Residential Credit Strategy | 18 March 2010  
SECURITISATION RESEARCH  
Reverse mortgages and HMBS  
Nicholas Strand  
As the baby boomer generation moves closer to retirement, the proportion of US  
population over the age of 65 is expected to surge over the next few decades. Many of  
these senior citizens will have to adjust to curtailed incomes in their retirement years.  
One financial product that can help supplement their income is a reverse mortgage,  
which essentially allows homeowners to exchange the equity in their homes for a  
stream of income. Over the past 10 years, this product has gained a foothold with  
seniors across the country. It looks to expand further as population demographics  
continue to shift.  
+1 (212) 412 2057  
Sandipan Deb  
+1 212 412 2099  
For investors, reverse mortgages provide unique cash flows with limited average life  
variability. We explore reverse mortgages in detail, with special emphasis on FHA’s  
Home Equity Conversion Mortgage (HECM) program and GNMA HMBS securities.  
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While reverse mortgages originations have grown in recent years, changing  
population trends and increased borrower awareness of the product suggest that  
origination levels are likely to increase sharply over the coming years.  
With the paralysis of non-agency origination, FHA’s HECM program is the dominant  
producer of reverse mortgage loans. Increasingly, these loans are being securitized  
into GNMA HMBS pass-throughs.  
In terms of cash flows relative to traditional mortgages, GNMA HMBS provide  
unique and extremely stable cash flows. This stems from the fact that refinancing  
risk is extremely limited for these loans, and thus these bonds have essentially no  
convexity.  
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Relative to comparable traditional mortgages, on a nominal spread basis GNMA  
HMBS trade at similar spreads levels to comparable average life. However, on an  
option-adjusted basis GNMA HMBS collateral pick up considerable spread to  
comparable MBS alternatives.  
PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 17  
Barclays Capital | Reverse mortgages and HMBS  
Basics of a reverse mortgage  
A reverse mortgage is a product targeted at elderly homeowners that has experienced  
substantial growth over the past decade. It provides a stable source of income to borrowers  
who have significant equity built up in their homes but have uncertain or limited income  
streams in other words, home-rich cash-poor seniors. Unlike a traditional mortgage, the  
borrowers are not required to make any monthly payments in a reverse mortgage. When  
the borrower dies or ceases to occupy the house as his primary residence, the proceeds  
from the sale of the property are used to pay off the loan.  
Basic cash flows and borrower equity growth path  
The basic cashflows in a reverse mortgage are quite different from those in a traditional  
mortgage. We compare the various cash flows over the life of both types of mortgage in  
Figure 1.  
The cash flow at initiation of the contract is similar in both cases. There is a transfer of funds  
from the lender to the borrower. The difference lies in the size of the transfer. In the case of a  
traditional mortgage, the entire borrowed amount is transferred to the borrower at initiation.  
In a reverse mortgage, funds are transferred to the borrower as well; however, there are  
several common payment options available. In an upfront lump sum, the entire borrowed  
amount is transferred at initiation. In the case of a simple line of credit, no funds are  
transferred. We discuss different types of payment options later in this report.  
Figure 1: Basic cash flows over the life of a mortgage  
Initiation  
Lifetime  
Termination  
Traditional Mortgage Lender to Borrower Borrower to lender  
(monthly)  
None, borrower owns house  
Reverse Mortgage  
Lender to Borrower Accrued interest is added Borrower to lender with  
to principal balance proceeds from sale of house  
Source: Barclays Capital  
The main difference lies in how principal and interest are repaid by the borrower. For a  
traditional mortgage, the borrower makes monthly principal and interest payments against  
the borrowed amount. With a reverse mortgage, interest accrued on the borrowed amount is  
added to the principal of the loan. A reverse mortgage contract is deemed to have ended  
when the underlying property is no longer the borrower’s primary residence, either due to  
mortality or other causes. At this point, the borrower or his designated estate pays back the  
accumulated amount to the lender, usually using the proceeds from the sale of the  
property. The amount paid back is the minimum of the amount owed to the lender and the  
proceeds from the sale.  
As can be inferred from the cash flow patterns just described, evolution of a borrower’s  
equity stake in the underlying property also follows different paths for the two types of  
mortgages. In a traditional mortgage, the borrower has a small equity position at the start  
on account of the down payment (Figure 2). The remaining is debt held by the lender. As  
the borrower makes monthly P&I payments over time, his equity position improves and  
debt is paid down. At the end of the contract, all debt is paid down and the borrower owns  
100% equity in the property.  
