HUD Grapples with Reverse Mortgage REO Properties

August 13th, 2009 | by Neil Morse Published in FHA, News, Reverse Mortgage | 63 Comments

Reportedly in need of an $800 million credit subsidiary to cover losses caused by declining house prices, the HECM program faces a related challenge stemming from REOs, or real-estate-owned properties, that have fallen (back) into HUD’s lap. As Sally Bene’, program director, Servicing Division, HUD’s National Servicing Center, Tulsa, Okla., notes: “In the reverse world, every loan is assignable at 98 LTV, but there are strict criteria for assignment that must be met, it’s not an automatic transfer at 98 percent. But if the loan is in default,” Bene’ explains, “that REO property can be marketed.”

Lenders also will start turning homes over to the FHA if the outstanding balance on the loan exceeds a home’s value. That would increase the agency’s exposure to real estate-owned properties at a time of swelling inventories.

At base, the problem is declining property values. By early spring of this year, there had been a 31 percent drop in housing prices across the country, from a valuation peak reached in the second quarter of 2006, according to the S&P/Case-Shiller U.S. National Home Price Index. Nationally, home prices are at levels similar to the third quarter of 2003.

The hardest hit neighborhoods are in the interior of California, where prices have plummeted as much as 70 percent. Conversely, the areas weathering the storm best are upstate New York, Pittsburgh, Texas and Charlotte, N.C. – in some cases, because there was little or no price speculation and in others (e.g. the “Oil Patch”) because employment levels remained relatively steady.

Neil J. Morse has been a communications professional working in the mortgage finance industry for more than a decade, currently specializing in the reverse mortgage sector. He can be reached at nmorse@morsecommunications.com

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Anonymous

The article is probably referring to the 98% assignment feature of the FHA insurance, whereby a servicer can assign the loan to HUD when the loan balance reaches 98% of the maximum claim amount. That way HUD can directly manage the properties most likely to result in a claim loss to the insurance fund.rnrnThe $798 million subsidy for FY 2010 is a projection of future needs during the entire lifespan of loans made in FY 2010 and has nothing to do with loans made in past years.rnrnAnd while FHA does periodically publish some information about their actual claims activity, let’s keep in mind three big challenges when dealing with this data, even if they did publish everything that happened thus far:rnrn1) There are still loans active from very early years of the program, including 1990. rnrn2) Until all loans are resolved for a few high volume years, we won’t have a satisfying ‘actuals’ answer as we’ll always have to rely on projections. Since the industry didn’t generate enough volume to be statistically reliable until much more recently and it takes 20+ years to have all the loans resolve.rnrn3) Even if we had a high volume year fully resolved to rely on, it isn’t likely to provide nearly the satisfaction that we might expect simply because the one thing everyone can be sure of is that home price changes in the future won’t mirror the past.rnrnSo at the end of the day this is always going to be a forecasting exercise no matter what we do, and while we can feel more comfortable with more data/experience to rely upon, we’re just going to have to get used to being wrong when we try to predict the future.rnrnThe real question seems to be what level of tolerance do we have for the potential magnitude of our errors in forecasting, plus or minus, in any given year? Given the political process/environment and the fact that the program is now in a government insurance fund that requires annualized accounting rather than blending the plus/minus forecasting errors over several years to achieve a longer term net number like most private insurance companies, the tolerance seems to be much lower at the same time the political process is directly affecting the most important inputs to the forecasting process.rnrnThe sooner we as an industry can get comfortable with managing some of these risks together with our key stakeholders in the political and regulatory process, the better.
The_Critic

Mr. Gruley,

I do not say this to be argumentative but the insurance argument is tired and hackneyed. AIG was an insurance company that in part insured mortgage backed securities. It also used financial models that showed there was little risk in insuring those securities. But who was challenging the validity of the models and did they have the ear of the model design management, risk management along with executive management and the board of directors? Was there sufficient independent review by any standard? History is full of these lessons.

