HUD Signals HECM Future
May 10, 2009
If you haven’t seen the recent Obama budget request for $800 million for the HECM program, the basics have been covered well over at RMD. What you might still be wondering though, is what does it really mean and how can the numbers possibly be that large. We’ll tackle both of these in today’s article, although I’ll admit it’s going to be a little longer read than our usual.
Two Options
For those of you who were fortunate enough to not major in accounting, there are two different possibilities here in how to interpret the request for $798 million as a specific dollar amount for the HECM program. The first is as a current year cash need, which would rightly cause much more alarm for our industry but in our opinion is the far less likely scenario, and the second is a non-cash insurance funding requirement. To illustrate the difference between the two, let’s do a quick breakdown of the numbers on each:
Current Year Cash Numbers
The first step in the calculation is to identify the sources of current year cash income for the HECM program.
Assumptions:
- 120,000 new (non-refi) HECMs endorsed in FY2010 at an average Max Claim Amount (MCA) of $250,000, for a total new endorsed MCA of $30 billion and Initial Mortgage Insurance Premium (IMIP) of $600 million
- 10,000 refi HECMs endorsed with average incremental MCA of $125,000, generating another $1.25 billion in MCA and $25 million in IMIP
- There are 408,000 endorsed HECMs in servicing today, with roughly $41.9 billion outstanding, which would generate $210 million in Monthly Mortgage Insurance Premium (MMIP)
- Together that equals $835 million in total MIP for the year, plus the subsidy request equals $1.632 billion in available cash to the program in FY2010
Taken together, this billion dollar warchest can pay a very substantial amount of claims for foreclosures. So let’s boil it down:
- Let’s assume 10% of current HECMs outstanding will terminate in FY2010 (40,800 loans)
- Let’s be generous and further assume that 50% of these incur losses where the loan balance is greater than the property value at termination
- Even with both of those assumptions, the average loss on each ‘bad’ loan works out to almost $80,000
- That’s a pretty high number when most forward portfolio estimates put a comparable number at $20,000-40,000
- It’s really high when you consider the average balance of HECMs right now is $103,000
If this were the case, not only would the program have some serious issues staying solvent, but the subsidy requests such as this one would stretch as far as the eye can see. Negative headlines this year will seem like a cakewalk compared to the years of bad press that would generate.
Let me reiterate that we don’t believe this scenario is actually what’s happening here, but it’s a useful exercise to put our industry in real-world terms that each of us can understand and consider what a worst case scenario might look like.
Insurance Accounting
The more likely scenario, in our opinion, is that HUD is recognizing that their new home price assumptions cause a shortfall in the expected future claims they’ll see and are prudently reserving against that eventuality. Leaving aside the discussions about government trust funds invested in government securities (Social Security being the most prominent example), the basic difference here from the above example is that the losses could be spread out over more loans over more years to equal the need for an additional subsidy request.
The key question here, however, is whether this subsidy is a catchup for all loans currently active or just the loans originated in FY2010. It might seem like a small point, but it has huge implications.
- If this is a catch up then HUD is telling us that moving from their old assumptions to their new assumptions caused perhaps a 15% increase in the level of insurance premiums needed for the program. ($798 million request divided by an estimated $6 billion in total MIP collected by HUD over life of program)
- If it’s just for loans originated in FY2010, that means the current insurance premiums being charged would have to almost double to pay the expected claims ($798 million request divided by estimated $600 million IMIP and $200 million MMIP for FY2010 loans over their expected life)
The first option is uncomfortable but manageable, while the second is downright scary. Assuming we don’t expect a lifetime of government handouts for our industry, can anyone think of how seniors might react to the FHA insurance premiums doubling? It’s already the largest line item on every single loan.
Real World Implications
So what does this mean to all of us that make a living in an industry providing a product that gives seniors the flexibility to live life on their own terms with their own assets?
- HECM LTVs are likely to be reduced. We think this is the single biggest takeaway from the subsidy request, and the most likely reaction to a cash need by the program. We don’t have any inside information, but it just makes sense – unless you think there’s a lot of additional room to raise the MIP.
- The only good news to a HECM LTV reduction is that it would actually make the product more attractive to the secondary market and servicers. This is because the loans would be expected to generate interest and service fees for a longer time before hitting the 98% assignment option. It would be a very bitter pill to swallow, even moreso than the Fannie Mae margin increases in our opinion, but if you have to find a silver lining this seems like it.
- There may be a public perception issue here as well. If the industry is seen as existing only because the rest of society is subsidizing it, there’s real danger that seniors might interpret that as unsustainable or at least uncertain when making a financial decision they could be living with for decades.
Given the number of unknowns here, particularly with respect to the cash vs. insurance and FY2010 vs. total portfolio questions, and the sizeable potential for these issues to affect our industry’s future, we’ll keep a close eye on this and let you know if we see anything further on this topic.
If you think we’ve missed something or have additional thoughts to share, don’t be afraid to contact us or comment below.
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Mr. Lunde,
The data presented is VERY interesting and valuable. However, your approach to explaining a HUD budgetary request is suspect. What is needed is a thorough explanation of the budgetary process, the accounting results of the ongoing results from losses incurred, and some analysis of the assumptions HUD uses in determining reserves, future losses, etc. I hope Peter Bell is right when he says that these issues are being addressed at the NRMLA regional conferences.
