To Be Or Not To Be
Sunday, 31 May 2009 16:00
A Question Looming Large For Fannie Mae
& The reverse Mortgage Industry
In several of our prior articles in The Reverse Review, we focused on some of the exciting changes in the Home Equity Conversion Mortgage (“HECM”) program stemming from the Housing and Economic Recovery Act of 2008 (“HERA”). Among other developments, HERA’s establishment of a single national mortgage limit and its creation of the HECM for home purchase program both promise to have a long term impact on the reverse mortgage industry. However, one change wrought by HERA, receiving scant attention within reverse mortgage circles, but promising to have an even greater impact within the industry, is a mandate requiring Fannie Mae and Freddie Mac (collectively referred to as government sponsored entities or “GSEs”) to reduce the size of their mortgage holdings. In this article we examine the GSEs, the centrality of Fannie Mae’s role as a source of liquidity for reverse mortgages, why the role of the GSEs is being reexamined and how these changes might serve to either curtail or promote the market for reverse mortgages.
The GSEs & the Federal Housing Finance Agency
Fannie Mae and Freddie Mac were each chartered by Congress for the primary purpose of establishing secondary market facilities for residential mortgages. Specifically, the mission of the GSEs has been to provide ongoing assistance to the secondary market for residential mortgages by (i) increasing the liquidity of mortgage investments and improving the distribution of capital available for residential mortgage lending, (ii) promoting access to mortgage credit, and (iii) supporting the financing of affordable housing to low- and moderate-income households. The GSEs have traditionally advanced this mission by (i) buying mortgage backed securities that they, or Ginnie Mae, have guaranteed, or private label mortgage backed securities issued by large lenders or Wall Street firms, and (ii) purchasing whole loans from lenders.
The portfolio holdings of the GSEs grew rapidly beginning in the 1990s through the early part of this decade. By the end of June 2008, their combined holdings of mortgage assets totaled nearly $1.6 trillion or approximately 13% of all residential mortgage debt outstanding. Given the size of these holdings, and the concern that the GSEs held insufficient capital to support the inherent risks they posed, law and policy makers have long debated whether the GSEs created an unacceptable level of systemic risk to the mortgage credit markets and the economy as a whole.
And then the unthinkable occurred, on September 6, 2008, the Federal Housing Finance Agency (“FHFA”), created by HERA on July 30, 2008, and charged with supervision and oversight of the GSEs, placed Fannie Mae and Freddie Mac into conservatorship. In order to prevent their capital from being exhausted, FHFA, after appointing itself conservator for the two GSEs, entered into Senior Preferred Stock Purchase Agreements (“Stock Purchase Agreements”) with the Department of the Treasury. Under the Stock Purchase Agreements, the ability of Fannie Mae and Freddie Mac to issue new guarantees of mortgage backed securities and to maintain and grow their mortgage portfolio holdings was enhanced through the Treasury Department’s commitment to acquire up to $100 billion of senior preferred stock of each GSE.
"After growing their portfolios through the end of this year, the Stock Purchase Agreements require Fannie Mae and Freddie Mac to reduce their mortgage asset portfolio by ten percent (10%) every year until each portfolio is reduced to no more than $250 billion. The bottom line is that the GSEs will collectively reduce their mortgage holdings from approximately $1.8 trillion to $500 billion."
Fannie Mae and Freddie Mac were also permitted to increase their mortgage asset investments up to $850 billion by December 31, 2009.
As a side note, on February 18, 2009, President Obama’s foreclosure alleviation program, the Housing Affordability and Stability Pan, was announced. Under that plan, the mortgage portfolio holdings limit for the GSEs was increased by $50 billion each, to $900 billion.
But what Uncle Sam gives with one hand, he oftentimes takes away with the other. After growing their portfolios through the end of this year, the Stock Purchase Agreements require Fannie Mae and Freddie Mac to reduce their mortgage asset portfolio by ten percent (10%) every year until each portfolio is reduced to no more than $250 billion. The bottom line is that the GSEs will collectively reduce their mortgage holdings from approximately $1.8 trillion to $500 billion. FHFA estimates that the mortgage assets of Fannie Mae and Freddie Mac will reach the target level around the year 2020, at which point no further reduction will be required. (Incidentally, President Obama’s Housing Affordability and Stability Plan did not alter the mandate to reduce the GSEs’ mortgage asset portfolios.) To implement HERA’s mandate, on January 30, 2009, FHFA issued an Interim Final Rule. The Interim Final Rule adopted the existing criteria for portfolio holdings in the Stock Purchase Agreements under which the GSEs currently operate (discussed above). Thus, under the Interim Final Rule, each GSE may grow its mortgage assets up to $900 billion by December 31, 2009. However, starting on December 31, 2010, the GSEs must hold ten percent (10%) less mortgage assets in their portfolio than at the end of the preceding year until those assets reach a level of $250 billion. The FHFA has requested comments concerning the Interim Final Rule, and may amend the rule after it receives and reviews all comments. The deadline for written comments is June 1, 2009.
