Reverse Mortgages and Linked Securities E-Book

Vishaal B. Bhuyan

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 301

Veröffentlichungsjahr: 2010

Beschreibung

An institutional investor's guide to the burgeoning field of reverse mortgage securitization

Reverse Mortgages and Linked Securities is a contributed title comprising many of the leading minds in the Home Equity Conversion Mortgages (HECM) industry, including reverse mortgage lenders, institutional investors, underwriters, attorneys, and regulators.

This book begins with a brief history of reverse mortgages, and quickly moves on to discuss how the industry has evolved-detailing the players in these markets as well as the process. It discusses the securitization of reverse mortgages and other linked securities and includes coverage of pricing techniques and risk mitigation. This reliable resource also takes the time to cover the current regulatory environment of the HECM market, which is constantly changing due to the current state of the real estate market.

• Highlights specific strategies that will allow institutional investors to benefit from the resurgence of reverse mortgages and linked securities
• One of the only guides to reverse mortgages and linked securities targeted towards institutional investors interested in securitized products

If you want to make the most of reverse mortgages and linked securities, take the time to read this book.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Preface

REVERSE EQUITY TRANSACTIONS

NOTE

Acknowledgments

List of Contributors

PART One - Reverse Mortgage Basics

CHAPTER 1 - Reverse Mortgage Primer

LOAN DISBURSEMENTS

OVERVIEW OF LENDER CHALLENGES

SUMMARY

CHAPTER 2 - The History of Reverse Mortgages: An Insider’s View

FORMATIVE YEARS

PRIVATE PROGRAMS

FIRST LIFETIME REVERSE MORTGAGES

FANNIE MAE STAKES A CLAIM TO THE MARKETPLACE

ROOTS OF THE SECURITIZATION OF REVERSE MORTGAGES

SUMMARY

NOTES

CHAPTER 3 - HECM Explained Reverse Mortgages Originated via the Home Equity ...

LEGISLATIVE HISTORY AND PROGRAM FUNDAMENTALS

DISBURSING FUNDS AND CALCULATING LOANS AND INTEREST

CHANGES TO THE PROGRAM FOLLOWING THE 2008 ACT

CONSUMER-FOCUSED ELEMENTS OF THE PROGRAM

SUMMARY

NOTES

PART Two - Underwriting and Risk Analysis

CHAPTER 4 - Underwriting Reverse Mortgages

UNDERWRITING LIFE EXPECTANCY

LIFE SETTLEMENT VERSUS REVERSE MORTGAGE UNDERWRITING

SIMPLICITY OF THE CURRENT REVERSE MORTGAGE UNDERWRITING PROCESS

WHY DOES UNDERWRITING MATTER?

PROPOSED ELEMENTS OF REVERSE MORTGAGE UNDERWRITING

SUMMARY

CHAPTER 5 - Risk Mitigation from Existing and Proposed Financial Products

REVERSE MORTGAGE RISKS

AGENCY VERSUS NONCONFORMING LOANS

SUMMARY

NOTES

CHAPTER 6 - Longevity Risk and Fair Value Accounting

LONGEVITY COST CALCULATOR AS A LOAN UNDERWRITING AND PRICING TOOL

REVERSE MORTGAGE LOAN PRICING USING THE LONGEVITY COST CALCULATOR

EXISTING ACCOUNTING FRAMEWORK

SUGGESTED GAAP-COMPLIANT METHODOLOGY TO STANDARDIZE LIFE SETTLEMENT UNDERWRITING

SUMMARY

NOTES

CHAPTER 7 - Risk Mitigation

HEDGING CROSSOVER COMPONENTS IN THE CAPITAL MARKETS

INSURANCE SOLUTIONS

SUMMARY

NOTE

CHAPTER 8 - Criteria for Rating U.K. Reverse Mortgage-Backed Securities

OVERVIEW OF REVERSE (EQUITY RELEASE) MORTGAGES

REVERSE MORTGAGE-BACKED SECURITIZATION

MORTALITY ASSUMPTIONS

PREPAYMENT ASSUMPTIONS

HOUSE PRICE INCREASE ASSUMPTIONS

COSTS AND SALE PERIOD

SUMMARY

PART Three - Tax Treatment

CHAPTER 9 - U.S. Federal Income Tax Aspects of Reverse Mortgages

WHAT IS A REVERSE MORTGAGE?

