Moody’s Investors Service has detailed its new methodology for analysing credit risks in reverse mortgage securitisations, replacing the previous approach that’s been in place since 27 May 2015.
Reverse mortgages, also known as “equity release” products, allow seniors to access finance using the equity in their homes while living in the property.
The Australian Securities and Investments Commission (ASIC), after reviewing the $2.5 billion reverse mortgage market, found that reverse mortgages tend to have higher establishment and service fees, as well as higher interest rates (around 2 per cent more than standard home loans). As the loan is payable when the borrower sells the property or dies, the interest compounds over time, making the outstanding bill on a reverse mortgage larger than expected, the regulator stated in its report.
In line with ASIC’s findings, Moody’s noted that a “major risk” in a transaction backed by reverse mortgages is that the value of the house may be insufficient to pay off the original loans plus accrued interest.
As such, the ratings agency said it takes into account future movement in prices of the homes in the pool.
Moody’s expects that the homes of reverse mortgage borrowers will depreciate more on average than those of population due to the following factors:
- “Elderly reverse mortgage borrowers are relatively unlikely to repair or refurbish their homes, although the heirs would benefit from any equity left in the property after paying off the loan with accrued interest.”
- “In contrast with a traditional mortgage, the balance on a reverse mortgage rises over time, which increases the likelihood that the home owner’s equity stake will be wiped out, reducing the incentive to maintain the home.”
- “A decline in the value of the home will not leave the borrower’s estate with an unpaid mortgage debt, also reducing the incentive for the borrower to maintain the home.”
Another major risk, according to the ratings agency, is that the maturity of loans is “uncertain”.
Moody’s, therefore, considers expected mortality rates of borrowers, taking into account gender, age, improvements in living standards, as well as advancements in, and accessibility of, healthcare technology.
The ratings agency also considers the likelihood of borrowers moving out of their home prior to death.
“The most important factors determining the likelihood of a health-related morbidity event is the age of the borrower(s) and whether there is a single borrower or joint borrowers,” Moody’s report states.
“For example, older borrowers are more likely to need the services of long-term care facilities or nursing homes, and there is a higher likelihood that a single person will need those services than both people in a joint-borrower mortgage. In contrast, older borrowers are less likely to move for non-health related reasons.”
As cash flow is “highly uncertain” due to there being no regularly scheduled payments, Moody’s said it also analyses the extent to which the assets or reverse funds provide the transaction sufficient cash to make the required payments on the bonds, as well as any additional risk that might arise if the bonds have a variable interest rate.
“In transactions with variable rates, we review the results of the cash flow model assuming various levels of long-term interest rates. We generally assume an interest rate level based on the applicable home price growth rate for each rating stress,” the report states.
“For additional scenario testing, we typically will also test the structure with alternate interest rate levels, while typically maintaining the difference between long-term interest rates and home price growth rates.”
Moody’s additionally noted that reverse mortgages pose “unique servicing challenges”.
“Unlike in traditional mortgage transactions, reverse transactions do not require the servicer to process payments or make collection calls. Its responsibilities instead include determining each property’s occupancy status (to determine if a maturity event has occurred), updating the property values using desktop or indexed valuation, and ensuring that payment of insurance is current,” it explained.
The ratings agency therefore suggested that the servicer should also monitor the borrower’s maintenance of the mortgaged property.