1 Comment

1. 

   James E. Veale, CPA, MBT

   January 12, 2015 at 4:15 pm

   Shannon,

   Your points were well taken and presented but there is still an elephant in the room weighing down on us.

   Just how deep will financial assessment cut into our HECM volume this fiscal year and next? While it seems HUD has created a strong means to measure property charge default tendencies of borrowers, per a reader poll at RMD the majority of respondents (as of 1:45 EST) expect the loss in business will exceed 15%. Add to that percentage those who believe that the loss will be 11% to 15% and the ratio of those who anticipate the loss will be greater than 10% rises to over 2/3rds of all respondents.

   Originators have given predictions on personal production. Some indicate the loss will be about 5% and some others expect a collapse of their production to 25% of what it was last year. Thus the range of personal loss from last year is from 5% to 75%. So when some declare that HUD is running them out of the business and destroying the industry, what seem like ridiculous claims of the few are to some degree understandable on a subjective level.

   Since most of the industry and HUD understand that to get the financial assessment system up and operating smoothly will take months for many lenders. It is now time to estimate the size of HECM borrowers who have been in serious property service default. (An example of a property charge default which is not serious is a payment which is delayed due to a temporary cash flow problem with no expected negative long-term default impact from the event but where the default is cured within weeks of the default; generally, it includes all those defaults where the borrower cures the default within a reasonable period of time depending on the nature of the problem that caused the default and there is no expected long-term default problems stemming from the incident causing the borrower to default.)

   While the highest percentage of property charge defaults publicly disclosed to date is about 10% of the active HECMs as of the end of fiscal 2012, that is not the same as the percentage of HECM borrowers who had experienced serious property charge defaults. If one includes HECMs which had terminated by 9/30/2012, that is all HECMs, the percentage would probably drop to about 8%.

   Now we need to look at the situation of the cohorts of HECMs that closed last fiscal year, if the percentage of most likely borrowers to default are 8% then we need to take out the percentage we cannot detect at origination because their defaults are caused by events subsequent to initial funding due to lower Social Security income from the death of a spouse, due to the termination of a high paying bond in a suddenly very low interest paying environment, due to the loss of a job, etc. Let us say that percentage is no more than one-eighth of the total so that we are looking to eliminate 7%.

   Now we need to look at the risk differences between the HECMs of 2012 and those of today. Based on lower principal limits (than fixed rate Standards) and the first year 60% of the initial principal limit disbursements limitation, the HECM of today has features which will mitigate the percentage of those who would otherwise default due to failure to pay property charges. Let us say that the percentage of borrowers who will default on property charges and can be detected at origination is about 5%.

   So assuming financial assessment is correctly calibrated to eliminate all those it should and the percentage of business lost is 16%, then 11.6% (i.e. 11% of the remaining 95%) of those who would not otherwise default will be improperly eliminated. Let us say that financial assessment only eliminates 60% of those it should, then 13.4% of those who should not be eliminated will be.

   So first let us hope that the loss in business is much lower than some percentage over 15%. Second let us hope that financial assessment is properly calibrated to eliminate a high percentage of those who have a propensity to default.

   Finally, we will not begin see the loss in business from financial assessment until endorsements for July are reported in the first part of August. We will most likely not see the full impact of financial assessment until the report for September endorsements. However, it will take several years until we can begin to reasonably determine the potential size of serious property charge defaults in the cohort of HECMs endorsed in fiscal 2016. At that time, HUD can begin to tweak financial assessment so as to mitigate the improper elimination of those who would not default and also more accurately target those who would.

   So getting financial assessment working at its most effective level will probably take until around several years in the future and perhaps not until sometime early in the next decade. But again there will always be property charge defaults no matter how great financial assessment turns out to be.

   (The opinions expressed in this comment are not necessarily those of RMS or its affiliates.)

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