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Figure 2: Debt-equity position of borrower in a traditional  
mortgage  
Figure 3: Debt-equity position of a borrower in a reverse  
mortgage  
100  
80  
60  
40  
20  
0
100  
80  
60  
40  
20  
0
1
32 61 92 122 153 183 214 245 275 306 336  
Equity Debt  
1
32 61 92 122 153 183 214 245 275 306 336  
Equity Debt  
Source: Barclays Capital  
Source: Barclays Capital  
In a reverse mortgage, the borrower starts with significant equity stake in the property and a  
relatively small debt position (Figure 3). Over time, as the borrower receives payments from  
the lender and interest accrues on the debt, the equity position is slowly eroded. By the end  
of the contract (most commonly due to death of the borrower), the borrower’s equity has  
almost been entirely eroded. As per the terms of the most common reverse mortgages, it is  
also possible for the debt outstanding to exceed the value of the property if home prices fall  
significantly, interest rates remain higher than expected at the time of initiation and/or the  
borrower lives for longer than average. We discuss each of these factors later in this report.  
The key takeaway from these charts is that in a reverse mortgage, a borrower extracts built-  
up equity in a home. In that respect it is not very different from a HELOC (home equity line  
of credit). The difference arises in the underwriting standards, lending limits, program  
structure and the fact that a reverse mortgage has no fixed tenure. Also, the borrower’s  
liability is limited to whatever equity he holds in the property.  
Outlook for reverse mortgage originations  
The Home Equity Conversion Mortgage (HECM) program was launched in 1987 by the  
Department of Housing and Urban Development. This is a federal reverse mortgage  
program and was launched to provide an opportunity to senior citizens to take advantage of  
their built-up home equity. The loans are fully guaranteed by the US government. Few  
borrowers utilized the program over the first decade. Through the 1990s, the annual  
number of reverse mortgage taken out remained small (Figure 4). However, the pace of  
originations picked up by 2000 and has been increasing ever since. Greater awareness  
about the product has helped increase the rate of origination.  
We expect strong growth in this product. From the demand side, demographics remain very  
favourable. The US population is aging rapidly and the number of eligible borrowers is set to  
increase sharply as the baby boomers retire (Figure 5) and life expectancy continues to  
increase. As per projections from the Census Bureau, there will be an estimated 85mn  
seniors above the age of 62 by 2025 and 112mn by 2050. As knowledge about the product  
increases, it is clear that there will be more demand for reverse mortgages. Potential  
changes to the tax code – such as high estate taxes – can also play a role in pushing seniors  
toward cashing out on their equity sooner.  
The supply picture is more uncertain as this market is almost exclusively dominated by  
government-backed issuance currently. Absence of widespread information on this product  
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has led to a limited, albeit dedicated investor base. However, that picture is likely to change  
as this is a very stable and attractive product. With significant growth opportunities, it is  
likely that this sector will continue to see greater investor interest.  
Home Equity Conversion Mortgage (HECM) program  
Reverse mortgages come in many forms and flavours with private as well as government-  
backed issuance. However, HUD’s HECM program controls a large portion of the overall  
reverse mortgage market. Congress created the program in 1989 and appointed the  
Department of Housing and Urban Development (HUD) as the administrator. Private  
origination has been a small sliver of the market, and after the credit crisis of 2008, it has  
been completely shut down. The Fannie Mae Home Keeper program also constitutes a small  
part of the market.  
We will focus on the HECM program. The following sections discuss the features and  
characteristics of HECM loans.  
Eligibility  
There are specific HUD guidelines on eligibility for HECM loans that we will discuss below.  
Do note, though, that none of these address the credit quality of the borrower. This is one of  
the main features of the program that allows borrowers with weak credit histories or low  
income to cash out on built-up home equity.  
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Age: Borrower and any co-borrower must be at least 62 years old at origination.  
Other debt: Borrower must own significant equity in the property in the home. Any other  
debt against the home must be paid off or be small enough to be payable from the  
proceeds of the reverse mortgage. Borrowers should also not be delinquent on any  
federal loan.  
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Property type: The property should be a single family home or a single unit in a 1-4 unit  
home. HUD-approved condos and certain manufactured homes are also eligible. The  
property must be the legal primary residence of the borrower.  
Figure 4: Origination volumes for reverse mortgages over the  
years  
Figure 5: US 60+ population distribution over time  
Number of loans (k)  
140  
Number of individuals (MM)  
35  
30  
25  
20  
15  
10  
5
120  
100  
80  
60  
40  
20  
0
0
60-64  
2010  
65-69  
70-74  
Age Range  
2025  
75-79  
80+  
2050  
Source: HUD, Barclays Capital  
March 18, 2010  
Source: US Census Bureau, Barclays Capital  
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Barclays Capital | Reverse mortgages and HMBS  
Interest rates  
Borrowers can choose from different available interest rate options for the reverse  
mortgage. Both fixed and variable rate options are offered. The variable rates are a function  
of the 1y CMT and can reset annually or monthly. Data show that the 1y CMT rate resetting  
monthly is by far the most popular choice for most borrowers, though there has been some  
decline in its popularity of late (Figure 6). Almost all HECM borrowers up until 2008 chose  
this rate type on their mortgage. However, for the 2009 vintage, there has been a sharp  
increase in the number of fixed rate loans and almost 20% of the loans endorsed to date  
had a fixed rate.  