DEDUCTIBILITY OF INTEREST PAYMENTS ON REVERSE MORTGAGES

SECURITIZATION OF REVERSE MORTGAGE LOANS VIA REMIC STRUCTURES

PRACTICAL OBSERVATIONS REGARDING INVESTMENT REVERSE MORTGAGE REMIC SECURITIES

SUMMARY

NOTES

PART Four - Reverse Mortgages in Context

CHAPTER 10 - Unlocking Housing Equity in Japan

IMPLEMENTATION IN THE JAPANESE CONTEXT

FEASIBILITY OF REVERSE MORTGAGES IN JAPAN

SUMMARY

NOTES

CHAPTER 11 - The Secondary Market in Home Equity Conversion Mortgages

THE REVERSE MORTGAGE TO LIQUIDATE HOME EQUITY

HECM: A FINANCIAL INNOVATION

CASH FLOWS, RISK, AND UNCERTAINTY

THE SECONDARY MARKET FOR HECM

HECM SECURITIZATION

LONGEVITY RISK EMBEDDED IN HECM

THE CONSTRAINTS OF THE UNDERLYING ASSET

CONCLUDING REMARKS

SUMMARY

APPENDIX A - Housing Wealth Among the Elderly

APPENDIX B - Reverse Mortgage Analytics

Glossary

About the Author

About the Contributors

Index

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Copyright © 2011 by Vishaal Bhuyan. All rights Reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Bhuyan, Vishaal B., 1983-

Reverse mortgages and linked securities : the complete guide to risk, pricing, and regulation / Vishaal Bhuyan.

p. cm.—(Wiley finance series ; 577)

Includes index.

ISBN 978-0-470-58462-0 (hardback)

1. Mortgage loans, Reverse—United States. I. Title.

HG2040.15.B48 2011

332.7’22—dc22

2010023295

To FIFA 1999-2008

Preface

Over the past few years, seniors and soon-to-be retirees (Baby Boomers) have lost tremendous value in their retirement plans and especially in their home values. In addition to the depreciation of assets held by this group of Americans, unprecedented amounts of leverage used to finance their daily living, automobile purchases, and children’s educations, as well as to purchase primary and even secondary residences in many cases, have left a large number of older Americans on the brink of financial ruin.

The Baby Boomers (born between 1946 and 1960) currently comprise 26 percent of the population of the United States or roughly 78 million people. Encompassing two cohorts (people born between 1946 and 1955 make up the first cohort and the second cohort, aka “Generation Jones,” is made up of people born from 1956 to 1964), the Boomer generation is one of the largest and wealthiest demographics in U.S. history. According to a study conducted by McKinsey & Company, the wealth of the Baby Boomers can be attributed to three major factors:

1. Size

2. Social change

3. Education

Clearly, the sheer size of the Baby Boomers cohort allowed them to generate more income on a collective basis, being that this generation is some 50 percent larger than the previous generation. Baby Boomers have earned an estimated $2 trillion more (roughly $3.7 trillion) than the previous generation had at the same age. Moreover, the Baby Boomers were the first generation to experience a much higher number of female workers, which also meant women having children at a later age and staying in the workplace for longer periods of time. Finally, the Boomer generation was one of the most educated generations to that point, which allowed them to capitalize on many economic and technological shifts.

