Archive for the ‘HECM Program’ Category

FHA Fiscal Year 2011 Annual Reports – Still Too Rosy

Friday, November 18th, 2011

HUD released its FY 2011 annual reports on November 15, 2011, including the HUD Mutual Mortgage Insurance (MMI) report, the FHA Annual Management Report (AMR), and the HECM MMI Actuarial Analysis. Upon review, our conclusion is that HUD is still significantly understating the expected future losses in the HECM book of business. Others have concluded the same about the forward loan book: The Wall Street Journal Editorial page took HUD to task on this point Thursday, November 17, 2011, and Wharton Professor Joseph Gyourko published a study for the American Enterprise Institute’s for Public Policy Research asking “Is FHA the next housing bailout?”

There are three central points addressed in this post:
1. Aggregate changes to the FHA’s overall HECM exposure;
2. Comments on the FHA’s prepayment conclusions; and
3. FHA’s Home Price Appreciation (HPA) assumptions, T&I defaults, and their impact on future losses.

Overall HECM Exposure

It is important to note the FY 2011 HECM Actuarial Analysis covers only the MMI Fund, not the GI Fund, where most of the HECM program’s exposure rests. While the Economic Value of the loans in the MMI Fund may be positive, it represents just 37% of HECMs, all of which were originated in 2009-2011, after the recent real estate bubble deflated. The brunt of the analysis should have focused on the GI fund. Instead, the economics of the GI fund is mentioned briefly deep in the notes to the FHA financial statements in the AMR.

We reported in our April posting that the Net Present Value of the entire HECM program was -$7.3 billion as of 9/30/10. Our calculation took FHA’s FY 2010 projected loss of $11.365 billion and offset it with historical receipts ($4.5 billion), and estimated realized losses ($400 million). The bulk of this $11.365 billion estimate comes from projecting future losses on existing books of business, primarily those loans originated in years 2005-2008, which account for 47% of all HECMs ever originated. This group of HECMs was originated at the height of the home appreciation bubble, and as a result, the overall program is particularly sensitive to prepayment assumptions and HPA forecasts, especially in the later years.

For FY 2011, The GI Fund reported Liabilities for Loan Guaranties (LLG) of $7.864 billion dollars, down $828 million from last fiscal year’s $8.692 billion projection. The LLG is defined as the net present value of anticipated cash outflows and cash inflows. The MMI fund, which has insured HECMs since FY 2009, reported an LLG of $2.149 billion, down $524 million from FY 2010’s $2.673 billion projection. Therefore, FHA’s overall projected exposure to future HECM losses is reduced by $1.352 billion to $10.013 billion.

How is this projection calculated? The two principal drivers for future performance in the HECM book of business are 1) future HPA assumptions; and 2) prepayment assumptions. Because reverse mortgage exposure to loss is back-ended, the magnitude of loss is particularly sensitive to expected home prices in the distant future. Future losses are also sensitive to prepayment speeds because the more slowly the loans pay off, the longer they are outstanding and subject to future home price appreciation/depreciation.

Prepayment Analysis

The Actuarial Analysis “HECM Termination Rates” Exhibit A3.1 (page A-10) suggests an annual prepayment rate of 6% even for new vintages. (The section on prepayments in the Actuarial Analysis is confusing and hard to follow.) Amid the blizzard of statistical formulae, we cannot find anything that resembles recent actual experience. In the AMR for example, we are told 73,093 HECMs were originated in FY 2011. Later in the report, it states that 560,843 HECM loans remained outstanding at the end of the year; the corresponding number in last year’s report was 510,144. That implies that 22,394 loans paid off, a prepayment rate of approximately 4.4%. One can easily do this math going back through previous years’ FHA AMRs to find that HECM prepayment rates have been falling steadily for almost six years. For the largest cohorts, the bubble-year vintages, prepayment rates are currently closer to 2%. See New View Advisors’ Prepayment Index tab here.

New View Advisors’ modeling of prepayment activity also incorporates mortality, mobility, and refinance, but in this environment, the latter two factors equal nearly zero. Actuarial life expectancy tables have been used since 1999 with extreme accuracy. They are a highly predictive indicator of prepayments, and much easier to comprehend. The tables we use are Annuitant mortality tables, not those of the population as a whole; this is essential for capturing the adverse selection of seniors who choose long-term financial products. The FHA Actuarial Review report states “base-case mortality rates were based on the 1999-2001 U.S. Decennial Life Exhibit, published by the Center for Disease Control and Prevention in 2004.” These tables appear to be for the population as a whole, and for major subgroups, but do not address annuitants. This may have introduced a serious sampling error into the Actuarial Review’s prepayment forecast.

