Lender Lead Solutions has gone through big changes over the past year and it all started when KBC Bank acquired their parent company Vertical Lend in October of 2007. In January of 2008, Vertical Lend became World Alliance Financial and over the next few months it became evident that KBC was committed to growing LLS into a top reverse mortgage wholesale lender.
With the credit crunch upon us, and recession looming, having the backing of an international financial institution with over $500 billion in assets has helped the company grow in a time where almost every company seems to be scaling back. A few weeks ago I had the pleasure of speaking with Gagan Sawhney, the managing director of KBC Financial Product’s real estate group about the current market conditions and what it means for our business.
RMD: People are starting to realize that the credit crunch is affecting the reverse mortgage business, do you agree?
[Gagan]: I think the credit crunch has been affecting the business for a while. I hope we are at the last end of the cycle. The credit crunch started affecting this business as far back as August of last year and is affecting everyone. However, some of the participants in the reverse mortgage business didn’t want to accept the reality or thought that there balance sheets would let them last through it. Now we are coming to a point where these institutions are no longer in a position to take anything more on their balance sheet and therefore the credit crunch is actually showing up at the consumer level in terms of higher rates, lower YSPs and lower advance rates.
[Gagan]: Well, I think LIBOR is the future of the market. I mean the fact is that the performance of every fund manager out there is being measured in terms of spread over LIBOR . So whether you are an insurance company or a traditional fund manager, or anybody in the different parts of the credit spectrum, you are working off the LIBOR index. Credit markets globally work off the LIBOR index. So, if you are not creating a product based on LIBOR, the market or the buyers for that product are very few.
That became a big issue during this credit crunch around August of last year because, traditionally the CMT and LIBOR indices have been very, very close to each other and so it was okay to originate loans based on CMT and then swap it into LIBOR to sell it to the investors. That is how people were doing business for the past year or so. Then the CMT and LIBOR indices spread became pretty wide and therefore it was no longer viable or financially reasonable to originate the product on CMT basis, put on a swap to convert the product from CMT to LIBOR and sell it to the investors. That whole game became impossible to execute, which is why the entire industry had to move to LIBOR originations, which I think is the right thing to do.
RMD: It’s interesting because it took wholesalers at least 6 months to make the jump to LIBOR products and then a few weeks ago Financial Freedom eliminated their LIBOR products and switched back to CMT.
[Gagan]: I think it’s a very short-term mentality. What is happening has to do with the last couple of weeks in the market place. In general, there has been a tightening of credit and concerns over what happened with Bear Stearns. This general set of concerns in the market has resulted in widening of spreads for all products including government guaranteed products. These products are trading at these wider margins, not because of any real fundamental logic, but because of market technicals And so, as a result of that, all the dealers, reduced their marks and pulled back on the prices they’re willing to pay for LIBOR product.
On the other hand, you know, the only participant in the market who buys CMT products is Fannie Mae (FNMA). So FNMA has its pricing and forwards out there, and the dealers who are pricing these products everyday on LIBOR are pulling back their LIBOR pricing as a result at the current moment, it pays more to originate a CMT based loan than it does to originate LIBOR-based loans. It makes no sense but for a period of time the CMT product became more attractive. And that’s the problem with reverse mortgage market to a certain extent, most participants in the business are significantly under capitalized. A company that is depending on warehouse lines to fund these mortgages, their ability to hold on to LIBOR product is non-existent; actually the ability to hold a whole lot of any product is non-existent. As a result, they have to keep shifting their originations based on what they can profitably sell off at that moment. We at KBC have the capital to take a more fundamental view of the market and are therefore sticking with LIBOR originations.
[Gagan]: Absolutely. If you look at the market place, there is one end buyer for CMT product which is FNMA. And there are hundreds of buyers for LIBOR products – all the fund managers across the entire spectrum of the current market. As a result, we are a lot more comfortable dealing with hundreds of buyers compared to dealing with one. Look at it this way, if I’m an originator and I’m looking at that market, I should be originating LIBOR-based products. However, at this moment, there is an anomaly in the market because there is a buyer for CMT which is giving a nice price for these loans. So while everybody is moving towards CMT in a rush, I’m pretty sure that market fundamentals will not allow that buyer to be at that price for a very long time. Further, also from a borrower’s perspective, I feel it is better for them to take a lower margin on LIBOR than to take a CMT-based product. This is because over time, as the market settles down and the Fed is done with its rate cuts, we might again be in the environment where LIBOR is very close to or even lower than CMT. The market is self-correcting and we take the long term view and prefer the consistent pricing that LIBOR can offer.
RMD: What are your thoughts on the jumbo reverse mortgage market? We have seen some lenders pull their products because different Wall Street players are no longer buying it. Do you see the jumbo market coming back soon or is it something that might take a little while?
[Gagan]: I think that it will take a while for it to come back. When the market starts to correct itself, it will first correct for low risk products before it starts to improve for high risk products. The point is that jumbos are a high risk product as compared to the HECM product, which by virtue of its government guarantee has a very low risk. So while the spreads have widened all throughout the market place today, the spread for jumbos is very wide right now, which is why Wall Street is not currently doing any jumbo business. When things get better in the credit market the first one to benefit will be the HECM. I think it will take a while for the market to come to a point where it is ready to fairly price the jumbo product.
[Gagan]: I am pretty sure that many of the Wall Street firms are buying the HECM products. You may not like the price but they are buying it nonetheless. I don’t think there is a Wall Street firm out there buying jumbo product right now.
[Gagan]: Most market participants are feeling the pinch of this pull back. Whether the different Wall Street firms officially pull products or not, I think for the last few months none of them have been aggressive buyers of jumbo product.
[Gagan]: Right, there is no doubt that you’re in a phase where housing prices are expected to go down and you can see it in different indices and prediction of indices out there . You know the market expects home prices to go down over the next year, potentially two years. So if you’re creating a jumbo product today, you need to be prepared that your jumbo product is ready for certain amount of market decline over the next two years. Therefore, lowering the LTVs to adjust for the the expected decline is the right move. Pulling it out is a reaction to a level of fear which exists in the market today. Hopefully, with a combination of a long-term commitment to the business and making the appropriate changes to the product to adjust to the current environment, we can make it work.
[Gagan]: Exactly, there are many things here, we are a Wall Street-oriented company, and KBC actually made the investment of acquiring World Alliance Financial. We have a much bigger commitment to the reverse mortgage sector than any other Wall Street firm. Most every other firm has a small three to five person desk that was buying product from different originators. So, while different Wall Street banks keep getting in and out of this business by hiring or firing their desks, we are here for the long term.
RMD: What are your thoughts on private insurers for reverse mortgages? While I’d be shocked if we see this in the next year. I could see it down the road. I think it would be great because it could help to create a product that can compete with the HECM.
[Gagan]: In regards to the HECM insurance premium, it’s easy to stand on the sideline and complain that the premiums are too high and its easy to look at how many billions of dollars HUD has collected in premium over the life of this product versus how little they have spent in terms of charge-offs. This is a very long duration product and you don’t know what the real insurance cost is until the mortgage terminates which typically happens in seven to eight years. So while HUD has collected a lot of premiums over the last few years, it may be too early to look at the costs and determine if this product is as profitable to HUD as it looks now. I have spent a lot of time talking to a number of private insurers, but because of their sub-prime and CDO related problems, I cannot find any insurer whose ready to talk to me about insuring a proprietary product.