Mar. 7: February lock data; LIBOR transition update, and primer on SOFR & LIBOR differences

The Federal Financial Institutions Examination Council (FFIEC) updated guidance identifying actions that financial institutions should take to minimize the potential adverse effects of a pandemic. Pandemic? That is normally associated with science fiction movies or the Spanish flu in 1918. Amazing to pause and think about what is happening out there. Whether it is from a human eating a snake that ate a bat, or bad fish, major events are being cancelled, fist bumps and elbow taps are replacing handshakes, and people are doing what their parents taught them to do decades ago about common sense or common courtesy: wash their hands, be careful about cleaning surfaces, and cover their mouths when they sneeze or cough!

Lenders are focusing on prioritizing pipelines, re-evaluating rate lock renegotiation policies, and dealing with employee burnout. Many are wondering why mortgage rates are stubborn and not going down or, in some cases, actually going up! More on this Monday.

Federal Reserve officials and economists say that the central bank has limited capacity for stimulus to blunt the impact of the coronavirus outbreak and that an increase in government spending might be needed. The Trump administration has not said whether it is receptive to fiscal stimulus to bolster the economy. Meanwhile, in mortgage land…

According to Informa Financial Intelligence February 2020 Mortgage Originations Data, rate-lock volume has increased 111% YoY and 17% MoM across all channels, while funded volume has increased 59% YoY and fallen 9% MoM. In the Retail channel, lock volume has increased 117% YoY and 17% MoM, while funded volume has increased 66% YoY and 2% MoM. Average 30-year Conforming FRM funded loan note rates have fallen 94bps from February 2019, with refinance rates lower by 106bps and purchase rates lower by 90bps. Compared to 2019, YTD Purchase lock volume is up 12% and funded volume is up 1%, while YTD Refinance (R/T & C/O) lock volume is up 193% and funded volume is up 206% YoY Informa sources a statistically significant data set directly from lenders to produce these benchmark figures.


While many are waiting for Freddie and Fannie, via the FHFA, to provide further guidance on the transition, others are moving ahead. No one wants a “last minute” conversion situation.

For example, Docutech sent out a, “New Data Integrity Check: Warning for LIBOR-Based ARMs Originated on or After October 1, 2020” piece worth a gander. And Docutech also sent to clients a “Roadmap to LIBOR Retirement”.

Want to see what your borrowers, or servicing clients, are reading about SOFR? Here’s a recent piece from Yahoo.

Yet there is caution, especially in commercial lending. “Nobody is relying on SOFR language today, but it will become a cascade. When the largest institutions become more comfortable, it’ll come together in a relatively quick timeframe.”

The credibility of LIBOR (London Interbank Offered Rate) was undermined slightly by a price-fixing scandal a few years ago, and LIBOR will be phased out as a benchmark borrowing rate as soon as a year from now. LIBOR has served as a key benchmark interest rate for the past few decades, despite only large banks borrowing at the actual LIBOR rate. It is familiar to millions of businesses and individuals because their borrowing costs are often tied to LIBOR (plus some spread). In the U.S., this new benchmark rate has been determined and is known as SOFR (Secured Overnight Financing Rate).


There are many technical differences between the two rates, but LIBOR and SOFR are highly correlated. Both benchmarks usually move in tandem with the effective fed funds rate, determined largely by the monetary policy stance of the Federal Reserve. Regardless of the specific drivers in any one instance, SOFR is more sensitive than LIBOR to changes in the mix of Treasury security collateral and cash, as well as some liquidity and leverage regulations. There tends to be more volatility in SOFR than in LIBOR.


The sensitivity of SOFR versus LIBOR has some market participants worried. However, the FOMC is expected to be on hold through 2021, with forecasts for real GDP growth and consumer price inflation likely not strong enough to induce Fed tightening. As a result, SOFR should remain largely unchanged over the next year or two at its current level of roughly 1.60 percent, easing apprehension over the transition. SOFR can encounter short periods of volatility, but Fed policymakers hope that their open market repo operations and Treasury bill purchases depress SOFR volatility.


One proposed solution to the potential problem of more borrowing costs as a result of the volatility with SOFR rates is to have households and businesses borrow at a term SOFR rate that is determined in arrears. Although SOFR can be volatile on a daily basis, its one-month moving average tends to be more or less as smooth as 1-month LIBOR. So, a one-month SOFR rate would be the moving average of the daily SOFR rate over the past month. It is not a perfect relationship, and it is important to bear in mind that a one-month moving average of SOFR is inherently backward-looking, whereas 1-month LIBOR is an inherently forward-looking rate. But consumers should not worry the transition is going to have a material impact on their borrowing costs.


There are other important differences between the two rates. SOFR is determined on a continuous basis by the interactions of numerous financial institutions in the Treasury security repo market, while LIBOR is based on a survey of only 16 global banks. SOFR is a secured rate, the transactions from which SOFR is based involve pledging U.S. Treasury securities as collateral in order to borrow cash from other financial institutions. For comparison, LIBOR represents the average rate at which select large banks can “fund themselves” in the wholesale, unsecured funding market. Another difference is that, as its name implies, SOFR is an overnight rate, whereas LIBOR traditionally has a term component to it (1-month LIBOR, 3-month LIBOR, etc.).


