Housing Market Won't Mind Libor's Lingering Around

 Housing Market Won't Mind Libor's Lingering Around

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Over $1 trillion worth of residential mortgages are estimated to have adjustable rates linked to the Libor benchmark.

Over $1 trillion worth of residential mortgages are estimated to have adjustable rates linked to the Libor benchmark.

Photo: Daniel Acker/Bloomberg News

The transition period away from the universal but tarnished funding benchmark, the London interbank offered rate, in the U.S. has gotten a bit longer for some loans. That will be mostly welcome news for many investors.

The typical investor’s exposure to the risks of a transition to a new benchmark aren’t terribly direct. Credit cards are typically floating-rate, but are often linked to the prime rate, not Libor—although the cost of funding for some card loans may be via securitizations priced in Libor terms. A subset of investors may own preferred shares, like those issued by banks, whose payouts are tied to Libor.

But a more common exposure is via mortgages. Over $1 trillion worth of residential mortgages are estimated to have adjustable rates linked to Libor. Funding for mortgage loans historically also is often Libor-based, via warehouse lines from banks, the securitization market or Federal Home Loan Bank advances. In addition to being home borrowers, many investors are now also betting on the mortgage business itself via stocks like rapidly growing and highly valued originator

For mortgages, a delay in the end of Libor might come at just the right time. U.S. regulators in November backed a proposal that while new debt still shouldn’t be linked to Libor beyond 2021, many existing debts can continue to reference it for another 18 months, through June 2023.

That means the transition period for many loans may be put off to a time when rates are less extraordinarily low, which could be a good thing. Right now there is relatively little demand for certain floating-rate mortgages or funding, which some analysts say has slowed the market’s evolution toward a new benchmark.

At historically low fixed rates, many existing homeowners are refinancing adjustable-rate mortgages into fixed ones, and many new buyers also are getting very favorable 30-year fixed rates. Adjustable-rate mortgages as a percentage of the number of weekly mortgages applications have dropped to below 2%, levels not seen since early 2009, according to Mortgage Bankers Association figures.

At the same time, banks have plentiful deposits right now and nonbank originators are flush with cash, reducing reliance on other forms of funding, particularly those at a floating rate. Analyst

Joseph Abate
in a recent note highlighted a related drop in demand for advances from Federal Home Loan Banks used to fund mortgage lending, depressing the use of advances linked to the new benchmark, the Secured Overnight Financing Rate, or SOFR.

Should the system become less flush with cash next year as conditions normalize, Barclays analysts forecast that FHLB advances linked to SOFR could jump from less than $10 billion to $100 billion by the end of next year. That would help with the further development of the broader SOFR market, Barclays argued.

Mortgage lenders and servicers will still have to learn whether the move to new benchmarks will affect borrower demand or cause complaints. But testing a new system now, while demand for many floating-rate loans is low, and then allowing more of the transition to play out in a different rate environment should promote a smoother transition.

Write to Telis Demos at telis.demos@wsj.com

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