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A N 8 D 8 B 18 AR CE WWW. NYLJ.COM SIN VOLUME 265!NO. 100 WEDNESDAY, MAY 26, 2021

Outside Counsel LIBOR Transition for RMBS and Other LIBOR-Indexed Securitizations

uch has been written over Generally, the interest paid to investors the past decade, in this in a securitization trust is not tied to

journal and elsewhere, By (although it certainly correlates to) the about the manipulation John M. interest rate borrowers agreed to pay Lundin of the London Inter-Bank in their mortgage notes. Rather, the MOffered Rate (LIBOR) and the subse- rates paid to investors are set in the quent decision to end its use as a securitization document and vary by benchmark interest rate. This article the amount of risk an investor is willing addresses the challenging issue of securitized into RMBS trusts. When a to take using sometimes-complex pay- LIBOR transition—that is, moving from lender makes a home loan, the loan typi- ment waterfalls. For many older trusts, LIBOR to another benchmark rate—for cally is secured by note and a mortgage. the interest rate paid to investors was asset-backed securities such as resi- The notes often have variable interest indexed to LIBOR. dential mortgage-backed securities rates. In the run-up to the 2008 !nan- Because crisis-era mortgages still (RMBS). RMBS is one of a class of assets cial crisis, residential mortgage notes— are outstanding, the residential mort- that face the complication of two levels and particularly sub-prime residential gage-backed security trusts into which of transition: LIBOR-indexed mortgage mortgage notes—often were indexed notes that are assets of an RMBS securi- to LIBOR. This means that the annual These uncertainties invite legis- tization trust, and LIBOR-indexed inter- interest rate the borrower paid was lative solutions and some have est rates paid on the securities issued not set at a !xed number but instead been adopted (more are pro- by the securitization trust. as LIBOR plus an additional percent- posed) to the problem of LIBOR age, such as LIBOR plus 3%. As LIBOR LIBOR-Indexed Mortgage Lending transition in securitization trusts. changed, the rate the borrower paid and Securitization was (at agreed time intervals) changed. those loans were securitized continue To understand the challenge, !rst In an RMBS securitization, these to exist. That means that there are and consider how residential mortgages are notes and mortgages (among other will be for years to come LIBOR-indexed rights relating to the loans) are trans- mortgage notes securitized in trusts ferred to a securitization trust. The paying LIBOR-indexed interest to inves- JOHN M. LUNDIN is a partner at Schlam Stone & Dolan. HANNAH ZELCER of Schlam Stone & Dolan, trust pays for the loans by issuing tors. If LIBOR ceases to exist, what is CHRIS MILNER of the Oakleaf Group and JOSHUA securities entitling holders to a share the interest rate that borrowers must STEIN of Joshua Stein PLLC assisted in the drafting this article. of the revenue generated by the loans. pay to the RMBS trust on their home WEDNESDAY, MAY 26, 2021 loan and what interest rates must the used this LIBOR de!nition and fallback language in securitization documents. trust pay to investors on the securities language: Since there are many fewer RMBS secu- it issued? That is the LIBOR transition The “Index" is the average of inter- ritization trusts than the many millions challenge facing many RMBS and other bank offered rates for one month of mortgage notes, it should not be LIBOR-indexed asset-backed securities. U.S. dollar-denominated deposits in unduly burdensome for a trust to deter- the London market ("LIBOR"), as mine how it is supposed to pay inves- LIBOR Transition and LIBOR- published in The Wall Street Journal. tors if LIBOR no longer is available. Indexed Mortgage Notes The most recent Index !gure avail- The de!nition of LIBOR in the pooling The initial level of complication in able as of the date 15 days before and servicing agreement for a typical the LIBOR transition occurs with the each Interest Rate Change Date is RMBS securitization trust, ABFC 2006- mortgage notes. It was common for called the "Current Index". If the OPT1, explains what the trustee is to mortgage notes to provide for LIBOR Index is no longer available, the do if LIBOR is not available, offering a being unavailable, but that still makes Note Holder will choose a new index waterfall of choices based on the infor- LIBOR transition complicated, particu- that is based upon comparable mation is available to the trustee. larly for securitized loans. information. The Note Holder will “One-Month LIBOR”: With respect First, many lenders use the Fan- give notice of this choice. The Note to each Interest Accrual Period, the nieMae/FreddieMac standard note Holder will deliver or mail to me rate determined by the Trustee on template, and that template contains [Borrower] a notice of any changes the related LIBOR Determination LIBOR replacement language that com- in the amount of my monthly pay- Date on the basis of the interbank monly was used in mortgage notes. ment before the effective date of offered rate for one-month United Even though most mortgage notes any change. States dollar deposits in the London used the FannieMae/FreddieMac LIBOR Here, once LIBOR ceases to be pub- market as such rate appears on the replacement language, at some point lished, the trustee of the securitization Telerate Page 3750, as of 11:00 a.m. soon, trustees and servicers will have trust, as the owner of the note, gets to (London time) on such LIBOR Deter- to analyze every mortgage note to make “choose a new index that is based upon mination Date. If such rate does not sure that they know, for every loan, how comparable information.” This is great appear on that page (or such other the interest rate on that loan will be for the trustee, perhaps not so much for page as may replace that page on affected by the end of LIBOR. the borrower. Even more, “comparable that service, or if such service is The question for investors (and information” is a vague term that is sure no longer offered, another service homeowners, of course) is what to to be the subject of litigation. There are for displaying One-Month LIBOR or do if trustees and servicers forgo that legislative solutions (both adopted and comparable rates as selected by the expensive and time-consuming process proposed) to the problem of litigation Trustee) on a LIBOR Determination and just work off the assumption that over the trustee’s choice of a replace- Date, One-Month LIBOR for the all notes use the LIBOR replacement ment rate that offer answers to this ques- related Interest Accrual Period will language in the FannieMae/FreddieMac tion. However, uncertainty—and hence be the Reference Bank Rate, deter- standard note template. substantial litigation risk—remains on mined by the Trustee as follows: Second, FannieMae/FreddieMac have the ultimate scope or effectiveness of (i) If on such LIBOR Determination adjusted their standard note template those legislative solutions. Date two or more Reference Banks and policies to account for the LIBOR provide Reference Bank Rates, LIBOR-Indexed Payments to RMBS transition and, as of the end of 2020, One-Month LIBOR for the related Investors no longer offer LIBOR-indexed prod- Interest Accrual Period shall be ucts. Prior to that, however, the Fan- As with individual mortgage notes, the arithmetic mean of such Refer- nieMae/FreddieMac standard note form there is no standard LIBOR fallback ence Bank Rates (rounded upwards WEDNESDAY, MAY 26, 2021

