Last week's inaugural securitization of a U.S. reverse mortgage loan portfolio by Financial Freedom Senior Funding Corp., for $317 million in bonds, raised the profile of what many mortgage-backed securities players are calling an emerging asset class that may have enormous promise for investors down the road.
With Lehman Brothers acting as lead agent on the transaction, Financial Freedom, an Irvine, California-based lender, securitized the HomeFirst reverse mortgage portfolio which it acquired when it bought TransAmerica in June.
Reverse mortgages allow a senior citizen to borrow against the equity in his or her home in order to access funds, and are considered by many to be a cost-effective option for seniors who need additional income.
"We think there is a large potential in the market for gentrification of the population and large equity holdings of seniors in this country," said Susan Barnes, a director at Standard & Poor's Ratings Group who rated the private transaction. "We do feel there is very large potential for reverse mortgages to become a growing asset class, and we predict many more such securitizations in the near future."
Reverse mortgage loans carry no regular payment obligation and are made to homeowners 62 years and older. The main advantage for older people is that the loans don't have to be repaid until the homeowner sells the property, has a contractual breach or dies, in which case the estate is liable for the mortgage.
According to Joseph Hu, another S&P director, a reverse mortgage is so named because the direction of its cash flow is in the reverse order of a regular mortgage. For a regular mortgage, the lender makes the loan to a borrower at an interest rate and maturity term and expects the borrower to repay the loan through monthly mortgage payments.
By contrast, for a reverse mortgage, the lender makes a loan to an elderly home owner at an interest rate but does not expect the loan to be repaid until the borrower has either died, moved out of the house permanently (mostly for health reasons to a nursing home), or sold the house. During the period when the mortgage is outstanding, the borrower has no monthly-payment obligation.
"We are going to see that as the reverse mortgage industry grows, there will be more securitization of reverse mortgage products, particularly as new products are brought into the marketplace and we achieve some velocity of originations," said James Mahoney, senior vice president of Financial Freedom. "We have seen a good healthy increase this year in new [reverse mortgage] originations, so we will be able to assemble pools fast enough to make securitizations feasible."
Borrowers: Is it a Risk?
Despite the fact that market players consider reverse mortgages to be viable instruments, the access that borrowers have to credit through other types of instruments - such as home equity loans and subprime loans - makes some experts believe that the growth potential of the reverse mortgage market has been somewhat overstated.
"I think that [reverse mortgages'] prospects may have been exaggerated," said Michael Youngblood, managing director or real estate at Banc of America Securities. "Many potential borrowers also have access to credit through home-equity lines, both fixed and revolving, and through subprime mortgage loans, which they may find to be more convenient or flexible than a reverse mortgage."
Additionally, from an investor's perspective, with home-equity loans, there is not a date at which the equity in the home could be exhausted.
However, S&P's Barnes says that borrowers would tend to choose reverse mortgages simply because they do not have to repay them, as opposed to home equity or subprime loans, which are repaid monthly. So for borrowers, a reverse mortgage provides an additional income stream.
"Seniors can use the funds just for living, on a month-to-month basis, or they can use it for major purchases, such as a large vacation or a car," Barnes said. "The benefit is that, if they have large equity holdings in their homes - and a lot of seniors have low monthly income, either from social security or retirement savings - this can be an income supplement."
Still, Youngblood believes that the ultimate scope of reverse mortgages is limited by the popularity of other widely available instruments.
"Is there anyone in the country who doesn't periodically get a flyer offering some form of a secondary mortgage?," Youngblood said.
Lehman Brothers, however, which worked on the Financial Freedom transaction, saw the current securitization as an opportunity to get into another market that its research teams had pinpointed as a burgeoning area.
"With this deal, we can offer our clients another security that they can use and enter into a market that has really been relatively untapped in the U.S.," said Jason Farago, a spokesman for Lehman Brothers. "The market is maturing and we heard Financial Freedom was looking for someone to help them out, so we were able to provide the capabilities and the platforms that you need to do transactions such as this."
How About Investors?
From the investor side, Barnes admitted that other options may be more viable than reverse mortgage products. When investors get closer to the crossover point for this product, the risk is greater, because at that point, accrued interest and principal on the loan may exceed the home value.
"However, lenders basically use actuarial tables, broken down by age and gender," Barnes noted. "They determine the amount they can lend up front, with an expectation of when that loan can be repaid. They forecast it that way."
Moreover, the difference with reverse mortgage products is that one starts with a very low loan-to-value ratio at the time of origination, added Financial Freedom's Mahoney.
"Although there is a risk in any one loan that over the course of time the loan balance can grow higher than the future value of the home, with the pooling aspects, both geographically and actuarally, you are getting a very predictable cash flow out of these products and indeed will make very good returns out of most loans because they will repay before the collateral is exhausted," he said.
Endorsements Sway the Market
Though Financial Freedom Senior Funding is the only reverse mortgage lender endorsed by the National Council of Senior Citizens - mainly because the company offers all products available in the marketplace - it is the attention of the government-sponsored enterprises that will ultimately determine the pace at which this relatively new market will tapped in the U.S.
"Fannie Mae has been the leader in establishing guidelines for this product and creating an exit strategy for lenders," said Barnes. "And that may have been a deterrent in the past if there was no exit and people were holding large portfolios, looking for a way not to transfer the risk."
Youngblood believes that if the possibilities for reverse mortgage securitizations had come to the attention of the agencies sooner and had received their standardization and endorsement earlier, then it would have been a much bigger, more significant market.
"It was never brought [to Fannie Mae] as a priority by lenders and as a result, its development lagged," Youngblood said. "But clearly, with the support of Fannie Mae and certain major lenders, we will see quite rapid growth in reverse mortgage lending and securitization."
Though Mahoney said that Financial Freedom has no firm plans yet for more upcoming reverse mortgage securitizations, he did say that he expects to work with Lehman again on similar types of transactions, mainly because "they have the research, the experience and the capital to be a major player in reverse mortgages."
"Leveraging our global expertise in mortgage-backed securities, the firm is committed to positioning itself as a leader in the emerging reverse-mortgage market in the U.S.," said Craig Corn, senior vice president of Lehman Brothers.