There are caps built into some of the adjustable rates. The annually adjusting rate cannot be  
adjusted by more than 2% each year and by more than 5% over the life of the loan. There is  
a 10% lifetime cap in the monthly resetting loans.  
Other fees  
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Origination fee and closing costs: Origination fee paid to lender at the rate of 2% for the  
first $200k or appraised home value and 1% for the amount above that, subject to a  
minimum of $2,500 and a maximum of $6,000. Closing costs include costs for appraisal,  
title search, and inspections. These costs can be rolled into the loan.  
Mortgage Insurance Premium (MIP): This is paid to HUD and the upfront cost is 2% of  
the lesser of the local FHA loan limit and the property’s appraised value. This can be  
rolled into the loan. An annualized MIP equal to 50bp of the mortgage balance is also  
charged monthly for the life of the loan. It is accrued onto the outstanding loan balance.  
Servicing fee: Servicing fees are capped at $30 for an annually resetting interest rate and  
$35 for a monthly resetting rate. The initial servicing fee is deducted from the proceeds  
of the loan. For every subsequent month, the fee is added to the loan balance.  
Payment options  
Borrowers can chose to draw down the loan in one of four ways  
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Tenure: Equal monthly payments for the life of the loan  
Term: Equal monthly payments for a fixed period of time  
Modified tenure/tenure: A line of credit along with fixed equal monthly payments either  
for the life of the loan or for a fixed time period  
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Line of credit: An initial line that can be drawn down at any rate anytime  
Data show that the last option mentioned above is the most popular choice with more than  
82% of borrowers opting for it (Figure 7). Borrowers typically tend to draw down on most  
of the line very early into the reverse mortgage. We discuss this in more detail in the section  
on drawdowns.  
Size of mortgage  
There are two related terms that define the size of a reverse mortgage:  
Maximum claim amount  
This denotes the value of the underlying asset and is calculated as the minimum of the  
currently appraised value of the property and the local FHA loan limits. This number is the  
starting point for calculation of the principal limit.  
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Figure 6: Distribution of interest rate types for HECM  
Figure 7: Distribution of payment options for HECM  
borrowers  
Share of origination  
100%  
Prepayment option  
Share of origination  
Tenure  
Term  
4%  
2%  
80%  
60%  
40%  
20%  
0%  
LOC + Tenure/Term  
Line of Credit  
12%  
82%  
Endorsement Year  
Monthly Reset  
Annual Reset  
Fixed  
Source: HUD, Barclays Capital  
Source: HUD, Barclays Capital  
Initial principal limit  
This is the maximum amount of money that can be initially withdrawn by the borrower.  
Starting from the maximum claim amount, the initial principal limit is calculated assuming a  
certain forward rate path, borrower life expectancy and an assumed profitability margin.  
How is principal limit calculated?  
Initial principal limit is calculated by discounting the maximum claim amount by the  
average expected interest rate over a time period reflective of the average remaining life  
of a borrower. We show an example here. Note: This is only illustrative, actual HUD  
calculations and assumptions may be different. To calculate an initial principal limit  
based on different parameters, please see the AARP reverse mortgage calculator.  
Property appraisal: $200,000  
Maximum claim amount: $200,000  
Age of youngest borrower: 67 years  
10 year swap rate: 3.75%  
Assumed MIP: 50bp  
Geographical FHA limit: $250,000  
Gender of youngest borrower: Male  
Assumed margin: 200bp  
Servicing fee: 10bp  
Total WAC = 6.35%  
Factor for 6.35% interest rate and 67 years from HUD table = 0.518  
Initial Principal Limit: $200,000 * 0.518 = 103,600  
The following factors influence the calculation of initial principal limit on a HECM loan.  
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Borrower age: The expected remaining lifetime of an older borrower is lower, thus  
reducing the number of years for which the loan will remain unpaid and accrue interest.  
Therefore, the principal limits for an older borrower tend to be higher as compared to a  
younger borrower, assuming same maximum claim amount.  
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Borrower gender: Actuarial studies show that female life expectancy is higher than male  
life expectancy. Therefore, initial principal limits for women tend to be lower than for  
men, all else being equal.  
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Geography: Areas with higher FHA loan limits will likely have higher maximum claim  
amounts. As a result, the initial principal limit will also be higher than a low FHA loan  
limit area.  
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Prevailing interest rates: The principal limit is a function of the “expected interest rate,”  
which is calculated from prevailing rates. In a high rate environment, the expected rates  
will be higher, and hence the initial principal limit will fall. The reverse will occur in a low  
rate environment where the low prevailing rates will result in a higher calculated  
principal limit. For adjustable rate loans, the expected rate used is the 10y swap rate plus  
a margin.  
