Please see the last page of this publication for important disclosures.  
February 25 2011  
GNMA HECM Primer and Relative  
Value  
Overview  
A reverse mortgage is a type of loan that allows older homeowners  
(minimum age 62) to stay in their home and draw cash from their home  
equity but does not require any scheduled mortgage payments during  
the borrower(s)’ lifetime. Instead, the loan accrues interest until a  
maturity event occurs (such as death of the borrower, sale of the  
property or prepayment), after which the loan and accrued interest are  
paid off.  
FHA Home Equity Conversion Mortgages (or HECMs) are the most  
ubiquitous type of reverse mortgage and also the only reverse  
mortgage program insured by the Federal Government. FHA ensures  
that the homeowner will receive all draws due them as long as they  
remain in the home. FHA also guarantees the lender that, when the  
property is sold, the loan balance (principal and accrued interest) will  
be fully repaid up to the maximum claim (guarantee) amount  
established when the loan is originated.  
This piece is broken down into two parts. Part one is a primer,  
detailing the FHA HECM loan program, including eligibility  
requirements, loan structures and repayment scenarios. Part two, for  
those familiar with HECM loans, looks at GNMA HMBS and HREMICs  
(pools and CMOs backed by FHA HECM loans), including factors  
affecting prepayments and relative value versus other MBS types.  
Figure 1: HECM Origination (number of loans per fiscal year)  
140,000  
120,000  
100,000  
80,000  
60,000  
40,000  
20,000  
0
Greg Reiter  
MBS, CMBS and ABS Strategy  
+1 203 897 4645  
Jeana Curro  
MBS, CMBS and ABS Strategy  
+1 203 897 4650  
Fiscal Year  
www.rbsm.com/strategy  
Bloomberg: RBSR<GO>  
* 2011 = Oct 2010 - Nov 2010. Fiscal Year ends Sept 30  
Source: FHA, RBS  
The Royal Bank of Scotland  
As the average age of the general U.S. population is increasing and  
traditional means of income for older people (e.g. social security, savings  
and retirement plans) may be less robust, HECMs should gain popularity.  
Part I: HECM Loan Overview  
What is a Reverse Mortgage?  
Reverse mortgages are loans offered to homeowners 62 years and  
older. They provide a way for the borrower to remain in their house for  
their lifetime while being able to draw cash from the equity in a home.  
Additionally, regular mortgage payments (as in a traditional mortgage)  
are not required. Instead of scheduled repayments, the reverse  
mortgage loan is repaid after a maturity event occurs, such as death of  
the borrower(s), sale of the property, prepayment, or a 12-month  
vacancy of the house. In addition, a reverse mortgage may only be  
taken out on a primary residence that is free and clear of other debt or  
one where the existing mortgage is small enough to be rolled into the  
reverse mortgage. We illustrate cashflow differences between a  
traditional fixed rate, level payment, self-liquidating mortgage and a  
reverse mortgage in the figure below.  
Figure 2: Traditional Fixed Rate vs. Reverse Mortgage  
Traditional Fixed-Rate Mortgage  
Reverse Mortgage LOC  
Initial Cashflow  
Homeowner  
Homeowner  
100% of borrowed amount  
Up to 100% of LOC  
Lender  
Lender  
Future Cashflows  
(before Maturity)  
Homeowner  
Homeowner  
Monthly P&I Payment  
Homeowner may draw on LOC, or receive scheduled  
payments  
Lender  
Lender  
Monthly Loan Balance  
Falls by each month's principal payment  
Homeowner  
Rises by any draw, interest accrual  
Homeowner (or Estate)  
Final Cashflow  
(at maturity/prepay)  
Principal & Accrued Interest at Maturity Event:  
1) Prepayment; or,  
2) Voluntary Sale of House  
3) Death of borrowers  
Final P&I Payment or Prepayment  
4) Failure to occupy property for 12 consecutive months  
5) Failure to maintain property or pay taxes and insurance  
Lender  
Lender  
Source: RBS, HUD  
2
The Royal Bank of Scotland  
Under a reverse mortgage arrangement, borrowers cannot be forced  
to vacate the home, and reverse mortgages are non-recourse,  
meaning that if the proceeds from the home’s sale are not sufficient to  
pay off the reverse mortgage, neither the estate nor its heirs have any  
obligation to cover any shortfall.  
Many older homeowners live on a fixed income, typically Social  
Security with perhaps a pension or income from savings, an IRA or  
defined contribution (e.g. 401K) assets. An older homeowner may find  
that using a reverse mortgage to tap the equity in their home is more  
feasible than a regular mortgage if:  
„ The borrower does not have enough income to cover (or simply does  
not want to make) regular mortgage payments.  
„ The borrower needs a stream of income from their house, either for a  
fixed period of time or their lifetime.  
While there are significant costs associated with reverse mortgages,  
their flexibility often appeals to borrowers who would shun a traditional  
mortgage, or even a home equity loan because of the need to make  
regular monthly payments.  
There are basically 3 types of reverse mortgage programs:  
1. HECM mortgages are guaranteed by the Federal Housing  
Administration, and hence are full faith and credit of the US  
government, similar to US Treasuries from a credit perspective. To  
date, they account for over 90% of the reverse mortgages originated in  
the U.S. Borrowers are required to pay an up-front and ongoing annual  
insurance fee. The maximum loan size is governed by FHA loan limits.  
