Interest rates on certain consumer financial products including mortgages, credit cards, home equity lines of credit, reverse mortgages and student loans rely on LIBOR as the benchmark rate to compute the interest rate consumers should pay. To prepare for the discontinuation of LIBOR at the end of 2021, industry bodies such as the Alternative Reference Rates Committee (ARRC) and regulators such as the Securities and Exchange Commission (SEC), Consumer Financial Protection Bureau (CFPB) and Federal Reserve have been providing frequent guidance to financial institutions to spur them to action by taking measurable and logical steps to promote consistency and transparency to parties impacted.
On August 18th, 2020, the ARRC released the LIBOR ARM Transition Resource Guide and the Legacy LIBOR-Based Private Student Loan Transition Resource Guide.1 Both documents focus on how to plan for remediating LIBOR-based contracts, as this rate will cease to exist after the end of 2021. The LIBOR ARM Transition Resource Guide is focused on adjustable rate mortgages and home equity products benchmarked to LIBOR, and the Student Loan Guide is focused on variable rate student loans based on LIBOR.2 Both guides were developed by the ARRC’s Consumer Products Working Group and reflect the ARRC’s efforts to develop recommended remediation actions, tools and resources for all stakeholders, with special consideration for effects on consumers/borrowers.3
What this means
The ARRC has been providing recommendations, guidance and checklists to help financial services firms make a thoughtful and timely transition of legacy impacted contracts to mitigate the risk of adverse consequences to bank issuers of Residential Mortgage-Backed Securities and Asset-Backed Securities (RMBS/ABS), their buyside counterparty investors and underlying customers/borrowers. The ARRC has also provided high level milestone dates for key transition events with the goal of ushering along financial services firms to engage with impacted stakeholders incrementally and in a phased approach via a methodical plan and well in advance of key transition dates.
For many underlying residential mortgage loan or line of credit borrowers as well as student loan borrowers the shift to a new alternative reference rate for their loan is not self-evident and may be confusing despite a lack of action required on their part to effectuate the transition. Thus, borrowers should be engaged early in the process with timely communications clearly explaining the demise of LIBOR and in summary, the changes to their loan (i.e., what the index is expected to be and how interest is to be calculated, options to pay off loan, re-finance to a fixed rate or allow the loan to transition to the new replacement rate).
Both the LIBOR ARM Transition Resource Guide and the Legacy LIBOR-Based Private Student Loan Transition Resource Guide include key milestones and timeframes, roles and responsibilities of stakeholders impacted, and associated guidance and tools. These practical guides offer a framework to assist stakeholders in thinking through impacts related to the transition from LIBOR, both operational and for consumers and provide potential examples and templates for stakeholders to consider and use.
- LIBOR ARM Transition Resource Guide Recommended Activities:4
- Establish key milestones and recommended readiness timelines to support the transition, include borrower communications and activities related to selecting a LIBOR replacement index.
- Assess impacts by stakeholders as there is no “one size fits all” across lenders and borrowers.
- Complete contract reviews and analyze all LIBOR ARM and ARM-related loan and contract documents.
- Develop LIBOR transition plans to establish milestones, execution and tracking, communication with borrowers, together with client education and index change notification. Actively manage the transition through program structure and governance.
- Choose a replacement index, and determine at the loan, contract or investor level who is to be responsible for operationally enacting the change and communicating decisions.
- Determine whether Federal or State regulatory requirements are relevant.
- Execute communication and education plans.
- Legacy LIBOR-Based Private Student Loan Transition Resource Guide Recommended Activities:5
- Inventory all LIBOR-based private student loan exposure, and quantify loan exposure in tenors, dollars and units.
- Assess LIBOR-based contracts and identify stakeholder responsibilities, and review trigger and fallback language.
- Assess operational, technical and cost impacts, and identify the timeline of changes needed to support borrower disclosure and notifications.
- Develop a LIBOR transition plan for implementation, communication and education.
- Choose a replacement index, and assess at the loan, contract or investor level who is to be responsible for selecting and providing approval for the replacement rate at the operations level.
- Establish what regulatory provisions are relevant at the State and Federal level.
- Execute communication and education plans.
While the ARRC is urging financial institutions to proactively commence transitioning their legacy RMBS and ABS contracts to the new reference rates, these recommendations do not constitute binding rules. Furthermore, each institution should decide what is relevant and the best approach given its size and complexity. Notwithstanding, this guidance should help market participants manage their efforts and effectively transition from LIBOR with less potential disruption.
As the deadline for transition nears and interim milestones for RMBS and student loans come up this year, firms need to stay disciplined and vigilant in planning and executing on the host of legal and operational considerations, many of which can be commenced now to mitigate adverse risks arising from the transition such as customer complaints, and unnecessary Unfair or Deceptive Acts or Practices (UDAAP) violations, among others.
How Accenture can help
To help firms respond to the LIBOR discontinuation, the following actions are recommended:
- Undertake a Health Check: Conduct an analysis of the organization’s current transition readiness including understanding of consumer credit and product impacts, current capabilities and known gaps, and preparedness for change activities.
- Ready Production Controls Program: Develop and implement an action plan to transition existing portfolio of consumer credit loans, including adjusting, developing and testing/stressing control programs.
- Ready Data and Reporting: Develop and make available proper and resilient decision-making tools and dashboards with a specific focus on consumer protection.
- Prepare People: Make sure the transition plan is understood and checked, third parties are equipped to adopt the changing requirements, customers are notified, and employees are educated in new controls and processes.
- “ARRC Publishes Transition Resource Guides for Adjustable Rate Mortgages and Private Student Loans – Guides Supplement Broader Transition Execution Plans to Facilitate Efforts to Move Away from LIBOR,” Alternative Reference Rates Committee, August 18, 2020. Access at: https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC_Press_Release_PSL_ARMs.pdf.
- “LIBOR ARM Transition Resource Guide,” Alternative Reference Rates Committee, August 18, 2020. Access at: https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/LIBOR_ARM_Transition_Resource_Guide.pdf.
- “LIBOR-Based Private Student Loan Transition Resource Guide,” Alternative Reference Rates Committee, August 18, 2020. Access at: https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/Legacy_LIBOR-Based_Private_Student_Loan_Transition_Resource_Guide.pdf.