I also have difficulty with the assumptions used in reaching conclusions. For example you conclude that investors will like lower LTVs because it will extend the period before the assignment option is reached. It is my impression that investors prefer liquidity and would more readily invest if the payoff periods were shortened.
Your financial ratio analysis is superb when it comes to the data you produce monthly. Again I say it is superb; however, such techniques are suspect when analyzing HUD budgetary matters.
I don’t understand your calculations. Why are you only using this year’s revenue to pay next years claims? From what I understand, HUD has paid almost no claims until now, so they should have many billions of dollars saved up for the possibility of future claims. I think that even if they have the 3 billion in claims that you assume they could, it certainly will not be that high every year. At some point in the future, claims will drop as home prices will, at some point rise, and premiums will continue to add to the reserve fund for them.
Whatever this cost to Taxpayers, the FHA HECM program is a
lot cheaper than paying for nursing home care thru Medicade.
Society in a decent civilization takes care of the aged.
We just have to get the thieves, cheats, and other scoundrels out of the system. Recently, I was informed Medicare is cheated out of sixty billion dollars a year on fraudlent durable medical equipent sales alone. Checks in
amounts as high as a half a million dollars monthly mailed
to P.O. Boxes or empty offices. Most Seniors have worked damn hard for what little they have at life’s end–chiefly home equity. Seniors didn’t cause the current home value problem, greedy bankers and unscrupulous mortgage people did. The situation will turn-a-round and this Country will be the better for the turmoil.
Thanks for the great comments. We’re always interested in hearing other people’s viewpoints on these complex subjects!
To Mr. Veale’s points, I would love to have enough information to do a thorough explanation of the assumptions behind the budgetary request, but that information does not exist in the public domain to my knowledge. I also think the suggestion Mr. Veale has made before of an annual report on the HECM MIP fund balance sheet, income/expenses and cash flow would be very enlightening for all involved in the industry.
As to whether investors would favor a shorter duration product or longer, it might be a toss up since there would undoubtedly be those favoring each side. From a pure economic value perspective I guess it would come down to discount rate and leverage ratios, but the investor’s profile and appetite would likely rule the day.
To Mr. Pinter’s question – We actually analyzed two different possible methods of accounting for the MIP funds because it’s not clear to us which is being used. Under a cash perspective, HUD would have access to only the current period cash flows in to pay cash flow needs out. Your point with respect to prior MIP funds paid in is absolutely relevant and comes into play under an accrual/insurance perspective. We expect there has been roughly $6 billion in MIP collected by HUD over the 20 year program life. In any scenario, the taxpayers, seniors and industry all deserve an accounting of that money.
Mr. Nelson makes a different argument entirely about the cost of possible HECM subsidies vs. alternative funding methods for seniors. We love our parents and grandparents as much as anyone else, but we’ll stay away from the political dynamite there since we don’t have any special insight into costs of healthcare or other government programs.
We have no doubt that seniors need to have options to fund their basic needs and our country will pull through the current downturn.
Nice job John, as always.
The only insite you need, John, is the cost of a month’s care at your local nursing home: that is, if even a bed is available. You young people astound me–the whole reverse mortgage industry is wound up in politics. Life itself revolves around politics; it just isn’t a bunch of numbers.
The information presented here is indeed interesting. I still insist that a fundamental understanding of the mechanics of the HECM program is required as well as the regulatory budget requirements involved. In the article I presented at RMD, I tried to cover both even those the mathematical assumptions are a little daunting. I will not repeat it here but for reference can be found at:
http://reversemortgagedaily.com/2009/05/07/obama-administration-requests-798-million-to-aid-reverse-mortgage-program/#comment-27124
Now some folks have taken a look at evaluating the HECM program financial requirements. Specifically the study in 2003 by David T. Rodda, titled “Refinancing Premium,
National Loan Limit, and Long-Term Care Premium Waiver for FHA’s HECM Program”, in which both a stochastic and non-stochastic analysis of the program is carried out with significant stress tests. The results (with HECM data up to that time frame) still showed the program with a negative liability. It would nice to conduct the same study but with the most recent data. Again the program must still be examined under the long term view and not just a few years.
As for the accounting requirements you must look at the US title code 12 CHAPTER 13,SUBCHAPTER V, § General Insurance Fund,paragraph (c) I quote:
“(c) Deposit or investment of moneys; purchase of debentures
Moneys in the General Insurance Fund not needed for the current operations of the Department of Housing and Urban Development with respect to mortgages and loans which are the obligation of the General Insurance Fund shall be deposited with the Treasurer of the United States to the credit of such Fund, or invested in bonds or other obligations of, or in bonds or other obligations guaranteed as to principal and interest by, the United States or any agency of the United States: Provided, That such moneys shall to the maximum extent feasible be invested in such bonds or other obligations the proceeds of which will be used to directly support the residential mortgage market.”
As I mentioned in the article in RMD if the HECM program is still under the GI fund then by statue the surpluses of year past were deposited to the Treasury and indeed there may be shortfall in the coming years and thus a “subsidy” is required. If the program would have kept the surpluses (ie reserves from all years past) this “subsidy” may have not been required. It is a contradiction that the program was designed to be sustainable over a long period of time, and not from a year to year basis as the bean counters in the OMB are doing. Another example of the left hand not doing what the right hand is doing in government. You would need a completely different algorithm if you were to make an insurance fund of this type sustainable (break-even) on a calendar year basis.