2. Home Keeper® mortgages from Fannie Mae. This product is  
similar to the HECM program.  
3. Private label reverse mortgages are available from a number of  
lenders.  
FHA HECMs represent the overwhelming bulk of reverse mortgage  
origination and remain the focus of this report.  
The History of the Reverse Mortgage Market  
The FHA HECM program began in 1990. Since then, over 657,000  
loans have been endorsed (through Nov 2010). As seen in Figure 1  
(first page) 75% of all HECM origination has occurred in 2006 or later.  
We show how the average HECM characteristics have changed over  
time (figure below). The average property value, maximum claim  
amount (or max amount FHA will insure) and initial principal limits (max  
loan size) have drifted higher, reflecting increases in conforming loan  
limits over the years, while the average age of the borrower has  
steadily declined.  
3
The Royal Bank of Scotland  
Figure 3: Total HECM Cases Endorsed for Insurance by Fiscal Year of Endorsement Plus Selected Loan  
and Borrower Characteristics  
Data As of 11/30/2010  
Borrower(s)  
Active Insured Cases  
Average  
Fiscal Year  
(Oct 1 to Sep  
30)  
Average  
Expected  
Average  
Property  
Average  
Maximum  
Claim(000)  
Average  
Initial Prin  
Number of  
Average  
Unpaid  
Count Balance (000)  
Loans Interest Rate Value (000)  
Limit (000) Borrower Age Single Female Single Male  
Multiple  
26.1%  
30.1%  
27.3%  
30.7%  
30.8%  
30.0%  
31.1%  
30.2%  
29.9%  
30.7%  
30.2%  
31.9%  
34.7%  
37.2%  
36.2%  
37.9%  
38.8%  
37.2%  
35.6%  
37.0%  
9.8  
9.3  
8.9  
7.6  
7.6  
8.6  
6.9  
8.1  
7.4  
6.5  
7.3  
6.7  
6.4  
5.4  
5.8  
5.7  
6.0  
6.0  
5.4  
76.7  
76.5  
76.6  
75.7  
75.2  
76.0  
75.9  
75.9  
75.7  
75.3  
76.0  
75.5  
75.1  
74.3  
74.3  
73.8  
73.8  
73.5  
73.1  
57.3%  
56.0%  
57.7%  
55.0%  
54.8%  
56.5%  
56.4%  
56.6%  
56.0%  
54.8%  
56.8%  
54.5%  
51.4%  
48.6%  
48.6%  
46.0%  
44.5%  
44.6%  
43.8%  
41.2%  
16.6%  
13.9%  
15.0%  
14.4%  
14.5%  
13.5%  
12.5%  
13.2%  
14.1%  
14.5%  
13.0%  
13.7%  
14.0%  
14.2%  
15.2%  
16.1%  
16.7%  
18.2%  
20.6%  
21.8%  
1990  
1991  
1992  
1993  
1994  
1995  
1996  
1997  
1998  
1999  
2000  
2001  
2002  
2003  
2004  
2005  
2006  
2007  
2008  
2009  
157  
389  
$108,716.9  
126414.9  
124667.9  
119657.9  
124944.0  
124832.0  
117161.1  
117502.1  
118660.3  
131914.6  
141669.8  
167141.7  
177977.9  
197554.5  
219437.6  
254864.1  
289660.3  
261939.5  
239337.4  
283307.8  
$84,208.4  
97482.7  
$39,005.1  
43460.1  
48611.8  
52600.1  
58015.4  
54340.8  
57305.1  
57952.5  
64299.5  
81619.8  
78571.4  
97403.2  
109953.1  
131292.4  
133909.7  
144387.7  
158891.6  
155652.1  
153718.7  
183994.4  
2
1
$98  
93  
1,019  
97415.6  
3
191  
116  
114  
126  
104  
100  
92  
1,964  
97900.7  
21  
3,365  
103808.1  
105367.6  
103335.3  
105203.9  
107018.7  
117789.3  
124616.5  
140595.1  
151335.9  
165922.7  
182201.0  
206043.5  
235616.7  
229336.2  
216407.2  
263219.8  
30  
4,166  
95  
3,596  
97  
5,207  
244  
7,895  
688  
7,923  
939  
100  
91  
6,637  
1,210  
1,818  
4,081  
6,926  
18,212  
27,904  
60,027  
94,159  
103,872  
108,988  
7,789  
102  
111  
130  
132  
148  
156  
143  
133  
155  
13,048  
18,084  
37,790  
43,082  
76,280  
107,368  
112,015  
114,641  
5.5  
72.9  
42.5%  
40.6%  
21.8%  
20.3%  
35.6%  
39.1%  
2010  
78,757  
6,551  
5.7  
5.2  
279880.0  
266316.0  
175491.5  
72.9  
72.5  
77,732  
11,830  
151  
2011*  
$264,950.4  
$252,774.2  
$163,204.0  
$123  
Data as of 11/30/2010. FY 2011 = Oct 2010-Nov 2010  
Source: FHA, RBS  
The Reverse Mortgage Market is Poised to Grow  
According to the U.S. Census Bureau, between 2010 and 2050, the  
U.S. population is projected to grow 42%, from 310 million to 439  
million. The population is also expected to become much older, with  
nearly one in five U.S. residents aged 65 and older in 2030. In the  
figure below, note that the number of people 62 and older is projected  
to nearly double by 2030. Finally, retirement plans are shifting away  
from defined benefit plans from an employer and towards employee  
contribution plans like 401k. As a result, we think there will be many  
house-rich, cash-poor U.S. citizens of retirement age who want to stay  
in their homes but need to convert some of their home equity to make  
ends meet.  
