Industry Analysts: Reverse Mortgages Not Subsidized by Forward Mortgages

The Home Equity Conversion Mortgage (HECM) program does not subsidize the traditional, forward mortgage program at the Federal Housing Administration (FHA), because the HECM program has shown significant economic improvement over the past few years; and the forward mortgage program’s volatility has demonstrably increased.

This is according to reverse mortgage capital markets and investment banking advisory firm New View Advisors, based on information published in FHA’s annual report to Congress published last month as well as an accompanying actuarial report submitted to FHA, as well as historical data collated by New View based on publicly available information and its own analyses.

HECM program is improving

New View published its very first blog entry in 2009, when the HECM program began to show its first signs of deficit, a time in which it was reasonably well-accepted to conclude that it was HECM that was subsidizing the forward mortgage program at FHA as opposed to the other way around. As HECM loans made prior to a series of program changes began to show signs of structural deficiency, FHA began to incur greater losses related to the HECM portfolio particularly as it grew.

However, many of those deficiencies have been addressed, which has led to improved performance of the HECM portfolio for FHA, New View says.

“Principal Limit Factors (PLFs) were lowered, the initial draw amount was restricted, and Financial Assessment (FA) was enacted,” New View writes. “The 80-year-old who could receive a 78% LTV HECM in 2009 could then borrow no more than 64%, even less depending on interest rates. As we have analyzed in previous blogs, the implementation of FA also materially reduced the number of HECM borrowers unable to keep current tax and insurance payments. Today, default rates for FA-era HECMs are a fraction of the default rates for pre-FA era HECMs.”

The program reforms create two primary implications: first that there are good and bad portions of the HECM book of business, and second that as time goes on, the HECM portfolio is increasingly composed of more stable, post-FA HECM loans, New View explains.

“According to this year’s FHA report (p. 110), about half the loans in the HECM portfolio were originated before FY 2015,” New View writes. “At a certain point in the not-too-distant future, FHA’s HECM book will consist almost entirely of FA-era loans.”

Types of loss

In describing HECM claims, they are divided into two types according to New View. “Type I” claims are those generated when a reverse mortgage borrower leaves the home, and the property associated with that loan is sold at a loss never having been assigned to the U.S. Department of Housing and Urban Development (HUD) representing material losses for FHA. “Type II” are those active HECM loans assigned to HUD from an investor when it reaches a 98% maximum claim amount (MCA).

“[A Type II claim] is a loan sale in which the investor assigns a HECM loan to HUD. HUD pays a price of 100%, or par. Again, HUD will not purchase any HECM loan that is matured or in default,” New View explains. “Investors therefore benefit from a put option that shields them from losses and shortens the otherwise very long duration of HECM loans. HUD then holds the loan in its ‘Secretary’s Notes’ portfolio until that loan pays off.”

“For loans in the Secretary’s Notes portfolio that are not underwater at the time of loan payoff, HUD can collect the full loan amount and make a decent profit,” New View explains.

The published FHA report to Congress does not offer a lot of information related to the Secretary’s Notes portfolio, but “reading between the lines” of the report, New View says, makes clear that a majority of expected HECM losses to the MMI Fund reside there. As the HECM book of business inside the MMI Fund becomes further populated with FA-era HECM loans, losses on the reverse side should decrease.

Reverse losses fall while forward volatility rises

When taken in, the details of the FHA report to Congress indicate that the conclusions being drawn do not appear to conform with much of the data presented, New View says.

“The FHA FY 2020 MMI Fund report states that projected reverse mortgage losses are falling, forward delinquencies are rising rapidly, and HECM is responsible for the entire $6 billion improvement in the fund’s loss reserve,” New View says. “Yet, it concludes that its forward mortgage program subsidizes its HECM reverse mortgage program. FHA bases this claim on prospective losses, but this will likely be proved wrong if current trends continue. Examining FHA’s own report, it appears that prospective losses are a rapidly moving target, changing significantly year to year due to changes in economic conditions, portfolio composition, and modeling assumptions.”

This means that New View ultimately does not think that forward mortgages are subsidizing reverse mortgages, since “a subsidy would mean outsized realized HECM losses, and a compelling case that this will continue,” New View says. “This is not demonstrated in the report. In fact, given current trends, a reversal of fortune is possible, in which the HECM program returns to surplus and forward mortgage enters a deficit.”

Current trends indicate for New View that the HECM program should prove profitable for taxpayers by the end of FY 2021, and by the following year the portfolio will have a majority of post-FA HECM loans representing a more refined, less volatile product when compared with pre-FA loans.

“The cash flow and Economic Net Worth of the HECM program could then be strongly positive,” New View explains.

According to a recently-revised independent actuarial report of the HECM program,  it is “already in the black,” New View says.

Read the post and further breakdowns of relevant data at New View Advisors.

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