Posts Tagged ‘HECM Prepayments’

FHA’s Underwater Problem – Is the Worst Over?

Monday, January 30th, 2012

FHA recently released another updated Home Equity Conversion Mortgage (“HECM”) loan level data file, this time showing all FHA-insured reverse mortgages originated through November 2011. Once again, prepayment rates declined to new lows: the annual prepayment rate for seasoned HECMs is about 4.7%, compared to the historical average of 6.8%. We have adjusted our HECM “Prepayment By Borrower Age” table accordingly.

Beginning with the prior release (January 2011), FHA added new fields to their data set. 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. As we explained last April, a good approximation of each loan balance can be calculated by rolling forward the draws, plus estimated accrued interest, MIP, and servicing fees.

Using this same methodology, and applying the data from the most recent FHA dataset, we rolled forward the approximately 580,000 HECM loans currently outstanding. We estimate the total outstanding balance of all HECM loans to be approximately $87.6 billion as of November 2011. This estimate is consistent with FHA’s most recent FY 2011 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. Once again, 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 108,000 HECM loans (or 19% of outstanding) are underwater by a total of $4.3 billion, an increase of nearly $1 billion over 10 months. 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 160,000 loans (28% of outstanding), underwater by $6.4 billion, and a 15% haircut to 196,000 loans (34% of outstanding) underwater by $7.9 billion.

Not surprisingly, HECM loans originated from 2005 through 2008 comprise substantially all of these underwater loans. In the 10% haircut scenario, they account for about 88% of the underwater loans. The 2006 and 2007 vintages alone account for nearly 60% of the problem loans.

Because of the 2005-2008 vintages, these numbers will get worse before they get better. The underwater numbers are simply a snapshot as of November 2011, in other words, how much FHA could lose if all the loans paid off at that cutoff date. But these loans are paying off slowly, and will take several years to pay off completely. 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 $10.013 billion (for HECMs originated through FY 2011) in their most recent Annual Management Report. (FHA made upward revisions to their loss estimates for HECMs originated through FY 2008, from their $8.7 billion estimate at the end of FY 2010, $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 anywhere from $700 million to $1 billion in realized losses from underwater HECMs that have paid off.

Last April we put the HECM program’s net economic value since inception at -$7.3 billion. With declining home prices, (down about 3% in the 12 months ended November 2011), slow prepayments, and accreting loan balances, one might expect FHA’s HECM bottom line to get much worse. But with several months of new loan production of improved HECM products, the overall outlook for FHA’s HECM insurance portfolio avoided further deterioration. With each new loan, FHA is collecting MIP at a higher rate on loans with lower Loan-to-Value ratios. As we noted in our previous blog, FHA reduced its estimate of future losses on its HECM portfolio. Combining FHA’s estimates of what will happen with our estimates of what has happened, the program’s net economic value since inception now stands at about -$5.4 billion. We think FHA’s current projections are a bit optimistic, but even using their old numbers, the program’s economic value held steady.

The details of the HECM program’s bottom line: probably a little over $5.3 billion in MIP collected to date (in present value terms), minus at least $0.7 billion in realized losses, minus the $7.9 billion in projected negative net present value (“NPV”), which includes nearly all of the $4.3 – $7.9 billion baked-in crossover loss we estimate, minus another $2.1 billion in projected losses for HECMs originated in FY 2009 – 2011. In sum, about $5.4 billion negative NPV for the program since its inception, with the vast majority of the damage coming from the 2005 – 2008 HECM loan cohorts. Even if FHA’s assumptions are too rosy by $2 billion, the program is still holding the bottom line in unfavorable economic conditions.

$5.3 Billion   MIP collected
-$0.7 Billion   Realized losses
-$7.9 Billion   1990-2008 originations: projected net loss
-$2.1 Billion   2009-2011 originations: projected net loss
-$5.4 Billion   HECM program Net Present Value 1990-2011

In our last blog on this topic, we note that unlike the forward mortgage industry, 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. Barring another housing catastrophe, the worst may be over. If so, the current position of the HECM will improve each year, as FHA’s HECM risk profile reflects an increasing percentage of the new, more conservative standard HECM loans and HECM Savers.

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Understanding Reverse Mortgage Prepayments: Focus on HECMs

Monday, July 26th, 2010

Part I: Mortgage Prepayment Risk in Reverse

Mortgage investors spend a great deal of time and effort analyzing prepayment risk, and with good reason. The mortgage borrower usually receives a valuable option: the ability to prepay at any time in whole, or in part, without penalty. This is sometimes easier said than done, especially in the current economic climate, but nonetheless the mortgage investor is short this option. Mortgage borrowers refinance to reduce their monthly payment and/or to cash out home equity that, under normal conditions, rises as the loan balance decreases, and the home value increases. Compounding the investor’s uncertainty is the fact that prepayments rise when interest rates fall (when reinvestment rates are lower), and prepayments fall when interest rates rise (when reinvestment rates are higher). As a result, mortgage investors must analyze the key drivers of forward mortgage prepayment rates: the mortgage interest rate, current mortgage rates, loan seasoning, the volatility of interest rates, and the available equity and refinancability of the underlying property.

For Reverse Mortgages (RM), the prepayment picture is fundamentally different. Borrowers don’t make a monthly mortgage payment, so their refinancing incentive is diminished. Under normal conditions, the RM borrower’s home equity decreases, further diminishing the attractiveness of refinancing. The age of the borrower matters more than the age of the loan. These are all natural consequences of the characteristics of the reverse mortgage loan, a product that combines mortgage and actuarial-based finance to provide liquidity to the senior homeowner, without the burden of a monthly mortgage payment.