4
The Royal Bank of Scotland  
Figure 4: Projection of the US Population 62 and Older  
120  
100  
80  
60  
40  
20  
0
2000  
2005  
2010  
2015  
2020  
2025  
2030  
2035  
2040  
2045  
2050  
62-64 65-69 70-74 75-79 80-84 85-89 90+  
Source: U.S. Census Bureau, RBS  
It should be noted that Bank of America, one of the larger issuers of  
reverse mortgages, announced early February 2011 that it would drop  
reverse mortgages from its menu of lending options.  
Recent Change:  
HECM Borrower and Property Eligibility  
Requirements  
HUD lays out very specific guidelines for HECM eligibility  
„
The borrower and any co-borrower must  
1. be at least 62 years of age.  
2. own the property outright or have a small mortgage balance  
that will be rolled into the reverse mortgage.  
3. occupy the property as a principal legal residence.  
4. not be delinquent of any Federal debt. And  
5. participate in a consumer information session given by an  
approved HECM counselor.  
Note that there are no income or employment qualifications (either  
minimums or maximums) required of the borrower. However, in  
early 2011 HUD announced plans to make sure borrowers are  
creditworthy at some point in the future.  
„
The following property types are eligible as long as they meet all  
FHA property standards and flood requirements:  
1. 1-4 family home (with one unit as the borrowers primary  
residence)  
2. Manufactured housing that meets FHA requirements  
5
The Royal Bank of Scotland  
3. HUD Approved condos (note co-ops are not eligible).  
Note: Homes of any value are eligible but HECM loan size is  
restricted by FHA loan limits.  
HECM Parameters  
The maximum loan size of a reverse mortgage (the Principal Limit or  
PL) depends on age, current interest rate, value of the home, and the  
limit factor (or PLF, the amount available to borrow as a percent of the  
home’s value, from which the PL is calculated) but in general, the more  
valuable the home, the older the borrower, and the lower the interest  
rate, the more a borrower can take out. We show an example below.  
Regarding age, if the loan is being taken out by joint borrowers, the  
age of the youngest borrower is used in calculating the loan amount.  
Additionally, since PL is based on rates, fees and closing costs, the  
dollar amount may vary by lender.  
Figure 5: Hypothetical Principal Limit per $100,000 Maximum Claim  
Amount  
Age  
HECM Standard  
2.51% (1ML+225)  
HECM Saver  
3.26% (1ML+300)  
Rate  
4.99%  
$58,542  
$61,142  
5.25%  
$46,532  
$48,532  
65  
70  
$46,542  
$49,942  
$33,132  
$35,532  
75  
80  
$53,642  
$56,742  
$64,142  
$66,642  
$38,232  
$41,032  
$50,232  
$51,832  
85  
$62,128  
$70,928  
$45,318  
$55,418  
Total Interest Paid = Rate + 125 bps MIP; 3/8 pt closing costs.  
Source: AARP, HUD  
Effective October 4, 2010 (FY 2011), HUD has lowered the effective  
interest rate floor for PLF determination from 5.50 to 5.00 percent.  
Thus, all interest rates of 5.00 percent or less will show the same,  
identical PLFs for each borrower age. In addition, for “expected”  
interest rates above 10 percent, PLF factors are set to zero. At this  
time, the actuarial calculations indicate that HUD cannot feasibly offer  
HECM products if interest rates were to rise to that level. Finally, HUD  
has changed the PLF cap from age 95 to age 90. Thus, all ages 90 or  
above will show the same, identical PLFs for each borrower age.  
Also effective 2011 FY, HUD reduced the amount of HECM proceeds  
made available. Roughly, the new Principal limit factor is 10% lower  
line with other measures that GNMA and FHA have been taking to  
improve the credit quality of loans. The result of these changes will be  
that HECM loans originated since October 2010 (1) will be smaller on  
average, (2) have longer maturities since the loans will take longer to  
reach the MCA and (3) will potentially slow prepayments for pre-Oct  
2010 HMBS.  
1 A reverse mortgage calculator can be found here : http://rmc.ibisreverse.com//rmc_pages/rmc_aarp/aarp_index.aspx  
2 The new PLF tables can be found at: http://www.hud.gov/offices/hsg/sfh/hecm/hecmhomelenders.cfm  
6
 
 
The Royal Bank of Scotland  
The Maximum Claim Amount (MCA) is the max amount that FHA will  
insure for any HECM loan and is generally the lesser of the home value  
or the national HECM FHA loan limit which is $625,500 for 2011. (The  
loan limit is set to be 150% of the conforming loan limit, which is  
currently $417,000)3.  
