Following the much-anticipated release of a pivotal mortgagee letter, the reverse mortgage program was subjected to the most drastic change it has faced since its inception.

With less than 30 days to adjust, the industry jumped into overtime in an effort to understand the new rules and prepare for their implementation. In effect, FHA’s recent guidelines revamp the HECM as we once knew it, creating a new type of reverse mortgage product that, by demanding a slower consumption of home equity, caters to a different type of borrower. With these new guidelines in place, originators will be forced to connect with a more planning-oriented consumer looking for a strategic financial tool to support retirement, rather than selling the product as a crisis-management tool for a more needs-based borrower looking for fast cash.

The changes have been a long time coming, and although some of the adjustments—like a reduction of the amount of available loan proceeds—were steeper than many expected, the industry can finally move past the speculation and focus instead on adaptation.

The changes will no doubt make for a rocky year ahead as the industry adjusts, with some expecting volume to dip as low as 50 percent. There are those who are skeptical about how well things will play out, hoping that HUD will be willing to revisit some of the guidelines down the road as to not completely exclude the needs-based borrower. Others are optimistic about the future of the product, and although they admit there are hurdles to jump, they’re eager to explore

new ways to market the HECM and tap into a greater slice of the potential market.

While time will tell how the industry will fare, one thing is certain: Those who are dedicated to the success of the HECM are unwavering in their commitment. They have reaffirmed their determination to see this product succeed in the mainstream marketplace, vowing to get creative with their marketing and choosing to view the HECM’s revamping as an opportunity to get to that next level.

FHA Acts, the Industry Reacts
FHA’s adjustments to the HECM program were designed to realign the reverse mortgage product with its original intent, from which it has strayed in the past several years. Prompted by a November 2012 audit of its Mutual Mortgage Insurance (MMI) Fund that attributed $2.8 billion in losses to the HECM program, FHA found the current use of the product to be too risky and detrimental to its long-term sustainability.

According to Colin Cushman, president and CEO of Generation Mortgage Company, the agency had little choice but to issue drastic change. “FHA was put in a position where it had no good options. The original intent of the program was to help retirees pay off existing debt and use the remaining line of credit as long-term cash flow to facilitate aging in place. But in recent years, the industry marketed the product as something different from this, which led to an adverse, increased risk to the MMI Fund, both in the form of losses and in mission failure,” he says.

Brien Brandenburg, a VP for regional lender TowneBank Mortgage’s reverse division, agrees that FHA had to take action to protect the fund. “While in the short term it may be a little challenging, it will be good for the overall economic viability and health of the program,” he says.

Although many agree that something had to be done, industry participants express mixed reactions to the changes that were made.

Mark Browning, CEO of New York-based lender HomeChex, says most of the new guidelines will be beneficial in the long term. “I think in the long haul these things are going to be good for the industry. It reorients the product for a planner-type consumer versus the immediate-need user. The changes seem thoughtful and well balanced,” Browning says. “Frankly, it’s more attuned to the kind of consumer we saw using this product earlier on in its history.”

Others, like John Mitchell of Texas-based Reverse Mortgage USA, are not as supportive. “I think that we’re ultimately going to see that HUD has overreacted on this,” says Mitchell. He predicts that the annual audit in November will show that the HECM is now cash positive for the fund, leaving the industry to question the institution of such drastic measures.

Joe Kelly of New View Advisors also thinks FHA might have taken it a step too far, with new principal limit factors (PLFs) drastically reducing the amount of loan proceeds, and increased mortgage insurance premiums (MIPs) making the product more costly. “The original HECM PLFs, we always thought those were too high, for years. But this round of cuts, combined 8 with the increase in the MIP, we think it’s overkill, frankly,” Kelly says. “Now I expect the HECM will be pretty profitable for FHA.”

