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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Our industry has seen quite a few margin increases in the past year or more, such that even with historically low index rates the higher margins are starting to reduce upfront funds available to seniors. We’re all aware of the consumer impacts, but what may be less intuitive is that margin increases by Fannie Mae may represent the reverse mortgage industry’s best chance at survival.
While it makes sense to think about how TARP and other stimulus programs might serve to assist the reverse mortgage industry, it’s also important that we consider the intermediate and long term perspective of surviving without becoming wards of the state at the mercy of political whims, as some recent recipients of federal money have belatedly discovered. In that light, let’s consider our current situation.
GNMA & Recycling Challenges
We as an industry presently have two primary mechanisms for recycling capital to make new loans: Fannie Mae’s whole loan purchase program and Ginnie Mae’s HECM MBS securitization program. Both provide an outlet for originators to sell loans, but what may be less well understood is why Ginnie Mae cannot yet replace Fannie Mae as the primary delivery vehicle for HECM loans.
While GNMA holds significant potential as an alternative source of capital to fund HECM loans and perhaps allow originators to earn premiums on subsequent draws by the borrower, there is a huge amount of risk to originators/issuers to use the GNMA structure for open ended loans, as the vast majority of HECMs currently are written.
Future draws by the consumer are priced for sale at current market prices, while the effective margin rate on that draw is fixed at time of closing by the originator/issuer. This disconnect means that originators who sell an open ended HECM that has not been fully drawn through a GNMA structure are taking on the risk of all future draws being priced at prevailing market prices when the borrower draws.
A simplified example to illustrate:
- Borrower A obtains a HECM Monthly in 2007 from Lender B. This Borrower draws $100,000 immediately from a $200,000 initial principal limit with a $350,000 maximum claim amount
- Lender B sells the initial draw of $100,000 through a GNMA structure to an investor and earns a 1% sale premium on the current balance, or $1,000
- 2009 rolls around and after seeing many investments decline by 50%, Borrower A decides to draw down another $100,000 to replenish short term cash.
- Lender B puts the additional draw of $100,000 into a new GNMA structure and offers it for sale to an investor
- Investor is currently paying 1% for HECM draws with a margin of 375, but what will they offer for a draw with a margin of 100? Let’s be generous and assume they’ll pay 95 – this still leaves the originator/issuer with a loss of $5,000 that more than offsets the initial profit from 2007 on this borrower’s loan.
If you were Lender B in this example, how likely would you be to consider the current GNMA a reasonable replacement for selling to Fannie Mae when Fannie Mae agrees to fund all future draws at par? Given this risk, it’s easy to see why Ginnie Mae has only been used by reverse lenders to date for fully drawn HECM loans, generally fixed and closed end loans.
Fannie’s Stiff (But Necessary) Medicine
So let’s consider what this really means for our industry. Simply put, the historical investor for the reverse mortgage industry (Fannie Mae) is under-water on every single active loan on a mark to market basis given that margins have increased dramatically in recent years. If Fannie Mae might be holding as much as $50 billion in HECMs, and we assume a similar 95 price in the current marketplace, even without taking into account balance sheet leverage and foreclosure costs, they could be staring down a multi-billion dollar problem.
Now we all know that Fannie Mae isn’t required to mark to market and has the financial resources to clear the market at whatever price they like. So why should they raise the margins and put their own balance sheet at risk? First, the federal government has required Fannie to shrink its balance sheet, and while our industry has had relatively favorable political support, there’s no reason to believe we should be exempt from that mandate. Secondly, while Fannie can clear the modest volumes of reverse mortgages at a price of its choosing now, if and when our industry grows we will eventually need additional investors at their marginal price to invest, so in light of that, Fannie’s pricing in isolation can’t truly be considered a ‘market’ price despite its ability to absorb current volumes. The reverse mortgage business has almost always been more ‘market to model’ than ‘mark to market’, and only additional investors can change that.
Now that we’ve seen the stark reality of the situation, let’s consider the path towards a solution for the industry. I think it’s pretty obvious given the above situation that the industry should count itself as very fortunate indeed to have enjoyed the support and backing of Fannie Mae for as long as we have, but should also make every effort to find additional investors to purchase growing volumes of product. As hard as it is to bear, the reality is that transition can mean only one thing: raising margins on reverse mortgage product to a level at which other investors become interested in holding reverse mortgage assets.
That is precisely what Fannie Mae has done, and I firmly believe that in the longer view we will be looking back on these trying times and tortuous margin increases fondly as the medicine that saved the patient. Where other segments of the broader financial services industry have caught major illnesses, what we’re going through is unsettling but no more than a stiff bout of flu in comparison.
There are early signs that investors are beginning to take a close look at reverse mortgages and may be ready to purchase in the near future, because after all, pensions and insurance funds can only park their money at 0% for so long without neglecting their core fiduciary/beneficiary obligations. HECMs, and particularly HECMs in a GNMA, represent a relatively high margin, government backed investment opportunity that stand to be an early beneficiary when investors do come out of hiding.
So at risk of looking foolish, we remain optimistic that Fannie’s painful margin increases are a positive development for the industy, even if they could have been handled somewhat less jarringly for reverse mortgage lenders.
There’s a lot to say about April, but the headlines will undoubtedly read that the industry set a second consecutive record for monthly endorsement volume, something we haven’t seen since early 2004. Total volume of 11,660 loans was up 3.5% from March and 21.9% from April 2008. YTD volume was also up 4.4% vs. ’08, the first positive reading on a YTD basis this year.
- Competition: The number of Active Lenders has stayed relatively flat despite the increase in volume, causing the average volume per lender to jump back into territory not seen since early last year. If this trend continues we expect we’ll have much happier readers, as this seems to be the most influential indicator we track when it comes to our clients’ relative happiness.
- Top 10: 8 of the top 10 lenders increased their volume in April, and One Reverse would have been up except for their ridiculously strong numbers in March. The industry heavyweights continued to take share, collectively representing 44.6% of YTD volume and 48.8% of April volume.
- Regions: The changing of the guard continues from a regional perspective, with Southeast/Caribbean and Pacific/Hawaii both flat to down, while several other regions charge ahead. Volumes were particularly strong in the NY/NJ and Mid-Atlantic corridor on the East Coast, while growth in the West continues to be about anywhere but the coast, as Southwest and Rocky Mountain regions produced. Midwest continues to quietly creep up on our leading regions, helped by strength in Chicago and surrounding areas.
- Metros: Lots of great stories to talk about in the metro looks, so be sure to check the report for full details. A few highlights:
- Greensboro is a great example of the divergence in the Southeast/Caribbean. Florida metros are struggling, while several other metros in the region are growing strongly. Greensboro stands out because there are relatively few lenders originating loans there, and though new lenders are entering the number of loans is still growing faster.
- If you can get licensed in New York, go originate as many higher limit HECMs as you can while no one else is paying attention. And if New York’s rumored 18 month licensing process is tying you in fits, check out San Francisco and the broader Bay Area in California for a very decent backup choice.
- Richmond continues to impress as the industry’ success in DC seems to be catching on regionally
- Des Moines is still small and could easily be ruined by too many lenders jumping in, but looks attractive for now
- The Twin Cities are starting to look like Chicago with less competition, and you can consider that a glowing recommendation!
- Texas and the Southwest are consistently strong across the board, with Houston as the only exception. Alburquerque and New Orleans are both growing well, but even Houston has a saving grace with relatively low competition.
When you’re ready to grow, contact us to find your best markets. Thanks for reading!
