As a wave of mergers and acquisitions (M&A) continues to impact the broader mortgage space, today’s deal activity in the reverse mortgage sector is less about splashy headlines and more about structural pressure building across the industry, according to Michael K. McCully, a partner at New View Advisors.
As McCully puts it, “there are two things that typically drive M&A.” One is accretion and the other is “lack of risk tolerance or too much exposure to the industry.” In his view, reverse mortgages check both boxes — efficiency is rewarded and balance-sheet exposure is increasingly scrutinized.
One key driver is capacity. “The HECM product has stagnated over the last handful of years and there continues to be excess capacity in the industry,” he says. The result, McCully argues, is predictable consolidation because “it’s more efficient to have fewer, larger originators and specialty issuers of the securities in the marketplace.”
That pressure is already showing up in issuer concentration and business exits. “That’s why you’ve seen the number of major HMBS issuers decline over time,” McCully notes, adding that “it looks like it’s just going to be three large participants now – Finance of America, Mutual of Omaha and Longbridge.”
In an interview with HousingWire’s Reverse Mortgage Daily, McCully — a career investment banker with more than 25 years of transaction, investment and operational experience — explains what this consolidation could mean for smaller players and the secondary market.
Editor’s note: This interview has been edited for length and clarity.
Flávia Nunes: We see a lot of M&A transactions happening in the broader mortgage space, but how is it impacting the reverse space?
Michael McCully: There are two things that typically drive M&A. There’s accretion; in other words, if two companies can make more money and be more efficient as one. That’s a motivating force for an acquisition. The other is lack of risk tolerance or too much exposure to the industry. Both are true in our space.
The HECM product has stagnated over the last handful of years, and there continues to be excess capacity in the industry. It’s more efficient to have fewer, larger originators and specialty issuers of the securities in the marketplace. That’s why you’ve seen the number of major HMBS issuers decline over time.
That’s a driving force behind why Onity sold much of its business to Finance of America (FOA). In our most recent blog post, we pointed out that they’re no longer issuing new-issue HMBS. It looks like it’s just going to be three large participants now: FOA, Mutual of Omaha and Longbridge.
Nunes: What happens to the smaller players in this context?
McCully: They’ll either continue to sell to those larger consolidators or they’ll go out of business. If they’re not looking to expand their product mix — certainly proprietary products and maybe second liens, such as closed-end seconds or home equity lines of credit (HELOCs) — it’s going to be hard to stay in business. I do think there’s going to be continued consolidation.
Part two is that HMBS 2.0 never got put into place. And some of the parties with the most seasoned portfolios — and the greatest exposure to loss — are making decisions to shrink their balance sheets, if not exit the business entirely, because it didn’t come to fruition. That’s another reason there’s going to be consolidation.
Because the whole industry is so small compared to the forward side, these aren’t splashy transactions. They’re not necessarily even publicly available, but there are sellers of mortgage assets and there are transactions occurring that are shrinking balance sheets. There’s enough activity that if the Department of Housing and Urban Development (HUD) doesn’t make any changes to the program and the industry stays at about 2,000 units a month, it’s just not enough to sustain so many players.
Nunes: Why are so many businesses no longer economically viable?
McCully: There’s a fair amount of infrastructure necessary to run the HMBS business. You’re the servicer of record. You have servicing oversight. You have risk management. There are many scenarios. One of the things that New View does for the market is value those future cash flows, and there are scenarios where you can lose money.
Even though there’s a HUD insurance wrap, it’s not guaranteed for every possible scenario, and there are plenty of situations where issuers lose money. So if you’re not growing your business and you have to maintain that infrastructure for what is essentially a shrinking industry, it becomes economically unviable.
Nunes: How attractive are reverse mortgages to forward lenders in this context?
McCully: I don’t think the forward industry is very attracted to becoming a HECM lender. They’re looking to the nonagency portion of the market and to proprietary products. As that continues to grow — with the high interest rate environment we’re in currently and with volume not likely to improve dramatically on the forward side — they should be looking at adding nonagency reverse mortgages to their product mix.
The industry has tried for years to make it attractive for the forward side of the mortgage market to enter our space, and it’s had modest success, but not nearly as robust as I think we all would have liked.