Loan repayment  
An HECM loan does not have a fixed term, unlike traditional mortgages. Loan repayment is  
mostly triggered once the borrower dies or moves out of his primary residence.  
Prepayments analogous to those in traditional mortgages are also possible but very rare.  
The main types of loan repayment are listed below.  
Mortality  
The death of the borrower triggers the repayment of the loan. The outstanding loan is paid  
off from the proceeds obtained by selling off the property, or by the deceased borrower’s  
estate. This is the largest source of repayments for the reverse mortgage universe  
accounting for about 80% of the overall repayments (Figure 8).  
Mobility  
When the borrower moves from the property backing the reverse mortgage and it ceases  
being the legal primary residence, the loan becomes due in full. For the demographics that  
this program targets, mobility comes not only from standard turnover (moving to a different  
house) but also from borrowers moving to nursing homes or other managed care. This is  
the second largest source of repayments (Figure 8).  
Other minor causes  
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Foreclosure: Under the terms of the agreement, the borrower is required to maintain the  
property to certain minimum standards and pay all taxes in time. When the borrower  
fails to satisfy terms, foreclosure proceedings can be initiated to pay off the drawn upon  
loan. About 2% of repayments fall under this category.  
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Voluntary assignment: A lender can assign an HECM loan to HUD when the loan  
balance crosses certain LTV thresholds due to negative amortization. About 3% of the  
repayments to date fall under this category.  
Refinancing: If a borrower gets more attractive terms due to lower prevailing rates  
and/or better home valuation, then he may have incentive to pay off the existing reverse  
mortgage using the proceeds from a new loan. Although, high upfront costs tend to  
dampen this dynamic to a large extent.  
Getting to know the HECM borrower  
Age  
The average age of borrowers taking out reverse mortgages has decreased steadily since  
the launch of the program (Figure 9). We attribute this shift to greater awareness of the  
product. This trend bodes well for future HECM origination as significant inflow is expected  
into the 62+ bucket in the near future.  
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Gender  
Loans with females as the primary borrowers accounted for more than 50% of all the  
reverse mortgage loans. Co-signed loans come next, followed by male-only loans. However,  
this statistic has also shifted over time with more men and couples taking out reverse  
mortgages today than they did earlier (Figure 10).  
Geographical distribution  
Trends in geographical concentration of HECM loans have changed significantly over time.  
At the start, most of these loans were originated in California and New York, though New  
York’s share was higher than its share in traditional agency mortgages. In the middle of this  
decade, the share of California HECMs shot up (Figure 11). We attribute this to greater  
product recognition in that area. However, once HECM origination started cranking up in  
2006-07, the share of Florida loans rose sharply. This does not come as a surprise given  
Florida’s well known reputation of being retiree-friendly. However, the subsequent bust saw  
Florida’s share go down again and home values suffered significantly. There was a pickup in  
concentration of HECM loans in Texas and New York – two states that weathered the  
housing downturn much better than others.  
Figure 8: Types of repayment on HECM loans  
Figure 9: Gender distribution for HECM borrowers  
Vol  
Assignment,  
5%  
1991-2000  
2007  
Single Male  
Single Female  
Couple  
14%  
56%  
30%  
18%  
45%  
37%  
Refinancing,  
9%  
Foreclosure,  
5%  
Mobility,  
23%  
Mortality,  
59%  
Source: HUD, Barclays Capital  
Source: HUD, Barclays Capital  
Figure 10: Age distribution for HECM borrowers  
Figure 11: Geographical distribution for HECM borrowers  
Share or overall origination  
6%  
Share of National Init Principal Limit  
50%  
5%  
4%  
3%  
2%  
1%  
0%  
40%  
30%  
20%  
10%  
0%  
62 66 70 74 78 82 86 90 94 98 102  
Borrower age at origination  
Endorsement Year  
1991-2000  
2007  
CA  
FL  
NY  
NJ  
TX  
Source: HUD, Barclays Capital  
Source: HUD, Barclays Capital  
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Repayment and drawdown behaviour  
As we mentioned above, the majority of HECM loans are taken out in the form of a line of  
credit. Most of the amount is drawn out upfront and the remaining is drawn out over the life  
of the loan. As such, repayment and draw behavior are the most important parameters for  
valuation of HECM loans and securities. In this section, we examine past data on repayments  
and draws based on reverse mortgages originated by HUD between 1989 and 2007. Based on  
this data, we will build our expectations for the parameters in the next section.  
Repayment behavior  
As mortality and mobility make up most of the explained prepays, they are likely to dictate  
repayment behavior, and we will focus on them.  
Mortality  
The leading cause of repayment is death of the borrower. Mortality is a function of two  
characteristics – gender and age.  
Age is the most important factor determining mortality. As a person grows older, the  
probability of mortality-related repayment increases. Though mortality increased rapidly in  
the early decades of the 20th century, the pace of increase has slowed down significantly  
and trends have become more stable. Mortality rates are not prone to fluctuation and thus  
repayments due to this factor can be projected with a fair degree of certainty. This  
characteristic imparts the stable repayment characteristic to reverse mortgages that makes  
the product very attractive from an investment standpoint.  