The Principal Limit and MCA have important implications in a HECM  
loan. Once the borrower reaches the PL, he can not take out any  
additional money; however, the loan continues to accrue interest,  
servicing fees and the Mortgage Insurance Premium (MIP). Once a  
loan accrues to 98% of the MCA, FHA allows Insurers to assign the  
loan back to the FHA. Assignment to FHA is one example of  
repayment, and for the investor in a HECM-backed security,  
Assignment is considered a prepayment. We will further discuss the  
importance of assignment on HMBS cash flows in the next section.  
HECM Structure  
A HECM loan can take one of the following forms:  
Line of Credit (LOC): This is the most common form of HECM. This  
structure allows a borrower to withdraw money at will, at the  
commencement of the loan or any time after, until the LOC is used  
up. There is no schedule upon which the borrower receives  
payments. Note that the LOC grows automatically as the borrower  
ages, meaning the unused portion of the LOC increases each year.  
Adjustable rate only (assuming not cash lump sum).  
Cash Lump Sum: Up-front one-time withdrawal (like an  
LOC drawn all at once). This is not very common.  
Borrower can choose fixed or adjustable rate.  
Tenure: (looks like a life annuity) the loan pays equal monthly  
payments as long as at least one borrower lives and continues to  
occupy the property as a principal residence. Borrower can  
choose fixed or adjustable rate.  
Term: (looks like a fixed-term annuity) the loan pays equal monthly  
payments for a fixed period of months selected by the borrower.  
Borrower can choose fixed or adjustable rate.  
Modified Tenure: This is a combination of a line of credit plus monthly  
payments for as long as one borrower remains in the property.  
Adjustable rate only.  
Modified Term: This is a combination of a line of credit plus monthly  
payments for a fixed period of months selected by the borrower.  
Adjustable rate only.  
LOC, Modified Tenure and Modified Term are all adjustable rate  
products. In the case of cash lump sum, tenure and term, borrowers  
3 Prior to 2009, the HECM limit was set equal to the conforming loan limit. Note that the HECM MCA does not vary by location,  
unlike regular FHA and VA loan limits.  
7
 
The Royal Bank of Scotland  
also have flexibility in determining how the interest on the loan is  
calculated, choosing either a fixed rate or an adjusting rate.  
Furthermore, borrowers can choose between monthly (more common)  
or annual reset (much less common) off of the CMT or LIBOR. Different  
adjustable rates are subject to different caps as well.  
„ Monthly Adjustable, CMT Index: the loan is subject to a lifetime cap  
established by the lender at origination  
„ Annually Adjustable, CMT Index: the loan is subject to a 2% annual  
cap and a 5% lifetime cap  
„ Monthly Adjustable, LIBOR: the loan is subject to a lifetime cap  
established by the lender at origination  
„ Annually Adjustable, LIBOR: the loan is subject to a 2% annual cap  
and a 5% lifetime cap  
Costs and Fees  
Similar to other FHA loans, a HECM loan includes several fees,  
including an origination fee, closing costs, and mortgage insurance  
premium. The borrower can finance the costs into the HECM and  
repay them from the proceeds of the loan. However, financing the  
costs as part of the loan also reduces the principal limit available. We  
list and briefly describe the fees below:  
„ Origination Fees:  
1. For homes less than $125,000, the max a lender can  
charge is $2,500  
2. For homes valued at $125,000 or more, lenders can  
charge 2% of the first $200,000 of the home's value  
plus 1% of the amount over $200,000.  
3. Max origination fees are capped at $6,000.  
„ Third Party Closing Costs: can include appraisal, title search,  
surveys, inspections, recording fees, mortgage taxes, credit checks  
and other fees.  
„ Mortgage Insurance Premium (MIP):  
1. Initial MIP is charged at closing and is 2% of the  
Maximum Claim Amount on HECM Standard loans and  
0.01% of the MCA on HECM Saver loans (Saver Loan  
program began Oct 4, 2010)4  
2. For the life of the loan, MIP is charged monthly at an  
annual rate of 125 bps. (note that the most recent  
4 The main distinctions between HECM Standard and HECM Saver are the upfront MIPs and the allowable loan amounts. More  
detailed information regarding the two plans can be found in HUD’s September 21, 2010 Mortgagee Letter, found here:  
8
 
The Royal Bank of Scotland  
increase (+25bps) to annual MIP for FHA loans  
assigned after April 2011 does not apply to HECMs)  
„ Servicing Fee: accrues monthly  
1. $30 if the interest rate on the loan is fixed or adjusts  
annually  
2. $35 if the loan adjusts monthly  
Repayment Options  
Repayment generally occurs at the end of the loan, unlike traditional  
mortgages which have monthly scheduled payments. However note  
that there is no penalty charged to the borrower if he voluntarily  
prepays. The loan (including accrued interest, MIP and other fees that  
were financed) must be paid in full once one of the following occurs:  
„ The last surviving borrower dies.  
„ The property is sold.  
„ The borrower does not pay property taxes or hazard insurance or  
violates other obligations.  
„ The borrower permanently moves to a new principal residence.  
„ The borrower fails to live in the home for 12 months in a row.  
„ The borrower allows the property to deteriorate and does not make  
necessary repairs.  
Historically, the vast majority of payments made to the lender are from  
the borrower, through either the sale of the home, refinancing, or with  
other funds. However in the rest of cases, FHA bought the loan from  
the lender. In most of these instances, the borrower’s loan balance has  
reached 98% of the MCA, so lenders assign the loan to FHA in  
exchange for 100% of the outstanding accrued balance.  