Blind faith in those who created a financial model whose reliability has yet to be proven is hardly warranted. Even if one argues it is, what happens when those people are gone or moved to other areas of responsibility? There must be a system of checks and balances in place to review the system, bring in adequate personnel replacements, provide for the adequate review of reasoned recommendations on how to improve the model and HECM system, and much more. Can you warrant those are in place?

New this year is the requirement of an independent actuarial review. This is great but why did it take twenty years to start doing it. But even this is questionable unless there is a trustworthy and reliable system in place to select that firm and they have the cooperation of the upper level HECM and HUD management team. Congress also needs to enter into this dialogue and communication process.

It is important to separate the challenge to the legitimacy of the program from the challenge that accepts the program but wants it independently reviewed and updated. I for one have no confidence that an unchallenged group of system designers are nearly as keen and effective at refinements as those who know the test of a strong independent review. We need more information, transparency, input, and involvement in the process if the program is to keep up with the challenges and changes in our economy and among seniors.

There are many questions about the model that linger. Is 4% (or whatever the percentage actually is) any longer adequate since the fall in home prices hit hardest where HECMs are the most highly concentrated? Are consumer borrowing habits the same when a borrower has a very low balance due but when added to the outstanding credit line the total exceeds the value of the home by over 100% or is there sufficient data yet to even know what the result will be? Why are the factors still dependent on mortality data that comes from 1980 or earlier? And much more.

Even justified faith in the current staff at HUD is fleeting. A simple change in personnel or management shake up could undermine all of that trust. Just remember all of those financial advisors who swore that the AIG executives would never allow AIG to be involved in a financial scheme that would endanger mortgage backed securities holders or AIG shareholders and then in that same decade…. It is hard not to believe what we were being told; yet it occurred. Only time, testing, validation, improvements, and transparency will usher in the information needed to justify blind faith in the only long-term element in HECM management that can be relied on, the system that underpins the entire program.
Anonymous

Considering the fall out in the Forward Mortgage Market, the requested ,stand by set aside reserve ,requested by HUD for Reverse Mortgages seems modest. Bob LaFay Reverse Mortgage Consultant
James_E_Veale_CPA_MBT

Hey Shannon,

Before I try to answer your questions, let me reiterate how much I like the podcast. Keep up the good work you and the staff at Reverse Fortune are known for.

On answering the questions in first paragraph, Mr. Lunde did a great job. It is the assignment of loans that is most significant. While there are differences between REOs of banks and HUD, the real issue is covering losses. It matters far less who technically owns the HECM as much as the fact that HUD incurs the liability for the loss to a bank or the loss it incurs in paying termination costs, not receiving the interest that accrued while it held the HECM, and any of the cash it invested in acquiring the assigned loan. Either way HUD incurs a loss whenever the balance due exceeds the value of the underlying security, the home of the borrower.

The cash used to purchase the assigned HECMs are not reflected in the budget request. It is only the cash needed or consumed in paying off losses that are reflected.

As to the $64,000 question (which would be multiples higher if correctly adjusted for inflation), Mr. Lunde is once again correct. There is absolutely no right answer. Since there is no fiscal year in which all HECMs endorsed during that fiscal have terminated, this is and will remain a moving target. For example since less than 200 HECMs were endorsed in the fiscal year ended September 30, 1990, even if there are two loans outstanding there are several variables to consider in determining if the revenues are adequate to cover the losses. First one must estimate when each HECM will terminate. Since there was no fixed rate HECM product at that time, one must project the interest rate for each month and if there are available proceeds how much will be taken out and when. Once the estimated balance due has been determined, one must estimate what the value of the home will be upon termination. I am sure there is more than I am thinking about with it being Friday and all that.

Even when all of that data is accumulated it cannot be projected to other fiscal years to estimate the losses for any of those years other perhaps than using the same interest rates for the same months of accruals. It is complicated, difficult, and imprecise. No doubt HUD maintains such data but they are nothing more than better “experience educated” estimates.

