Written by Michael Gluf, as originally published in The Reverse Review.

Obtaining approval under Ginnie Mae’s HECM Mortgage Backed Securities program can provide loan originators direct access to the most important

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liquidity source in the HECM market, but this opportunity is not without risk. An understanding of issuer obligations is essential in building a sustainable platform that utilizes the HMBS takeout. It would serve the health of the HECM marketplace to diversify its issuer base, spreading the overall amount of issuer risk across more firms, thus creating greater efficiency in market pricing. But this is only possible if issuers carefully manage their responsibilities according to Ginnie Mae’s MBS guide. My goal here is to give a snapshot of the most important obligations to which issuers will be held.

Capital/Net Worth Requirements
Initially, new issuers must meet the minimum net worth requirement of $5 million to enter the HMBS program. Beyond that, they must maintain a ratio of 6 percent of net worth to total assets to meet ongoing eligibility requirements. Additionally, there is a liquidity requirement wherein 20 percent of the net worth must be in the form of cash or cash-equivalent assets.

Commitment Authority
In order to issue securities, the issuer must first obtain commitment authority from GNMA in the amount equal to the aggregate unpaid principal balance (UPB) of the loans to be securitized. The pricing for commitment authority is $500 for the first $1.5 million and $200 for each additional $1 million or portion of a million. Using this formula, every $100 million of commitment authority will cost $20,300.

GNMA Guarantee Fee
Six basis points are due to GNMA annually on all outstanding issuance, and this is paid on a monthly basis. The issuer is responsible for making these payments, which will not be reimbursed until maturity of the loan. The security that any given loan is in will accrue six basis points less than the actual HECM note rate so that at maturity, there will be an excess payable to the issuer for this amount.

Funding Future Principal
The issuer is obligated to fund any additional principal on the loan beyond the initial draw. This will include monthly MIP payments on all loans, as well as future line-of-credit draws on ARM products; it can also include repair set-aside draws. At the time of issuance, the total available UPB on the loan can enter the security, but beyond this, a separate loan balance is tracked for all future disbursements of any type. These “external” balances can be separately securitized into pools so that the issuer can monetize the draws earlier than maturity.

Interest Shortfall
Unlike forward mortgage loans, when the borrower prepays or pays off his reverse mortgage mid-month, he is only required to pay interest until the day of the prepayment or payoff. On those loans, the issuer is required to make up the difference in interest accrued until the end of the month, which is guaranteed to the security holder. Any interest shortfall in a given month will be billed to the issuer.

Buyout at 98% of Maximum Claim Amount (MCA)
When any given loan participation reaches 98 percent of its original MCA, the loan must be bought out of the securitized pool by the issuer using its own funds. The funds then flow through to the bond investor just as in the case of any payoff, and the issuer can then assign the loan to FHA. There will be a period of time when the issuer will again have to utilize its own funds to finance that loan while going through the assignment process. In addition, the loan cannot be assigned to FHA if it is in any kind of default, such as having delinquent tax or insurance payments. For this group of loans that reach 98 percent in a default status, the only options are to cure the default by resolution with the borrower, or to outlay cash to make tax and insurance payments current. Until then, the issuer must carry the entire loan utilizing its own funds.

Foreclosure and REO Management
A HECM loan will become due and payable in the event that the borrower passes away, sells the property or the last surviving co-borrower fails to occupy the property for more than 12 months. The issuer must then notify HUD that the loan is due and payable and work with the borrower or the estate to satisfy the debt. If the estate cannot satisfy the debt, the issuer can then go through the foreclosure process to liquidate the property and file a sales-based claim with HUD.

The first area of exposure occurs between the “due date” (the date HUD is notified of due and payable) and the date the claim settlement is paid. For this time period, HUD will only reimburse interest on the loan at the debenture interest rate as opposed to the note rate. Depending on the note rate (if the loan stays in the security) and the issuer’s warehouse financing rate, the debenture rate, which is set at the time of the loan closing, may be much lower and could result in negative carry cost.

The second area of exposure involves management and liquidation of REO. Once a property becomes REO, the issuer has six months from the date of foreclosure to file a claim with HUD. During this time, some costs are claimable to HUD. Only one appraisal fee is covered, and two-thirds of legal fees are covered. If the property is sold within six months at the HUD-approved appraisal value for less than the balance of the loan, the issuer can file a sales-based claim with HUD for the difference. If the property cannot be sold during this period, the issuer can file an appraisal-based claim for the difference between the appraised value and the balance of the loan. Consequently, it can become important to obtain additional updated appraisals of the property during and after this six-month window, even though they come at the cost of the issuer after the first. Beyond the six-month point, no further claim can be made to HUD and the issuer becomes responsible for all closing and legal fees involved if and when the property actually is sold. In addition, the issuer is still financing the remaining balance on that loan and is exposed to further decline in property value and preservation costs.

Final Certification
To initially certify a pool of loans, documents for each loan in the pool must be delivered to a GNMA-approved custodian who will be in charge of ensuring that they meet GNMA criteria. Within 12 months of the initial certification, the issuer is responsible for delivering the final recorded mortgage, assignment and title documents. If this deadline is not met or an extension is not requested and granted by GNMA, the issuer will be considered in default and unable to certify any further pools.

Issuing and servicing HECM securities can be a cash-intensive operation. It is important for current and new issuers to continue to effectively manage their financing and liquidity in order to ensure that they remain compliant with GNMA. The obligations set forth in the MBS guide have been put in place as guardrails against issuer defaults and to help issuers absorb mandatory cash events and potential losses on loans. There is much work to be done in creating a more dynamic marketplace for the HECM product, especially with the growth that is projected for the space over the next five years. The more active participants we have who understand the requirements of the HMBS program, the more even the playing field will be.