By the Numbers
FHA LIBOR reverse mortgages will transition to SOFR
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More than half of outstanding reverse mortgages adjust monthly or annually based on LIBOR, an index that goes away in mid-2023. The Federal Housing Administration plans to index these reverse mortgages to SOFR after that time, consistent with most other mortgages and mortgage-backed securities that use LIBOR. Although there is still some ambiguity about Ginnie Mae’s plans, it is most likely that pools of reverse mortgage loans will also transition to SOFR, accruing and passing through cash flows in sync with the loans.
FHA reverse mortgages—called Home Equity Conversion Mortgages, or HECMs—are available with fixed and floating rates, although floating-rates have been the more common type since 2013. Most floating-rate HECMs floated off monthly or annual LIBOR until the FHA stopped originating those loans in early 2021, although issuance of LIBOR-indexed reverse mortgage pools continues since borrowers can draw additional funds using existing loans. LIBOR-indexed loans account for more than 50% of outstanding HECMs (Exhibit 1).
Exhibit 1: Outstanding FHA reverse mortgage balances
Source: Ginnie Mae, Amherst Pierpont Securities.
The FHA plans to transition all LIBOR-indexed loans to SOFR when publication of LIBOR ends on June 30, 2023. But there is some ambiguity regarding whether it will use a forward- or backward-looking SOFR-based index. The FHA is relying on authority granted by the Adjustable Interest Rate (LIBOR) Act of 2021 to alter the index on these loans, since some reverse mortgage notes do not specify how to handle a discontinued index. The act recommends that consumer loans like HECMs should be indexed to forward-looking term SOFR plus a spread specified in the law. But the FHA intends to use compounded 30-day SOFR—a backward-looking measure—for any loans originated using a SOFR index. It seems unusual that the same program would use different SOFR indices. Furthermore, the amendment to the federal code states that loans “…must be transitioned to the spread-adjusted SOFR replacement index approved by the Secretary…”, which suggests that the specific index has not been selected. More information on the LIBOR Act and the LIBOR transition can be found here.
Although the FHA has allowed origination of SOFR-indexed loans since last year, Ginnie Mae is not yet able to pool them. So most, if not all, HECMs have been originated indexed to a constant maturity treasury (CMT) yield. Originators and borrowers seem satisfied with monthly floaters that reset to 1-year CMT so there may not be much demand for new SOFR-indexed loans. Ginnie Mae has also not stated what happens to the cash flows for existing LIBOR pools after the loans transition to SOFR. Presumably the pools will also transition to SOFR in conjunction with the loans, so that Ginnie Mae and investors do not face any basis risk.
The FHA also plans to limit the lifetime interest adjustment on reverse mortgages that reset monthly to no more than 5% higher or lower from the rate at origination. Currently originators can select any amount, and most use either 5% or 10%. The lower cap benefits borrowers and the FHA, since a higher accrual rate when interest rates are high causes loan sizes to increase faster. Servicers can make an insurance claim and assign a loan to the FHA when the loan accrues to 98% of its maximum claim amount—the amount the FHA insured. Slowing the accrual rate will delay those assignments and maintain more capital in the insurance fund.
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