In 1981, Tom Petty and the Heartbreakers released a song entitled “The Waiting.” The chorus refrain from that song is as follows:
“The waiting is the hardest part,
Every day you see one more card,
You take it on faith, you take it to the heart,
The waiting is the hardest part.”
In working with executives and businesspersons, I have been told more than once that business leaders do not necessarily hate bad news. They do not like it, but in fact they expect it, occasionally, as everything does not always go as planned and nothing is perfect. However, one of the most difficult things to deal with is a lack of information about pressing issues. In the words of an acquaintance of mine, who is the general counsel of a mortgage company: “We measure everything at my company, create metrics and then make judgments as to how to manage against that knowledge base. But I cannot manage what I cannot measure, and I cannot measure when I do not have adequate, sufficient and reliable information.” Thus, one cannot manage what cannot be measured, and one cannot measure what one does not know.
Perception Is Reality, but Is It Real?
With the release of the FHA 2012 HECM Actuarial Study and MMI Fund Report in November 2012, HUD is projecting a potential (but temporary) shortfall in the HECM program and an overall potential shortfall (also temporary) in broader FHA-insured loan programs. The result is that for the first time in its 78-year history, FHA may need to draw on a credit line from the U.S. Treasury—maybe.
Is Reality, but Is It Real?
Is the FHA broke? In short, the answer is no, or at least not yet. Will it be, and will it need to draw on a credit line from the U.S. Treasury? The answer today is, “It depends.” Currently, the FHA has $30 billion, but reportedly $70 billion in potential and pending claims on the 2009 and 2010 books of business (the majority of these claims, by the way, are from forward mortgages). But those claims are just that: claims. The FHA will not pay all of them immediately, and in some cases, it won’t pay them at all. And of the claims that are paid, there will be recoveries in the form of sold REO properties and indemnifications made against mortgagees. In the meantime, the FHA will continue to collect mortgage insurance premiums, which will amount to as much as $11 billion in fiscal year 2013 in actual cash (unlike “potential” or projected claims).
Government budgetary accounting and math is like an enigma wrapped in actuarial jargon and hidden in a black box. To make matters worse, government budgetary analysis is often presented or explained to us by technocrats who have not been media-trained. To date, the HECM program has created what is called a “negative credit subsidy.” What does that mean? In short, it means the HECM program, although designed to be “revenue neutral” (or to break even), generally has, since its inception in the late 1980s, made money for the government. What happened to that money? Was it lost in the black box and enigma of government accounting and budgetary math? In short, who knows and who cares? Does that really matter now in a “what have you done for me lately” world built mostly on perceptions and not on reality?
Cynicism aside, the perception now is that the HECM program will cause the FHA to lose money unless changes are made to the program. Whether that is accurate or not, that is the perception. Not knowing exactly what those changes will be, or when they will occur, is generating angst among the reverse mortgage business leaders. From a review of the report, it seems as though the FHA could take a number of actions: do away with the HECM standard fixed-rate program; use HECM Saver principal limit factors (PLFs) for that program; establish some sort of a principal limit utilization (PLU) test; or institute some sort of limited underwriting or financial assessment for HECM borrowers. From the report, it also seems that HUD thinks it needs legislation to make some or all of these changes. I do not totally agree with that assessment, although it seems that changes to HECM regulations might be needed either to institute limited underwriting or financial assessment for HECM borrowers, or more importantly, to address the consequences of such underwriting, which might lead to required property charge set-aside accounts and/or limits on payment plan changes.
However, even without legislation, such regulatory action could take a year or more. It seems that a PLU test could be crafted by regulation and would not require legislation, and regulations would not be required to change the PLFs. HUD previously adjusted the HECM PLFs by Mortgagee Letter 2010-34, effective October 4, 2010.
Why Cut Off Your Nose to Spite Your Face?