As to the $798 million dollar budget request again Mr. Lunde did a great job answering. You are correct it only involves HECMs that are estimated to be issued during the fiscal year ending September 30, 2010 and no others. The budget simple reflects the discounted cash value of all future MIP revenues from this group of HECMs and the future expected losses from that same group of HECMs.
Anonymous

Mr. Lunde,rnrnBravo!!! Your response has improved immensely since you first grappled with it months ago. Well said. Well put together.rnrnI would make a few additional comments. The budget is not an accounting. Accounting is historical in nature. The budget amount is nothing more than the present value of projected future cash flows from the HECMs that are expected to be endorsed during the fiscal year ending September 30, 2010.rnrnMore than our tolerance, it is the tolerance of those in Congress that must be tended to. Without their considerable support, the help we bring seniors will only diminish. What this subsidy fight has shown is that it is difficult for Congress to support a program that needs subsidies in times when the public is keenly aware of budget matters.rnrnWe must learn why Congressional support wanes during these difficult times beyond the obvious and find ways to help the majority in Congress support this program. Lashing out at our detractors in Congress does not help our cause. We need to elicit the support of AARP and other groups who also support seniors. This effort will not take a month or a year but such efforts can provide measureable future benefits. Do not expect support from those who are in the industry for short-term profits. We need to gain the grass roots support of politically active and inactive seniors who will carry this fight to those who represent them. This is a long, long process. Let’s hunker down and get the job done. Supporting the efforts of NRMLA is certainly a part of that process.rn
shannonhicks

Jim,

Thanks for your clarification and input. Once again you've helped clear the muddy waters.
http://www.firstloans.net/ Mike Gruley

Critic,

You're not argumentative, you are correct. Thanks for the articulate clarification. My point is not that we should have blind faith, but we should have faith in the system of checks and balances (if they exist) and in those who perform those checks and balances (as long as they are impartial)to help us make rational decisions about the future of the program. At this point, some of the projections and estimations are still a little fuzzy one way or another, and until we have a bit more clarity, demonizing or glorifying the product itself is of no value to seniors, our industry, or the taxpayer.

Thanks for the clarification!
Anonymous

Mr. Gruley,rnrnI do not say this to be argumentative but the insurance argument is tired and hackneyed. AIG was an insurance company that in part insured mortgage backed securities. It also used financial models that showed there was little risk in insuring those securities. But who was challenging the validity of the models and did they have the ear of the model design management, risk management along with executive management and the board of directors? Was there sufficient independent review by any standard? History is full of these lessons.rnrnBlind faith in those who created a financial model whose reliability has yet to be proven is hardly warranted. Even if one argues it is, what happens when those people are gone or moved to other areas of responsibility? There must be a system of checks and balances in place to review the system, bring in adequate personnel replacements, provide for the adequate review of reasoned recommendations on how to improve the model and HECM system, and much more. Can you warrant those are in place?rnrnNew this year is the requirement of an independent actuarial review. This is great but why did it take twenty years to start doing it. But even this is questionable unless there is a trustworthy and reliable system in place to select that firm and they have the cooperation of the upper level HECM and HUD management team. Congress also needs to enter into this dialogue and communication process.rnrnIt is important to separate the challenge to the legitimacy of the program from the challenge that accepts the program but wants it independently reviewed and updated. I for one have no confidence that an unchallenged group of system designers are nearly as keen and effective at refinements as those who know the test of a strong independent review. We need more information, transparency, input, and involvement in the process if the program is to keep up with the challenges and changes in our economy and among seniors. rnrnThere are many questions about the model that linger. Is 4% (or whatever the percentage actually is) any longer adequate since the fall in home prices hit hardest where HECMs are the most highly concentrated? Are consumer borrowing habits the same when a borrower has a very low balance due but when added to the outstanding credit line the total exceeds the value of the home by over 100% or is there sufficient data yet to even know what the result will be? Why are the factors still dependent on mortality data that comes from 1980 or earlier? And much more.rnrnEven justified faith in the current staff at HUD is fleeting. A simple change in personnel or management shake up could undermine all of that trust. Just remember all of those financial advisors who swore that the AIG executives would never allow AIG to be involved in a financial scheme that would endanger mortgage backed securities holders or AIG shareholders and then in that same decade…. It is hard not to believe what we were being told; yet it occurred. Only time, testing, validation, improvements, and transparency will usher in the information needed to justify blind faith in the only long-term element in HECM management that can be relied on, the system that underpins the entire program.rn
Anonymous