Gender is also a determinant of mortality as females typically have higher life expectancy  
than males. Pools with higher concentrations of female borrowers can therefore be  
expected to have higher average life, all else being equal.  
Mobility  
Some mobility is always present within a population due to unexpected changes in needs or  
circumstances, analogous to turnover in standard mortgages. Typically, causes include  
relocation due to personal or financial reasons or into a bigger house. However, for the  
demographic under consideration, mobility also ends up correlating significantly with  
mortality due to their particular circumstances. As borrowers get older, many end up  
moving to nursing homes or other managed care facilities. Such a move triggers the  
primary residence clause in the mortgage and the loan becomes due. This correlation with  
age makes mobility trends fairly stable, due to the same reasons outlined for mortality.  
Empirical prepay data suggest little refinancing activity  
In order to gather some insight into the repayment behaviour for HECM loans, we looked at  
a sample of 480k reverse mortgage loans endorsed by HUD between 1989 and 2007. These  
data cover more than 85% of the entire reverse mortgage market and are a very good  
representation of the trends in this space.  
Prepays by loan age and vintage  
Figure 12 shows the repayment rate on HECM loans across vintages along loan age. The  
stable repayment trends seen across vintages – despite that loans were originated and  
serviced across very different macroeconomic environments – are striking indeed. This goes  
back to our earlier point on stability of mortality trends. Given that almost all the  
repayments can be attributed to mortality and mobility, trends remain independent of the  
broader housing and interest rate environment.  
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Will prepayments always remain this stable?  
Prepayment trends for HECM reverse mortgages have been very stable over time. However,  
the key question in the minds of any new investor in this space is most likely: will this trend  
hold? We believe that it is unlikely that prepayments will deviate significantly from historical  
trends due to four reasons.  
1. Prepayments have historically been mostly a function of mortality. Given that mortality  
does not fluctuate significantly over a large timeframe, prepays attributable to mortality  
are likely to remain stable.  
2. High origination costs tend to widen the rate incentive required to make the refinancing  
economic. Origination fees tend to range between 3 and 4% of total claim amount,  
which can be 5-8% of the initial principal limit. That can be a significant disincentive for  
opportunistic refinancing.  
3. The only objective of a borrower in refinancing the reverse mortgage would be to  
extract more equity given lower prevailing mortgage rates. However, the rate for  
calculation of initial principal limit is floored at 5.5%1. Therefore, significant rate rallies  
are unlikely to affect the initial principal limit by much – especially when initial loans are  
originated in low rate environments such as the present one.  
4. Finally, elderly borrowers are also not very efficient at exercising the refinancing option,  
thus leading to muted prepayment even in the face of some refinancing incentive.  
A note on fixed rate HECM prepayments  
As shown in Figure 6, most of the HECM origination to date has variable interest rates.  
Hence, most of the observed prepayment data is based on variable rate reverse mortgages.  
Given the rise in issuance of fixed rate loans recently, a valid question may be raised on the  
applicability of conclusions drawn on the basis of this data on prepayments of fixed rate  
loans. We believe that fixed rate loans will exhibit prepayment behaviour similar to that of  
variable rate loans.  
Given that there is no monthly payment to be made in reverse mortgages, the main aim of a  
borrower is to withdraw more cash against the home. The initial principal limit depends on  
the average expected interest rate. For an adjustable rate loan, the 10y swap rate is used as  
the index for the average expected rate. Within certain bounds, the long-end swap rate can  
be assumed to behave similarly to the fixed rate used to calculate the initial principal limit.  
This allows us to translate prepayment history for variable rate loans into expectations for  
fixed rate loans.  
Thus, we do not believe that fixed rate prepayments will differ significantly from historical  
ARM prepayments. The reasons that lead to muted ARM prepayments (described in the  
preceding section) apply equally to fixed rate loans.  
1 HUD Mortgagee Letter 2004-18  
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Figure 12: Non-claim terminations (prepays) by vintage  
3-month avg CPR  
20  
16  
12  
8
4
0
1
13  
25  
37  
49  
Pool age  
61  
73  
85  
97  
1993  
2000  
1994  
2001  
1995  
2002  
1996  
2003  
1997  
2004  
1998  
2005  
1999  
Source: HUD, Barclays Capital  
Figure 13: Non-claim terminations for different borrower age  
buckets over time  
Figure 14: Non-claim terminations over time controlled for  
borrower age  
3mon avg CPR  
50  
3mon avg CPR  
30  
25  
20  
15  
10  
5
40  
30  
20  
10  
0
0
83  
84  
85  
86  
87  
88  
1
13  
25  
37  
49  
61  
Borrower age  
Months since origination  
1997  
2000  
1998  
2001  
1999  
2002  
65  
85  
70  
90  
75  
95  
80  
100  
Source: HUD, Barclays Capital  
Source: HUD, Barclays Capital  
Drawdown behaviour  
We show historical drawdown behaviour of HECM pools in Figure 15. Typically, there is a  
sharp drawdown spike in the first month and then the rate settles at a much lower steady  
number for the rest of the life of the pool. However, the drawdown behaviour of recent fixed  
rate reverse mortgage originations has been quite different. As a term of the low fixed rate,  
borrowers were required to drawn down upon the entire balance upfront. As a result, there  
is no possibility of future draws on these loans.  
