Jeff Traister Comments: Pine River Embracing Reverse Debt To Dodge Bernanke: Mortgages

December 7 2012, Bloomberg News

Ben S. Bernanke is motivating bond investors to bet on the longevity of senior citizens.

Bonds tied to reverse mortgages are drawing cash from investors including Pine River Capital Management LP’s real estate investment trust Two Harbors Investment Corp. (TWO) and Metacapital Management LP, one of this year’s top performing hedge funds. The government-backed loans, which let homeowners 62 and older borrow against their houses, are increasingly attractive as the Federal Reserve pushes down mortgage rates to record lows.

Investors are targeting the $38 billion market for bonds tied to reverse mortgages as Fed Chairman Bernanke’s stimulus efforts help more homeowners refinance, which reduces the value of government-backed securities containing traditional home loans. Reverse mortgages — pitched to seniors in TV ads by actor Robert Wagner and former Senator Fred Thompson — are usually repaid only when a borrower dies or sells the property.

“The cash flow is very reliable,” said Bill Roth, chief investment officer of Two Harbors, which has $1.9 billion of its about $18 billion in assets in so-called home equity conversion mortgages, or HECM, securities. That’s up from $658 million in mid-2011. “These types of bonds are not affected by the effort to keep the 30-year mortgage rate low.”

The loans are insured by the Federal Housing Administration and packaged into bonds with a further guarantee from U.S.-owned Ginnie Mae. Shaun Donovan, secretary of the Department of Housing said at a Congressional hearing yesterday the FHA may make “blunt changes” to its reverse mortgage program on an interim basis including new limits on the terms of the loans to protect its finances, as the agency faces a projected $16.3 billion shortfall in its insurance fund.

While borrowers don’t make monthly payments, they are considered in default if they aren’t current on their property taxes and insurance. As long as the borrower stays in the home and the equity isn’t exhausted, the securities accumulate interest on the loan.

“For retired homeowners that have paid down their mortgage, a reverse mortgage can be a way to obtain a low cost line of credit with no fear of eviction,” said Merrill Ross, an analyst with Baltimore-based Wunderlich Securities Inc. “It allows the homeowners to age in place while paying medical or other bills.”

Fewer homeowners took out the debt this year as the largest lenders exited the market. There were about 49,080 new loans this year through November, according to data provider Reverse Mortgage Insight Inc., down from 64,058 in the same period last year and a peak of 115,176 in 2008.

Wells Fargo & Co. (WFC) and Bank of America Corp. stopped giving the loans in the aftermath of the housing crisis and criticism from advocate groups including the National Consumer Law Center, which alleged that some unscrupulous lenders use the wwwuct to take advantage of elderly homeowners.

San Francisco-based Wells Fargo was accused in a class action lawsuit filed last year of foreclosing on homes with reverse mortgages after the owners died without giving heirs a chance to purchase the property at 95 percent of appraised value, as FHA rules require.

“It was a profitable line of business for us, but it simply was a narrow market, a very complicated wwwuct,” Michael Heid, president of the bank’s home-loan unit said in a May conference call to investors.

Only 2 or 3 percent of the 24 million households in the U.S. that are eligible have taken out a reverse mortgage against their properties, according to Walter Investment Management Corp. (WAC), which last month bought originator and servicer Reverse Mortgage Solutions.

“While the reverse mortgage market is significant today, we anticipate it will grow tremendously in the coming years as it rebuilds from the economic downdraft, loss of key participants, and most importantly as a result of both demographic and economic factors,” Walter Investment chairman and chief executive officer Mark O’Brien said on a September call with investors.

The U.S. census bureau estimates that by the year 2030 the number of eligible households will grow to more than 40 million, said O’Brien. “The industry is obviously poised for explosive growth,” he said.

Specialty firms such as Atlanta-based Generation Mortgage Co., Urban Financial Group, and One Reverse Mortgage, a division of Quicken Loans Inc., are filling in the lending gaps and raising the visibility of reverse mortgages. Ocwen Financial Corp. (OCN) agreed in October to buy Genworth Financial Home Equity Access Inc., the company that started a new campaign with actor Wagner, who starred in “It Takes a Thief” and played Number Two in the “Austin Powers” trilogy.

About $7.3 billion in reverse mortgage bonds have been issued this year through November after almost $10 billion in 2011, according to Bloomberg data compiled by Knight Capital Group Inc. (KCG) Ginnie Mae said it had $38 billion of the securities outstanding at the end of October.

Underwriters introduced securities tied to floating lending rates that helped to increase issuance, according to Darren Stumberger, head of agency MBS trading at Knight Capital in New York.

Spreads on fixed-rate reverse mortgage bonds have narrowed to about 50 basis points, or 0.5 percentage point, over swaps from 140 basis points at the start of the year, according to Knight. That compares to negative 13 basis points for 3.5 percent Ginnie Mae bonds, according to Bloomberg models.

“They have explicit government guarantees, little prepayment risk, limited policy risk and wider spreads” than other Ginnie Mae securities, said Deepak Narula, the head of New York-based Metacapital, which oversees $1.6 billion.

Purchasers of HECM bonds receive unscheduled payments of principal and interest when a loan in the pool is repaid. If a borrower defaults, the individual loan is removed from the pool and the FHA pays off the bonds. The FHA also takes out loans if the principal balance reaches 98 percent of the maximum claim amount. That means that even if “the fountain of youth” is discovered, said Roth, mortgage investors won’t suffer significant extension risk.

In addition to the Fed’s bond buying program, President Barack Obama’s re-election has fueled investors’ concerns that the government will seek to accelerate refinancing, increasing interest in housing debt that’s less likely to be repaid early.

“They call these borrowers ‘one and done,’” said Jeff Traister, a reverse mortgage trader for New York-based Cantor Fitzgerald LP. “It’s a very, very small amount that prepay.”

Mortgage bond investors monitor prepayment rates since they influence returns. Bondholders risk losses when buying debt for more than 100 cents on the dollar as the value can be erased when homeowners take out new mortgages too quickly to repay existing debt. With debt trading below face value, returns increase when repayments accelerate.

Two Harbors, the publicly traded Minnetonka, Minnesota- based REIT, has also bought single family rental homes and acquired prepayment-protected Fannie Mae and Freddie Mac securities that will help it avoid having to reinvest in debt at lower rates.

Even as investors such as Two Harbors see value in reverse mortgages, the collection of mortgage bonds is smaller and less liquid than the broader $5.2 trillion government-backed market. That means it can be more costly to buy and sell the securities.

“The market is young so there are lower volumes and spreads are generally a bit wider than comparable asset classes,” Stumberger said. “Once originations increase, the market will become more meaningful with more supply creating new demand and improving liquidity.”