Let’s get a little more technical. SOFR is based off of repo transactions, which provide a way for an institution to borrow or lend cash for a specific period of time using financial securities as collateral. The repo transactions relevant to SOFR specifically focus on borrowing cash overnight collateralized by Treasury securities. As a result, movements in Treasury repo markets that affect SOFR are driven by the supply and demand for both loanable cash and Treasury securities.


The cash reserves of over 5,500 depository institutions that maintain accounts at the Federal Reserve Banks serve as a key source of loanable cash in the Treasury repo market. Prior to the financial crisis, banks were reluctant to hold excess cash reserves because those reserve holdings did not earn interest. Legislation that Congress enacted during the Great Recession gave the Federal Reserve the authority to pay interest on reserves. Accordingly, reserves that the banking system held at the Federal Reserve mushroomed from late 2008 to 2014 due to the quantitative easing that the Fed undertook during those years.


Reserves became an important component of high-quality liquid assets that banks must now hold as part of regulatory requirements post-Financial Crisis. These reserves held at the Fed are an asset of the banking system but a liability of the central bank. Banks moved towards willingly holding excess reserves in sizable quantities until the Federal Reserve began unwinding QE in October 2017 by allowing the Treasury securities and MBS that it owns to slowly run off its balance sheet, shrinking the asset side of the Fed’s balance sheet to shrink the Fed’s liabilities. As a result, reserves held at the Fed have receded by more than 50 percent over the past few years.


Treasury supply has increased roughly $2.4 trillion over the past two years, as the drop in bank reserves held at the Fed (a liability on the Fed’s balance sheet) was matched in part by a decline in Fed holdings of Treasuries (an asset on the Fed’s balance sheet). More influential on supply, securities outstanding increased as a result of the increase in the federal budget deficit. FY 2019 saw a budget deficit of $984 billion, an increase of more than 100 percent from just four years prior in FY 2015 ($439 billion).

The Urban Institute’s Housing Finance Policy Center has just published a new brief: The Termination of LIBOR: An Update on Implications for the Mortgage Market. You’ll find an examination of the status of the US mortgage market in preparing for the transition at the end of 2021 from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR) index; LIBOR is the index used to set interest rates on mortgages and millions of other financial contracts. There are signs of slow progress. The authors believe that many market participants will look to Fannie Mae, Freddie Mac, and their regulator, the Federal Housing Finance Agency, for guidance on how to handle the shift from LIBOR to SOFR with minimal disruption to the US mortgage market.

UK financial firms are increasingly confident of a smooth transition from Libor to the Sterling Overnight Index Average by the end of 2021. “The UK is leading the rest of the world on the transition, and its progress has been very good,” says an executive overseeing the switch at one UK bank.

Andrew Hauser, executive director for markets at the Bank of England, was quoted saying that banks should accelerate a move away from Libor. He said that haircuts will begin in October for Libor-linked collateral and that any such collateral issued after October will be ineligible for use at the central bank. The BoE will also begin posting a compounded Sterling Overnight Index Average index in July. “These initiatives are aimed at turbocharging sterling transition, helping the market deliver against its commitment to transition away from Libor and further de-risking sterling markets,” Hauser said.

Buckley LLP reported to clients on testimony from Fed Chairman Jay Powell on the upcoming transition from LIBOR to the Secured Overnight Financing Rate (SOFR), stating that federal regulators are working to ensure financial institutions are prepared for LIBOR’s possible cessation. “When asked whether Congress should ‘simply give the Fed the right to prescribe backup rates when the debt instruments do not do so,’ or explicitly adopt SOFR, Powell responded that he did not believe a federal law change is necessary at this time. Powell further responded that the Fed will inform Congress if a change in federal law is needed, emphasizing that the Fed’s ‘process is ongoing’ and that it is ‘committed to having the banks ready by the end of next year to switch. . .away from LIBOR in case [the rate] is no longer published.’ Powell noted that while SOFR will be the main substitute for LIBOR, the Fed is ‘working with regional [banks] and some of the larger banks, too, about the idea of also having a credit sensitive rate.’”

Two guys grow up together, but after college one moves to Maryland and the other to Miami. They agree to meet every ten years in Myrtle Beach to play golf and catch up with each other.

At age 32 they meet, finish their round of golf and head for lunch.

“Where you wanna go?”


“Why Hooters?”

“They have those gals with the cleavage, the tight shorts, and the gorgeous legs.”

“You’re on.”

At age 42, they meet and play golf again.

“Where you wanna go for lunch?”


“Again? Why?”

“They have cold beer, big screen TVs, and side action on the games.”


At age 52 they meet and play again. “So where you wanna go for lunch?”



“The food is pretty good and there’s plenty of parking.”


At age 62 they meet again.

After a round of golf, one says, “Where you wanna go?”



“Wings are half price and the food isn’t too spicy.”

“Good choice”

At age 72 they meet again.

Once again, after a round of golf, one says, “Where shall we go for lunch?”



“They have six handicapped parking spaces right by the door and they have senior discounts.”

“Great choice.”

At age 82 they meet and play again. “Where should we go for lunch?”



“Because we’ve never been there before.”

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Rob Chrisman