We feel it is important to mention that drawdowns do not directly affect repayment of  
HECM loans. However, loans get bought out of HMBS pools once they hit the 98 LTV cap,  
and hence drawdowns end up altering HMBS repayments. We discuss this in more detail in  
the next section.  
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Figure 15: Drawdown rates on HECM pools  
Figure 16: Cumulative HMBS Issuance ($mn)  
% of Initial Principal Limit  
70%  
6,000  
5,000  
4,000  
3,000  
2,000  
1,000  
60%  
50%  
40%  
30%  
20%  
10%  
0%  
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15  
0
Policy Year  
Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09  
Source: HUD, Barclays Capital  
Source: HUD, Barclays Capital  
HECM Backed Mortgage Securities (HMBS)  
Though HECM loans constitute a disproportionate portion of the reverse mortgage market,  
HECM loans were slow to be securitized or traded actively in the secondary market. On the  
other hand, private reverse mortgage securities have been around since 1999.  
Difficulty in managing two directional cash flows (drawdowns from investor to borrower  
and repayments from borrower to investor) as well as limited investor appetite to hold non-  
cash flowing accrual securities hampered development of an active secondary market. The  
first HECM mortgage backed security (HMBS) was issued in 2006. In the past two years  
more than $5bn of HMBS has been issued (Figure 16). Given the rapid increase in HECM  
loan endorsements, it is likely that issuance will increase in the future. In the following  
sections we discuss the mechanics of HMBS.  
Basic structure of security  
A pool of HECM loans with outstanding balances is used to create an HMBS. Beyond this  
point, investors in this pool are not responsible for any additional draws. The incremental  
drawn-out balance is securitized separately and sold as separate securities. This handles the  
problem of two directional flows between investors in a security and underlying borrowers  
and simplifies the structure significantly.  
Coupon  
The securities are structured as WAC passthroughs, and the coupon on the securities is  
simply a weighted average value of the interest rates on the underlying loans less the  
servicing fee and guarantee fee. These securities do not pay out any monthly coupon; it is  
amortized back into the loan balance instead. The monthly guarantee fee and servicing fee  
are also added to the security balance.  
G-fee and servicing fee  
Issuers pay a monthly guarantee-fee of 6bp annualized on the outstanding HMBS to Ginnie  
Mae, which is amortized into the HMBS balance. The servicer charges a monthly servicing  
fee that is either flat at $30-35 or variable at 19-69bp annualized on the HECM balance. The  
pro-rated share of this attributable to the HMBS (using balance of HECM that is securitized  
under the specific HMBS) is added back to the HMBS balance.  
March 18, 2010  
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Barclays Capital | Reverse mortgages and HMBS  
Stated maturity  
There is no stated maturity on an HECM loan, and thus stated maturity of HMBS is  
undefined. However, to ease book-entry requirements, stated maturity is assumed to be  
100 years from date of HMBS origination.  
Pool parameters  
Minimum pool size is $1mn. HECM loans underlying an HMBS must have similar interest  
rate type with the same reset date and same index. They can, however, have different  
payment options.  
Paydowns in HMBS  
HMBS get paid down when the HECM loans repay due to mortality, mobility or other  
factors. Once repayment is triggered, the funds equal to the minimum of accrued balance of  
the HECM or proceeds from sale of the property are owed to the trust. Given that the  
security is guaranteed by the full faith of the US government, any shortfall from the  
outstanding balance is covered by Ginnie Mae. Please note that only the pro-rated share of  
balance that was securitized with this trust is paid back.  
Buyouts  
An interesting feature of HMBS is the LTV based buyout. If the LTV on a HECM loan exceeds  
98%, then the loan is either assigned to FHA or repurchased by Ginnie Mae from the HMBS.  
This tends to extend greater cash flow predictability to HMBS investors in the event that  
realized interest rates turn out to be much higher than expected at origination or life  
expectancy unexpectedly increases. In our analysis, it significantly affects cash flow patterns  
and tends to shorten the average life of the security.  
Modelling HECM and HMBS  
Forecasting mortality, mobility and drawdown rates  
We forecast these vectors based on historical data and expectations on key drivers  
discussed earlier.  