In my early years in the consumer financial services industry as in-house counsel to a subsidiary of a large bank, I learned one of the so-called formula of consumer finance, and that formula is as follows:
T-D / T
where “T” equals a total loan portfolio (comprising new originations as well as the portfolio of performing loans), and “D” equals defaulted and non-performing loans in that portfolio. Maintaining certain assumptions (explained below), as long as “T” continues to grow, primarily through new originations, the loan company will be profitable. (The assumptions are that the interest rates that companies charge are greater than the cost of funds and operational expenses, minus delinquencies or charge-offs. These assumptions primarily apply to forward mortgage lending.) If “T” is no longer growing, delinquencies must be monitored very closely and aggressively.
Why is this relevant and what does this mean for the FHA? A review of the report shows that the 2009 and 2010 books of HECM business are expected to cause the most strain to the Mutual Mortgage Insurance (MMI) Fund. The 2011 and 2012 books of HECM business appear strong, in part due to increased HECM MIPs and better home price appreciation assumptions for those years. However, if the FHA makes changes to the HECM program now that cause a decrease in loan volume, that will in turn reduce the amount of HECM-related MIPs that are paid to HUD. In short, if HUD understood the “secret formula” of
Life Is Not Fair
Importantly, in 2008 the Housing and Economic Recovery Act made HECM loans part of the MMI Fund, effective for fiscal year 2009 and beyond. Prior to 2009, HECMs were part of HUD’s General Insurance Fund. Why is this important? Well, under federal law the MMI Fund must be actuarially sound, and HUD is required to commission an annual actuarial report on the MMI Fund and submit it to Congress (thus this year’s report and related potential fallout).
After 2008, due to those legislative changes, HUD moved funds around in the black box in conjunction with prior annual budget re-estimate processes, in part to build loss reserves against anticipated future net claim expenses for outstanding loans. Some transfers were made to create loss reserves for the HECM program, which first entered the MMI Fund in fiscal year 2009 and had no opportunity to build reserves prior to the financial crisis. The question is: Did HUD move enough funds then? Again, reverting back to cynicism, who knows and who cares in a perception-laden “what have you done for me lately” world?
In spite of this, as we recall, the HECM program has consistently made the government money in the past. But it does not appear that the reverse mortgage industry will get credit for that now. Nonetheless, it would seem that the smart thing for HUD to do would be to give the industry that credit for the past profits it made for the government and take steps now not to reduce HECM volume, but to increase it.
In light of the report, what will HUD do to “shore up” the HECM program, and when? It seems it has several choices, as noted above. It does appear though that if any action were to happen soon, it could be a reduction of PLFs. What does this information mean for the reverse
mortgage industry, and how does one manage against it? It seems that HECM volume will shrink, initially, as fewer reverse mortgages will be originated due to reduced PLFs. But then volume could grow again as property values continue to recover and lenders adapt (perhaps by reducing the expenses of the point-of-sale compensation). We may see growth fueled by an increase in demand for other HECM product offerings (such as the HECM for Purchase) or the continuing search for synergies with the more informed use of reverse mortgages in financial planning.
Today, however, it is the “not knowing,” and not knowing for how long you will not know, that causes the most angst. In the words of Carly Simon, in her song “Anticipation”:
“We can never know about the days to come,
But we think about them anyway,
And I wonder if I’m really with you now,
Or just chasing after some finer day...
Is making me late,
Is keeping me waiting.”
Nevertheless, uncertainty also creates opportunity. Witness the recent exponential growth of several medium-sized reverse mortgage companies after the exit of the large banks. Furthermore, HUD has stated that it believes it is possible to return the MMI Fund capital ratio to a positive level within a year, minimizing the likelihood that the FHA will need to call upon the Treasury for assistance.
Thus, I submit that every day we will “see one more card,” and I “take it on faith” that we in the reverse mortgage industry are not merely “chasing after some finer day,” and will not have to wait much longer to obtain information against which we can and will manage, and manage well.
This article is based on the personal views of Jim Milano and does not represent the views or opinions of the law firm of Weiner Brodsky Kider PC, its clients, Tom Petty, the Heartbreakers or Carly Simon.