As this article went to press, NRMLA was working in concert with its members to develop the industry’s statement in response to FHFA’s request for comments on the Interim Final Rule. The industry’s response to the Interim Final Rule could lead to changes in the rule, and also could influence the implementation by FHFA, as Fannie Mae’s conservator, of the planned ten
"The end result of the mortgage portfolio reduction by Fannie Mae could be challenging for the reverse mortgage industry. The reduction in Fannie Mae’s portfolio holdings could mean a decrease in capital available to reverse mortgage lenders and less liquidity for reverse mortgage investments."
percent (10%) mortgage asset portfolio reduction.
To begin to appreciate what this might mean for the reverse mortgage industry, it is helpful to share two interesting facts. Based on Fannie Mae’s Quarterly Report for the period ending March 31, 2009, Fannie Mae’s market share of reverse mortgage loans was approximately 90%. Consider further that, based on the same Fannie Mae Quarterly Report, HECM loans accounted for approximately 90% of the total reverse mortgage market as of December 31, 2008. While Fannie Mae’s charter allows it to invest in various types of reverse mortgages, including proprietary reverse mortgages, we understand that Fannie Mae’s current reverse mortgage purchases are limited to HECMs and overwhelmingly these purchases have been on a whole loan basis. Given these circumstances, the importance of Fannie Mae’s continued ability and willingness to purchase HECM loans can hardly be overstated. Undoubtedly, then, the rules prescribing how the GSEs will reduce their mortgage portfolio holdings will significantly impact our industry.
The Effect of Planned Reductions in Mortgage Holdings by the GSEs on Reverse Mortgages
Decreased Funding
The end result of the mortgage portfolio reduction by Fannie Mae could be challenging for the reverse mortgage industry. The reduction in Fannie Mae’s portfolio holdings could mean a decrease in capital available to reverse mortgage lenders and less liquidity for reverse mortgage investments. The FHFA stated that it expects the mortgage asset reduction to be achieved largely through natural run-off of the GSEs’ existing loan assets. However, presumably, Fannie Mae will be required to reduce its purchases of mortgage assets, which could include reverse mortgages, to accomplish the required overall reduction of its mortgage portfolio.
It remains to be seen what share of Fannie Mae’s reverse mortgage purchases will be affected by the portfolio holdings reduction. Assuming a ten percent (10%) pro rata reduction across Fannie Mae’s broad portfolio of mortgage assets, reverse mortgages could see a corresponding ten percent (10%) drop in secondary market financing. Such ten percent (10%) reduction could occur each year, well into the future, until Fannie Mae’s portfolio reaches the projected $250 billion goal in the year 2020.
Moreover, HECM loans, quite possibly, could be more severely impacted than other mortgage assets. This is so because other mortgage loans, such as traditional “forward” mortgages, are currently more easily securitized and can be delivered and sold to Fannie Mae and Freddie Mac, as well as to other secondary market investors. With a “thinner” securitization market and Freddie Mac currently not purchasing reverse mortgages at all, Fannie Mae’s decisions on how it meets FHFA’s mandate to lower its mortgage holdings could have a greater impact on HECM lenders than the overall reduction in GSE purchases of conforming “forward” mortgage loans will have on forward mortgage lenders.
Increased Pricing
As many reverse mortgage industry participants undoubtedly are aware, Fannie Mae recently changed its pricing policies for the HECM loans it purchases. These recent price changes have generally resulted in higher margins that lenders utilize with the HECM loans they originate. Many industry participants believe that Fannie Mae is encouraging higher margins to attract new investors to the HECM secondary market. This, in turn, is consistent with the mandated loan portfolio reduction that Fannie Mae must accomplish under HERA and the Interim Final Rule issued by the FHFA.