Despite the awesome earning power of the Baby Boomers, this group of Americans is grossly undersaved. This financial unpreparedness was merely amplified by the global credit crisis; according to the Center for Economic and Policy Research, over 18 percent of Boomers had negative equity in their homes, and Boomers ages 45 to 54 lost an estimated 45 percent of their median net worth, and those ages 55 to 65 lost roughly 38 percent.

The financially vulnerable Baby Boomers are now facing an even worse crisis, as the U.S. government borrows record amounts of debt, thus jeopardizing the Social Security, Medicare, and Medicaid programs. In the United States, Social Security and Medicare currently account for roughly 7 percent of the GDP, but within the next 25 to 30 years these programs will account for nearly 13 percent, essentially the majority of the entire federal budget as Baby Boomers move toward retirement.

The aging crisis in America, and in other developed nations such as the U.K. and of course Japan, will put tremendous strain on an already-weak federal balance sheet. In The Age of Aging, UBS Senior Economic Adviser, George Magnus, states:1

The number of people aged over 60 is expected to reach one billion by 2020 and almost two billion by 2050, some 22 percent of the world’s population. In Japan, this age group is expected to double to about 38 percent of the population, only a few percentage points higher than it is expected to be in China. In Europe and America it will account for about 28 percent and 21 percent respectively. And those aged over 80 are expected to account for about 4 percent of the world’s population, four times as big as now.

He continues to write:

These changes in age structure are going to lead to significant changes in dependency, which in turn will have enormous economic and financial consequences. Dependency ratios are defined as the number of old or very young people as a percentage of the working age population, that is, those aged 15-64.

Most developing countries will still have falling dependency ratios for the next 20 years because youth dependency is falling, and old-age dependency isn’t rising especially fast yet. Western countries, on the other hand, have completed the decline in youth dependency and now face a rapid increase in old-age dependency.

With so much uncertainty in the reliability of government-run social safety nets, many Americans (as well as Europeans and Japanese) must rely on themselves to generate sufficient supplemental income to maintain their standard of living, pay down debts, or someday retire. In many cases, Baby Boomers continue to take care of their retired parents and their adult children who continue to live at home. These Kids in Parents’ Pockets Eroding Retirement Savings (“KIPPERS,” as coined in the U.K.), which is a phenomenon directly attributed to the success of the Baby Boom generation, are merely further strangling a financially strapped demographic that is desperately in need of liquidity.

As health-care costs rise and these Boomers realize that they cannot rely on their children or the government for financial support, they will turn to liquidating assets (that still have value) to fund their health-care and retirement costs. Currently the Boomers are the largest consumers of prescription medication in the United States. Seniors over the age of 65 spend on average $3,899 per year on health care and Boomers will spend roughly 22 percent of the U.S. GDP over the next 10 years to meet their medical needs.

In a post-credit crisis preretirement era, however, Boomers may not have enough time or sufficient capital to earn back the losses they have incurred in their equities and real estate portfolios to budget for increases in medical expenses or retirement costs. This will give rise to one of the greatest bull markets in history—reverse equity transactions (i.e., reverse mortgages and the secondary market for U.S. life insurance policies).

REVERSE EQUITY TRANSACTIONS

A life settlement is a transaction in which a senior citizen, usually 65 years and older, sells his or her existing life insurance policy to an institutional investor, through a state-licensed intermediary known as a provider for more than the cash surrender value but less than the death benefit. The investor makes an offer on the policy based on the expected life expectancy of the individual. Once the transaction is complete, the investor continues to make all future premium payments until the maturity of the policy, at which point the death benefit of the policy is paid out to the investors. The legal foundation for the life settlement market was established in 1911 by Justice Oliver Wendell Holmes, who deemed life insurance an asset similar to real estate, stocks, bonds, or gold, which could be sold to a third party. Holmes wrote about life insurance: “Life insurance has become in our days one of the best recognized forms of investment and self-compelled saving.” The life settlement market is currently estimated at roughly $16 billion and is estimated to grow to roughly $160 billion over the next few years, according to Conning Research.