Whether or not you agree with FHA’s actions, the bottom line is that a modified program is better than no program at all. John Lunde of Reverse Market Insight says the choice was either shut it down or change it. “If they didn’t make these changes, then in the next six months to a year they might have had to cancel the program entirely,” Lunde says. “Put in that context, I think these changes are great.”

Indeed, by instituting reforms, FHA has demonstrated its long-term commitment to the program. While the new guidelines may seem unnecessary to some, FHA’s renewed commitment is a major bonus for an industry whose future has been hanging in the balance. As Mitchell says, “That’s maybe the silver lining in all of this.”

PLF Cuts and Utilization Restrictions
With the consolidation of the HECM Standard and the HECM Saver, FHA created a new reverse mortgage with a lower PLF, meaning that it offers less proceeds to borrowers. While a reduction in PLFs was expected, most did not anticipate the cut to be so steep: about 15 percent, according to industry analysts.

“Compared with what the industry was expecting, I think maybe it’s a notch or two worse,” Lunde says. “I think for most people in the industry it was a little bit of a surprise.”

Some, like Cushman, object to the steep cuts. “I can understand why they implemented the cuts, but I fundamentally believe it was the wrong thing to do,” he says. “Every time you cut the drawable equity, you cut the opportunity for seniors to succeed in the program.”

RMS CEO Marc Helm says that while he too was surprised by the steep PLF reduction, the fact is this is the new reality and the industry must learn to deal. “It is a deeper cut than we thought it would be, but it is what it is and we’ve just got to learn to live with it and make the best of it,” Helm says.

In addition to a reduction in available proceeds, the new rules restrict the amount of money a borrower can take at closing and in the first year of the loan to 60 percent of the total loan amount. This restriction in how borrowers utilize the proceeds from their reverse mortgage is intended to encourage them to draw on their equity slowly, rather than consuming it immediately in one lump sum. The inevitable result of the PLF cuts and this utilization restriction is that loan volume is going to take a nosedive in the coming months.

“I don’t think anybody knows how damaging the changes are going to be,” Mitchell says. “I think it’s a fairly reasonable expectation that you’re going to see a 30 to 40 percent decline in funded loans initially.”

Lunde and his team at Reverse Market Insight attempted to put a number on the potential impact, running July and August funded-loan totals as if the new rules were in place. According to their findings, the impact of the reduced PLF, coupled with utilization restrictions, reduced unpaid principal balances by 49 percent. “But that’s a simple number,” he says. “There are a lot of other factors that could come into play.” Lunde says both home price appreciation and consumer behavior could impact future volume to an unpredictable extent. If home prices continue to appreciate, they could help mitigate the drop. But he says consumer behavior could be more problematic. “If we get more borrowers thinking, ‘Hey, why are you telling me how to use my money?’ that could definitely be a bad thing,” he says.

Many say they hope HUD will revisit the PLF table down the road.

“The question on everyone’s mind is: Can PLFs ever go up? They’ve always gone down. I guess we’ll find out,” says Kelly. “FHA may actually find their profit from this new HECM is lower, because the volume will be lower, so it will be interesting. It’s going to take a while, but I think the industry is hoping FHA will see the light. This was probably harsher than needed.”

Cushman is among those who hope for reassessment down the line. “My hope is that upon future review, FHA determines that the other policy changes it recently administered reduce the expected losses enough to increase the PLFs again. Of course, that cannot happen until the next president’s budget: October 1, 2014. Until then, I believe industry participants willing to learn or relearn the true value proposition of this program will not have a problem increasing sales in spite of the PLF cuts.”

Financial Assessment
Another major change to the HECM program was the establishment of a financial assessment, which institutes underwriting guidelines that include a credit history analysis and an analysis of cash flow and residual income to ensure borrowers have the ability to pay their property taxes and insurance.

Industry participants express mixed reactions about Financial Assessment, with some recognizing the need for tougher underwriting and others concerned about the practicality and subjectivity of the process.