In other instances, FHA paid a claim to the lender because the  
proceeds from the sale of the home were less than the balance due.  
Note that borrowers cannot be forced to vacate the home (assuming  
they are current with property taxes and hazard insurance, maintain  
their property, and do not vacate it for longer than 12 consecutive  
months), and reverse mortgages are non-recourse, meaning that if the  
proceeds from the home’s sale are not sufficient to pay off the reverse  
mortgage, the estate or the heirs still do not have any obligation.  
9
The Royal Bank of Scotland  
PART II: HMBS and Relative  
Value  
GNMA HMBS and HREMICs  
Balances related to a HECM loan (called participations) can be  
pooled into HECM Securities (or HMBS), which are guaranteed by  
GNMA. As a result, they carry the full faith and credit of the US  
government, and are credit-comparable to US Treasuries. GNMA’s  
involvement began in 2007. Prior to that FHA HECMs existed but were  
mostly securitized in non-agency MBS. GNMA HECM pool issuance  
was fairly limited at first, but picked up starting 2H09 (chart below left)  
when GNMA began structuring REMICs off HMBS (HREMICs). The  
chart below right shows monthly HREMIC issuance, to date there have  
been 35 deals done since the first one in late 2009 (GNR 2009-H01).  
Figure 6: GNMA HMBS: Monthly Issuance  
Figure 7: GNMA Monthly HREMIC Issuance  
1600  
1200  
800  
400  
0
1400  
1200  
1000  
800  
600  
400  
200  
0
1yr CMT  
1yr LIBOR  
1mo CMT  
1mo LIBOR  
Fixed Rate  
Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan- Feb-  
09  
09  
10  
10  
10  
10  
10  
10  
10  
10  
10  
10  
10  
10  
11  
11  
Source: CPR CDR, RBS  
Source: GNMA, RBS  
HMBS are interest-accrual pass-through securities and therefore do  
not provide scheduled payments of principal or interest to investors.  
However, investors will receive unscheduled payments (principal and  
interest) when the borrower (or borrower’s estate) repays the loan  
either voluntarily or after a repayment event occurs. In addition, when a  
loan reaches 98% of MCA, the participation is bought out of the HMBS  
security and the payment is passed on to the borrower.  
While HMBS looks like an accruing-interest mortgage bond that returns  
cash whenever a payment event occurs, in some ways they can be  
more complicated. 2 main intricacies are:  
1) Participations (balances) are securitized so one HECM loan  
can be represented in more than one HMBS pool. For  
example, in the most common type of HECM loan, the LOC,  
suppose a borrower makes 3 separate draws over time, each  
$50,000. These can be securitized into 3 separate HMBS  
pools. However prepays are distributed pro-rata.  
10  
The Royal Bank of Scotland  
2) The accrual rate and LOC growth rate of the collateral can be  
different. The underlying balance from an LOC accrues at one  
variable rate, but the LOC also increases each year at the rate  
the loan balance is expected to grow. Given the variable  
nature of a Line of Credit (meaning it can be drawn at any  
time); the future balance growth is rate is unknown.  
Figure 8: Participations from the same HECM Loan can get pooled separately  
$275,000.00  
$163,075.00  
-$5,500.00  
-$1,780.00  
$155,795.00  
Home Value  
Principal Limit (based on Age)  
less FHA MIP  
Closing Costs  
Available Amount for LOC  
LOC grows at 3.0%, Interest Accrues at 2.5%  
$155,795.00  
borrower takes out  
$50,000.00  
remaining balance  
$105,795.00  
At start of loan:  
this participation becomes securitized  
HMBS #1  
$50,000.00  
After 1 year:  
remaining balance  
$110,468.85  
LOC grows by 3%  
$160,468.85  
borrower accrues interest at  
2.5% on first draw, which gets  
paid to HMBS#1  
+$1,250.00  
-$1,250.00  
available amount  
$109,218.85  
borrower takes second draw  
$50,000.00  
remaining balance  
$59,218.85  
this participation becomes securitized  
HMBS #2  
HMBS #1  
$51,250.00  
$50,000.00  
After 2 years:  
remaining balance  
$64,032.92  
LOC grows by 3%  
$165,282.92  
borrower accrues interest at  
2.5% on draws, which gets paid  
to HMBS#1 & HMBS #2  
-$2,531.25  
+$1,281.25  
+$1,250.00  
available amount  
$61,501.67  
HMBS #1  
HMBS #2  
$52,531.25  
$51,250.00  
After 5 years:  
remaining balance  
$76,827.85  
LOC grows by 3% for 5 years  
$180,609.10  
borrower accrues interest at  
2.5% per year on draws, which gets paid  
to HMBS#1 & HMBS #2  
-$7,979.81  
+$3,940.64 remaining balance is drawn and becomes securitized  
+$4,039.16  
HMBS #1  
HMBS #2  
HMBS #3  
$56,570.41  
$55,190.64  
$68,848.05  
Source: RBS, HUD  
We show how securitization of participations works in the above  
example. Suppose a borrower has a home worth $275,000. Based on  
11  
The Royal Bank of Scotland  
principal limit tables, his principal limit is $163,075 given this home  
value, his age and the interest rate provided by the lender. After  
borrowing closing costs and the MIP, there is $155,795 available to the  
borrower which he uses as a LOC. We assume the line of credit grows  
at 3%/year (based on a projected interest rate) and the interest  
accrues at 2.5% / year- these rates are usually variable but for  
simplicity we assume it doesn’t change and a simple annual  
compounding rate.  
