WSJ: Government Officials Concerned About FHA’s Loan Losses

image With all the talk about the Federal Housing Administration’s request for a $798 million subsidy for the HECM program, government officials are starting to voice their concern over FHA as a whole as many feel its reserves could fall below the level demanded by Congress. 

Edward Pinto, a mortgage-industry consultant and former chief credit officer at Fannie Mae, told the Wall Street Journal that, "They’re probably going to need a bailout at some point because they’re making loans in a riskier environment… I’ve never seen an entity successfully outrun a situation like this."

Over the last two years, the number of loans insured by FHA has soared, with its  market share to 23% in the second quarter, up from 2.7% in 2006, according to Inside Mortgage Finance.

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However, a senior official at HUD, told the WSJ that there is "no risk" that the FHA would require money from Congress if the ratio falls below 2%. Asked about the agency’s capital ratio, the official said a report detailing that number won’t be completed until the FHA’s fiscal year ends Sept. 30. 

Rising defaults have eaten through the FHA’s cushion. Some 7.8% of FHA loans at the end of the second quarter were 90 days late or more, or in foreclosure, according to the Mortgage Bankers Association. That is up from 5.4% a year ago.

Like the HECM program, resulting FHA losses are offset by premiums paid by borrowers and Federal law says the FHA must maintain, after expected losses, reserves equal to at least 2% of the loans insured by the agency. The ratio last year was around 3%, down from 6.4% in 2007.

After the WSJ article was published, FHA Commissioner David Stevens said that the agency would not need a congressional subsidy even if its capital reserve ratio fell below 2%.  In a statement Stevens said:

"Even if that level falls below 2 percent, FHA continues to hold more than $30 billion in its reserves today, or more than 5 percent of its insurance in force. Given this reserve level, FHA will not need a congressional subsidy even if the congressional capital reserve calculation falls below 2 percent."

Loan Losses Spark Concern Over FHA

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  • It floors me that the quote about the risk of reverse mortgage defaults and FHA Mortgage Insurance claims comes from a former FNMA officer. FNMA itself singlehandedly did more to increase that future risk in one stroke on March 26th, 2009 than any unfolding declining market pressures or rising rates.

    When FNMA increased loan margins overnight by 1.25%, it automatically created the otherwise unlikely circumstances that have made LIBOR ARMS less competitive than Fixed Rate HECMs in terms of Principal Limits.

    Without that margin increase, the LIBOR ARM loan balances that were never originated would be growing more slowly than the Fixed Rate balances, and defaults caused by deaths during a declining market would be partially offset by some unused Line of Credit equity.

    Now we generally have to use the Fixed Rate HECMs to make payoffs. The tradeoff for that larger loan amount is the liklihood that the values will be upside down if they live longer than 10-15 years, with no automatic flexible access to any unused tax-advantaged loan funds, and little possibility of a future HECM refinance for the exact same closing costs as the loans that offer these potential benefits and flexibility.

    The Fixed Rate HECM was designed to primarily benefit investors, and to be marketed by playing on a historically unfounded variable rate paranoia ( if this were a real problem, people would have been wanting the annually adjusting HECMs) and extra back-side compensation. It is selling maximum debt at higher unchangable rates. It couldn't compete with the CMT or LIBOR ARMs on its own merits until a big finger tipped the scales on March 2009.

    FNMA's margin increase has changed the present reverse mortgage from its intentionally designed-in long-term flexibility to one of short-term one-time funding. It has flattened planning opportunities that used to distinguish the Consultants from the Yield Spread seekers. We used to say that reverse mortgages were a financial planning tool that happened to be a mortgage. Now, they are becoming more mortgage than tool and the consumer is the worse off for it.

    • Good comments. I would just add a few facts here to make sure we keep the story straight.