Cushman supports the assessment, but admits that it may take some time to work out the kinks. “The program needs the transparency and legitimacy that comes with Financial Assessment in order for it to become a mainstream program. Leveraging home equity contains risks and rewards and, like any loan program, should be subject to basic underwriting to assess whether borrowers are willing and able to meet their financial obligations,” he says. “This is the first policy of this nature for the program, and so it will take an iterative process to home in on policy that successfully weeds out borrowers who were not going to succeed in the program.”

Kelly is also a proponent. “I think there should be some form of financial assessment,” he says, adding that New View Advisors has been advocating for a financial assessment for several years now. But Kelly also says that it remains to be seen how well this proposed version, which will not be implemented until January 2014, will pan out. “It’s looking like a pretty thorough underwrite. Whether that’s overkill, we’ll find out.”

Others, like Browning, fundamentally object to a financial assessment of retired borrowers. “What the Financial Assessment tries to do is overlay protocol associated with traditional transaction lending on your retirement product… We’re making long-term projections based upon the unpredictable,” he says. “I think there’s a lot of work that needs to be done on the Financial Assessment protocol, and I’m hopeful we’ll do that before January comes around.”

The Bright Side
One positive result of these changes, some say, is that it will essentially make the program “safer”—at least, for FHA. By eliminating risky borrowers whose inability to make property tax and insurance (T&I) payments can sometimes lead to default or foreclosure, the program is more viable in the long term.

“I think FHA is taking some of the most risky borrowers out of the market,” Lunde says. “I think T&I default rates will come down, and I think foreclosure rates will likely come down a little bit too. But the reality is we’re taking out a really big chunk of the market to do that, so the medicine hurts.”

Some are also hopeful that this revamped HECM will help the industry repair its damaged reputation. By eliminating risky borrowers whose stories often inspired damning news headlines that fed the public’s mistrust, the reverse mortgage product might have a chance of revamping its image.

Browning is among those who think the changes could help reduce the media scrutiny. “I think we’ve lost part of the market because of the reputation problems the program has had. I know that our referrals from trusted advisors—meaning lawyers, accountants, those types of people—have been way off over the past several years. People just aren’t comfortable recommending a reverse mortgage with the type of negative publicity it’s been getting,” he says. “I think this is a step in the right direction.”

The Secondary Market’s Response
In the wake of such drastic product change, some are left wondering how the secondary market will react. What will happen, they say, when an already small market gets even smaller?

According to Darren Stumberger, who heads HMBS trading at Stifel Nicolaus & Co., the HECM market may constrict to half its size in the coming months, and that could present a problem from an investor standpoint.

“Investors are going to want to sit on the sidelines and see the performance data of this new product and which of these variations are going to pre-pay faster than others,” Stumberger says, adding that despite the potential impact on volume, he does believe the changes were necessary for long-term sustainability.

“Yes, the program is safer and it has mitigated some of the issues related to tax and insurance default and broker steering and stuff like that, so that’s great. But the investor base is going to see a small market getting much smaller,” Stumberger says. “You really, really have to believe in originators and their ability to increase penetration rates.”

Kelly, though, says he is not too worried about the secondary market’s reaction. “I’m not as concerned 8 about that. It’s still a Ginnie Mae [program],” he says. “I think there will be some temporary problems in the secondary market, but I don’t see that as being the main problem here. I think the market will find a level and go on from there. The real problem is volume.”

Cushman also thinks things will eventually work out in the secondary market. “I believe the secondary market will—in the long run—gravitate to this product. The challenge of the day is getting them and us in alignment for the long haul.”

Stumberger says finding that alignment might be tough at first. “It’s going to be tough sledding, honestly,” he says. “The value proposition at the end of the day doesn’t change. If anything, the value proposition of these loans is still there, it’s just how much volume and support and sponsorship will there be on the dealer side and the capital market side to keep everything contained and not let spreads widen. That’s to be determined.”

Entering the Mainstream
For reverse originators, the challenge now is learning how to connect with an entirely new segment of borrowers. In order to succeed in selling this revamped HECM, originators will need to rethink their entire sales approach.