Hey Shannon,rnrnBefore I try to answer your questions, let me reiterate how much I like the podcast. Keep up the good work you and the staff at Reverse Fortune are known for.rnrnOn answering the questions in your first paragraph, Mr. Lunde did a great job. It is the assignment of loans that is most significant. While there are differences between REOs of banks and HUD, the real issue is covering losses. It matters far less who technically owns the HECM as much as the fact that HUD incurs the liability for the loss to a bank or the loss it incurs in paying termination costs, not receiving any portion of the interest, MIP, and servicing fee that accrued while it held the HECM, and any of the cash it invested in acquiring the assigned loan. Either way HUD incurs a loss whenever the balance due exceeds the value of the underlying security, the home of the borrower and the borrower or an heir is not repaying the full balance due.rnrnThe cash used to purchase the assigned HECMs is not reflected in the budget request; neither is the cash received at pay off on the HECMs which HUD owns as a result of assignment It is only the cash needed or consumed in paying off losses that are reflected. rnrnAs to the $64,000 question (which would be multiples higher if correctly adjusted for inflation), Mr. Lunde is once again correct. There is absolutely no right answer. Since there is no fiscal year in which all HECMs endorsed during that fiscal year have terminated, this is and will remain a moving target. For example since less than 200 HECMs were endorsed in the fiscal year ended September 30, 1990, even if there are two loans outstanding there are several variables to consider in determining if the revenues are adequate to cover the losses. First one must estimate when each HECM will terminate. Since there was no fixed rate HECM product at that time, one must project the interest rate for each month it will yet be outstanding and if there are available proceeds how much will be taken out and when. Once the estimated balance due has been determined, one must estimate what the value of the home will be upon termination. rnrnEven when all of that data is accumulated it cannot be projected to other fiscal years to estimate the losses for any of those years other perhaps than using the same interest rates for the same months of accruals. It is complicated, difficult, and imprecise. No doubt HUD maintains such data but they are nothing more than better u201cexperience educatedu201d estimates.rnrnAs to the $798 million dollar budget request again Mr. Lunde did a great job answering that question. You are correct it only involves HECMs that are estimated to be issued during the fiscal year ending September 30, 2010 and no others. The budget simply reflects the discounted cash value of all future MIP revenues from this group of HECMs and the future expected losses from that same group of HECMs.rn
The_Critic

Mr. Gruley,

I for one appreciate your comments. This kind of interaction is helpful to readers and helps people like me to articulate and formalize ideas and concepts.

Fundamentally we are on the same page fighting for a program we both believe in. It may not sound like it but I really appreciate and look up to those who created the program and now oversee it. They, like you, provide a real service to our seniors. I wish HECM detractors would spend the time to see what they are so ardently trying to tear down.

Have a great weekend.
http://www.reversefortunes.com Shannon Hicks

Jim,rnrnThanks for your clarification and input. Once again you’ve helped clear the muddy waters.
http://www.firstloans.net/ Mike Gruley

Critic,rnrnYou’re not argumentative, you are correct. Thanks for the articulate clarification. My point is not that we should have blind faith, but we should have faith in the system of checks and balances (if they exist) and in those who perform those checks and balances (as long as they are impartial)to help us make rational decisions about the future of the program. At this point, some of the projections and estimations are still a little fuzzy one way or another, and until we have a bit more clarity, demonizing or glorifying the product itself is of no value to seniors, our industry, or the taxpayer.rnrnThanks for the clarification!
Anonymous

Mr. Gruley,rnrnI for one appreciate your comments. This kind of interaction is helpful to readers and helps people like me to articulate and formalize ideas and concepts.rnrnFundamentally we are on the same page fighting for a program we both believe in. It may not sound like it but I really appreciate and look up to those who created the program and now oversee it. They, like you, provide a real service to our seniors. I wish HECM detractors would spend the time to see what they are so ardently trying to tear down.rnrnHave a great weekend.

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