Nunes: What role does servicing play in the M&A wave?
McCully: Servicing is a scale business, and with our industry not growing materially, I don’t see the advantage of adding servicing — unless the existing lending community is unhappy with the quality of service. In that case, there may be motivation to bring servicing in-house. But from a volume and profitability perspective, subservicers will continue to cover the space adequately.
Nunes: Looking to the secondary market, what should we expect after the HMBS 2.0 proposal did not take off?
McCully: The request for information (RFI) that Ginnie Mae put out last fall — due in December and extended to early January — we thought might stimulate action, but instead we’ve seen inaction. I don’t think the industry is very optimistic that it’s going to come out anytime soon.
Part of that, frankly, has to do with the change of administration. It was a Biden-era product and it didn’t get launched before the new administration. I don’t know if they want to launch a product that came from a previous administration. I’m not optimistic about its launch.
Nunes: What is the current state of the secondary market?
McCully: The secondary market is functioning extremely well. There are two parts to it: new issues and more seasoned paper. For new issues, the secondary market needs supply. We could be originating five times, 10 times as much paper, and there would still be plenty of appetite from the investor community.
Securitization and the secondary capital markets are functioning extremely well. The problem is that the HECM product has become so safe — it’s a belt-and-suspenders product now — and that’s causing origination to stall.
The buyouts have been securitized successfully. The industry has continued to issue securities. They haven’t been as efficient as the HMBS 2.0 program could have been, but the market is working adequately. Spreads have continued to tighten over the last couple of years, and the market has functioned well. We’ve had no hiccups to date. There’s been no dramatic change in interest rates or home price appreciation. There have been no securitizations that have “blown up.” The market is getting more comfortable with the asset class.
Nunes: What changes are needed for the industry, in your opinion?
McCully: If they did one thing, one thing only, it would be to drop the initial mortgage insurance premium or make it very small. They could even increase the ongoing mortgage insurance premium if they needed to, but they don’t need to. The business and the product have made so many improvements to HECM since 2015, when they introduced financial assessment. Ten, 11 years later, they don’t need all that excess insurance, and it’s stalling program volume.
If they were to drop that upfront premium, that’s a huge barrier to entry for borrowers who are concerned about writing a $26,000 check at time zero for insurance. It’s a showstopper.
Nunes: How do proprietary products change this conversation?
McCully: Nonagency is growing. Lenders are lowering the minimum balance necessary to qualify, and proprietary products are going to continue to eat into the HECM business, all else equal. And as long as the securitization market doesn’t have any hiccups or bumps in the road — and spreads continue to tighten and investors gain confidence in the product — the space should drive more proprietary production volume, bring interest rates down and improve structures.
No one can predict the future, but if all goes well, that will continue to outstrip HECM going forward. Lenders that offer proprietary products alongside HECM may not have been able to survive if they only had HECM. It’s been a lifeline for the larger players to have both proprietary and HECM business.
Nunes: How are reverse mortgages competing with other home equity products on the market, such as home equity investments (HEIs), HELOCs and closed-end second liens?
McCully: There’s no question they’re taking away some market share and volume from reverse mortgages. They’re all tapping into senior home equity.
HEIs have some growing pains ahead. There are structural challenges with the product and it’s complex. It’s difficult to explain to borrowers. You may have seen that the CFPB put out a notice that it’s going to consider requiring HEIs to be recategorized as debt rather than equity. That will be a battle, but it says something about the state of that industry. That said, securitizations are getting done, though the subordination levels are not great.
We saw that happen on the reverse mortgage side. There were appreciation-share products in the early and mid-1990s, and borrowers didn’t understand what they were getting into. Two class-action lawsuits were brought against lenders in the reverse mortgage industry, and the reverse mortgage lenders did prevail. They had adequate disclosure and the cases were settled favorably for the industry, but nonetheless it left a negative taint that lingers to this day on the product. I think the HEI space has to be concerned about that.
Seconds and HELOCs are legitimate alternatives. There’s a whole group of homeowners who don’t want to give up their low-interest rate loans. That part of the industry will continue to grow, especially as innovation is added to those products, and these are legitimate alternatives for borrowers. We’ll continue to see those areas grow.