As a result, reverse mortgages provide the investor with a unique opportunity: a mortgage with considerably less market-driven prepayment risk, governed instead by predictable actuarial factors, capable of sustaining premium value over a sustained period. For HECM/HMBS investors, FHA provides an additional benefit: the 98% Maximum Claim Amount “put” that caps extension risk and shortens the duration of their investment in a predictable, measurable way. Informed mortgage investors have come to appreciate the reverse mortgage prepayment advantage, which goes a long way in explaining the recent HMBS boom.

But how do we measure reverse mortgage prepayments? By which yardstick? Using what data? Doesn’t refinancing sometimes happen, into a new reverse mortgage, or another kind of mortgage? Also, there haven’t been “normal conditions” in the housing market for some time. Instead, a period of rapid home depreciation has followed a period of rapid appreciation, throwing the housing market into turmoil. These are all important questions, but we can’t answer all of them in one essay. Suffice to say, the study of mortgage prepayments is practically a science unto itself, so let’s keep it simple (at least for Part I) and understand the basics.

Finding The Data
New View Advisors began publishing a prepayment index for seasoned HECMs and proprietary RMs several months ago. We compile this data from our clients and other private sources. The prepayment rate is simply a fraction, expressed as a percentage, the numerator of which is the number of loans paid in a given period of time, and the denominator of which is the number of loans outstanding at the beginning of the same period. Importantly, we define HECM prepayments from the investor’s perspective, which means the earlier of the loan prepayment or assignment to FHA.

The most commonly used measure is Constant (or Conditional) Prepayment Rate, or “CPR,” equal to annualized prepayment rate over a stated period. For example “1 Month CPR” is equal to the annual rate of prepayment, based on one month of prepayments. (The Monthly Rate is referred to as “Single Monthly Mortality,” or SMM, and is approximately equal to one-twelfth of the 1 Month CPR.) 12-Month CPR is a useful yardstick as it averages out a year of data, smoothing out seasonal and other anomalies.

For seasoned HECMs, our index showed 12-Month CPRs of 4.4%, 4.6%, 4.7%, 4.5%, and 4.2%, for the 12 months ending September 2009, October 2009, November 2009, December 2009, and January 2010, respectively. Proprietary loans generally pay faster (in forward and reverse mortgages), and recent experience is no exception.

FHA published a very useful HECM prepayment study in 2007, but its relevance diminished as time passed, especially as that time reflected very different economic conditions. Also, this study presented the data in summary format; no loan level data was made available to the public.

However, FHA recently published a mother lode of HECM prepayment data, a comprehensive loan level file disclosing the main loan characteristics for every HECM loan that ever closed (and a number that didn’t) from the inception of the program through January 2010. The FHA plans to update this file every six months.

Analyzing the Data
The new FHA data reveals a great deal. Since 2007, as the New View Advisors index also shows, prepayments have fallen dramatically. Under normal conditions, they should rise for each vintage of origination, as borrowers age and an increasing percentage of loans are put back to HUD at the 98% Maximum Claim Amount.

A comparison of the 1999 vintage and the 2006-2007 vintages illustrates the impact of the housing crisis, as seen on this spreadsheet. During the unseasoned period (i.e., the first two years) both cohorts show very low prepayments. In fact, they both pay at 2.79% CPR within the first three months after their origination period. But after that, their paths diverge. Aided by rising home values, and presumably much higher homeowner mobility, the 1999 vintage climbs to a double-digit CPR in a little over two years. But the 2006-2007 vintage has never approached double digits, and has yet to crack even 5% CPR over a 12 month period. Interestingly, reverse mortgage prepayments have been falling even during a period of record low interest rates — hardly in line with conventional mortgage prepayment behavior.

Nonetheless, prepayments for this cohort are rising ever so slowly. The 2006-2007 vintage roughly approximates the population used for our index, and indeed confirms our published numbers, averaging a mere 0.2% difference.

Breaking down the numbers by borrower age, we see a strong correlation, with prepayment rates rising from 3.5% for 62 year olds, 6.9% for 77 year olds, and 26.1% for borrowers 90 and older. These numbers reflect HECM experience since the program’s inception; current prepayment numbers are lower across the board, but still show a strong borrower age correlation.

Conclusions
We will have much more to say about this topic, but for now the data confirms that reverse mortgages have unique prepayment characteristics that derive from the unique features of those mortgages and their unique borrower population. However, they are hardly immune from prevailing economic conditions. HECM prepayment rates have fallen dramatically as the economy has decimated mobility and refinancing opportunities. Also, the FHA assignment feature significantly protects investors against extension risk, and prepayments for a given cohort will still tend to rise over time, however slowly.

The strength of the borrower age/prepayment correlation commands investor attention, not only in analyzing existing loans and HBMS pools, but also with respect to the future of tailor-made HMBS pools, comprised of narrow ranges of borrower age groups (and therefore tailor-made ranges of likely duration.)

The new FHA data are an important contribution to the understanding of HECM prepayments. Supplemented with the monthly updates of our own index, they help the proper analytic foundation for understanding the risks and rewards of reverse mortgage investments.

For more detailed information on prepayment analysis by vintage, borrower age, loan age, HECM type, etc., please contact us.

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