Transactions such as life settlements and reverse mortgages will allow seniors to tap into equity in their homes and life insurance policies that are largely independent from traditional creditworthiness metrics such as FICO credit scores and income levels. These transactions are instead based on the projected life expectancy of the individual(s). Simply put, the shorter the life expectancy for an individual the higher the payment she may receive for her life insurance policy or the higher the amount she may be eligible to borrow from a reverse mortgage.

Although life settlements and reverse mortgages differ in many ways, the longevity-linked asset class offers institutional investors steady returns that are largely uncorrelated to more traditional markets. Life settlements, and synthetic longevity-mortality structures, offer returns almost completely isolated from the real estate, equities, commodities, and bonds markets. Although reverse mortgage investment profits (or losses) are linked directly with the relative value of the underlying homes, the credit rating of the borrowers is not as important as in the traditional mortgage market. Therefore, a portfolio of reverse mortgages or a reverse mortgage-backed security is vulnerable mainly to longevity risk, the risk of longer-living borrowers, and home price risk. A complete list of all associated risk will be discussed in detail later in this book.

Although the concepts of life settlements and reverse mortgages have been in existence for quite some time, these transactions are now more important than ever. Over the next 5 to 10 years, the reverse mortgage will play an increasingly important role in the market for structured financial products and a strong grasp on the part of financial services firms and asset managers of longevity- and mortality-linked securities will be vital to compete in the modern marketplace.

The purpose of this introductory book is to create a foundation for understanding the mechanics of the reverse mortgage transaction (for information on life settlements and longevity finance, please reference Life Markets: Trading Mortality and Longevity Risk with Life Settlements and Linked Securities, also published by John Wiley & Sons). The book covers a wide array of reverse mortgage-specific topics from the history, taxation, and actuarial underwriting to the rating methodology and analysis of reverse mortgage-backed securities. Chapters are pulled from the foremost experts in their specific fields and the contributors to book are highly regarded in the longevity/mortality-linked markets.

There are four parts to Reverse Mortgages and Linked Securities. Part One provides the reader with a formal introduction to the asset class touching on basic concepts, the history of reverse mortgages, and a discussion of the Home Equity Conversion Mortgage (HECM), which accounts for the majority of loans in the reverse mortgage market today.

Part Two deals with the actuarial underwriting of reverse mortgages and other associated risks. As it is discussed at length in the book, reverse mortgages are actuarially dependent as opposed to credit dependent, so understanding the various methodologies of determining life expectancy is critical. The section also discusses interest rate and housing price risks and also offers up possible risk mitigation solutions. It may be confusing as to why the chapter called “Longevity Risk and Fair Value Accounting” is in Part Two, as opposed to Part Three, but despite the title, the chapter serves in understanding the development of actuarial analysis. Part Two also includes Standard & Poor’s rating mythology for reverse mortgage-backed securities, which focuses on the risks of these assets.

Part Three establishes the tax treatment of reverse mortgage borrowers and lenders, and investors in reverse mortgage-backed securities.

Part Four puts reverse mortgages into varying contexts, first discussing the viability of the reverse mortgage product in Japan, and then comparing the economics of reverse mortgages to other products such as life settlements and home equity lines of credit.

Appendix A, “Housing Wealth among the Elderly,” is a simple discussion of the wealth possessed by seniors in the United States, Australia, and Japan.

Appendix B, “Reverse Mortgage Analytics,” provides another view on the quantitative aspects of reverse mortgages. Although the subject matter in this section is discussed in previous sections, it is isolated in this appendix for quick reference.

At the end of each chapter I provide a very brief commentary on the subject matter discussed by the contributing author. The purpose for doing this is to emphasize certain key points or offer up some further considerations and discussion points.

NOTE

1 George Magnus, The Age of Aging: How Demographics Are Changing the Global Economy and Our World, (Hoboken, NJ: John Wiley & Sons, 2008).