      The HECM Principal Limit Calculation algorithm calculates the maximum proceed to the borrower, assuming a lump sum payment at closing so that the expected losses equal the expected premiums during the life of the loan. So in this case, from a risk perpective a fixed rate or adjustable rate HECM has the same risk profile. The HECM algorithm assumes a worst case scenario. The fact that there is a line of credit for the adjustable loans does help when it comes to actual numbers but the worst was already assumed. Therefore, fixed rate HECMs with a lump sum are not more riskier than adjustable rates in that sense.
      Another thing to keep in mind is that interest rate risk is higher for the fixed rate. The lender has no way to compensate for future interest rates hikes like the adjustable rate HECMS. So my point is that if in the future inflation and therefore interest rates do climb (which even the Federal reserve chairmain has said that at some point they will have to do) these fixed rate HECMs may not look so bad after all.
      The one thing that I always had a little issue with is how the fixed rate product was approved by the government, with the caveat of course, that the lenders would have to offer the line of credit/tenure payment option at an “alternative interest rate” as is shown in the HECM 4235 manual. So technically there are fixed rate HECM products with line of credit but the rates on those are very high, almost the same as the maximum amount cap for the adjustables rates. Of course, the lump sum payment at a lower rate, does decrease the risk to the lender in the sense that speeds up the rate of assigment of the loans to HUD.

      Af for the comments on FNAMAE I would say this was a lack of political direction/vision on behalf of the government. While it was mandated to lower the loan portfolio carried by the agencies, they didnt have to take the approach used for the adjustable rate HECMS. HECMs were not in the highest risks pools in their portfolio.

      • Mr. Torres,

        I am surprised by your remarks. What does any of this have to do with the article? The article is about FHA as a whole; it is not about HECMs in particular.

        You did a great job of pointing us to this information before. Please do not get lost in HECM land.

      • Mr. Critic,

        I was just replying to the comments by Mr. Peters, just as you did. You are correct in that the current story has nothing (up to point) to do with HECMS, but like yourself, I had to respond to some of the comments about fixed hecms and fnmae. This is what is typically called thread hickjacking. You are right we should stick to the main story and no I am not lost in HECM land; my landscape is way larger than HEMCS.

    • Mr. Peters,

      While I strongly agree with some of the underlying statements you make, what application do any of them have to this article? This article has very little to do with HECMs, other than marginally so. It is a story about FHA as a whole of which HECMs are an insignificant and immaterial part. Declining home values were and still remain a terrible threat to FHA as a whole, not the actions of Fannie Mae in March of this year.

      As to HECMs, the decision by Fannie Mae to require higher HECM margins had absolutely no impact on any HECM funded before March, 2009. To be clear, many fixed rate HECMs were funded before that date. As Joe Kelly pointed out in recent RMD comments, seniors generally like fixed rates over adjustable. Further the vast majority of the endorsed HECMs still active and outstanding are adjustable rate HECMs not impacted by the March 2009 decision of Fannie Mae. Your fixed rate HECM arguments have great application to the requested HECM subsidy for the fiscal year ending September 30, 2010 but your comments fail to address the budget issue.

      Personally I have great difficulty with your idea that HECMs were ever “a financial planning tool that happened to be a mortgage”. Yes, there are aspects of HECMs that can be used for cash management purposes but they are and always have been mortgages.

    • Mr. Peters,

      What tax authority has ever opined that HECM proceeds are “tax advantaged”? Too many “consultants” in this industry have strangely warped ideas about HECM proceeds in this regard.

      How are HECM proceeds any more “tax-advantaged” than proceeds received from any other loan? Simply stated, they are not. In some cases, they are far less “tax-advantaged” than those related to recourse debt. If you extend the argument to the growing nature of the unused line of credit, how is that any more tax-advantaged than any other increase to a line of credit?

      Have you seen or heard one credible ad from a forward mortgage marketer (in a major market) that describes mortgage proceeds as “tax-advantaged?” The reason is simple; unless proceeds are cancelled (tax lingo), they must be repaid. Is there one insurable HECM that has never been repaid to the owner/holder of the related note — in full? Seniors incur fees and risk their homes as part of that guarantee. What is so special about a HECM in regard to taxes? These mortgages have no special status in tax law. Such discussions and advertising are groundless and very misleading.