if necessary to the nearest whole In addition, the multi-level aspect And, of course, uncertainties create the multiple of 0.001%); of the securitization creates potential potential for litigation and its attendant (ii) If on such LIBOR Determina- mismatches between the interest rate costs (including depletion of the trust tion Date fewer than two Refer- paid on a trust’s assets and the interest estate to pay the trustee’s legal fees) ence Banks provide Reference rate paid to the trust’s investors. To the and delay. Bank Rates, One-Month LIBOR for extent stakeholders in the trust struc- Other Securitized Assets the related Interest Accrual Period ture, such as the trustee or servicer, shall be the arithmetic mean of the have discretion to choose what the This article focuses on RMBS, but rates quoted by one or more major LIBOR replacement rates will be, it is similar LIBOR transition issues exist banks in New York City, selected by an open question how they will exercise with other securitized or structured the Trustee after consultation with that discretion and for whose advan- assets, such as commercial mortgage- the Depositor and the NIMS Insurer, tage they will exercise it. Adding to the backed securities and collateralized as of 11:00 A.M., New York City time, complexity, who will bene!t and how loan obligations. on such date for loans in U.S. Dol- will vary depending on many factors, Conclusion lars to leading European banks for a period of one month in amounts These uncertainties invite legislative The initial level of complication approximately equal to the aggre- solutions and some have been adopted gate Certi!cate Principal Balance in the LIBOR transition (more are proposed) to the problem of the Offered Certi!cates and the occurs with the mortgage notes. of LIBOR transition in securitization Class B Certi!cates; and It was common for mortgage trusts. They offer some solutions to (iii) If no such quotations can be notes to provide for LIBOR being the issues discussed above, but uncer- obtained, One-Month LIBOR for the unavailable, but that still makes tainty—and hence substantial litigation related Interest Accrual Period shall LIBOR transition complicated, risk—remains on their ultimate scope be One-Month LIBOR for the prior particularly for securitized loans. or effectiveness. I expect to address Distribution Date. those legislative responses in a future This LIBOR fallback language—which including the status of the securitiza- article. is common—is well-suited to the situ- tion trust and of each class of securities ation where LIBOR is temporarily issued by the trust, the design of the unavailable, but not to the situation trust’s payment waterfall, whether the we now face, which is that LIBOR will trustee also is a security-holder, and permanently be unavailable. In particu- who has the right to do a clean-up call lar, clause (iii) means that variable-rate (that is, the right to purchase all of the securities would become fixed-rate trust’s assets). securities, with the rate permanently Uncertainties in the LIBOR transi- set at the LIBOR rate last used by the tion—whether because of the right of trust before LIBOR terminated. players in the trust structure to exer- It is uncertain what trustees will do cise discretion or because of questions with this language, and this, coupled about how laws passed to facilitate the with the uncertainty associated with transition will (or can) be implement- how LIBOR transition will be handled ed—will impact how asset-backed secu- for each mortgage note, creates a dou- rities should be valued and whether Reprinted with permission from the May 26, 2021 edition of the NEW YORK ble dose of litigation risk and valuation such uncertainties create !nancial risk LAW JOURNAL © 2021 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-256-2472 questions for RMBS owners. or, alternatively, trading opportunities. or [email protected]. # NYLJ-05262021-493725