What Decreased the Value of HUD's Reverse Mortgage HECM Fund from FY15 to FY16?

On November 15, 2016, the U.S. Department of Housing and Urban Development (HUD) published the Actuarial Review of the Federal Housing Administration Mutual Mortgage Insurance Fund HECM Loans for Fiscal Year 2016. This review, prepared by HUD's independent actuary, contained several major methodological changes from the FY 2015 version of the review. Those changes resulted in the economic value of the HECM portion of the Mutual Mortgage Insurance Fund (MMIF) falling to negative $7.7 billion from positive $6.8 billion the year before.

Now that we know the history and mechanics of HUD’s Federal Housing Administration (FHA) Home Equity Conversion Mortgage (HECM) reverse loan program, let’s dig into how the valuation of the HECM portion of the MMIF changed so dramatically.

The FY16 Actuarial Review estimates that, as of the end of FY16, the HECM portion of the MMIF had an economic value of negative $7.7 billion, a sizeable decline from the FY15 estimate of positive $6.8 billion. The Actuarial Review lists five major factors that combined to decrease the economic value by $15.8 billion, overwhelmingly offsetting the $1.3 billion in net gains the HECM fund experienced:

Factor 1: Actual HECM Portfolio Performance Updates

The first driver of the change comes from updated data, that is, replacing projections with actuals for FY15 and FY16. This realized program performance and actual composition of the endorsed loans not only affect the performance of previously endorsed books (without any changes in model specification), but also updates the forecasted compositions of future books of business. Furthermore, when reporting the updated economic value due to data updates, the Actuarial Review includes the capital resources change year-on-year.

The combined impact of the updated data is reported as a $1.764 billion decrease in economic value.

Factor 2: FY16 Model Updates

The second driver is changes in the tax and insurance default (T&I) model and the conveyance/payoff choice model. The
T&I model determines the probability that a HECM borrower will default due to a failure to pay property tax and/or insurance premiums. The conveyance/payoff choice model determines the probability that a post-assignment HECM borrower(s) sells their property upon termination (payoff) versus satisfying the debt by transferring the property deed to HUD (conveyance).  As the FY16 Actuarial Review notes, the independent actuary did not update the base models for terminations due to mortality, refinance, and mobility, because the Social Security Administration did not provide information regarding the deaths of HECM borrowers. As such, there is no change in economic value from the termination model.

These model updates decreased the economic value for future fiscal years, including the FY16 economic value, which decreased by $918 million.

Factor 3: Incorporation of a House Price Sale Discount (or “Haircut”)

Prior to the FY16 Actuarial Review, the independent actuary relied on third-party data to estimate the ultimate sales price for HECM properties that experience a claim, both for Claim Type 1 and for Claim Type 2 loans. For the FY16 review, the FHA Single Family Acquired Asset Management System (SAMS) and the FHA Home Equity Reverse Mortgage Information Technology (HERMIT) system provided data regarding the actual recoveries from HECM property sales.

The new data showed a steeper discount to the projected sales price than previously observed. The independent actuary factored these new sales price data into the model, which resulted in lower recoveries. The independent actuary’s rationale behind the haircut included the condition of HECM properties being worse than the properties underlying conventional forward mortgages being sold (As written in the FY16 Review: “[P]resumably because there is lack of resources or incentive to maintain a HECM property relative to non-HECM properties.”) and the “REO-stigma” price discount when the lender or insurer, rather than the borrower, sells a property.

Due to the higher house price discount haircuts, the economic value for FY16 decreases by $6.452 billion.

Factor 4: Incorporation of Additional Property Disposition Expenses

The HUD data sources also provided data on property disposition expenses. The actuaries incorporated management and operation (M&O) expenses for conveyed Claim Type 2 properties and foreclosed Claim Type 1 properties. Those M&O expenses include possible components, such as, “disaster repairs, mold treatment, property management fees, homeowners’ association fees, demolition, clean-up and debris removal, yard maintenance and winterizing and snow removal fees.” These additional expenses increased the total expenses from 7% of the sales price for Claim Type 1 properties in the FY15 Review to 25% in the FY16 Review. The corresponding increase for Claim Type 2 properties was from 19% in FY15 to 26% in FY16.

Incorporating the higher M&O expenses causes the FY16 economic value to decrease by $2.254 billion.

Factor 5: Revision of the HECM Claim Type 2 (Assignment Claim) Assumption

The HECM program allows lenders to assign loans to HUD when the UPB reaches 98% of the MCA. In earlier versions of the Review, the independent actuaries assumed that this occurred for all loans. However, when examining historical data for the FY16 Review, the actuary determined that lenders assign only 40% of the eligible loans.

While this change appears straightforward, it implies that the “other 60%” may eventually default and proceed to a Claim Type 1 (with its associated higher losses). In other words, the lower Claim Type 2 assignment does not increase the economic value, but leads to a net decrease of $4.449 billion in the economic value between the FY15 and the FY16 reviews.

Conclusion

The sharp decrease in the economic value of the HECM portfolio between the FY15 and FY16 actuarial reviews was driven by updated HECM performance and new sources of data. Updates to the actuary’s models, holding the other four factors constant, account for less than $1 billion of the $14.5 billion decrease.