable Interest Rate (LIBOR) Act) to provide additional detail about how the LIBOR Act would be applied, including confirming the various benchmark replacements chosen by the Fed Board.
On the heels of the adoption of the LIBOR Act Regulations, Fannie Mae and Freddie Mac, on December 22, 2022, announced their choice of SOFR-linked benchmark replacements for existing “legacy” LIBOR-linked mortgage loans for which they are the “determining person,” as defined in the LIBOR Act. Those announcements follow multiple guidance publications issued by the GSEs beginning in February 2020 (the first of which is discussed in our blog post, Fannie Mae and Freddie Mac Issue Guidance for a LIBOR-less World).
Authority for Specification of Benchmark Replacement ARM Indices
The LIBOR Act defines a “determining person” as the party to a LIBOR contract, “with the authority, right, or obligation, including on a temporary basis (as identified by the LIBOR contract or by the governing law of the LIBOR contract, as appropriate) to determine a [LIBOR] benchmark replacement.” This definition and the provisions of the LIBOR Act therefore permit the GSEs to determine the replacement index for LIBOR for their loans, provided they have that authority under the loans.
The GSEs may or may not have that authority, however, depending on the terms of the loan documents. Although the GSEs use standardized loan documents, the specific terms in those documents have changed over time, and some loans contain variations on the standard terms or omit a discussion of replacement indices altogether (in part because some existing legacy loans go back decades). In anticipation of the transition away from LIBOR, the GSEs updated the forms of LIBOR notes and riders in February 2020 to include language recommended by the Alternative Reference Rates Committee for this purpose. But prior to that change, most of the GSEs’ note forms contained more general language stating that: “[i]f the Index is no longer available, the Note Holder will choose a new index which is based upon comparable information.” As noted by Fannie Mae, however, some notes, particularly those used before 2009, may have non-standard language or may not have any language specifying how a replacement index will be selected.
If the GSEs do not have the requisite authority under the applicable loan documents, the LIBOR Act authorizes the Fed Board to specify the benchmark replacement. More specifically, the LIBOR Act provides that on the “LIBOR replacement date” (July 3, 2023, the first business day following the last day on which ICE Benchmark Administration will publish LIBOR on a representative basis, June 30, 2023), the benchmark replacement specified by the Fed Board will become the benchmark replacement for any LIBOR contract, (a) that contains no fallback provisions specifying a method for determining a replacement for the LIBOR benchmark, (b) that contains fallback provisions, but such fallback provisions don’t identify a specific benchmark replacement or a determining person, or (c) for which a determining person fails to select a benchmark replacement. As noted above, the Board-selected benchmark replacements are set forth in the LIBOR Act Regulations.
Benchmark Replacement Rate Selections by Fannie Mae and Freddie Mac
Despite the possibility that different loan terms may lead to different sources of authority for determining the applicable LIBOR replacement rate , it ultimately will not matter whether that authority is the GSEs, as determining persons for their loans, or the Fed Board, as the authority to designate benchmark replacements under the LIBOR Act. That is because the GSEs adopted the Fed Board-recommended benchmark replacements in their December announcements. So, whether the GSEs or the Fed Board chooses the replacement under a particular loan, the same benchmark replacements can be expected to be used.
In keeping with the benchmark replacements selected by the Fed Board in the LIBOR Act Regulations, the GSEs each selected the following SOFR-linked benchmark replacement rates for the legacy LIBOR loans (and certain related instruments and agreements) for which they act as a determining person:
|Single-Family Adjustable-Rate Mortgages (and related mortgage-backed securities)
|Relevant tenor of CME Term SOFR + applicable Tenor Spread Adjustment, including a one-year transition period, as published by Refinitiv Limited as “USD IBOR Cash Fallbacks” for “Consumer” products.
|Multifamily ARMs (and related mortgage-backed securities, as well as Single-Family and Multifamily Credit Risk Transfer securities, and Single-Family and Multifamily Collateralized Mortgage Obligations)
|30-day Average SOFR + Tenor Spread Adjustment
In their December 2022 announcements, the GSEs also confirmed that the transition for these legacy contracts will occur on the LIBOR replacement date, the same date that would apply if the Fed Board’s selections were to be used.
Subsequently, on January 25, 2023, Fannie Mae and Freddie Mac formalized the selections announced in December for residential mortgage loans relying on 1-month, 6-month and 1-year LIBOR indices via a servicing notice and a guide bulletin, respectively. These materials provide more granular detail for loan servicers with respect to replacement index codes and other details, and a mandate to use the applicable replacement index published by Refinitiv Limited (a provider of financial market data), as set forth in the respective tables provided in the notice and bulletin. The notice and bulletin also provide additional instructions for servicers, including a requirement that they provide borrowers with written notice identifying the replacement index and otherwise follow all regulations and policies applicable to adjustable-rate mortgage loans.
Application to Privately Held or Securitized Loans Using Fannie Mae and Freddie Mac Documents
Although Fannie Mae and Freddie Mac are obviously the primary users of their forms of loan documents, many other lenders use those forms as a “market standard” for residential mortgage loans. The GSEs authority to designate a replacement rate index (assuming that authority is included in the notes) arises out of their role as holders of those notes, so their selection of rates does not apply to the loans held by other investors. For loans that have not been delivered to the GSEs, that authority will rest with these other note holders, assuming the related loan documentation so provides.
For the owners and servicers of these loans, the choice of a replacement index is a more open question, at least technically. If the notes use language that would be sufficient to qualify the note holders as “determining persons” under the LIBOR Act, the note holders could choose a benchmark replacement that is different than those chosen by the GSEs or mandated by the LIBOR Act Regulations (although the safe harbor provisions of the LIBOR Act provide a powerful incentive to choose a SOFR-based replacement rate). If notes do not specify a benchmark replacement, or the note holders do not qualify as determining persons and therefore cannot specify a benchmark replacement, however, the Fed Board’s selected benchmark replacement should apply.
As a practical matter, we expect most private holders of LIBOR-indexed residential mortgage loans to follow the lead of the GSEs and the Fed Board. There undoubtedly is some safety in taking the same approach as the creators of the forms and the designated federal authority on the issue. That said, the particular situations of different private loan owners may vary, and different approaches may be seen in some cases in the market.