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HECM Risks: A Balancing Act

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FHA is addressing risks on both sides

The federally-insured reverse mortgage or Home Equity Conversion Mortgage while holding tremendous value has been challenged with continued losses paid from the FHA’s insurance fund. In the wake of the housing bubble and economic crisis the program, several changes were enacted. The repeal of the standard fixed-rate HECM, the introduction of the HECM Saver, increases in mortgage insurance premiums, the financial assessment, first-year distribution limits, repeated principal limit factor reductions, and most recently, the enactment of the second appraisal rule as part of the Collateral Risk Assessment. The pace of these changes increased with the passage of the Reverse Mortgage Stabilization Act of 2013 which allows HUD to establish new rules via mortgagee letter rather the previous protracted rule-making process. The intention was to allow the agency to act quickly to slow the mounting losses incurred by the program.

When it comes to HECM risks there are basically two types: front end and back end. Front-end risks would include the valuation of the home, lending ratios or principal limit factors, and product design.

Download the video transcript here

 

6 comments

Terri Nettles November 26, 2018 at 7:19 am

It seems to me that the reason for issues with the mortgage insurance fund is a result of old FHA loans. The newer loans based on the lower PLF and MIP would obviously not be reflected as quickly. I am surprised that they expect such a quick result given some of the changes only took place last year.

Reply
James E. Veale, CPA, MBT November 26, 2018 at 10:40 pm

Terri,

Unfortunately that is not the case. The total estimated loss per FHA for the cohort of the HECMs endorsed during fiscal year 2017 is $1.811 billion. That is the second largest loss for any cohort other than the $3.276 billion total estimated loss for the cohort of HECMs endorsed during fiscal year 2009, making the average loss per HECM for fiscal 2018, $31,969. The highest loss per HECM endorsed in any fiscal year since 2008 is fiscal 2017 with an average loss per HECM of $32,736. The average loss per HECM for a fiscal year is simply dividing the MMIF loss for that fiscal year by the total HECMs endorsed during that same fiscal year. (The total HECMs endorsed in fiscal 2017 were 55,322 and for fiscal 2018, 48,359.

The average per HECM loss per fiscal year bottomed in fiscal 2014 but has been rising since. It capped in fiscal 2017 per HUD/FHA and is down only 2.4%. As a result some have stated that Mortgagee Letter 2017-12 was too harsh when looking at the demand for HECMs in fiscal 2018. I disagree with the reasoning that we do not know how high the loss for fiscal 2018 would have been without the implementation of that mortgagee letter. Beyond that, the vast majority of HECMs endorsed in fiscal 2018 had case number assignments prior to 10/2/2017 so that it is generally believed by HUD/FHA that in the first twelve consecutive month period where few, if any, HECMs had a case number assigned before 10/2/2017, Pragmatically because of the way HUD/FHA reports the results of operations on the HECM portion of the MMIF, that will not be until the fiscal year ending 9/30/2019 (a little over 10 months from now).

Please note all losses reported on in this comment come from the HUD/FHA estimate of losses, not Pinnacle since their job is merely to confirm the reasonableness of the total estimate of the value of the HECM portfolio in the MMIF as made by HUD/FHA.

As to what is causing the current rise in losses, that lies with the adoption of financial assessment. HUD/FHA decided to remove as much risk as possible upfront from borrowers defaulting on the payment of property charges. By those efforts, they also sucked almost all of the risk of such events happening so that the biggest risk from HECMs today comes from longevity of the HECM when the HECM collateral has little home price appreciation.

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Jeff Featherson November 28, 2018 at 9:09 am

Who developed the formula that an “average” loss can be accurately projected by dividing a year’s loss experience by the current number of endorsements, rather than by the actual number of that year’s actual foreclosures to yield a ‘per unit’ cost, than that number by the recent total of new endorsements?

Program losses are systemic due to the loan-end recuperation process. As there is no current incentive in place to foster a higher sales or auction value, no one cares about the selling price and it’s far to easy for the program to get low-balled. Initial Lenders get bailed out, as it should be, but the burden of re-selling the empty home will ultimately always relegate itself to becoming a capitalist’s goldmine.

One thought comes to mind is a conditioned auction rather than absolute sale, and attaching a seven (7) year lien for a “minimum” value, interest accruing amount based on the outstanding indebtedness. That could be one way to avoid the “property-flippers” that feed off friends in the auctioning or disposal process. Another, offer an “income only” qualification to re-finance, featuring low interest conversion options to beneficiaries or family members wishing to acquire the property, with a cost based on i.e, debt + 10-15%, or bid, if higher.

Limit the growth increase in the available but unused P/L by a rate that is, for example, 2% LESS that the interest rates being paid on the mortgage amount, rather than growth computed as the ACTUAL amount of charged interest.

Limit the sales commission on FHA liened properties to just 3% plus closing and recording fees.

Another possibility that might win a popularity contest would be to create a “merged” program with the VA that permits VA qualified buyers a low entry accompanied with a reasonable infusion amount for repairs.

Create a National Coalition of AMCs that limit their oversight fee to just $100 per unit. Employ a “non-certified” post-vacancy inspection process by licensed inspectors to estimate costs for cleaning and restoration repairs necessary to achieve a reasonable market value, work to be performed by VA-employee companies.