We see that if the borrower makes an initial draw of $50,000 at  
inception, this participation accrues (at a rate of 2.5% / year per our  
assumption) to $51,250 after 1 year, $52,531.25 in 2 years and  
$56,570.41 in 5 years. If this participation is securitized, the HMBS  
current face will also grow by this amount.  
Subsequent draws are securitized separately but continue to accrue in  
the same fashion. Despite participations being pooled separately, in  
the event of a prepayment, all draws receive P&I pro rate. We discuss  
this in the next section.  
GNMA vs. Private-Label Execution  
FHA HECM mortgages have been securitized into both non-Agency  
and Ginnie Mae HMBS. In the table below, we show a few key  
differences between a GNMA-wrapped HECM MBS and a private label  
deal holding HECMS as collateral. For example, the GNMA MBS has  
the credit quality of a US Treasury, and is structured as an accrual  
bond, while the private label MBS requires credit enhancement such  
as reserves, but has the flexibility to make current pay bonds. Also, in  
GNMA securitization, a loan can be split into participations to securitize  
multiple HMBS, as HMBS are funded over time whereas in Non-agency  
Reverse mortgage MBS, a loan cannot be split and used as collateral  
in different securities.  
Figure 9: Comparison of HECM Backed Security Structures  
Private Execution  
Ginnie Mae HMBS  
Whole loan securitized, funded and unfunded.  
Reserve required to fund future borrower draws and advances.  
Funded balances only. Securitized as Participations.  
No reserve required. Future borrower draws and advances  
securitized in subsequent HMBS.  
Can be used as collateral in conjunction with Ginnie Mae forward  
collateral in HREMIC.  
Current pay  
Accrual bond.  
Tranched structure.  
AAA  
Payments distributed pari passu.  
Guaranteed by the full faith and credit of the United States  
Government.  
Source: HUD.  
HMBS Pooling  
HMBS pools may only be issued under the GNMA II program. Each  
HMBS pool must be originated and administered by a single HMBS  
issuer. Fixed rate HECM loans cannot be pooled with adjustable rate  
HECM loans. Based on the interest rate option on the underlying  
participations, the pools will have the following suffixes:  
„ RF: fixed rate  
12  
The Royal Bank of Scotland  
„ RM: adjustable rate, monthly reset CMT  
„ RA: adjustable rate, annual reset CMT  
„ ML: adjustable rate, monthly reset LIBOR  
„ AL: adjustable rate, annual reset LIBOR  
Furthermore, for adjustable rate HMBS, the loans must have the same  
reset date and frequency. The minimum pool size is $1,000,000 and  
must be backed by at least 3 participations each relating to a distinct  
HECM loan.  
HMBS Prepayments  
Because HECM loans do not have scheduled maturity dates, but since  
a maturity date is required for securities by the Federal Reserve, HECM  
Pools are given maturities of 50 years. In reality, HECMs pay-off much  
sooner than that on average, due to refinancing, assignment to HUD,  
mobility, or borrower death. The majority of HECM loans terminate or  
are assigned to HUD within ~7 years.  
HECM mortgages, similar to a traditional mortgage, demonstrate a  
pronounced seasoning curve. In the figure below (left), we show  
historical HECM seasoning curve by origination year for several  
origination year cohorts. In the chart below right, we show a time  
series for seasoned HECMs (greater than 24 WALA). We see that  
HECM prepayments have come down considerably from their peak in  
2006.  
Figure 10: HECM Aging curve: 2001-06 Origination Figure 11: Reverse Mortgage Prepayment Index  
(WALA>24mo)  
20.00%  
18.00%  
24  
16.00%  
14.00%  
20  
16  
12  
8
12.00%  
10.00%  
8.00%  
6.00%  
4.00%  
2.00%  
0.00%  
4
0
3
9
15  
21  
27  
33  
39  
45  
51  
57  
63  
69  
Loan Age (months)  
2004  
1 Month CPR  
12 Month CPR  
2001  
2002  
2003  
2005  
2006  
Source: FHA, RBS  
Source: New View Advisors, RBS  
Borrower age has a direct correlation with prepayments, as historical  
evidence shows older borrowers repay much faster than their younger  
counterparts within similar seasoning range. In the figure below, we  
show the average 12-month CPR by borrower age for HECMs  
originated Jan 2001 – Jan 2010. The 12-month CPR for borrowers for  
borrowers in their 60s averages ~5%, roughly 7 CPR lower than  
borrowers in their 90s.  
13  
The Royal Bank of Scotland  
Figure 12: HECM Prepayments by Borrower Age (Jan 1991- Jan 2010)  
16.0%  
14.0%  
12.0%  
10.0%  
8.0%  
6.0%  
4.0%  
2.0%  
0.0%  
Borrower Age  
Source: New View Advisors, HUD.  