Mortality is the dominant driver of Maturity Events, and depressed home prices slow down the rate at which matured HECMs are liquidated (i.e. loan paid off and/or property sold), putting still more downward pressure on prepayment rates. FHA’s faster prepayment assumptions are painting too rosy a picture of future expected loss.

Home Price Appreciation (Depreciation)

As for the impact on future HPA, each of the five scenarios portrayed in the Actuarial Review fails to contemplate the effect of a prolonged real estate slump or the effect of volatility on future losses. As mentioned above, because reverse mortgages suffer realized losses at the end of their life, short-term swings in home prices do not have nearly the deleterious effect on loss that long-term economic trends do. Exhibit B2.1 in Appendix B of the Actuarial Review clearly depicts the five different HPA scenarios used to test sensitivity. Every scenario has HPA returning to between 3% and 5% annual growth by 2015, with a relatively smooth curve that ignores the volatility of the housing market.

Home prices rose at an unprecedented 6% annual growth from HECM’s inception in 1989 until 2007, and HPA was 3-4% from 1945 until the bubble in 2007, but this doesn’t predict future home values. Assuming this period as the norm conveniently forgets that it is bracketed by the Great Depression and the Great Housing Bust. One could argue the recent 30% drop in HPA is the reversion to the mean, and that a relatively quick return to 5%, then 3.4% (Page 6 of the Actuarial Review) annual growth is not a plausible “Base Case.” What would happen if HPA spiked and fell again? That would also be devastating, as a new book of business would be originated at another temporary peak in the real estate market. While no one has a crystal ball, at a minimum, the FHA should be showing the effect of volatility and a prolonged flat or negative HPA in some of its sensitivity scenarios.

If we can’t predict the future, we at least can examine the past. Home prices fell over the last year, at about 5% on average during FY 2010. If prepayments were slower than expected and home prices fell, how can FHA justify an LLG decline of nearly $1.4 billion?

Default

The Actuarial Review Appendix D forecasts a T&I default rate of 2.2%. Once again, this bears no semblance to recent reported experience. At the annual NRMLA conference in Boston last month, the FHA themselves reported T&I defaults in its portfolio were running north of 8% and growing, nearly four times this assumption. Where did 2.2% come from? It is neither descriptive of historical experience nor plausible as a forecast. Unfortunately, the severity of loss for defaulted loans was not disclosed, so it is not possible to understand the impact of default on realized losses for these books of business.

Conclusion

FHA’s $10 billion expected loss from its HECM book is likely low, based on overly optimistic HPA, loss, and prepayment assumptions. How far off is anyone’s guess, but sensitivity analysis is supposed to show worst case, base case, and best case execution, and these reports have failed to do so. Nonetheless, we emphasize that FHA has taken many of the proper steps necessary to reform the HECM program. The reverse mortgage industry has reduced the amount it lends, weaned itself off Fannie Mae, and introduced financial assessment to minimize loss.
Considering HECM is less than 1% of the overall mortgage market, the FHA needs to take a sober look at the forward side of its business. The astonishingly high Loan-to-Value ratios of FHA’s forward mortgage programs are a good place to start.

FHA’s Underwater Problem – And Its Way Back to the Surface

Monday, April 25th, 2011

FHA recently released an updated loan level data file showing all HECMs originated through January 2011. Not surprisingly, prepayment rates have declined. We have adjusted our HECM “Prepayment By Borrower Age” table accordingly.

The real news is that FHA included some new data fields in the January 2011 data set that were not released previously. This new data enables us to get a sharper picture of the economic state of the HECM program. These include data showing the amount borrowed for each loan, and the year it was drawn. For example, for a loan that has been outstanding four years, the FHA file shows the amounts drawn in year 1 (mostly the initial draw at closing), year 2, year 3, and year 4. That’s not the same as simply showing the cutoff balance for each loan as of January 2011, but we can get a good approximation by rolling forward each of those draws, plus estimated accrued interest, MIP, and servicing fees.

