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Mortality, default and HECMs during pandemic

| January 29, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

MBS backed by reverse mortgages can be an attractive security for investors trying to trim exposure to some traditional MBS risks. Among other things, the risk of default is lower in times of high unemployment since most reverse mortgage borrowers are retired and since the loan does not require principal or interest payments. Reverse mortgage default rates have trended slightly lower through pandemic despite economic downturn. But reverse mortgage borrowers do face greater health risk from Covid-19. So far, there has been very little increase in mortality-driven prepayments, although they do appear poised to increase modestly in 2021.

Most investors know Ginnie Mae’s HMBS program. These securities are backed by FHA-insured Home Equity Conversion Mortgages, or HECMs. Under the HECM program, a lender makes a loan secured by equity in an eligible borrower’s property. Borrowers have to be at least 62 years old with limited debt. Instead of making monthly payments, however, the borrower repays the loan when the home is sold by either the borrower or the borrower’s estate. Periodic interest and fees are added to the loan balance. And FHA insures the lender against loss in case the accumulating loan balance turns out to be greater than the value of the home when sold. HMBS consequently do not pay a periodic coupon but instead accrue a rising balance.

Prepayment speeds in HECMs from mortality increased slightly in 2020, while prepayments due to defaults slowed (Exhibit 1). Loans are grouped into vintages by origination year. There has been a slight pickup in overall mortality each year, mostly from the most recent production, which was ramping up. Prepayments due to defaults, however, have been trending lower over the last couple of years. Borrowers don’t owe principal or interest but can default if they fail to pay property taxes, hazard insurance, homeowner’s association dues, and related expenses.

Exhibit 1: Mortality and default prepayment were relatively unchanged in 2020

Source: Ginnie Mae, Intex, eMBS, Amherst Pierpont Securities

There is a lag between when the final borrower on a loan passes away and the time the loan is removed from the pool, and these loans are identified by Intex. This data is a leading indicator of prepayments due to mortality and has trended higher since roughly April. That coincides with the onset of the pandemic, suggesting the increase is due to Covid-19. The number of loans with deceased borrowers had increased roughly 1%, to 3% overall, since April.

Exhibit 2: An increasing number of loans in pools have no living borrowers

Source: Ginnie Mae, Intex, eMBS, Amherst Pierpont Securities

Mortality prepayment speeds should increase by roughly 1 CPR in 2021. Although HECM borrowers are in an age group that is extremely vulnerable to Covid-19 they appear to have faced lower mortality than their age cohort overall. This may be because they are living in their own homes and more easily able to practice social distancing. The current vaccination effort should further mitigate mortality, and this slight lift to speeds should eventually disappear.

Similar data from Intex is available for defaults (Exhibit 3). The green line shows that overall the number of loans in default has fallen, mostly from the older vintages. The 2013–2016 group increased slightly in 2020, while the 2017–2020 group was basically unchanged. These borrowers are typically retired and face little exposure to increases in the unemployment rate. HECMs are also less affected by home price depreciation in a downturn since the borrower has a put option on the home to the FHA. There is no incentive to default if the home loses value. Most defaults typically cure. For example, the aggregate prepayment speed due to defaults was 0.7 CPR in 2020 although close to 4% of loans were in default at any time. Therefore, it does not seem likely that HECMs will face an increase in default prepayments in 2021.

Exhibit 3: Fewer HECM loans were in default in 2020

Source: Ginnie Mae, Intex, eMBS, Amherst Pierpont Securities

The FHA allows borrowers that are in default to request up to a 12-month delay before a servicer can consider the loan due and payable. The borrower can request an initial 6-month delay and subsequently extend by another six months, similar to forward mortgage forbearance. But the drop in defaulted loans and low default prepayment rates suggest few borrowers have needed this assistance.

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