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Untitled Document
Mortgage Movements: Transitioning from LIBOR to SOFR
The London Interbank Offered Rate (LIBOR) has been a cornerstone of the fixed income markets since its introduction in January 1986. It has been called “the most important number in finance,” forming the basis for interest rates on an estimated $350 trillion of floating-rate bonds, fixed-income derivatives, and other financial products. During the financial crisis, however, LIBOR was marred by the discovery of rate manipulation scandals involving many of the key banks that set its value each day.

In the wake of these scandals, global regulators last year mandated a transition from LIBOR to a series of newly created short-term indices, including (for US dollar assets) the Secured Overnight Funding Rate (SOFR). Based on actual market transactions in the highly liquid and resilient Treasury securities overnight repo market, SOFR is designed to be a more tamper-resistant indicator of short-term interest rates than LIBOR. However, while LIBOR is nominally a direct representation of unsecured bank borrowing costs across a range of short-term maturities, SOFR is fundamentally a narrower representation of overnight borrowing costs against risk-free assets. A LIBOR-SOFR basis thus arises, essentially representing the market-estimated credit risk premium for unsecured debt of large banks. This transition to SOFR has implications for originators, investors and servicers across the fixed income markets, including the mortgage industry.

On the single-family asset side, ARMs constitute 7.2% of new conventional mortgage originations nationwide, according to data from Ellie Mae. That figure can be even higher regionally; for example, ARMs constitute 22% of all home mortgages outstanding in Connecticut. Because a large proportion of those ARMs are LIBOR-indexed, the transition from LIBOR to SOFR may imply substantial shifts in the daily operations of many retail mortgage servicers.
The effect will be even more pronounced in the multifamily and commercial mortgage industry, where variable-rate loans constitute even more of the lending market, and hedging instruments such as LIBOR-based interest rate swaps or caps are commonplace.
On the liability side, both single-family and commercial real estate mortgage servicers often fund their operations through LIBOR-based debt obligations, while the financed assets themselves may be fixed-rate or may reference other interest rate indexes.
Operational Changes
The shift from LIBOR to SOFR implies operational changes across the financial services industry – some obvious, others subtler. In the mortgage industry, these will include:

Developing a comprehensive inventory of existing LIBOR-indexed assets and liabilities
Portfolio-wide assessment of loan and derivative contract language provisions for LIBOR transition or unavailability
Modification and validation of procedures for calculating interest due on LIBOR-based assets
Measurement and recalculation of basis risk for non-LIBOR/SOFR assets funded by LIBOR/SOFR liabilities
Design, implementation, and validation of modifications to interest rate risk management models, stress testing, Value at Risk, and similar calculations and procedures
How Signet Partners Can Help
With over thirty years of experience in the financial services industry, Signet Partners can help public- and private-sector financial institutions navigate their compliance, business process development, and risk management needs. Our seasoned professionals offer decades of direct, proven experience in the mortgage finance and financial risk management industry, including:

Forensic examination and review of multibillion-dollar loan portfolios on behalf of federal agencies including the Federal Deposit Insurance Corporation and Small Business Administration;
Providing capital markets expertise in senior roles at the Treasury Department’s Troubled Asset Relief Program (TARP) and Federal Housing Finance Agency, including forensic work on LIBOR;
Structuring and origination, including modeling, documentation, and marketing, of nearly $5 billion in LIBOR-based investments;
Development and validation of interest rate and liquidity risk models for transactions and portfolios at regional lenders, global banks, and leading private equity firms.
To complement our in-house capabilities and expertise, Signet Partners also teams with leading-edge modeling and data analytics providers to provide clients with integrated financial risk management solutions. We are a small business that has served public- and private-sector clients in the financial services industry since 1988. With offices in metropolitan Denver, Colorado and Washington, DC, Signet Partners offers a focused suite of services that include:

Review and oversight of compliance and risk management for financial asset portfolios, real estate (commercial, multifamily, and residential), and federal financing programs;
Analysis, design and implementation of business processes;
Financial and transaction advisory and structuring services.
We have been institutional investors, project managers, consultants, quantitative analysts, and federal regulatory officials. In these roles, our experience spans a wide range of relevant activities, including structuring and marketing of investment funds; oversight and review of federal initiatives; and valuation and compliance oversight of fixed income portfolios. Signet Partners offers focused, relevant expertise at the intersection of public- and private-sector investment from the perspective of every seat at the table.