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LIBOR to SOFR: The New Adjustable Rate Mortgage

LIBOR to SOFR: Banking Securities Measuring Financial Services for Accredited Investor SEC Rule Amendments and Waiver - FinTech Industry

On July 22, 2019, Fannie Mae and Freddie Mac issued a joint statement covering their plans to develop new adjustable rate mortgage (“ARM”) products that would be priced based upon the Secured Overnight Financing Rate (“SOFR”) instead of the London Interbank Offering Rate (“LIBOR”).

For background on the development of LIBOR and steps relating to its replacement – probably, but not necessarily by SOFR – see my prior blog post, “Measure for Measure:” LIBOR, SOFR, and the U.S. Dollar ICE Bank Yield Index.”

What’s the Difference?

The two Government Sponsored Entities (“GSEs”) pledged to incorporate the framework provided by the Alternative Reference Rate Committee (“ARRC”) in its whitepaper titled “Options for Using SOFR in Adjustable Rate Mortgages.” That whitepaper identifies some proposed differences that ARRC sees as appropriate from existing LIBOR-based ARM products.

  1. Under the ARRC framework, ARM would be based on a 30- or 90-day average of SOFR rather than a 1-year LIBOR.
  2. The interest calculation is to be computed in advance based on SOFR at the beginning of the interest period rather than in arrears at the end of the period. In order to minimize the risk that the SOFR rate computed in advance will be materially different from market rates during times of rapidly changing (increasing or decreasing) rates the ARMs might well require that the floating rate be adjusted every six months, rather than once a year as is typically the market standard for LIBOR-based ARMs. In order to reduce the risk that such conditions (determining rates in advance, and adjusting them every six months) might produce “payment shock,” the change (and especially any increases in the rate at the six month adjustment) would be capped at 100 basis points, rather than 200 basis points as is now the case.

How Will the Mortgage Market Measure Up?

Neither the GSEs nor ARRC have clearly addressed exactly how existing LIBOR-based ARMs should transition to SOFR or any other reference rate once LIBOR ends as of December 31, 2021. ARRC does have model contract language out for comment on how to address the transition. Those comments are due September 10, 2019.  Also, the U.S. Treasury Department on Wednesday, August 7, 2019, announced that it was considering using floating rate notes linked to SOFR. This came in response to the endorsement by ARRC of SOFR in ARMs. But as the financial press has recently noted, banks remain concerned that SOFR, which would be based on the actual cost of overnight borrowings secured with U.S. government debt as collateral, may prove materially different from the estimates of the cost going into the future over short-term periods as is the case under LIBOR.

Will It Adjust to SOFR?

The financial press reports that several borrowers including JP Morgan Chase & Co. and Honeywell International Inc. have used ARRC proposed language adopting SOFR as a replacement for LIBOR. However, market participants are worried that SOFR is too backward-looking and when averaged or, worse, compounded over several months can produce unpredictable results. This stands in contrast to LIBOR, which although based on estimates, is forward-looking, making the payment stream predictable. There are some suggestions that ARRC may address these worries using futures to derive a forward-looking rate from overnight SOFR. Needless to say, one does not yet know what “Measure” will measure $200 plus trillion of financial contracts after 2021.


The efforts to accomplish an orderly transition may be helped by the expected proposal of the Financial Accounting Standards Board to allow existing contracts as revised to address the end of LIBOR and the use of a new reference rate to be treated as amendments rather than terminations and replacement.

See also the discussion in my blog post, “Oh How Will We Measure When the Ruler is Uncertain: More Observations on the LIBOR Saga.” If you have any questions about this post or any other related matters, please feel free to contact me at