We rolled the draw balances forward, using historical data for adjustable rate base indices as applicable. About 540,000 HECM loans are currently outstanding. Of these, about 510,000 were outstanding at the end of FY 2010. We estimate the total outstanding balance of all HECM loans to be approximately $76 billion as of January 2011. This estimate, derived from the most recent FHA dataset, is consistent with FHA’s most recent FY 2010 report.

The dataset also contains the estimated Property Value at origination for each loan, as well as the mortgaged property’s location: Metropolitan Statistical Area (MSA), State, Zip Code, etc. For about 92% of the loans in the file, we were able to link these data fields to publicly available data showing historical price levels by MSA, and thereby estimate each loan’s current underlying property value. For the remaining 8%, we used state level home price data. Comparing these property values to the rolled balances, we can estimate the current state of the HECM program with respect to crossover losses.

Our analysis shows the following: approximately 93,000 HECM loans (or 17.1% of outstanding) are underwater by a total of $3.3 billion. However, those numbers simply compare loan balance to property value; a more accurate measure haircuts the property value to reflect the cost of property disposition. As a practical matter, only the net property value (home price minus the property disposition cost), is available to pay off the HECM loan. Unfortunately, property disposition costs grow significantly as the mortgage balance approaches the crossover point; a haircut of 10% or even 15% is not unreasonable. If the loan is in default or foreclosure, the cost can be much higher. Applying a 10% haircut to property values raises the number of HECMs effectively “crossed over” to 135,000 loans (24.9% of outstanding), underwater by $4.9 billion, and a 15% haircut to 166,000 loans (30.6% of outstanding) underwater $6.1 billion.

These amounts are small in absolute numbers compared to forward mortgage, but similar in percentage terms: for example, the analytics firm CoreLogic estimates that 23.1% of all outstanding forward mortgages were underwater as of yearend 2010.

Not surprisingly, HECM loans originated from 2005 through 2008 comprise substantially all of these underwater loans. In the 10% haircut scenario, they account for 91% of the underwater loans. The 2006 and 2007 vintages are the worst offenders: each accounts for about 30% of the problem loans.

These numbers will get worse before they get better. The underwater numbers above represent how much FHA might lose if the loans paid off immediately. Most likely, they will pay off slowly over the next several years. During those years, accreting loan balances and borrower advances, especially if combined with slow prepayments and a struggling housing market, will make the problem worse. This fact is reflected in FHA’s estimate of a Loan Loss Liability of $8.692 billion (for HECMs originated through FY 2008) in their most recent Annual Management Report. This is consistent with the $8 billion crossover loss New View Advisors predicted in July 2009. (FHA has continually made upward revisions to their loss estimates for HECMs originated through FY 2008, from their $4.8 billion estimate at the end of FY 2009 and $1.5 billion the year before.) We also estimate, based on the FHA dataset, that FHA has already experienced about $400 million in realized losses from underwater HECMs that have paid off.

The HECM program’s bottom line: probably a little over $4.5 billion in MIP collected to date (in present value terms), minus about $0.4 billion in realized losses, minus the $8.7 billion in projected negative net present value (“NPV”), which includes nearly all of the $4.9 – $6.1 billion baked-in crossover loss we estimate, minus another $2.7 billion in projected losses for HECMs originated in FY 2009 and FY 2010. In sum, about $7.3 billion negative NPV for the program since its inception, with the vast majority of the damage coming from the 2005 – 2008 HECM loan cohorts.

$4.5 billion   MIP collected
-$0.4 billion   Realized losses
-$8.7 billion   1990-2008 originations: projected net loss
-$2.7 billion   2009-2010 originations: projected net loss
-$7.3 billion   HECM program NPV 1990-2010

If there is good news in all this, it is that the reverse mortgage industry has already undergone the painful process of reform, including reducing loan-to-value ratios (principal limits) and weaning itself off Fannie Mae. In contrast, the forward mortgage industry has kicked those cans down the road. FHA loans are still available for as little as 3% down. Fannie Mae and Freddie Mac account for over 60% of the forward market, with FHA taking the lion’s share of the remainder. But for the reformed HECM program, FHA and the taxpayer are better protected, with Principal Limits much lower and monthly MIP rates much higher than before. FHA’s FY 2012 budget predicts a modest surplus from newly originated HECM loans; this is a plausible estimate reflecting a more conservative HECM program.