On Wednesday the House Financial Services Committee held a second in a scheduled series of hearings to look into the financial condition of the Federal Housing Administration (FHA). The sole witness at the hearing titled "Bailout, Bust, or Much Ado about Nothing?: A Look at the Federal Housing Administration's 2012 Actuarial Report" was Carol Galante, Assist Secretary of the Department of Housing and Urban Development and Acting FHA Commissioner.
Galante briefly recounted the history of the housing collapse, FHA's response to that event, and its role in the current state of housing recovery which, according to Moody's Analytics, prevented house prices from falling an additional 25 percent resulting in 3 million more job losses and a reduction of economic output of $500 billion. It has also continued to service its historic target population, insuring 1.2 million single family mortgages worth $213 billion in 2012, 79 percent of which were for first-time buyers and accounting for 50 percent of home purchase mortgages for African American borrowers and nearly as many for Hispanic and Latino households.
FHA's market share, however is declining as the economy recovers and private capital returns to the market. New endorsements in 2012 continued to decline from the peak levels of 2009. Its market share of refinance and purchase transactions was 14.6 percent in 2012 but the dollar volume was the lowest since the start of the crisis and is now at 2002-2003 levels; more indicative of the reduction in the size of the market than of abnormal levels of FHA activity.
Home Equity Conversion Mortgage (HECM) insurance endorsements in FY 2012 were also down by 25 percent from FY 2011 levels, to 54,591 loans, the third consecutive year HECM volume declined.
Galante said that FHA's contribution has not been without stress. An independent actuarial review conducted by Integrated Financial Engineering (IFE) and released in November 2012 measures the economic net worth of FHA's portfolio at the end of the fiscal year and found it had a capital reserve ratio of a negative 1.44 percent, and the Fund's economic value stands at negative $16.3 billion.
FHA's Mutual Mortgage Insurance (MMI) Fund operates with two primary sets of financial accounts: a Financing Account, which reflects the business transactions related to insurance operations, and a Capital Reserve Account, which reflects secondary reserves to cover unexpected increases in program costs, including higher claim expenses, or lower fee collections. The Capital Reserve Account was established to assist in managing to the two-percent capital ratio requirement enacted by Congress in 1990. Under what is called "permanent indefinite budget authority" FHA has access to the U.S. Treasury for any funds needed to pay claim obligations.
The Fund is subject to two distinct portfolio valuations each year which project all future revenues and expenses based upon a forecast of loan performance under defined economic conditions. One is performed by an independent actuary the other is the annual subsidy re-estimate performed by the Administration and published in the President's Budget.
Loans originated from 2007-2009 continue to be the prime source of stress to the Fund, with fully $70 billion in claims attributable to these books of business alone but the actuary attests to the high quality and profitability of books insured since 2010. Thus, even though books of business insured since 2010 are the strongest in agency history, there is still work to be done in mitigating the impact of older books of business.
The actuary's findings regarding the economic net worth of the fund is of serious concern but it will not determine whether FHA will need to draw on permanent and indefinite budget authority from the Treasury, Galante said. The President's budget will outline the Administration's expectation about such assistance and the ultimate need will be borne out in the actual performance of the FHA single family program and the steps FHA takes to increase revenue or reduce losses.
The President's budget submission last year anticipated a Treasury draw of nearly $700 million but at the end of FY 2012 the Capital Reserve Account held $3.3 billion because of policy changes that substantially improved the value of the Fund. Likewise, the series of additional changes FHA has announced are designed to reduce the likelihood that FHA will need Treasury assistance at the end of FY 2013.
Galante said the actuarial assessments estimate that the economic value of the Fund as of the end of FY 2012 is negative $16.3 billion against an active portfolio of $1.13 trillion. The economic value of the forward portfolio was estimated at negative $13.5 billion, the HECM portfolio at negative $2.8 billion. These economic values represent capital reserve ratios of negative 1.28 percent and negative 3.58 percent respectively. The actuary projects that the MMI Fund capital reserve ratio will be positive by FY 2014 and reach 2.0 percent during FY 2017 assuming no changes in policy or other actions by FHA. Policy changes that were announced when the actuarial report was released are expected to accelerate the time to the Fund's recovery.