„
Mortality: Forecasting mortality is fairly straightforward. We use the life expectancy  
tables published by the US Census Bureau. We incorporate the difference in life  
expectancy for the two genders into the model (Figure 17). Assuming that most of the  
prepays are attributable to mortality, we model mobility as the residual left over after  
mortality has been accounted for. However, actual data seem to suggest a high residual  
after accounting for mortality. There also seems to be a ramp-up in the initial months,  
which cannot be explained by mortality (Figure 18).  
Research has shown 2 that the average mortality of HECM borrowers is higher than the  
average population. Even HUD’s initial principal limit calculation assumes higher  
mortality than average (1.3x). This is due to the fact that many times some illness or  
medical condition of the borrower triggers taking out a reverse mortgage. It therefore  
follows that this borrower pool experiences higher mortality. Our analysis suggests a  
higher multiple than the 1.3x used by HUD. We use a 1.6x multiple for our model.  
The initial ramp can be explained by underwriting standards. It is unlikely that a  
borrower near death is in a position to go through the process of taking out a reverse  
mortgage. Thus, the mortality rate over the first few months of a pool does not reflect  
the statistical mortality of the borrowers. We therefore use an 18-month ramp before  
switching to pure statistical mortality expectations.  
2 “Reversing the Trend: The recent expansion of the reverse mortgage market,” Hui Shan, Federal Reserve Board, 2009  
March 18, 2010  
13  
 
Barclays Capital | Reverse mortgages and HMBS  
„
Mobility: Though there are no direct data available on mobility, we can impute it from  
the overall prepayment data. Given that there is a fair degree of certainty around  
mortality-related prepayments, the residual non-claim terminations seen in pools can be  
attributed to mobility. We show the residual component in Figure 18. We assume a  
ramp on mobility over the first 48 months, assuming that the older and physically  
weaker borrowers moved out of their homes. Beyond that, we assume constant mobility  
as mortality dominates at that point.  
„
Long-term cap: We also set long-term overall prepayments to 16 CPR. Historical  
prepayment trends suggest that the long-term overall prepay rate has mostly never  
exceeded this value (Figure 12). This is slightly counterintuitive as empirical mortality  
trends would suggest that the prepay rate should forever keep increasing as the pools  
age. We believe that due to positive selection, only the healthier and younger borrowers  
are left behind in the pool (with weaker borrowers having moved out through a  
combination of mobility and mortality). Thus, the prepayment rate flattens after rising  
six to seven years.  
„
Drawdowns: Though we have no ready access to drawdown data, based on our  
discussion with HECM experts and other research, we expect drawdowns to follow the  
pattern shown in Figure 15. For analyzing fixed rate loans, we will use no draws,  
assuming that the total balance has been drawn down at the start. We discussed the  
reason for this in the section on drawdowns above.  
„
Claim terminations: Claim terminations can be of two types:  
Assignments: This usually occurs when the loan hits certain LTV caps and is  
therefore assigned to HUD. We do not model this as a separate vector but handle it  
within the cashflows of the individual loans.  
Loss terminations: Occurs in case of foreclosure on a borrower (due to significant  
non-maintenance) or an unsuccessful mortgagor’s sale. The occurrence of these  
terminations is very rare (<4%) and hence we will not model them separately.  
Figure 17: Mortality by age  
Figure 18: Mortality, mobility and overall model  
Proability of death in next year  
35%  
3 mon avg CPR  
18  
16  
30%  
25%  
20%  
15%  
10%  
5%  
14  
12  
10  
8
6
4
2
0%  
0
62 65 68 71 74 77 80 83 86 89 92 95 98  
Age  
1
16 31 46 61 76 91 106 121 136 151 166  
Pool Age  
Male  
Source: Census Bureau, Barclays Capital  
March 18, 2010  
Female  
Mortality Model  
Mobility Model  
Overall Model  
Source: HUD, Barclays Capital  
14  
Barclays Capital | Reverse mortgages and HMBS  
Figure 19: Prepayment model vs observed  
3 mon avg CPR  
16  
14  
12  
10  
8
6
4
2
0
1
6
11 16 21 26 31 36 41 46 51 56 61 66 71 76 81  
Pool Age  
Overall Model  
Observed Prepayments  
Source: HUD, Barclays Capital  
Cashflows  
We now present cashflows obtained by running the above assumptions on a fixed rate  
HECM pool consisting of 930 loans originated in 2009 and 2010. The overall characteristics  
of the pool are show in Figure 20. We modelled mortality on individual loans using a  
probability-weighted function. Given the large pool size, the results are stable across runs.  
„
Base case collateral balance versus HMBS balance: As this is a completely drawn down  
fixed rate pool, there is very little difference between the collateral and HMBS balance  
profile (Figure 21). The collateral balance tends to be slightly higher on account of the  
higher coupon (servicing fee and g-fee is not passed onto the HMBS bond). It is  
noteworthy that the collateral and the bonds both have average lives of 6.8 years,  
despite an effectively perpetual underlying loan.  
