Our industry has seen quite a few margin increases in the past year or more, such that even with historically low index rates the higher margins are starting to reduce upfront funds available to seniors. We’re all aware of the consumer impacts, but what may be less intuitive is that margin increases by Fannie Mae may represent the reverse mortgage industry’s best chance at survival.
While it makes sense to think about how TARP and other stimulus programs might serve to assist the reverse mortgage industry, it’s also important that we consider the intermediate and long term perspective of surviving without becoming wards of the state at the mercy of political whims, as some recent recipients of federal money have belatedly discovered. In that light, let’s consider our current situation.
GNMA & Recycling Challenges
We as an industry presently have two primary mechanisms for recycling capital to make new loans: Fannie Mae’s whole loan purchase program and Ginnie Mae’s HECM MBS securitization program. Both provide an outlet for originators to sell loans, but what may be less well understood is why Ginnie Mae cannot yet replace Fannie Mae as the primary delivery vehicle for HECM loans.
While GNMA holds significant potential as an alternative source of capital to fund HECM loans and perhaps allow originators to earn premiums on subsequent draws by the borrower, there is a huge amount of risk to originators/issuers to use the GNMA structure for open ended loans, as the vast majority of HECMs currently are written.
Future draws by the consumer are priced for sale at current market prices, while the effective margin rate on that draw is fixed at time of closing by the originator/issuer. This disconnect means that originators who sell an open ended HECM that has not been fully drawn through a GNMA structure are taking on the risk of all future draws being priced at prevailing market prices when the borrower draws.
A simplified example to illustrate:
- Borrower A obtains a HECM Monthly in 2007 from Lender B. This Borrower draws $100,000 immediately from a $200,000 initial principal limit with a $350,000 maximum claim amount
- Lender B sells the initial draw of $100,000 through a GNMA structure to an investor and earns a 1% sale premium on the current balance, or $1,000
- 2009 rolls around and after seeing many investments decline by 50%, Borrower A decides to draw down another $100,000 to replenish short term cash.
- Lender B puts the additional draw of $100,000 into a new GNMA structure and offers it for sale to an investor
- Investor is currently paying 1% for HECM draws with a margin of 375, but what will they offer for a draw with a margin of 100? Let’s be generous and assume they’ll pay 95 – this still leaves the originator/issuer with a loss of $5,000 that more than offsets the initial profit from 2007 on this borrower’s loan.
If you were Lender B in this example, how likely would you be to consider the current GNMA a reasonable replacement for selling to Fannie Mae when Fannie Mae agrees to fund all future draws at par? Given this risk, it’s easy to see why Ginnie Mae has only been used by reverse lenders to date for fully drawn HECM loans, generally fixed and closed end loans.
Fannie’s Stiff (But Necessary) Medicine
So let’s consider what this really means for our industry. Simply put, the historical investor for the reverse mortgage industry (Fannie Mae) is under-water on every single active loan on a mark to market basis given that margins have increased dramatically in recent years. If Fannie Mae might be holding as much as $50 billion in HECMs, and we assume a similar 95 price in the current marketplace, even without taking into account balance sheet leverage and foreclosure costs, they could be staring down a multi-billion dollar problem.
Now we all know that Fannie Mae isn’t required to mark to market and has the financial resources to clear the market at whatever price they like. So why should they raise the margins and put their own balance sheet at risk? First, the federal government has required Fannie to shrink its balance sheet, and while our industry has had relatively favorable political support, there’s no reason to believe we should be exempt from that mandate. Secondly, while Fannie can clear the modest volumes of reverse mortgages at a price of its choosing now, if and when our industry grows we will eventually need additional investors at their marginal price to invest, so in light of that, Fannie’s pricing in isolation can’t truly be considered a ‘market’ price despite its ability to absorb current volumes. The reverse mortgage business has almost always been more ‘market to model’ than ‘mark to market’, and only additional investors can change that.
Now that we’ve seen the stark reality of the situation, let’s consider the path towards a solution for the industry. I think it’s pretty obvious given the above situation that the industry should count itself as very fortunate indeed to have enjoyed the support and backing of Fannie Mae for as long as we have, but should also make every effort to find additional investors to purchase growing volumes of product. As hard as it is to bear, the reality is that transition can mean only one thing: raising margins on reverse mortgage product to a level at which other investors become interested in holding reverse mortgage assets.
That is precisely what Fannie Mae has done, and I firmly believe that in the longer view we will be looking back on these trying times and tortuous margin increases fondly as the medicine that saved the patient. Where other segments of the broader financial services industry have caught major illnesses, what we’re going through is unsettling but no more than a stiff bout of flu in comparison.
There are early signs that investors are beginning to take a close look at reverse mortgages and may be ready to purchase in the near future, because after all, pensions and insurance funds can only park their money at 0% for so long without neglecting their core fiduciary/beneficiary obligations. HECMs, and particularly HECMs in a GNMA, represent a relatively high margin, government backed investment opportunity that stand to be an early beneficiary when investors do come out of hiding.
So at risk of looking foolish, we remain optimistic that Fannie’s painful margin increases are a positive development for the industy, even if they could have been handled somewhat less jarringly for reverse mortgage lenders.