Acknowledgments

I would like to thank all of the co-authors who took the time to make highly insightful contributions to the book. Thank you again for helping to shape and nurture the life markets.

List of Contributors

Vishaal B. Bhuyan Managing Director VB Bhuyan & Co. Inc.

Micah Bloomfield Partner Stroock & Stroock & Lavan LLP

Chris DeSilvaManaging Partner Risk Capital Partners, LLC

Mike Fasano President Fasano Associates

Kai Gilkes Analyst Standard & Poor’s

Victoria Johnstone Analyst Standard & Poor’s

Apea Koranteng Analyst Standard & Poor’s

Peter Mazonas Managing Member Life Settlement Financial, LLC

Olivia S. Mitchell Chair, Department of Insurance & Risk Management The Wharton School, University of Pennsylvania

Karen Naylor Analyst Standard & Poor’s

Nemo Pererra Co-Founder & Principal Risk Capital Partners, LLC

John Piggott School of Economics University of New South Wales

Andrea Quirk Analyst Standard & Poor’s

Joseph R. Selvidio Associate Stroock & Stroock & Lavan LLP

Charles Stone Associate Professor Brooklyn College City University of New York Department of Economics

Boris Ziser Partner Stroock & Stroock & Lavan LLP

Anne Zissu Professor Citytech City University of New York Department of Business The Polytechnic Institute of New York University Department of Financial Engineering

PARTOne

Reverse Mortgage Basics

CHAPTER 1

Reverse Mortgage Primer

Vishaal B. Bhuyan Managing Partner, V. B. Bhuyan & Co. Inc.

A reverse mortgage is a longevity-linked loan that allows senior citizens, age 62 and older, to release the equity in their home without meeting any credit or income requirements. As opposed to traditional mortgages, there is no obligation to repay a reverse mortgage loan until the borrower passes away or no longer uses the home as a primary place of residence. Upon the death of the borrower(s), sale of the home, or breech of contract, the loan plus interest and fees must be repaid by the sale of the home. It is up to the reverse mortgage lender to sell the home at the time of the borrower’s death, as the lender is the rightful owner of the residence at that time.

If at the time of loan expiration (death, or sale) the sale price of the home exceeds the loan amount extended to the senior, the senior (if still living) or his or her heirs (if the senior has passed away) will receive the difference in value. If at the time the sale of the home is insufficient to repay the debt, then the lender must take a loss on the transaction or make a claim to the insurer of the loan, which in the case of Home Equity Conversion Mortgages (HECM) is the Department of Housing and Urban Development (HUD). Although there are a number of varying reverse mortgage products in the market, HECM reverse mortgages make up almost 90 percent of the loans in the current marketplace. Other types of reverse mortgages will be described in later chapters.

For seniors, the requirements to obtain a reverse mortgage are fairly simple:

• The person must be at least 62 years of age for an FHA HECM loan; however, this age minimum may be at the discretion of the lender for nonconforming mortgages.

• The senior’s home must be owned outright or have an existing mortgage that may be paid off by the proceeds of the reverse mortgage loan at closing.

• The property must be the borrower’s primary residence.

• The senior must not be delinquent on any federal debt.

• The senior must participate in a consumer information session given by an approved HECM counselor.

The FHA HECM program will be discussed in further detail in the next chapter, and other agency loans as well as nonconforming jumbo reverse mortgages will be discussed in later chapters; however, the majority of principles apply to both conforming and nonconforming mortgages. Currently, conforming mortgages, according to the FHA HECM program, are loans equal to or less than $625,000 (which had been increased from $200,000 to $417,000 in 2008). Conversely, mortgages above $625,000 would be considered nonconforming, or jumbo, reverse mortgages.

LOAN DISBURSEMENTS

It is important to remember that (FICO) scores and income requirements are not a prerequisite for many reverse mortgages, especially HECM loans; however, in the case where the senior moves out of the home, repayment risk does exist. Although the senior is not required to make principal or interest payments on the loan, the borrower(s) are responsible for paying all maintenance costs, homeowners insurance, and property taxes associated with the home. In that respect, it should be noted that a lender should be confident that a borrower has the means to maintain the quality of the property and stay current on all taxes.

