Reverse Mortgages and Linked Securities

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.

Preface xi

Acknowledgments xvii

List of Contributors xix

Part One

Reverse Mortgage Basics 1

Chapter 1

Reverse Mortgage Primer 3

Loan Disbursements 4

Overview of Lender Challenges 6

Summary 6

Chapter 2

The History of Reverse Mortgages: An Insider’s View 8

Formative Years 8

Private Programs 9

First Lifetime Reverse Mortgages 10

Fannie Mae Stakes a Claim to the Marketplace 12

Roots of the Securitization of Reverse Mortgages 13

Summary 15

Notes 16

Chapter 3

HECM Explained: Reverse Mortgages Originated via the Home Equity Conversion Mortgage (HECM) Program 17

Legislative History and Program Fundamentals 18

Disbursing Funds and Calculating Loans and Interest 19

Changes to the Program Following the 2008 Act 21

Consumer-Focused Elements of the Program 24

Summary 26

Notes 28

Part Two

Underwriting and Risk Analysis 33

Chapter 4

Underwriting Reverse Mortgages 35

Underwriting Life Expectancy 36

Life Settlement versus Reverse Mortgage Underwriting 37

Simplicity of the Current Reverse Mortgage Underwriting Process 37

Why Does Underwriting Matter? 38

Proposed Elements of Reverse Mortgage Underwriting 38

Summary 42

Chapter 5

Risk Mitigation from Existing and Proposed Financial Products 43

Reverse Mortgage Risks 46

Agency versus Nonconforming Loans 48

Summary 53

Notes 54

Chapter 6

Longevity Risk and Fair Value Accounting 55

Longevity Cost Calculator TM as a Loan Underwriting and Pricing Tool 61

Reverse Mortgage Loan Pricing Using the Longevity Cost Calculator 74

Existing Accounting Framework 75

Suggested GAAP-Compliant Methodology to Standardize Life Settlement Underwriting 77

Summary 78

Notes 79

Chapter 7

Risk Mitigation: Available Hedges and Products in Development for Risk Transfer 81

Hedging Crossover Components in the Capital Markets 82

Insurance Solutions 86

Summary 90

Note 90

Chapter 8

Criteria for Rating U.K. Reverse Mortgage–Backed Securities 91

Overview of Reverse (Equity Release) Mortgages 91

Reverse Mortgage-Backed Securitization 92

Mortality Assumptions 93

Prepayment Assumptions 94

House Price Increase Assumptions 95

Costs and Sale Period 97

Summary 97

Part Three

Tax Treatment 99

Chapter 9

U.S. Federal Income Tax Aspects of Reverse Mortgages 101

What Is a Reverse Mortgage? 102

Deductibility of Interest Payments on Reverse Mortgages 102

Securitization of Reverse Mortgage Loans via REMIC Structures 103

Practical Observations Regarding Investment Reverse Mortgage REMIC Securities 105

Summary 106

Notes 107

Part Four

Reverse Mortgages in Context 109

Chapter 10

Unlocking Housing Equity in Japan 111

Implementation in the Japanese Context 112

Feasibility of Reverse Mortgages in Japan 117

Summary 121

Notes 124

Chapter 11

The Secondary Market in Home Equity Conversion Mortgages 127

The Reverse Mortgage to Liquidate Home Equity 127

HECM: A Financial Innovation 130

Cash Flows, Risk, and Uncertainty 131

The Secondary Market for HECM 132

HECM Securitization 134

Longevity Risk Embedded in HECM 137

The Constraints of the Underlying Asset 140

Concluding Remarks 145

Summary 146

Appendix a Housing Wealth Among the Elderly 149

Wealth in Housing 149

Owner-Occupancy Rates 152

How Risky Is Housing Wealth? 153

Do the Elderly Decumulate Their Housing Wealth? 155

Notes 159

Appendix B Reverse Mortgage Analytics 161

Determining the Payout Values: Practical Considerations 162

Computing Payout Values: An Example 163

Notes 165

Glossary 167

About the Author 171

About the Contributors 173

Index 181

VISHAAL B. BHUYAN has been involved in the “life markets” for over five years and has focused on analyzing and investing in life settlements, reverse mortgages, and other linked assets. He has advised a number of large investment funds on the longevity and mortality risk asset class and has been invited to speak at various investment and industry-specific conferences across the United States, Europe, and Asia. Bhuyan is also the editor and coauthor of Life Markets: Trading Mortality and Longevity Risk with Life Settlements and Linked Securities (Wiley) and will be releasing The Esoteric Investor (FT Press) in 2011.

Over the past few years, seniors and Baby Boomers alike have lost tremendous value in their retirement plans and homes. In a post-credit crisis, pre-retirement 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 in order to budget for coming increases in medical expenses or retirement costs. This will give rise to one of the greatest bull markets in history—reverse equity transactions, such as reverse mortgages.

With contributors from among the foremost experts in their fields, Reverse Mortgages and Linked Securities offers institutional investors a practical framework for understanding the mechanics of the reverse mortgage transaction. The book begins with a brief history of reverse mortgages, while providing a road map of the industry today: who are the market participants (from lenders and investors to borrowers and underwriters) and what is the process? It then discusses the actuarial underwriting of reverse mortgages and other associated risks. The second section also discusses interest rate and housing price risks and offers up possible risk mitigation solutions. The book goes on to explain the tax treatment of reverse mortgage borrowers, lenders, and investors in reverse mortgage-backed securities, and concludes with a discussion of the ever-changing regulatory environment of the Home Equity Conversion Mortgage (HECM) market.

While there are many low-end, retail books on the subject of reverse mortgages, targeted to seniors who want to learn how to reverse their own mortgages, Reverse Mortgages and Linked Securities is one of the only books targeted to institutions and institutional investors interested in reverse mortgage securitization. It offers the critical information you need to compete successfully in this burgeoning field.