The low capital ratio today anticipates that the current pool of insured loans still has significant foreclosure and claim activity yet to occur. Projected losses for 2007-2009 vintage loans alone total $70 billion in claims.
Loans with seller-funded down payment assistance have been particularly costly to the Fund and are projected to cost $15 billion more through their elevated claim rates. In fact the Actuary estimates that had FHA had not insured any seller-funded-downpayment loans, the net economic value of the MMI Fund would be positive $1.77 billion today. Congress eliminated seller- funded down payment loans in 2008.
The loan endorsements in fiscal years 2010 through 2012 are expected to produce significant net revenues that will partially offset losses from older loans. The contrast in quality between these pre- and post-2009 loans is based, at least in part, on the impact of key policy changes which have added over $20 billion to the Fund since 2009.
FHA has taken to significant actions to date to improve the health and trajectory of the MMI Fund, Galante said. The changes to FHA policy since 2009 are projected to have improved the economic value of the Fund by at least $20 billion.
A first step was to improve FHA's monitoring and oversight of lenders including substantial improvements to risk analysis and policy changes to focus on high risk areas. As a result record numbers of lenders have been withdrawn from FHA programs, and there were substantial improvements in lender compliance, and a number of settlements with lenders and servicers for violations of origination or servicing requirements. FHA has also taken recent steps to increase oversight of lender advertising.
FHA has also worked to strengthen its credit policies, implementing Congress's elimination of seller-funded down payment assistance programs and enacting increased down payment requirements for borrowers with credit scores below 580. FHA has also proposed regulations to reduce the amount of allowable seller concessions that increase risks from inflated appraisals, required manual underwriting for borrowers with credit scores below 620 and debt to income (DTI) ratios over 43 percent, made enhancements to FHA's TOTAL Scorecard, and proposed an increase in the required down payment for borrowers seeking loans in excess of $625,500.
Galante said that, while it was a difficult choice, FHA has increased mortgage insurance premiums five times since 2009. The most recent increase in response to the FY 2012 actuarial review will add an average $150 to borrowers' annual costs but the combined increases have yielded more than $10 billion to the Fund.
FHA has also taken steps to control costs and limit losses through improvements to its REO disposition processes and loss mitigation strategies. Better oversight of REO contractors and compliance monitoring along with measures to promote competition and continuity have reduced the gap between appraised values and REO sales prices by 62% and the time in inventory has fallen by 45%.
Last year FHA implemented a significant expansion of its program to sell non-performing loans in pools via auction to investors. The Distressed Asset Stabilization Program (DASP) expands the number of loans sold in each sale and introduces innovations to promote stability in hard hit areas. The initial results from the first DASP sale were positive and the Actuary estimated more than $1 billion in improved economic value from this initiative over the next two years.
FHA is implementing a series of additional actions to continue improving the Fund's trajectory over both the short and long term which are projected to provide billions of economic value for the MMI Fund in FY 2013.
- Throughout the past fiscal year, FHA has ramping up alternatives to foreclosure. These alternatives, primarily short sales, comprised about 15%-20% of total dispositions since 2010, with average loss severities about 20% lower than from REO. DASP and other actions have had a measurable effect, as loss severities have already fallen by 9% in the last year.
- FHA has redesigned its standards for modifications, repayment plans, and other mitigation products, gearing them towards greater payment relief for borrowers. This should result in more sustainable payment outcomes for borrowers over the long term.
- FHA will introduce a streamlined pre-foreclosure sale policy removing certain barriers for obtaining a short sale. This change is expected to increase the number of defaulted loans resulting in short sales rather than foreclosures which provide significant savings to the Fund.
- FHA plans to expand a Claim without Conveyance pilot program for FHA-insured loans that have been foreclosed. Lenders can offer the properties for sale at a reserve price slightly below the outstanding unpaid principal balance of the loan with the aim of selling them to a third party without after conveying the title to FHA and eliminating some FHA carrying costs.
- Beginning in 2013, FHA will launch a large-scale proactive marketing campaign to make more borrowers aware of and able to take advantage of these loan modification opportunities, while reducing foreclosures and decreasing associated losses for FHA. FHA will also pursue more creative strategies to dispose of REO properties in geographies where traditional asset disposition methods yield net negative recoveries for FHA.