„
Prepays: The overall prepayment rate is shown in Figure 22. At first glance, the high  
prepayment rate may seem a little shocking. After all, we had assumed a cap of 16 CPR on  
lifetime prepayments. However, one has to model in the effect of the LTV cap based  
buyout. As discussed in the HMBS section above, FHA buys out all loans that exceed 98 LTV  
due to accrual of interest and other costs. This leads to much faster overall prepayments as  
compared with just mortality- and mobility-related prepayments. Figure 23 shows  
prepayments assuming no buyouts. As expected, those prepayment rates remain quite low.  
March 18, 2010  
15  
Barclays Capital | Reverse mortgages and HMBS  
Figure 20: Collateral characteristics of sample pool  
Figure 21: Collateral and HMBS balance over time  
Balance ($mn)  
Maximum claim amount  
Initial principal limit  
LTV  
252,573  
180  
160  
140  
120  
100  
80  
163,702  
65%  
73.1  
Borrower age  
Number of loans  
Average WAC  
930  
5.56  
60  
40  
20  
0
0
10 20 30 40 50 60 70 80 90 100 110 120 130  
Months forward  
Collat Balance  
HMBS Balance  
Source: Barclays Capital  
Source: Barclays Capital  
Figure 22: Overall collateral prepayment  
Figure 23: Collateral prepayment without buyouts  
CPR  
CPR  
90  
90  
80  
70  
60  
50  
40  
30  
20  
10  
0
80  
70  
60  
50  
40  
30  
20  
10  
0
1
11 21 31 41 51 61 71 81 91 101  
Months forward  
1
11 21 31 41 51 61 71 81 91 101  
-10  
Months forward  
Source: Barclays Capital  
Source: Barclays Capital  
„
Average life sensitivity to prepayments look to be rather small: We check the average life  
sensitivity of HMBS to the mortality multiple assumptions for HECM borrowers and find  
that the results do not change significantly with that assumption. The average life of the  
collateral pool remains within a reasonable range, even over a wide range of multiples  
(Figure 24). Most of this is a result of the fact that buyout-related prepayments are  
expected to be much higher than mortality- or mobility-related prepayments. As a result,  
changes in mortality assumptions do not alter the outcome significantly.  
This can be attributed to the initial principal limit not being set using appropriate life  
expectancies. If the life expectancy used in the calculation were spot on, then the  
borrower would die before the loan hit the LTV cap. Thus, there would be very few  
buyouts. The fact that it is not so reflects that higher life expectancy is being used than  
what data show. This works out to be in favour of the investor, as one would prefer a  
guaranteed and predictable prepayment event (HUD buyout) over a relatively less  
predictable event (mortality).  
March 18, 2010  
16  
Barclays Capital | Reverse mortgages and HMBS  
Figure 24: Sensitivity of average collateral life to mortality multiple  
Mortality multiple  
Average collateral life  
1.0  
1.3  
1.6  
1.9  
2.2  
7.0  
6.9  
6.8  
6.7  
6.6  
Source: Barclays Capital  
Relative value analysis  
Given the unique nature of HMBS securities – accrual securities with a fairly range bound  
average life there are relatively few securities that they can be compared with. In the  
mortgage space some reasonable comparisons can be made with GNMA 15 collateral and  
intermediate PACs off of GNMA collateral. We believe that the securities show in Figure 25  
come closest in terms of cash flows, and we evaluate the relative value of HMBS against  
each of these.  
Figure 25: Relative value analysis of HMBS with comparable assets  
Coupon  
Price  
I-Spd  
OAS  
AL  
AL +200 AL -200  
Yield  
HMBS Pass-thru  
15y GNMA PT  
5.5%  
4%  
109-25  
103-2  
106-5  
82  
85  
83  
89  
12  
33  
6.9  
4.5  
6.6  
6.9  
5.2  
8.7  
6.9  
2.8  
1.8  
3.99  
3.21  
3.93  
GNMA PAC 5/5  
Source: Barclays Capital  
5%  
A couple of things stand out in this analysis. First, on a nominal spread basis, all the bonds  
that we considered pick up about 80-85bp relative to Treasuries. However, the key  
difference arises when we examine option-adjusted spreads for HMBS pass-throughs  
relative to 15y GNMA and the 5/5 GNMA PAC. As the HMBS have no negative convexity to  
speak of, they pick up 89bp of OAS to Treasuries, a pick of 50-70bp to the other bonds that  
we have considered. This difference is also displayed in the average life sensitivity of these  
other bonds. While HMBS pools maintain a stable average life, even with large changes in  
interest rates, the 15y GNMA and 5/5 GNMA PACs are subject to considerable average life  
variability in these scenarios.  
March 18, 2010  
17  
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We, Sandipan Deb and Nicholas Strand, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any  
or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related  
to the specific recommendations or views expressed in this research report.  
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