As discussed earlier in our primer, the average age for more recent  
HECMs is declining, largely due to an increasing number of younger  
borrowers, which helps explain the recent slower prepayments. If the  
distribution of borrower age in a HECM pool continues to drift towards  
the younger population, we would expect HECM prepayments to  
remain muted, holding other variables constant.  
FYE 2011 HECM Program Changes and Effect on Prepayments  
Recent Change:  
As described above, HUD made a number of changes to its HECM  
program effective FY 2011 (October 4, 2010), two of which should have  
significant (but opposite) impact on prepayments.  
First, the new HECM Saver will make it easier for an existing HECM  
borrower to refinance (into a HECM Saver). Since the HECM Saver has  
virtually no up-front fees vs. the Standard Program (1 bp vs 200 bps),  
then any borrower who chooses to refinance in order to take advantage  
of a lower rate or different HECM loan amount or type (fixed to floating,  
LOC to tenure, etc.) can do so readily. However, the HECM Saver has  
a much lower PLF compared to the HECM Standard (ranging from  
25%-30% less).Recall that borrower age and home value are the  
primary eligibility requirements for a HECM loan. There are no borrower  
credit, income or asset tests.  
Second, the new PLF tables mean that any new HECM loan will be  
sized smaller than before the change. This will have the effect reducing  
refinancings for pre-Oct 2010 HECM borrowers, especially those who  
are near or at their PLF.  
Recent Change:  
Additionally, HUD announced in February, 2011, that it plans to  
eventually require borrowers to be creditworthy before being able to  
obtain a HECM which can also curb refinancing and hamper new  
issuance.  
14  
The Royal Bank of Scotland  
The HPC Prepayment Convention  
The "HPC" (Home Equity Conversion Mortgage Prepayment, or MHP on  
Bloomberg) curve is a step-function prepayment scale with a 360-  
month seasoning ramp. The convention is meant to reflect seasoning  
behavior of a HECM borrower.  
HPC Prepayment Curve  
100% HPC  
A prepayment rate of 100% HPC equates to a starting rate of 0.0%  
CPR gradually increasing to the CPR rates associated with the  
referenced months in the table (left). For example, in months 24-48,  
100% HPC means 9.50% CPR in month 24, 9.67% in month 25,  
reaching 13.5 CPR in month 48.100% HPC terminates at 43.0% on the  
360th month. A constant 43.0% CPR is assumed for the remaining life  
of the mortgage.  
Increase/ month  
Month  
1
CPR  
-
0.50  
0.29  
0.17  
12  
6.0  
9.5  
24  
48  
13.5  
37.0  
43.0  
0.12  
0.05  
.
240  
360  
Source: Bloomberg  
Figure 13: 100% HPC – HMBS Prepayment Curve  
100% HPC  
50  
45  
40  
35  
30  
25  
20  
15  
10  
5
0
0
50  
100  
150  
200  
250  
300  
350  
400  
Months  
Source: Bloomberg.  
HECMs are generally priced to a spread on the HPC curve. Based on  
historical evidence, we believe HMBS seasoning ramp is very close to  
the actual HPC curve.  
Predicted Cash Flows  
HECMs have no predefined cash flows so assumptions must be made  
on draw amount, draw frequency, and prepayments. Since the  
underlying HECM collateral has no scheduled payments, the HMBS  
accrues interest HMBS. Instead, the cashflows of the HMBS are fully  
dependent on prepayments. Rate-related refinances are a less  
common source of prepayments, unlike a traditional mortgage. Other  
causes of prepayments, such as borrower mobility, borrower death or  
assignment to FHA, are more common. As a result, a HECM pool’s  
cashflows are somewhat erratic, as seen in the chart below (next  
page).  
Below we plot the cashflows from a sample deal, TEMP RBS-H10  
HMBS under different speed assumptions: 0 HPC, 50 HPC, 100 HPC  
and 200 HPC. Given that there are no “scheduled” payments to the  
underlying, we see no cashflows in the first three years under the 0  
HPC (no prepays) assumption. Across all scenarios (including 0 HPC),  
the jagged cashflow graphs represent the prepayments that come in  
15  
The Royal Bank of Scotland  
as a result of assignment (loan reaching 98% of MCA). Also, we see  
that as prepays increase, so do cashflows for the first 3-4 years.  
Figure 14: Sample Cash Flows for HREMIC: TEMP RBS-H10 HMBS  
4.0  
3.5  
3.0  
2.5  
2.0  
1.5  
1.0  
0.5  
0.0  
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023  
0 HPC  
50 HPC  
100 HPC  
200 HPC  
Source: Bloomberg.  