Galante said it is also vital to take additional steps to strengthen new books of business to ensure the long term health of the MMI Fund. Accordingly, in the second quarter of FY 2013, FHA will implement the following policies for new originations.
- FHA will no longer cancel mortgage insurance premiums (MIPs) on loans for which the outstanding principal balance reaches less than 78% of the original principal balance while continuing 100 percent coverage. It is estimated that $10 billion in revenues will be lost in the 2010-2012 vintages as a result of the current cancellation policy and that 10%-12% of all claims losses may occur after MIP cancellation.
- FHA will increase annual mortgage insurance premiums by an additional 10 basis points. This premium increase, $13 per month for the average FHA borrower, which FHA plans to implement in 2013 will add significant revenue to the Fund and ensure that FHA does not take on additional market share while not affecting borrower access to credit or threatening the emerging housing recovery.
- FHA intends to develop new policies which incentivize, or in some cases require, borrowers to complete a pre-purchase housing counseling program prior to the purchase of a home using FHA-insured financing.
Galante said that changes in borrower utilization of the HECM program and the FY 2012 actuarial review show substantial stress in the HECM program. Under its current regulatory authority over FHA has limited ability to address root-cause issues and will, therefore, be forced to make blunt changes to the program on an interim basis. FHA will take immediate action to ensure that HECM consumers are better protected and able to sustain their reverse mortgage while also protecting the Fund.
- In administrative guidance dated January 30, 2013, FHA consolidated the Fixed Rate Standard program with the Fixed Rate HECM Saver product, which will result in a reduction of the maximum amount of funds available to a HECM borrower.
- Recently larger numbers of estate executors of HECM borrowers have been choosing to convey these properties to FHA rather than sell them, adding costs and reducing recoveries for FHA. By incentivizing the sale of properties by executors, FHA is able to avoid property management, maintenance, and marketing costs associated with the REO disposition process, thereby reducing losses to the Fund on these properties.
- Over a longer term, either through the granting of the legislative authority described below or via the much longer rule making process, FHA will also pursue other material changes to ensure the long-term viability of the HECM program including: limiting the draw at origination to mandatory obligations (i.e. closing costs, mortgage liens and federal debt); performing a financial assessment of borrowers as a basis for loan approval and determining the suitability of various HECM products to protect consumers from acquiring loans not fit for their situation; and establishing a tax and insurance set-aside to ensure an ability to pay taxes and insurance on the mortgaged property.
Galante said FHA needed Congressional help to increase its ability to hold lenders accountable for non-compliance with FHA policy and provide greater flexibility for the agency to make changes as emerging needs and trends are identified and avoid unnecessary losses before they occur. Congressional approval is needed, she said, for the following:
- Indemnification Authority for Direct Endorsement Lenders: This
provision, which FHA
has been seeking since 2010, would allow FHA to seek indemnification from Direct Endorsement
lenders which represent 70% of
FHA approved lenders rather than only from lenders with Lender
Insurance (LI) approval.
- Revised Indemnification Authority: This change would eliminate the "knew or should have known" standard with regard to fraud or misrepresentation.
While the GSEs require lenders to retain all fraud related risk,
FHA only holds lenders accountable
for fraudulent activity if they "knew or
should have known" of its occurrence. Providing proof limits
ability to hold lenders accountable for fraud, and a change would significantly improve FHA's
ability to avoid losses related to fraud.
- Authority to Terminate
Origination and Underwriting Approval: FHA needs enhanced ability to review lender
in terminating the approval of an
originate or underwrite single family mortgages.
has been seeking this authority since 2010.
- Revised Compare Ratio Requirement: This
would revise the statute governing the
Termination Initiative allowing the Secretary to compare rates
of early defaults and claims
insured single family mortgage
loans among lenders on any basis the Secretary determines
appropriate, such as geographic
standards, or populations served and to implement such comparisons
regulations, notice, or
Mortgagee Letter. This will
to obtain meaningful comparisons of lenders in varying market conditions, providing greater clarity for lenders and a more refined understanding of
- Authority to Transfer Servicing: In order to facilitate more effective loss mitigation, this change would give FHA the authority to require poorly performing servicers to transfer individual loans to another servicer with better performance results.