DBRS Morningstar’s Takeaways From U.S. RMBS Frontline Perspectives Panel: What Reverse Mortgage Securitizations Are, Who Invests, and How Deals Have Performed

As part of its takeaways series, DBRS Morningstar is publishing the below write-up about the key ideas discussed at its U.S. RMBS Frontline Perspectives panel about reverse mortgage securitizations. Moderated by Mark Fontanilla, a consultant for DBRS Morningstar, the panel gathered experts from the analytical, banking, issuer, and legal sides to give an overview of the market and what the future holds.

-- What is a reverse mortgage and how is it securitized?
Simply put, a reverse mortgage is a way for older homeowners to tap into their home equity as a source of cash. They can borrow against the value of their home and receive funds as a lump sum, fixed monthly payment, line of credit, or a combination of these. Unlike for a conventional mortgage, the homeowner does not make any monthly loan payments. The entire loan balance becomes due when the borrower dies or moves and sells the home. Over the loan’s life, the homeowner’s debt increases and home equity decreases, ignoring the effect of rising home prices. The home itself serves as the collateral for the loan. When the homeowner moves or dies, the proceeds from selling the home go to the reverse mortgage lender to pay the unpaid balance.

There are two main types of reverse mortgages: home equity conversion mortgages (HECMs) from the federal government and proprietary loans from private-label lenders. Ji Kim, Director at Reverse Mortgage Funding (RMF), explained the differences between the two. HECMs are insured by the Federal Housing Administration (FHA) and backed by the Department of Housing and Urban Development. Because HECMs are guaranteed by the federal government, they must follow certain regulations, such as a payment of a mortgage insurance premium or a cap on the size of the loan. There are no such requirements for proprietary loans. Kim also noted that the minimum borrower age is younger for proprietary loans. RMF’s minimum age is 55 years old in the states where it is allowed, down from 62 years old for HECMs.

In terms of securitization, HECM issuance is close to $60 billion since 2008, according to Derek Moran, Senior Vice President at DBRS Morningstar. The proprietary market is about half of that, but the exact amount is hard to determine. “We don’t know how much private-label [volume] is being done because half the market is privately rated,” he said. In total, DBRS Morningstar has rated about $20 billion in reverse mortgage loans and bonds and $40 billion worth of homes.

-- What do reverse mortgage securitizations look like?
According to Nomura’s Morgan Griff, Executive Director, HECM securitizations generally include six or seven tranches of notes. The most senior class is typically about 75% of the unpaid principal balance of the transaction. In general, the proprietary deals have the same fixed interest rate on all three to four tranches and negative credit enhancement on the most senior class because the coupon is set very low relative to the collateral weighted-average coupon, and the collateral is newly originated, so it has a low initial loan-to-value ratio. The credit enhancement increases over the life of both HECM deals and proprietary deals as the loans accrete because of interest rate accrual, principal advances, servicing advances, mortgage insurance premiums (for HECMs), and servicing fees.

Most securitizations have mandatory call dates that are typically five or six years after the deal’s closing date, per Seth Messner, Partner at Katten Muchin Rosenman. When the deal is called, the auction procedure starts for any outstanding classes of notes that did not get paid off. If the first auction fails, another one occurs and so forth until all the outstanding notes have been auctioned off. However, Moran noted that DBRS Morningstar does not give credit for auctions in its rating analysis and assumes they fail.

Moran also highlighted that various reserves are necessary to make up for the times when the deal is not receiving any cash flow, as the reverse mortgage doesn’t become due until the borrower dies or moves and sells the house.

As a way to mitigate risk, Kim’s company, RMF, has been including constant prepayment rate (CPR) triggers recently in its deals. When a deal’s CPR hits a certain level, it allows the issuer to inject more collateral into the deal.

-- Who invests in reverse mortgage securitizations?
The investor base for these deals has expanded. According to Griff, there are approximately 85 investors in HECM securitizations issued by Waterfall Asset Management, RMF, Nationstar, and Finance of America, up from five to eight investors at the beginning. The investor base for proprietary securitizations is about 25 to 30 investors. Most investors in the industry are insurance companies that use these securitizations as a natural hedge in their investment portfolios.

Moran agreed, saying that insurance companies make up the bulk of investor questions he has received.

-- What is important to know when reviewing these deals?
According to Kim, the main question regarding the borrower’s financial health is can they maintain the taxes and insurance for the home. Borrowers do not have to pay principal and interest like in a conventional mortgage. Overall, the underwriting process focuses more on the home’s value and less on the borrower’s monthly income. Generally, at least one appraisal from an FHA-approved appraiser and an automated valuation model is required, and more than one appraisal is required for higher home values.

-- How have they performed?
Defaults have been minimal. One reason for this is that, per Moran, at the loan level, the lender sets aside some money for taxes and insurance if the borrower forgets. However, this is not a guaranteed backstop to prevent default.

Moran has been gathering data for every reverse mortgage deal DBRS Morningstar rates. Based on this dataset, half of the proprietary loans become inactive (i.e., stop paying out to the homeowner) because the borrower died. On the other hand, two thirds of the HECMs loans become inactive because the borrower failed to pay taxes and insurance on the home or became bankrupt. The borrowers for proprietary loans do not default as much, as they tend to have more expensive homes not subject to HECM size limits. For both proprietary loans and HECMs, occupancy defaults represent about 10% to 20% of the time a reverse mortgage loan becomes inactive. In these instances, the borrower has not sold the home but is not using it as a primary residence, thereby breaking the residency requirement for a reverse mortgage. A loan can become inactive for more than one reason (e.g., the homeowner dies and defaults on taxes and insurance), so this dataset accounts for that.

Has the Coronavirus Disease (COVID-19) pandemic had any impact, and what is the future for the industry? So far, the pandemic has not had a significant impact on mortality rates for reverse mortgage borrowers, per Kim.

In the future, Griff believes there will be more innovation in the industry. He also noted that reverse mortgages are becoming an increasingly important tool as baby boomers, a large demographic, age and retire.

Steven Kats, Vice President at Waterfall Asset Management, agreed with Griff and added that home equity has gone up as home price appreciation has increased.

Kim believes the borrower profile is changing. They are becoming strategic in their decision making as they navigate today’s turbulence. There may be a shift toward proprietary reverse mortgages. However, she noted there is still room for growth in that the perception of reverse mortgages is not as positive as it should be. She referenced “a study we did with potential borrowers,” laying out the features of a home equity line of credit (HELOC; another way for homeowners to tap into their home equity) and the features of a reverse mortgage. When the features were labeled as HELOC and reverse mortgage, initially 75% of the potential borrowers wanted HELOC over a reverse mortgage. Without the labels and just the features on display, the percentages flipped; 75% wanted a reverse mortgage.

Written by Caitlin Veno

Notes:
All figures are in U.S. dollars unless otherwise noted.

For more information on the industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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