“I think now it’s gut-check time,” Lunde says. “It’s clear that this is going to have a really big impact on business as usual, so I think it’s time to find new niches and new tactics to grow the market. This industry has really only addressed a relatively tiny slice of the total opportunity.”

In order to thrive despite these changes, the industry needs to figure out how to increase its penetration rate, which is estimated to be around 2 to 3 percent of the market’s potential. Now that a large portion of the borrowers once targeted, those who were the most needs-based, will essentially be removed from the equation, figuring out how to tap into the rest of the market will be key.

“Everybody talks about millions of senior homeowners out there who are addressable—20 million, or somewhere in that neighborhood—but the reality is that all the marketing has been spent on probably the 2 million or 3 million who are the most needs-based and motivated to get rid of an existing mortgage or get a lump sum of cash to bail them out of their financial problems,” Lunde says. “FHA is basically saying, ‘That’s not what we want the market to be,’ so we’ll have to figure out a way to address the whole rest of the market, which frankly has always been the industry’s challenge.”

Stumberger agrees that increasing the industry’s reach is imperative. “Originators need to increase market penetration to increase volume; that’s the only way the program is going to flourish at this point,” he says.

Those who are convinced of the HECM’s potential are certain that it’s possible to reach a greater segment of the potential market, but many concede that it may take some time. As Cushman says, the industry needs to reevaluate its approach in order to attract a wider audience. “What the industry is missing right now is a level of expertise that is required to attract the mainstream. We need to be transparent. We need to demonstrate the value proposition of our product in a way that borrowers can see where they can go wrong and where success lies,” he says. “The industry is young. In order to grow up, it needs to quickly find a way to attract the mainstream to all that leveraged home equity has to offer.”

A New Kind of Borrower
In order to advance the HECM into the realm of a mainstream financial product, originators will need to connect with a larger audience, and this requires a new approach to marketing the product. Originators will need to retool their marketing efforts to connect with a different kind of borrower, one who is less needs-based and more focused on opportunities in retirement planning.

According to Cushman, the program changes leave the industry without a choice. “They demand that we elevate the conversation from ‘How much money can you get at loan closing?’ to ‘How can you succeed in retirement?’” he says.

In light of this fact, many are stressing the importance of connecting with the financial planning community to spread the word about the HECM’s value. While this has long been a goal for the industry, the progress thus far has been slow.

Lunde acknowledges that this could be a decent pathway to greater market share, but it might take some strategic thinking to develop a solid referral base among this group. “The financial planning [community] encompasses a lot more than a single profile, so I think there’s going to have to be some drill-down on that opportunity, but it’s definitely big.”

Cushman is less enthusiastic about the benefit of connecting with financial advisors. “I believe financial planners play a role in this future, but I surely don’t believe they are the solution for this industry. The product we offer can be valuable to too many people who do not have a financial advisor, so believing financial planners are our solution is relatively shortsighted.”

Some suggest originators look for opportunities in the HECM for Purchase market, and also consider focusing on converting potential HELOC borrowers. As Lunde says, “Focus on people who are taking HELOCs, those who are age eligible… and were thinking about taking HELOCs but didn’t qualify. That’s a pretty good-sized segment to look at. If you just look at those who already have [a HELOC] loan in place, that’s roughly 8 million.”

The Potential for a Proprietary Market
With FHA’s new product limitations, some are talking about the potential return of a proprietary, or jumbo, reverse mortgage product.

“I think a natural byproduct of this is going to be the jumbo reverse, or the non-agency reverse mortgage,” Stumberger says. “That market is going to resurface.”

While some agree that this wave of change makes the opportunity for the return of a proprietary market more attractive, they are skeptical as to how helpful that would be. As Lunde points out, it will take some time for a proprietary market to grow. “I don’t think it’s necessarily the saving grace for the industry,” he says. “The reality is it’s not something that will go from zero to 3,000 loans overnight. Even back in its heyday it was a lower unit volume product, even though the dollars were bigger per loan.”

