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.
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.
- 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.
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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