Yesterday, RMD brought you guest poster James Veale’s deep dive into the effects of the recent rule changes to the Home Equity Conversion Mortgage program, as well as the ongoing Financial Assessment requirements. We pick up where we left off with the second part today.
HECM FA exasperates expected losses in the MMIF
An industry myth says that Financial Assessment reduces losses in the Mutual Mortgage Insurance Fund. Yet no data shows that. In fact, the Federal Housing Administration provided estimated data that shows exactly the opposite.
More specifically, no Department of Housing and Urban Development data can be found supporting the notion that foreclosures from property charge defaults in the early years following closing create substantial losses in the MMIF.
Clearly, there are no defaults from nonpayment of property charges in the first year following closing since taxes and insurance must be prepaid in closing for one year in advance. Unless the value of the home dropped significantly in the immediate years following closing, foreclosure should produce little or no loss unless the home had a low appraised value at closing and foreclosure costs were relatively high.
For example, a borrower takes out a HECM in 2014 and in 2018, exactly 48 months later, the lender completes foreclosure from defaulting on property charges. At closing, the home is worth $400,000, the principal limit is $230,000, and the loan is a fixed-rate HECM for Purchase with an interest rate of 5.25%.
At termination, the balance due is approximately $298,000. If the appreciation rate is a negative 3% per year, then the value of the home at termination would be $354,120, making home equity a positive $56,120 before foreclosure, fix-up, and selling costs. The example is skewed in that it assumes negative appreciation, and all proceeds are taken at closing. If the appreciation was just a positive 3% per year, the home would be worth $467,943 at termination, making home equity before foreclosure, fixup, and selling costs a positive $169,943 — which should result in some gain to the homeowner and no reimbursement from HUD to the lender for any loss.
Despite the claims of some experts, FHA shows that FA is not protecting the MMIF from losses.
The projected average loss per HECM for fiscal 2014 of only $14,000 came as a huge surprise, since HECM borrowers related to the HECM cohort for that year did not undergo FA.
During fiscal 2015, HECMs related to borrowers who did undergo FA were endorsed in fiscal 2015, but most of the HECMs whose borrowers who underwent FA in fiscal year did not have their HECM endorsed until fiscal 2016. Only a small percentage of HECMs that were endorsed in fiscal 2016 were related to borrowers who did not undergo FA. Essentially, all HECMs endorsed in fiscal 2017 were subject to FA.
Notice how the loss per HECM grows as the percentage of HECMs subject to FA grows by fiscal year. The principal difference between a HECM endorsed in fiscal 2014 and fiscal 2017 is FA and only FA.
Fiscal 2017 ranks as the worst year so far for loss per endorsed HECM in the history of HECMs account for in the MMIF. At $35,447 fiscal 2017 is the first time that the average loss per HECM exceeded the average loss per HECM of $28,319 for fiscal 2009. That is an increase loss per HECM of over 25%. The AR cohort projected losses were evaluated as of 9/30/2017 using very similar if not identical assumptions; these losses were calculated by HUD and not the independent actuaries (Pinnacle).
Were the adjustments made by ML 2017-12 sufficient to get us to a $0 loss per HECM for fiscal 2017? It is very unlikely. In fact, getting the losses down to $0 per average HECM for loans endorsed in fiscal 2019 will require further reductions to the PLFs. Low PLFs seems to be the price for FA. So is the alleged enhanced image of HECMs due to FA worth its cost in lower PLFs? The dreadful endorsement count of 2,838 for June 2018 clearly says no.
The logic behind the increased losses caused by FA
Looking at similar-sized cohorts of HECMs (fiscal 2017 and fiscal 2015), one can only conclude that the average life of a HECM in the cohort with FA (fiscal 2017) will be longer than the average life of HECMs (endorsed in fiscal 2015) where only a small percentage (or none) of HECMs underwent FA.
So in summary, FA is expected to increase the life of a HECM in a cohort where all HECMs were subject to FA over cohorts where no — or only an insignificant number of — HECMs were subject to FA. As a result of their expected longer lives, HECM cohorts undergoing FA are believed to produce more average MMIF losses than HECMs which do not undergo the current FA.
Dispose of or adjust FA?
Disposing of FA is not likely. After three years of marketing FA as a consumer protection, how would it look to back away now?
Can it be changed? Certainly, it can be, if HUD is so inclined. There are alternatives, but will the result be that the average life of a HECM goes down? Anything that would bring back the default risk for property charges of the past would likely be rejected.
So someone with a deep and responsible understanding of how to deal with FA and its results needs to provide direction. Unfortunately, until three months ago, no one had openly addressed this striking impact of FA.
The post-October 1 PLFs seem too high to bring down the average loss per HECM and will need to be reduced further either later this fiscal year or early next.
Only FHA/HUD data from the AR presented
The best public source of information for understanding the financial issues currently facing the MMIF is the Actuarial Report. Page 7 of the AR tells us how the function of the actuary has changed for fiscal 2017 as follows: “This year, the independent actuary was responsible for providing an independent assessment and opinion regarding the reasonableness of FHA’s Cash Flow NPV estimate, in contrast to prior years when a financial engineering firm produced the baseline estimates, which were validated for reasonableness by an independent actuary.” As a result only information provided by FHA/HUD in the AR is presented.
Something new, stand-alone reporting
Starting at the bottom of Page 5 of the AR, HUD claims: “New Stand-Alone Reporting on Home Equity Conversion Mortgages (HECMs) and Forwards Provide Fiscal Insights—… on the fiscal condition of the MMIF by estimating ‘stand-alone’ … cumulative contributions of each program to the MMIF since HECMs became part of the MMIF starting with new endorsements in FY 2009.”
This one correction to eight years of questionable financial reporting is a major improvement in reporting on HECMs in the MMIF and has been crucial for comparing financial data from one fiscal year to another.
The charts and table in yesterday’s article are based on HECM data from the current AR, which is substantially if not completely free of any data related to the forward mortgage portfolio of the MMI Fund. The last Administration freely mingled forward mortgage portfolio reserves into the HECM portion of the MMIF reports as if it were proper financial reporting, which it is not. This paragraph is not political in nature, but is a clear condemnation of some of the accounting reporting practices related to the HECM portfolio in the MMIF during the last administration.
Written by James Veale
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