As you all no doubt have noticed, the $798 million FY 2010 HUD subsidy request for the HECM program is the story that won’t (and shouldn’t) die. We just read another interesting article over at Reverse Mortgage Daily and since we don’t mind stirring the pot a bit occassionally, thought we’d chime in.
The article focuses primarily on the foreclosures HUD is experiencing on HECMs written in California, Florida, and other particularly hard hit corners of the national real estate market. While the article is a bit short on hard numbers (How many foreclosures? How big a loss for the HECM insurance fund?) and only indirectly refers to topics of interest like the $798 million subsidy request (still working its way through the political machine) and default/foreclosure policies for HECM (will HUD start enforcing T&I defaults through foreclosure), it brings up another interesting opportunity.
We’ve stated here before that the FY 2010 HECM subsidy request has nothing to do with HECMs endorsed in prior years, but it bears repeating given that this was one of the first questions in the article comments.
Why Actuals Aren’t As Important As Forecasts
We and others have been passionate (as much as you can be about accounting) about seeing a full audit of actual claim experience on the HECM program, but it’s important to also understand that this isn’t a silver bullet to the current subsidy challenges.
While FHA does periodically publish some information about their actual claims activity (including a great presentation that we’ve reposted here for ease of reference), let’s keep in mind three big challenges when dealing with this data, even if they did publish everything that happened thus far:
1) There are still loans active from very early years of the program, including 1990.
2) Until all loans are resolved for a few high volume years, we won’t have a satisfying ‘actuals’ answer as we’ll always have to rely on projections -the industry didn’t generate enough volume to be statistically reliable until much more recently and it takes 20+ years to have all the loans resolve.
3) Even if we had a high volume year fully resolved to rely on, it isn’t likely to provide nearly the satisfaction that we might expect simply because the one thing everyone can be sure of is that home price changes in the future won’t mirror the past.
So at the end of the day this is always going to be a forecasting exercise no matter what we do, and while we can feel more comfortable with more data/experience to rely upon, we’re just going to have to get used to being wrong when we try to predict the future.
Forecast Errors Are Inevitable, Tolerance Is Not
The real question seems to be what level of tolerance do we have for the potential magnitude of our errors in forecasting, plus or minus, in any given year? Given the political process/environment and the fact that the program is now in a government insurance fund that requires annualized accounting rather than blending the plus/minus forecasting errors over several years to achieve a longer term net number like most private insurance companies, the tolerance seems to be much lower at the same time the political process is directly affecting the most important inputs to the forecasting process.
The sooner we as an industry can get comfortable with managing some of these risks together with our key stakeholders in the political and regulatory process, the better.
After a great deal of interest around the industry from our recent post on HUD’s FY2010 subsidy request for the HECM program, some friends in the industry have been kind enough to help clarify some questions we raised in the original post.
In the original piece we offered several possible perspectives for understanding the size of the request relative to the HECM program, a way to back into HUD’s estimates as to how much the program costs relative to the MIP premiums that we see everyday.
- The first point to clear up is that the budget request is not applicable to cash claims to be paid in FY2010 due to prior year loans terminating. It’s a projection of current cash needed to fund the present value of future losses from loans above and beyond MIP.
- That underlines some of the thoughts in the ‘insurance’ section of the original piece, and we’ll specifically focus on our second bullet point there – the subsidy request is in fact for expected performance of just FY2010 HECMs under the new assumptions. This means HUD is telling us that on top of the 200 initial MIP and additional 100-250 monthly MIP accrued over the life of the average loan (depending on draw and interest assumptions), they’re expecting an additional 266 basis points of claims in present value terms ($798 million divided by $30 billion total endorsed). That suggests the current MIP premiums, which already represent one of the two largest costs of the program to borrowers, would have to rise 60-90% to fully offset expected claims if nothing else changes.
As the world stands today it seems we have four options at this point, any combination of which might form the best answer:
- Ongoing subsidy requests by HUD to fund claims in excess of premiums – relying on continuing political favor each year, indefinitely
- Increasing MIP – already one of the largest and most visible program costs to consumers and we’re not hearing many originators saying there’s a lot of room to raise from a consumer acceptance perspective
- Reducing LTVs – as much as the higher loan limits have helped the industry recently, lowered LTVs have the potential to substantially reduce the appeal of the product, although this might open a wider door for proprietary products at some future time (a thin silver lining for now)
- Limited endorsement authority – capping the HECM production on an annual basis at some level lower than otherwise expected production
Our industry faces a major decision. If we believe the new assumptions are likely to continue indefinitely (and I don’t think many people are predicting a rapid rebound in home prices at this point), then we can either let our future be decided for us through the appropriation process or suggest an alternate course (or courses) to set our industry on a more independent path.
If our industry wants to re-instate our status as a budget-neutral program that cannot be attacked as a giveaway to seniors, we have a very important discussion in front of us on the best way to achieve that goal. It seems premature to suggest that lowering LTVs or raising MIP is the best way to achieve the goal, even if we may end up there eventually, simply because it’s too important to rely on back of the envelope assessments of such critical economic elements of our industry.
Call us biased, but we’d suggest that the next step in this case should involve a rigorous analysis of the substantial history we’ve created as an industry to craft a reasoned, intelligent, and most importantly, factual, recommendation for the HECM product’s future. We’re certainly not suggesting that a recommendation would emerge unscathed from the deliberation process, but it seems the surest path to reasonable discussion – with the industry having more than a token presence at the table.
What do you think?