Since the credit profile of a borrower is of less importance in a reverse mortgage than in traditional mortgages, there is a significant weight put on the life expectancy of a borrower. Up-to-date and sufficient actuarial data is needed in order to develop accurate pricing models for reverse mortgage loans. Although HUD-insured reverse mortgage loans protect the lender from “longevity risk” (the risk that a borrower lives longer than expected), it is in the best interest of the lender to utilize accurate mortality tables. HECM-issued loans, which are made to seniors age 62 and older, are structured using outdated and inaccurate actuarial data. These loans are priced to be losing investments, no matter whose balance sheet the loss ends up on.

The concept of marrying actuarial underwriting to the capital markets is not new, and is best illustrated in the secondary market for life insurance, where investors analyze pools of life insurance for purchase. These investors are developing increasingly more sophisticated actuarial views. Unfortunately, the reverse mortgage market is lagging behind the life settlements market in this regard. Underwriting will be discussed in detail in Part Three of this book.

In all reverse mortgages, the lender calculates the amount to be disbursed to the senior(s) by considering the following:

• The age and life expectancy of the borrower, or the age of the younger borrower in the case of a married couple.

• Current interest rates. (FHA HECM interest rate calculations will be explained in the next chapter.)

• The appraised value of the home, with consideration of ongoing maintenance costs and geographic location.

• How the loan is to be made to the borrower (i.e., lump sum, credit line, etc.).

Loans may be disbursed to the borrower in a number of ways. Although the FHA offers many types of loan programs, the most common ones are shown in Table 1.1. Private lenders may introduce variations on these programs or entirely new products to the marketplace.

A reverse mortgage loan may be costly for certain seniors. In the case of HECM-insured loans, the borrower’s origination and servicing fees are highly regulated and limited in many cases. For example, HECM loans are limited to roughly a $6,000 origination fee, which, at the time of this writing, has been reduced even further. No such cap on origination fees exists in nonconforming reverse mortgage loans, which are not insured by HUD or any other government agency. From an investor’s standpoint, this may present a tremendous opportunity in the nonconforming sector of the market, as longevity and real estate risk maybe more favorably and accurately priced.

TABLE 1.1 Reverse Mortgage Disbursement Options—U.S. Department of Housing & Urban Development

TenureEqual monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.TermEqual monthly payments for a fixed period of months selected.Line of creditUnscheduled payments or installments, at times and in amounts of your choosing, until the line of credit is exhausted.Modified tenureCombination of line of credit with monthly payments for as long as you remain in the home.Modified termCombination of line of credit plus monthly payments for a fixed period of months selected by the borrower.

OVERVIEW OF LENDER CHALLENGES

Because senior citizens are responsible for the upkeep of the house they are living in, but do not own, a reverse mortgage can present a lender with a number of challenges. Among those challenges is the case of default on the part of the senior. A senior may allow the home’s pipes to freeze, landscape to run wild, and roof to weaken without giving much thought to making repairs. Although homeowner’s insurance covers the majority of these issues, seniors may still not want to deal with deductible payments or premium increases or may be just generally apathetic to the appearance and structural quality of the home. The senior may even unknowingly fall behind on property taxes or insurance payments. In these very delicate situations, where the senior is in direct breach of the loan agreement, the lender may be forced to remove the senior from his or her home. Clearly, the sight of a sheriff evicting a 75-year-old woman from her home does not sit well with anyone, so careful attention must be given to the systems in place to monitor and manage a portfolio of reverse mortgage loans. Although this ethical and headline risk may not be the norm, it is something all potential reverse mortgage participants should be well aware of.