While attracting new investors to the reverse mortgage secondary market is clearly in the long term interests of the industry, higher margins do have an immediate and detrimental impact on HECM borrowers in the form of reduced principal limits. The borrower’s initial principal limit under a HECM loan is based in part upon the expected interest rate. Because the expected interest rate generally increases with higher margins, the principal limit, or the loan proceeds available for disbursement to the senior borrower, may correspondingly decrease as a result of rising HECM margins.
What’s Next: Possibility of New Secondary Market Players
According to Fannie Mae’s Quarterly Report for the period ending March 31, 2009, the outstanding unpaid principal balance of reverse mortgages in Fannie Mae’s mortgage portfolio was $41.6 billion as of December 31, 2008 and $45.9 billion as of March 31, 2009. As described above in this article, beginning in 2010, Fannie Mae must reduce its mortgage assets by ten percent (10%) each year. Of note, also, is that reverse mortgage assets on the books of investors do not necessarily experience the same level of run-off as traditional “forward” mortgages due to the fact that there is no debt service (i.e., no monthly mortgage payments by the borrower) with reverse mortgages and the loan balance of a reverse mortgage increases over time. As a result of such negative amortization and the growing balance of its current portfolio, Fannie Mae’s ability to invest in new reverse mortgages will necessarily be constrained.
The question on everybody’s mind is what will happen if Fannie Mae scales back on its purchase of whole loan HECMs. Under a doomsday scenario, the reverse mortgage market becomes more constrained and lives or dies with Fannie Mae as its single investor. However, a different result is possible based on three strategies. The first, as we’ve already noted, is Fannie Mae’s upward trend in pricing conceivably designed to spur broader investor interest. As credit markets stabilize, we are likely to see more investors pursue the FHA insured HECM product. Also, in the long run, the return of secondary market investors could then drive down HECM margins by increasing competition.
"While attracting new investors to the reverse mortgage secondary market is clearly in the long term interests of the industry, higher margins do have an immediate and detrimental impact on HECM borrowers in the form of reduced principal limits.”
Another positive trend in the reverse mortgage space is the emergence of Ginnie Mae’s program to securitize FHA-insured HECMs (known as the Home Equity Conversion Mortgage Backed Security program or “HMBS”). With this relatively new securitization program, the FHA-insured status of the underlying HECM loans helps protect the investor against the risk of loss on the underlying HECM loan (i.e., the credit or collateral value risk). In addition, the Ginnie Mae guaranty protects investors against the issuer risk, i.e., the risk of default by the issuer of the HMBS security. The first HMBS issuance took place in 2007. The Ginnie Mae HMBS program has its own unique rules, ample opportunities, and a few challenges. With the possibility of Fannie Mae scaling back on its whole loan purchases of reverse mortgages, the increased popularity of Ginnie Mae’s HMBS program could become an important source of additional liquidity for reverse mortgage markets.
Finally, Fannie Mae can potentially employ another strategy to better support the reverse mortgage industry, namely holding a larger percentage of its reverse mortgage assets as securities rather than as whole loans. In this way, more HECM reverse mortgage loans can bypass the FHFA portfolio restriction as Fannie Mae’s dollar for dollar investment is leveraged over a larger number of reverse mortgage loans. As the Ginnie Mae HMBS program gains traction, we are hopeful that Fannie Mae and Freddie Mac will become major investors in these securities.
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As should be apparent, the possibility of Fannie Mae portfolio holdings reduction in the near future could have a significant impact on the entire mortgage lending industry. Because of Fannie Mae’s approximate 90% market share of the total reverse mortgages market, that impact might even be greater on the reverse mortgage industry. However, there are several promising developments now afoot, as outlined above, which could promote a healthier, more diverse secondary market for reverse mortgages. For the immediate future however, NRMLA is weighing in and preparing a response to the FHFA’s request for comments on its plans to reduce the mortgage portfolios of the GSEs. We remain hopeful that the baby doesn’t get thrown out with the bath water and reverse mortgages remain broadly available to meet the needs of a growing population of seniors.
By Joel Schiffman and Fed Kamensky, of the law firm of Weiner Brodsky Sidman Kider, P.C. The law firm serves as General Counsel to the National Reverse Mortgage Lenders Association and advisor to reverse mortgage lenders and industry participants throughout the nation. The firm has offices in Washington, D.C., Newport Beach and Dallas. Additional information can be found at www.wbsk.com or by telephone at 202.628.2000. Messrs. Schiffman and Kamensky can be reached at
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and
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, respectively.
This article provides only an overview of some of the federal laws and regulations that may affect reverse mortgage lending and finance matters. Because of the generality of this article, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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