The thin capitalisation of Reverse Equity Mortgages
Quote:
Originally Posted by
Snoopy
What does surprise me is the very low shareholders equity needed to support the assets on the books:
FY2013: $0.059m/$6.628m = 0.89%
FY2014: $0.234m/$5.430m= 4.3%
Anyone offer an explanation as to how they can get away with such thin capitalisation?
OK, I will attempt to answer my own question.
The reverse equity loan (REL) business is very different from other kinds of lending businesses. When people take out a reverse equity loan, they do so retaining ownership of their property. But this isn't how the bank lending them the money sees it. The bank takes the money that they leant on the REL, then turns that 'financial receivable' into an asset on the bank's balance sheet. Our 'owners' loan agreement with the bank means that the bank has effectively taken over the ownership of a substantial part of the property, despite the 'owner' still being listed as 'the person who took out the loan' on the property title.
Even better than this (from the bank's perspective) is that the value of their asset (finance receivable) keeps going up as the interest bill keeps rising. Short of being unable to recover the value of the property when it is finally sold, the bank simply cannot lose on this deal. The bank's asset (finance receivable) can only increase in value over time. So you can run an REL business on hardly any capital because that capital will never be called upon to bail out the loan.
Capital 'never be called upon to bail out the loan'? That sounds too good to be true, and it is. But by limiting the amount of capital loaned on a property to say 50% of its market value (I made that figure up) and using the expected life of the people who took out the loan as a calculation input figure the bank can virtually eliminate the possibility of the loan going bad. Any property slump can be ridden out by just making the residual balance required to be retained by the property owner high enough. You would have to be a very incompetant banker to lose on such a deal.
SNOOPY