SUMMARY

Many institutional investors are currently examining various ways to participate in this marketplace, aside from traditional mortgage lenders such as Wells Fargo and Bank of America (Countrywide), which have reverse mortgage platforms. One group, KBC Financial Products, a unit of the Belgium-based KBC Bank, has actively participated in this space by purchasing an entire reverse mortgage lender at one point, and reselling the firm’s $800 million reverse mortgage pool in February 2010. Another notable market participant is Knight Capital Group (NASDAQ: NITE), which purchased Urban Financial in March 2010.

The securitization of reverse mortgages is the ultimate “holy grail” that has been eluding both this asset class and other life-linked assets such as life settlements. In both cases, with focus on reverse mortgages, the unpredictability of cash flows seems to be one of the most important hurdles to overcome in the structuring of these loans. Although there has been a Ginnie Mae reverse mortgage-backed security, it has experienced limited demand. The development of more widely accepted actuarial and pricing methodologies for reverse mortgages should give rise to a more successfully structured product. This would allow investors to participate in the demographic shifts occurring here in the United States as well as in other parts of the world, such as Japan.

Securitization of reverse mortgages and opportunities for the reverse mortgage product in Japan are both discussed in further detail in later chapters.

CHAPTER 2

The History of Reverse Mortgages: An Insider’s View

Peter M. Mazonas Life Settlement Financial, LLC

The first reverse mortgage-type loans are thought to have been done in Europe, probably France.1 In French, the system is called viager, after a word for “pension.” The most famous of these is a lesson in longevity risk. In 1965, Andre-Francois Raffray approached Jeanne Calment and offered her the equivalent of $500 per month for life in exchange for his inheriting her country house when she died. Mr. Raffray was most certainly convinced he had a good deal because at the time, he was 45 years old and Ms. Calment was 90. He died in 1996 at the age of 77 and she outlasted him by two years, dying at 122.

FORMATIVE YEARS

Except for one-off reverse mortgage-type loans in the United States, the first organized reverse mortgage program began in 1963 in Oregon as a property tax deferral program to ease the financial burden for seniors and allow them to remain in their homes. In this case, the Oregon Public Employees’ Retirement Fund advanced monies to the seniors with the expectation of repayment when the seniors moved from their homes. State and county government in other states followed suit. These were simple loan programs tied to need and promoted by social responsibility.

In 1979, the San Francisco Development Fund contacted Anthony M. (Tony) Frank, who was then CEO of Nationwide Savings and chairman of the Federal Home Loan Bank board, about creating a pilot Reverse Annuity Mortgage (RAM) program. This program was launched in Northern California and closed the first RAM loan in 1981. Tony was later my partner in creating Transamerica HomeFirst, the private reverse mortgage subsidiary of Transamerica Corporation. The RAM program expanded throughout California in 1982 under the direction of Bronwyn Belling, later the program director at AARP.

Much of the credit for creating the reverse mortgage industry then and for the next 20 years goes to a handful of dedicated people like Ken Scholen, Bronwyn Belling, Don Ralya, Jeff Taylor, and Katrina Smith Sloan at AARP. Although AARP has never endorsed a specific reverse mortgage vendor, they have been the principal sponsor of educational programs and a force in channeling legislation and model statutes in favor of reverse mortgages.

By 1984, the Senate was working on proposals to introduce an FHA reverse mortgage program where the loans would be insured by HUD. It was not until 1987 that the pilot program, called a Home Equity Conversion Mortgage (HECM), was approved and the first loans were written in 1989. In 1990, the pilot program was expanded to a limit of 25,000 loans using FHA loan limits and with a program sunset date of September 31, 1995. In January 1996, the program was extended.

PRIVATE PROGRAMS

The first private reserve mortgage companies and programs began coming to market in 1988. These were typically insurance company-backed operations taking advantage of the insurance carriers’ low cost of capital and need for high returns on investment. Among these companies were Capital Holdings, Louisville, Kentucky, and Transamerica, San Francisco, California.