      Municipal bond interest is federally (and in some cases state) “tax-advantaged;” for most taxpayers so are proceeds from the sales of stocks, bonds, and other assets that result in long-term capital gains along with certain dividends. If someone had a choice between HECM loan proceeds and increased net wages, who would advise them to take HECM proceeds? Economically that person will keep everything they receive in salary beyond what is paid out in taxes; the same is not true with HECM proceeds.

      By worthless claims of “tax advantaged” (and worse “tax-free”), we are signing up for the FTC to come trolling. When I first came in to this industry and even until recently, I have heard the false claim that there is a special IRS ruling treating HECM proceeds in a special way. With over 38 years of experience as a tax professional and researching extensively into this matter for over five years, there is no such document. In fact there are far more “documents” evidencing that Big Foot exists and that Elvis is “still in the building.”

  • Hi Abel,

    Point taken on the comparatively level risk in the Principal Limit calculations.

    Risk parity in calculations aside, its the actual numbers that concern me if present trends continue. I don't fault the lender or investor for picking a higher-than-adjustable rate for their fixed products. If you want the lender/investor to shoulder the interest rate risk alone, you can expect to pay a premium for that insulation.

    We have several gripes about the way the Fixed HECM was designed and launched, and I have more about how they actually work. I've never even shown much less originated one of the “Open-End” Fixed HECMs; at double digit rates, it seems pointless.

  • To The Critic:

    If I overreacted to Mr.Pinto's statement, I suppose it is because I felt, like many of you, that Washington was slow to realize the positive impact that the HECM program could have made to minimize the spreading ripples of declining property values among the senior population. Action was late and sometimes, as it appeared in the case of FNMA's March surprise, counterproductive. We got what looked like a daft adjustment rather than deft one.

    Yes, anyone who took out an adjustable rate HECM loan before March 2009, used up the maximum available funds, and who then sold or died when their property value had fallen significantly in a rising rate environment could become a default. Yes, sustained declining values are the far bigger problem, but the FNMA action appeared to fan the fire of new future default risks from current originations instead of dousing it. I don't think I said anything to suggest otherwise unless the statement that FNMA’s action accelerated what organic rate increases might have done over a longer period was unclear.

    My claim that reverse mortgages are a financial planning tool that happened to be a mortgage is simply figurative speech, not a literal denial of fact. It comes from being more interested in what a financial product actually does for people rather than what it is called or what license it requires. Reverse mortgages are a funding tool even if all you're doing is paying off an existing mortgage; what we used to refer to as a Cash Flow sale. if you have some additional loan funds remaining, then structuring what and how and why it funds whatever it funds is the front end of the planning. The built-in ability to change a payment plan of an adjustable HECM with any remaining loan funds easily and with little cost has frequently prevented damage to other portfolio assets, retirement benefits, investment accounts, and/or insurance products. This is the post-closing end of the planning. Life changes occur more frequently to seniors, and these other financial instruments are often less accommodating of unanticipated changes. Fixed HECM loans take the post-closing changes out of the picture and throw it all onto the other pieces of their portfolio, if any.

    Example: If your IRA investments are now down in value and you were taking income from it, that means you probably have to sell more shares to get the same amount of cash, and that negative compounding will accelerate spend-down of the account. But if you could take income from a reverse mortgage instead, you give the IRA a chance to recover.

    • Even if I do not agree with your conclusions, your first two paragraphs are very well reasoned.

      Although I believe that the HECM can be a financial planning tool, your explanation limits it to a cash management tool. Here it is your conclusion I agree with, not the reasoning. What the last paragraph fails to point out is how it extends from cash flow planning and management to financial planning.

      Moving to financial planning, there are income tax and estate planning aspects to this product. It also can be used to reduce mounds of paperwork and significant administrative costs associated with loans it can replace at lower interest rates and less risk to borrowers. It can be an effective tool in Medicaid planning. Of course there is much more. This takes HECMs from being a mere cash management tool to being a true financial planning tool.

  • Mr, Veale,

    Reverse mortgage proceeds are treated no more favorably by the IRS than those of any other loan; I never meant to suggest otherwise. In fact I did not suggest anything and that omission led you to connect the wrong dots.

