Portfolio Strategy

February 25, 2022

By the Numbers

Awaiting a LIBOR transition plan for Ginnie Mae HMBS

Brian Landy, CFA | February 25, 2022

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

The fate of many FHA reverse mortgages indexed to LIBOR is still unresolved despite a scheduled end to the index on June 30 next year. Ginnie Mae recently released a guide to the transition away from LIBOR for its securities, but it is unfinished for pools backed by the FHA reverse mortgages, commonly known at home equity conversion mortgages or HECMs. The roadmap is clear for REMICs backed by HECMs, where any floating rate classes indexed to LIBOR will transition to SOFR. Pools will almost certainly adopt SOFR as well.

The FHA stopped insuring LIBOR-indexed HECMs and offered to start insuring SOFR-indexed HECMs last May. However, Ginnie Mae is not yet issuing pools of SOFR-indexed loans, so originators of SOFR-indexed loans have not had a way to finance their positions through securitization. As a result, loans currently use the only index through Ginnie Mae pools, 1-year CMT. To further complicate the picture, Ginnie Mae still issues new LIBOR pools to satisfy the ongoing funding needs for legacy LIBOR loans. The transition plans for these LIBOR pools is also unresolved.

As background, the FHA’s HECM program allows people to borrow against the equity in their home. Borrowers do not make mortgage payments; instead, interest on the borrowed amount accrues to the loan balance. All floating rate HECMs allow borrowers to use the loan as a line of credit, drawing up and paying down the balance at any time. A lender may finance a HECM by securitizing the loan in a Ginnie Mae HMBS pool, which also pay no coupon. However, an existing HMBS pool’s balance does increases due to interest accrual. Any subsequent draws must be securitized in a new pool. Therefore, HECMs typically back many Ginnie Mae pools; these are known as a loan’s participations in Ginnie Mae pools. Participations after the first are called tails. HECMs are available in fixed-rate and floating-rate varieties, and floating rate HECMs have been the most popular loan type since 2013.

HECMs that reference LIBOR

Most floating rate HECMs were indexed to monthly or annual LIBOR, but origination halted in early 2021. Ginnie Mae stopped pooling new LIBOR-indexed loans in March and the FHA stopped insuring new loans in May. The FHA had offered loans that reset monthly and annually (Exhibit 1). The annual reset loans became the dominant product after the FHA stopped permitting fixed-rate loans with a line-of-credit option in 2014. The annual loans include periodic caps that shield the borrower from some interest rate risk, which is more appealing to borrowers that would prefer a fixed-rate loan but also want a line-of-credit. Borrowers face more interest rate risk with monthly loans that do not have periodic caps.

Exhibit 1. Legacy LIBOR-indexed HECM program

Source: FHA, Ginnie Mae, Amherst Pierpont Securities

However, LIBOR pool issuance has not stopped. Ginnie Mae still issues new LIBOR-indexed HMBS pools backed by tails if the first participation was already issued in a Ginnie Mae MBS. This is necessary to support the funding needs for existing LIBOR-indexed loans.

HECMs that reference CMT

Loans indexed to 1-year CMT dominated origination after LIBOR HECMs were discontinued last year. The FHA offers loans that reset monthly and annually (Exhibit 2). But annual-reset CMT loans have never been popular, so origination shifted into the monthly-reset loans. It is possible that servicers wanted to shift production into monthly-reset loans that make it easier to finance borrower draws in a rising rate environment.

Exhibit 2. CMT-indexed HECM program

Source: FHA, Ginnie Mae, Amherst Pierpont Securities

HECMs that reference SOFR

The FHA authorized HECMs indexed to 30-day compounded average SOFR in May (Exhibit 1). These loans will only reset annually, not monthly, even though the index is a 30-day moving average. Lenders will need to increase the margin over the index to compensate for the tenor mismatch. And when interest rates are increasing servicers will need to fund draws by selling bonds at a discount. Ginnie Mae is still working on a SOFR pooling program so it is unlikely many, or any, of these loans have been originated.

Exhibit 3. New SOFR-indexed HECM program

Source: FHA, Ginnie Mae, Amherst Pierpont Securities

The FHA needs an assumption for future interest rates to determine the fraction of the maximum loan amount that a borrower can at origination. This gives the loan room to accrue to the maximum loan size. That rate is called the “expected average mortgage interest rate.” All CMT-indexed and SOFR-indexed loans will use the 10-year CMT rate since there isn’t an equivalent 10-year term SOFR rate.

REMICs backed by HECMs

Ginnie Mae HMBS pools are typically structured into CMOs, called HECM REMICs (HREMICs). Ginnie Mae authorized the issuance of SOFR-indexed bonds and adopted the ARRC’s recommended SOFR fallback provision in March 2020, and ceased issuing LIBOR-indexed securities in January 2022. New securities can be indexed to compounded average SOFR or simple average SOFR. Bonds may also use a CMT index, but this is uncommon. LIBOR bonds will switch to SOFR at LIBOR cessation. Ginnie Mae can choose 30-day SOFR or term SOFR.

HECM floating rate collateral is typically carved into a floater and IO pair.  The floater accrues to a formula linked to one of the allowed CMO indices. However, the underlying pools often accrue using a different index.  For example, GNR 2022-H01 FA is backed by pools that accrue at 1-year CMT. The IO is structured as a WAC IO that receives any excess accrual that does not go to the floater. These are called basis IOs since the interest accrual is tied to the basis between the collateral index and the floater index. If the collateral accrual is lower than the floater accrual then the floater accrual is capped by the collateral and the IO receives nothing. Bondholders only receive cash when a loan is curtailed or pays off, because otherwise the borrower isn’t paying any cash.

Historically most HECM floaters were indexed to 1-month LIBOR and 1-year LIBOR, while most production in 2021 was indexed to 30-day compounded average SOFR. A handful of bonds were indexed to 1-year CMT, which is still allowed. Therefore, a variety of basis combinations are possible, with three different CMO indices and two different HECM indices commonly used. Once 30-day SOFR-indexed pools are available then the floater and collateral coupons would follow the same index, so the IOs would not have any basis exposure. Similarly, the basis exposure will go away for LIBOR deals backed by LIBOR loans, if both deal and loan convert to 30-day SOFR. The only wrinkle would be if Ginnie Mae switches to term SOFR. This would create a small amount of basis exposure between forward-looking term SOFR and the backward-looking SOFR average, unless the FHA also converts the loan index to term SOFR.

Brian Landy, CFA
1 (646) 776-7795
blandy@apsec.com

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