Securitizations backed by reverse mortgages are expected to boom in the second half of this year, with as many as six deals being discussed in the market, according to private and rating agency sources. The sector has piddled along in recent years, restrained by low volume and secondary market unfamiliarity. Now, sizable strides in origination volume and more accommodating regulatory changes have drawn the interest of investment bankers - always happy to stumble upon a new and, at least initially, higher-yielding asset class.
"We're pretty bullish about the growth of our industry, and particularly as it relates to the secondary market. We're getting a lot of interest from traditional investors that have been buying bonds and loans in the (traditional mortgage) market," said Jim Mahoney, chief executive of Financial Freedom Senior Funding Corp., a subsidiary of IndyMac and the largest U.S. reverse mortgage lender by market share.
A run-up in housing values, along with an aging U.S. population, has an increasing number of mortgage lenders interested in issuing the loans. First Freedom's dollar volume alone increased to $1.1 billion in the first quarter from $506 million a year earlier. (Secondary market developments within the reverse mortgage market contributed to IndyMac's decision not to spin the company off in an IPO this year.) The lender, which historically has sold its proprietary loan product to Lehman Brothers, has negotiated a deal to sell its Federally insured strain of reverse mortgage loans to an additional private investor. The lender is also considering the prospect of direct securitization, Mahoney said.
Reverse mortgages are essentially an alternative to home equity loans for elderly homeowners. In a reverse mortgage, the lender typically pays the borrower, either once, monthly or in a line-of-credit fashion, based on the home's value and length of time the borrower is expected to live or occupy the residence.
Growing market
Up until now, all reverse mortgage securitizations have been backed by uninsured loans, which are tough to accumulate because they comprise only a sliver of the market, and are expensive to securitize. Roughly 95% of reverse mortgages are the Federal Housing Administration-insured Home Equity Conversion Mortgages (HECMs), and up until recently, Fannie Mae has scooped up the majority of them for its portfolio. But within the last several years, regulatory changes that allow for the HECMs to be securitized within REMIC structures have prompted a number of investment banks to intercept Fannie Mae's hold on these loans.
Adding to the sector's momentum, a bill currently idling in Congress would work to increase HECM loan limits and lift a cap set on the number of such loans that can be originated, according to Darryl Hicks, associate director of the Reverse Mortgage Lending Association, the industry's trade organization. The number of HECM loans issued this year is up 77% over last year, Hicks said. The Department of Housing and Urban Development last year reported some 450 lenders approved to issue the HECM loans, compared to about 200 in 2004, he said.
"If you look at the fact that (HECM loans) represent 90% of the unit count in originations these days, the first place where investors will go is where the loan volume is, and that is with the FHA conversion mortgages, so I think you'll see a HECM securitization in the near future," Mahoney said.
Secondary market develops
Investment banks are at various stages of readiness to issue reverse mortgages securitizations; some are acquiring loans and structuring their deals while others are simply feeling the waters.
"We've had inquiries from several investment bankers on about half-a-dozen or so transactions that they are putting together and expect to bring to market in 2006," said Vincent Barberio, a managing director in Fitch Ratings' RMBS group. Most of the inquiries, he said, are regarding the HECM loans. Standard & Poor's is also anticipating as many as six transactions this year, while Moody's Investors Service in its esoteric ABS outlook for this year predicted one deal.
Likewise, only one reverse mortgage deal came to market last year - the $503 million Structured Asset Securities Corp. Reverse Mortgage Loan Trust Series 2005-RM1. The deal was the first to come to market since 2002; it was brought by Lehman Brothers and serviced by Financial Freedom. Mirroring past reverse mortgage securitizations, the deal came as a two-tranche, triple-A and double-A, structure protected by subordination, excess spread and a separate $151 million funding account required to cover the undrawn portion of the portfolio's reverse mortgage loans.
Securitizing HECM loans, on the other hand, would require significantly less credit enhancement. The primary rating agency concern with reverse mortgage loans is the so-called "cross-over point" - essentially where the collateral value is less than the outstanding loan. This could happen as a result of decreased home value, for example. Helping to mitigate that risk, the lender has the ability to assign HECM loans back to HUD if they reach a 98% LTV ratio, Barberio said.
Securitizations backed by HECM loans could include a larger triple-A tranche, Barberio said. "I think people are going to focus on the higher credit tranches. We have seen several proposals that have been quite innovative," said Terry Osterweil, a director at S&P. "The structures are probably going to get more interesting."
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