The key to rescuing this invaluable housing program is to find a way to MAINTAIN OVERSIGHT after the home is vacated using cost effective resources possibly already in place and limiting the blood-letting after a property is vacated. jf

Reply
James E. Veale, CPA, MBT November 28, 2018 at 2:23 pm

Jeff,

All of your ideas are great, I guess, but they have little to do with either the HUD Annual Report to Congress on the Financial Status of the MMIF FY 2018 or the Actuarial Review of the HECM portfolio in the MMIF FY 2018. Both documents heavily rely on estimates. Actual results may tweak some aspects of the assumptions used in estimating the results of operations but each documents is expressing the anticipated results of gain or loss resulting from termination of all HECMs in a cohort (all HECMs endorsed in a particular fiscal year after fiscal 2008).

Congress (with HUD/FHA) oversees this program and wants to know what the approximate value of the overall portfolio of HECMs in the MMIF are worth. How can you tell them anything about the FY 2018 cohort of HECMs in a report dated 11/15/2018 on an actual basis? How many HECMs that were endorsed in 2018 also terminated in 2018? Both of them, maybe?

This is not a mortgage program. It is an insurance program. Unless a policy opens and closes in the same year, there is no way for an insurance company to report on earnings for that year; that is why estimates are used. Here the HECM will not terminate in most cases for over 8 years. So without estimates, there is no way that Congress can obtain the answers they need. The only choice is to close down the program until all of the outstanding and active HECMs have terminated so we have actual results and then see if the program should be reopened which is in line with your appeal to “actual results.”

I really do not know how a life insurance company could be managed if one had to wait for actual results.

So as I clearly stated: “The total estimated loss per FHA for the cohort of the HECMs endorsed during fiscal year 2017 is $1.811 billion. That is the second largest loss for any cohort other than the $3.276 billion total estimated loss for the cohort of HECMs endorsed during fiscal year 2009, making the average loss per HECM for fiscal 2018, $31,969.” These are estimates and as such are the estimates of results from operations that management (Congress plus HUD/FHA) need to run the program.

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Jerry Hanley November 26, 2018 at 9:35 am

Shannon, I found this video most timely. While many of us struggle to deal with all the changes to our HECM product, some of us are relying more and more on internet leads. Bill Baskin’s comments in his Lead Minute segement were spot on. I am going to make sure that all of my fellow RMF loan originators are urged to take the time to view this video. All of us should write down and study his Sales 101 – Elements of a Sale comments along with all his other “truths” regarding internet leads.

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James E. Veale, CPA, MBT November 26, 2018 at 4:21 pm

The HECM program is not a mortgage program but an insurance program for a particular type of mortgage.

Unlike the reports for the results of operations on other types of business, the HECM reports are quite unusual. There are no costs of operations for 1) personnel costs such as salaries, retirement, health, training, transportation, life term insurance, and human resources; 2) office costs such as rent, furniture, utilities, maintenance, and telephone costs; and 3) other costs such as legal expenses, outside accounting services, and actuarial review expenses. The ONLY costs that the MMIF pays are 1) lender reimbursement claims, 2) collateral REO disposition costs, 3) loan acquisition costs when the HECM is going into assignment, and 4) HECM related REO property maintenance and related costs.

Like most insurance reporting, management must report losses as soon as they are measurable and in this case estimate profits. Congress and taxpayers demand that the MMIF capital reserves be estimated annually so that the Fund is not only transparent but also properly funded with taxpayer dollars as soon as the need is indicated. Since the MMIF is a vehicle that incorporates more than one FHA/HUD mortgage program, contingent funding from taxpayers is only required when the sum of the cumulative results of operations for all mortgage programs covered by the MMIF is an overall loss and only to the extent of those losses. Since the end of fiscal 2008, the overall position of the MMIF has been positive except in fiscal 2013 when the HECM portion of the MMIF was more negative than the other mortgage programs positive; approximately $1,7 billion was taken from the US Treasury to cover those net cumulative losses.

Even though a service titled actuarial sciences provides (or confirms) the results of HECM operations, the work of the actuary like that of an auditor is more art than science. Because HECMs may not terminate for decades and an estimate of the results of operations must be estimated in year one and for each fiscal year thereafter until all HECMs in that cohort have terminated, actuaries must analyze each cohort of endorsed HECMs and determine the results of operations for those HECMs that have terminated and estimate the results of operations on those that have not terminated. Back in fiscal 2012 when HUD was still summarizing active HECMs by their year of endorsement, there were still 2 HECMs that had not been terminated even though endorsed in fiscal 1990.

When HUD/FHA had to restate its MMIF results from operations for fiscal 2017, Pinnacle did as well. The result was that the Pinnacle average loss per HECM estimate was much closer to the HUD/FHA average loss per HECM by cohort than its original estimate. The original Pinnacle review appeared to have determined that Financial Assessment was far less costly to the MMIF than HUD/FHA. While HUD/FHA restated average loss per HECM trimmed down its estimate for fiscal 2017 by 7.6% , Pinnacle increased its average loss per HECM for fiscal 2017 by 31.2%, Despite the restatement, the HUD/FHA restated estimate for the fiscal 2017 cohort average loss per HECM remains 21% higher than the Pinnacle estimate.

It is the job of Pinnacle to determine if the overall value of the HECM portfolio accounted for in the MMIF (not the G&SRIF) as reported by HUD in its Annual Report is materially correct. Before the new Administration it was the job of the independent actuaries (or engineering) firm to determine the value of the portfolio that HUD/FHA used in its Annual Report to Congress. Beginning in fiscal 2017, that practice ended and now HUD/FHA is the responsible party with Pinnacle determining if the total value for the HECM portfolio is materially reasonable.

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