When a HECM loan is prepaid (either partially or in full), available funds  
come into the deal and are then distributed to each securitized  
participation pari passu:  
Figure 15: Example: In the Event of Prepayment, Participations Receive Cash Flow Pro-Rata  
Home Value  
Principal Limit (based on Age)  
less FHA MIP  
$275,000.00  
$163,075.00  
$5,500.00  
Closing Costs  
$1,780.00  
$155,795.00  
Initial Amount for LOC  
$155,795.00  
LOC grows at 3.0%, Interest Accrues at 2.5%  
Draws  
Total Draws + Interest  
$50,000.00  
Remaining Balance for LOC  
$105,795.00  
HMBS #1  
$50,000.00  
Initial Draw:  
After 1 year:  
After 2 years:  
HMBS #1  
$51,250.00  
HMBS #2  
$50,000.00  
$101,250.00  
$59,218.85  
HMBS #1  
HMBS #2  
$52,531.25  
$51,250.00  
$103,781.25  
$61,501.67  
HMBS #1  
$56,570.41  
31.32%  
HMBS #2  
$55,190.64  
30.56%  
HMBS #3  
$68,848.04  
38.12%  
At 5 years:  
$180,609.10  
$0.00  
Borrower Makes Partial Prepay:  
$50,000.00  
$15,661.01  
Participations receive payments pro rata:  
$15,279.03  
$19,059.96  
HMBS #1  
$56,570.41  
-$15,661.01  
$40,909.40  
HMBS #2  
$55,190.64  
-$15,279.03  
$39,911.61  
HMBS #3  
$68,848.04  
-$19,059.96  
$49,788.08  
HMBSs experience prepays pro rata  
Source: RBS  
16  
The Royal Bank of Scotland  
The chart above refers to our example from earlier. Let’s assume a  
borrower draws his line of credit three times: at closing, after 1 year,  
and after 5 years. The draws ($50k, $50k and $68.848k respectively)  
are separately securitized into three separate HMBS pools. However, if  
a borrower curtails, say for $50k, that amount gets divided to pay a  
part of each participation simultaneously, despite HMBS 1 being  
originated 5 years before HMBS 3. As a result, each HMBS pool  
experiences a prepayment and receives cash proportionate to its  
outstanding size.  
Relative Value  
HMBS and HREMIC Securities are attractive to investors for a number  
of reasons. First, they are GNMA MBS so they benefit from the full-faith  
and credit of the US government and trade at a 0% risk weighting.  
Additionally, as these products tend to be less rate sensitive and more  
age sensitive, HMBS offer good convexity. The cashflows can be  
erratic, but the investor is often compensated with a yield pick to other  
assets, which makes HMBS an attractive investment for yield and total  
return oriented investors, but less appealing to current income seeking  
investors.  
In the example below, we compare a new-issue HREMIC (a simple  
pass-through structure) TEMP RBS-H10 HMBS to a GNI 5% TBA pass-  
through and GNR 2010-91 GA, a 4X4 3.4 year sequential CMO. The  
HREMIC has a coupon of 4.815% is backed by fixed-rate HECM  
participations (GWAC 5.065%, 1 WALA, 599 WALA). All three  
securities are priced around $105 with 4.5% to 5% coupon range.  
Figure 16: Yield and Average Life Profiles of GNMA Securities  
GNSF 5.0, 30- year passthrough, Price: 105-24+, Settle: 3/21/11  
Cpn: 5.0%, GWAC: 5.50%, WAM: 344, WALA: 16  
Shift  
PSA  
300  
114  
200  
132  
100  
192  
0
347  
-100  
665  
-200  
956  
-300  
1015  
Yield  
WAL  
4.212  
9.65  
4.156  
8.88  
3.962  
6.92  
3.419  
4.20  
2.166  
2.19  
0.854  
1.45  
0.563  
1.35  
Spread/N  
67/AL  
73/AL  
94/AL  
136/AL  
114/AL  
0/AL  
-27/AL  
GNR 2010-91 GA, 4.5x4.5 SEQ, Price: 104-26, Settle: 2/28/11  
Cpn: 4.5%, GWAC: 4.924%, WAM: 346, WALA: 13  
Shift  
PSA  
300  
109  
200  
121  
100  
148  
0
223  
-100  
540  
-200  
1135  
-300  
1368  
Yield  
WAL  
3.570  
6.10  
3.511  
5.68  
3.375  
4.91  
2.942  
3.42  
1.417  
1.66  
-1.420  
0.84  
-2.598  
0.70  
Spread/N  
78/AL  
86/AL  
101/AL  
125/AL  
54/AL  
-211/AL  
-320/AL  
TEMP RBS-H10 HMBS, HECM CMO, Price: 105-05, Settle: 3/23/11  
Cpn: 4.81477%, GWAC: 5.065%, WAM: 599 WALA: 1  
MHP  
Yield  
WAL  
0
3.999  
6.38  
20  
3.950  
6.27  
50  
3.872  
6.06  
100  
3.735  
5.35  
125  
3.662  
5.01  
150  
3.587  
4.70  
200  
3.431  
4.15  
Spread/N  
114/AL  
112/AL  
111/AL  
122/AL  
127/AL  
132/AL  
140/AL  
Source: Bloomberg, RBS.  
For the traditional MBS bonds, we use the Bloomberg Consensus  
speeds for the rate shift scenarios. For HMBS bond speeds, we use  
percentage of MHP (or HPC, as discussed above). For example, in the  
base case, we use 100% MHP (corresponding to roughly a 10 CPR  
average-life equivalent CPR).  
17  
The Royal Bank of Scotland  
The HMBS has a higher yield than the pass-through and CMO over a  
variety of scenarios. In the base case, the HMBS yields 3.73% at 100%  
MHP, vs. 3.42% for the pass-through and 2.94% for the CMO. We see  
how stable the HREMIC’s yield and WALs are, given their low  
sensitivity to rates. This property is especially valuable in deep rallies,  
where the PT and CMO give in yield.  
18  
The Royal Bank of Scotland  
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19