Kelly agrees that the road to a thriving proprietary market—and one that could compete with FHA-insured loans—is a long one. “With a proprietary program, you don’t have turnkey program with great liquidity like HMBS has. You’ve got to rebuild brick by brick… You’ve got to painstakingly rebuild the non-agency securitization machine.”

The Strong Will Survive
In the meantime, the road ahead for the reverse space may be a bit rocky, and it’s likely that some lenders will opt out of the journey. New Day Financial, which recently ranked 11th on the list of top lenders, announced its exit from the space just four days after the changes were released.

Many expect that other companies with marginal commitments in the space will follow suit.

“I believe the folks not fully committed and who don’t fully understand this program will exit the industry, and in the long run, that will be a good thing,” Cushman says. “The folks who stick around and fully appreciate the value of this program, and more importantly who can capably articulate it to prospective borrowers, will survive.”

Lunde agrees that exits and consolidation are inevitable, but insists that opportunity remains. “I think that for folks who are dedicated and really willing and able to do some of the work required to address these other market opportunities and really change their business, there is absolutely a good business here still. It has just changed from what it was a couple of months ago.”

Remaining Committed
In the wake of this major change, there is speculation as to how various entities in the space will fare.

Browning predicts that smaller companies may have an easier time adapting. “I think smaller companies will have an easier time adjusting to the new target consumer. I think they will be more nimble with respect to the consultative sales process, especially compared with a call center model,” he says.

Some say lenders that are also Ginnie Mae issuers will fare slightly better than the rest, since the shift to an ARM market means they’ll be able to collect revenues on future draws.

“I think Ginnie Mae issuers are going to make out OK because they’re able to securitize the tails of these lines of credit,” Stumberger says. “For folks who aren’t Ginnie Mae issuers, it’s not going to be pretty.”

But no matter what, the changes are bound to be tough on everyone. Companies will need to weather a rough patch as they adjust processes and realign distribution models to accommodate the program changes.

In the meantime, there is little to do but study the new rules and prepare for implementation. A Helm says, the goal right now is to learn the new program. “We need to continue to submit questions to NMLRA and FHA about the program for clarity, and there are a number of things that needed clarity. We need to make sure we’re all on the same page and that we understand every aspect of how the program works.”

However frustrating these program changes may be, one positive fact is that the wait is now over. As Browning says, “Now the question is over, the industry debate has finished and we can finally move forward.”

In order to move forward, reverse professionals are going to have to roll up their sleeves and get busy strategizing how they can retool their sales processes to reach a new audience.

Many, including Brandenburg and his team at TowneBank, are doing just that. “We are committed to the space and we’re making plans for how we are going to attract this new market and what we’ll need to do when the rest of the changes happen in 2014,” he says.

Despite the hurdles, many remain optimistic about the value of the product. “The big picture is the demand for our product is tremendous and it’s getting bigger,” Mitchell says. “The reverse mortgage idea is the best idea I’ve ever seen in my life, simply because people are ill-prepared for retirement and their houses are their biggest assets. And you’ve got 10,000-plus a day turning 62—that is just a tidal wave of good news for the reverse mortgage business.”

Helm echoes Mitchell’s optimism about the HECM’s potential. “We’ve heard hundreds and hundreds of these wonderful stories about what a reverse mortgage can do. So I’m going to be just as committed today as I was a week ago or two months ago or after the last program change, to make sure we continue to be a provider of this reverse mortgage product as long as it’s around,” Helm says. “We’ll do everything we possibly can to make sure that all the people who qualify and need a reverse mortgage get one.”

With similar passion, Brandenburg says he also remains deeply committed. “There have been a million changes, and there are people who have been through these ups and the downs and are still committed to the program because of what it does for our customers. I’m committed to helping seniors have a better quality of life,” he says. “The question is: Are you?”