    In order to accomplish an income stream or anything similar to line of credit withdrawals with a Fixed HECM, the loan proceeds distributed after closing could be stored as cash under the mattress and managed by a diligent borrower. It is more likely that they would be placed into another type of financial instrument or account. This secondary transaction would probably have tax consequences of one sort or another even if it just goes into checking account. Compare the tax treatment of funds used from such secondary accounts to that of the loan proceeds and the loan proceeds are indeed more advantageous for the borrower for tax purposes unless a modest income does not require them to pay.

    That’s all that “tax-advantaged” was supposed to mean here, no warping going on.

    • As to “tax-advantageous”, first you say you did not suggest anything by using that term but then you go on to say in the next paragraph: “Compare the tax treatment of funds used from such secondary accounts to that of the loan proceeds and the loan proceeds are indeed more advantageous for the borrower for tax purposes unless a modest income does not require them to pay.” You obviously did intend to say they are somehow in some way “tax-advantageous.”

      How can I “compare the tax treatment of funds used…”? The use of funds in this context does not create a tax transaction. Based on your prior statements, there are loan proceeds in “the secondary accounts.” I do not understand what point you are attempting to make because you have already conceded that loan proceeds that are used to purchase or increase assets may have taxable or non-taxable growth or earnings. So how would loan proceeds from the secondary accounts be treated any different than loan proceeds from the line of credit? Truly, I have no idea.

      How are there secondary accounts? Surely you are not implying that a HECM line of credit is primary to checking or savings accounts? Let me make this clear, if the borrower dies, the heirs keep everything inside of a checking or savings account. The line of credit dies with the last surviving borrower. The line of credit is not a container for borrower assets; it is a source from which borrowers can obtain cash. If the security for the HECM is sold, that source terminates. Not so with a checking or savings account. We call that portability. A bank account, checking or savings, has no direct relationship to a line of credit so as to be called “secondary”.

      You seem so overly focused on the tax benefits of loan proceeds you have lost the essence of the economic issue. Here you want to use $1 of loan proceeds that will have to be paid back rather than receiving $1 of taxable income that will almost never have to be paid back in order to avoid 40¢ (at the most extreme) in tax. I have many taxpayers who have come to me over the years saying: “Jim, my accountant told me I need some tax write offs.” When I ask them what they mean by that statement, they talk about how their friends are writing off entertainment expenses, business travel, etc. I always tell them to spend the money but remember is it worth getting 40¢ by spending a dollar because they will be giving up 60¢ net, but if it makes sense, write off all they can legitimately document and support.

      Further you confuse income and cash. For example, I have no idea what you mean by “a stream of income” in relation to a line of credit. Income is a source of assets. Cash is a type of asset. Assets are listed on balance sheets of companies; cash is the first asset normally listed. Income is listed at the top of income statements. “Cash” and “income” are not interchangeable.

      In the movie “To Kill a Mocking Bird” an attorney’s fee (income) was paid with a bag of walnuts (the asset). Employees who earn tax-deferred compensation (income) are exchanging work today for an unfunded promise (the asset) of a different asset in the future. That future asset could be cash, stock, bonds, or any other kind of asset.

      As to HECMs you seem to want to believe that not only do upfront costs increase the balance due but so do proceeds which you equate to income. That means both if proceeds are equivalent to income, then income and its opposite, costs/expenses, both increase the balance due on a HECM. Is that logical or even correct? Too many in this industry market or condone marketing that calls HECM proceeds “tax-free income.” Not only is this wrong, it is ….

      Since 2006, the State of California has condoned the concept of reverse mortgage proceeds as being income by requiring that the term “additional income” be used in describing reverse mortgage proceeds within a separate disclosure statement that borrowers must sign. After much discussion indicating how deceitful and misleading this term actually is, California state lawmakers have drafted legislation that has been passed by both the Assembly and the Senate that in part removes this wording. California HECM originators beware; upon expected enactment, California state law will no longer condone the use of the word “income” to describe reverse mortgage proceeds within California Civil Code 1923.5.

      Your use of the words income and “tax-advantageous” is very confusing and confused. I know you do not believe it, but to someone who is licensed and paid for his understanding of such terms in opining on financial statements and consulting on income tax matters, they are.

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