One non-insurance-carrier reverse mortgage startup, Providential Home Income Plan, also from San Francisco, had a meteoric rise to become one of the most successful IPOs in 1992. The company was founded by Bill Texido, a pioneer from the rail car leasing business. Modeled in much the same way as a rail car lease, the product design was all about leverage and fees. However, before the end of the “lockup period,” when insiders could start to sell stock, the Company cratered because of a combination of an interest rate mismatch in sourcing and lending of funds, and speculative product design. The combination led to the SEC invoking accounting treatment, which was very unfavorable to the Company and their speculative product design. Providential was borrowing at high interest rates in the short-term market and lending long term at significantly lower interest rates.

Providential’s product design was loaded with front-end origination and front-loaded equity sharing fees that the SEC believed unjustly accelerated income (in advance of the planned IPO). On September 2, 1992, the SEC issued an opinion letter stating that reverse mortgages should be accounted for in the same way as annuities.2 This was one of the first implementations of fair value accounting that required Providential and all other companies to capitalize origination costs and spread them over the life of a hypothetical pool of mortgages.

This SEC ruling meant that aggressive product design was punished and more conservative products received income recognition advantages. When this letter ruling was applied to Providential’s pool of loans, it drove their pool internal rate of return below 10 percent. By contrast, the similar, but conservative, product from Transamerica HomeFirst enjoyed an annualized projected rate of return of over 20 percent.

The period in the late 1980s and 1990s saw numerous innovative reverse mortgage product designs. As far back as 1985, Bronwyn Belling and the United Seniors Health Cooperative, Washington D.C., conceptualized a line of credit product. This product design suffered from the same fault as many later programs in that these were loans with fixed terms: 10 years, 20 years. This meant that at some predetermined future date “the bank” would come in and seize the home in the unfortunate case where the senior was still alive and living in the home.

FIRST LIFETIME REVERSE MORTGAGES

This product design flaw was corrected in 1991 when, through Transamerica HomeFirst and Robert Bachman of Home Equity Partners (later called Freedom Financial), I introduced the first lifetime reverse mortgages. Although different in design, they allowed the senior(s) or the surviving senior to remain in the home until they permanently moved out, typically for medical reasons. Home Equity Partners accomplished this by using the proceeds from a private reverse mortgage to buy an immediate annuity that paid the senior(s) income for life. This product design benefited Home Equity Partners because all of the fee income was immediate and got around the SEC ruling. It also eliminated any need for loan servicing by shifting that responsibility to the annuity provider. As with other private reverse mortgage programs, the continued viability was dependent on the issuing insurance company’s appetite to stay in the business.

Transamerica HomeFirst’s design approach was different. Under Transamerica’s lifetime reverse mortgage, “HouseMoney,” the senior received monthly payments funded by Transamerica. The initial advance to the senior at the close of escrow include additional funding to purchase a deferred annuity that took over making monthly payments at a predefined point in the future. This point was approximately 18 months before the senior’s average life expectancy. By design, this meant that between 60 and 70 percent of seniors purchasing this product would receive the equivalent of their single premium deferred annuity payment back in monthly payments before reaching life expectancy, and then, income for life from the annuity. Another unique feature of the deferred annuity is that the annuity providers, Transamerica and MetLife, issued the annuity directly to the senior with no commission or upfront profit to anyone. The survivors would continue to receive annuity payments for the rest of their lives whether or not they remained in their homes. This patented design offered higher monthly payments because principal payments under the loan were truncated when the annuity took over making the monthly payments.

Despite the elegance of design, this product was criticized because some homeowners died before they began receiving payments from the annuity, thus incurring high front-end loan costs. A second new feature introduced in this product, shared appreciation, also drew fire in lawsuits brought by disgruntled family members. Shared appreciation features were incorporated into FHA and later Fannie Mae reverse mortgages, but these government and quasi-government organizations were not as easy to bring suits against as a publicly traded corporation.