FHA Is Not Done with Reform Yet

Post date: Nov 16, 2010 6:21:10 PM

WASHINGTON—Under David Stevens’ lead, the FHA has implemented a whirlwind of reforms, including higher net worth requirements for government-approved lenders, steeper downpayments for borrowers with low FICO scores, and a new mortgage insurance premium structure that was approved by Congress. And he’s not done yet. His focus on reducing credit risk, while ensuring access to FHA financing, has been unrelenting. The commissioner has been tough on enforcement, too. He never forgets to mention that some 1,500 lenders have been kicked out of the FHA single-family program under his watch.

Well received on Capitol Hill and appreciated by the industry for his knowledge of the mortgage business, it might be said that Stevens has surpassed expectations.

But there is one test that he could fail despite all his efforts: the FHA annual report card prepared by the agency’s independent auditors, Integrated Financial Engineering of Rockville, Md.

IFE is busy estimating and creating models to determine how steep the insurance fund’s losses could be under different economic models. And it’s no secret that when judging $961 billion in loans, even a little change in assumptions can make a big difference in regard to reserves.

FHA’s auditors assess not only loan quality, but how each year’s book of business will perform over 30 years. And over the past three years, one major driver of performance has been house prices.

Last year, around this time, the new housing commissioner opened the agency’s fiscal year 2009 actuarial report to find that the FHA’s capital cushion had dropped to 0.53%, down from 3% in FY 2008 and below the 2% statutory minimum. (Congress created the 2% capital minimum after the FHA barely survived the S&L and banking disasters of the late 1980s and early 1990s.)

The FY 2009 report was sobering to Stevens, to say the least. “There are real risks to FHA and we are aggressively addressing those real risks with real reforms,” Stevens said last November.

This November, he hopes to be whistling another tune. But he isn’t holding out much hope either.  “I am not optimistic or pessimistic. I think we are too close to zero to be comfortable,” Stevens said in an interview with ON.

As long as the capital ratio remains above zero, he can assure Congress that the FHA will not need a “bailout”—at least for one more year. A good report will allow the FHA commissioner to ease up on further tightening. “We want to be sure we don’t overcorrect if we don’t have to,” he told ON. The FHA is currently considering cutting seller-concessions in half to 3%.

Allowing sellers to pay 6% of the closing costs leads to inflated appraisals and higher claims, Stevens recently told a congressional panel. The agency will review the final recommendations on seller concessions over the next few weeks and issue a final rule before yearend.

But his life could become miserable if the GOP wins control of the House, and the actuarial report projects the FHA to be in the red. Key Republican lawmakers already want to increase the FHA 3.5% downpayment to 5% and other restrictions may be proposed if the capital ratio slips below zero and Congress has to appropriate funds to recapitalize the insurance fund.

“Good news to me would be anything north of zero,” Stevens said in the interview. A bad actuarial report will also be troublesome for Stevens because he is convinced FHA will grow out of its problems.

“There is no question that the future book years that come under the new policies will strengthen FHA,” Stevens said.

The commissioner also is pleased with the quality of the FHA’s FY 2009 and FY 2010 books which now comprises 50% of FHA insured portfolio.

Early default data show the performance of FHA loans originated in the past 24 months is improving with each new quarter. The latest data show FHA loans (90 days or more past due or in foreclosure) peaked at 5.1% in the final quarter of 2009. Since then, the early default rate has dropped to 3.7% as of June 30.

Meanwhile the percentage of all FHA loans 90 days or more past due has declined to 8.2% from 9.7% back in January 2009. But it seems to be stuck above 8%.

Stevens points out that the FHA loans originated from FY 2006 through FY 2008 continue to go into delinquency. And the serious delinquency rate on those vintages is over 20%. “We inherited a portfolio with a ton of stress,” the commissioner said, and “it will take years to work its way through.”

However, the FHA portfolio is performing “much better” than the FY 2009 actuarial report forecast. He noted that foreclosures are lower, delinquencies are better and capital reserves are higher. But that won’t help if the auditors forecast that home prices will decline over the next few years. “The biggest overlay to what the actuarial report is going to look like is home prices,” Stevens said. “It is the single biggest driver.”

Last year the auditors based their projections on home prices declining by 6.5% in FY 2010, which ended Sept. 30. As it turned out, prices were fairly stable.

This year, the auditors are using a new house price index and he hopes it will take a “more rational view of how the portfolio may perform.”

But he has no say over the HPI or other projections the auditors use in calculating the capital ratio. “I have no idea what it will come out at,” he said. Currently, the FHA has a 30% share of the single-family housing market and 80% of its purchase mortgages go to first-time homebuyers.

The FHA insured nearly $300 billion in single-family loans in FY 2010, which ended in September.  FHA production will likely remain at that level in FY 2011.

“We are playing a critical role in housing finance,” Stevens said, by ensuring the availability of mortgage credit while private sources remain on the sidelines.

He suspects FHA’s market share will remain abnormally high until private investors become more comfortable with the regulatory and home price environment.

“We are still in a very tenuous housing market as it relates to financing being available outside of Freddie Mac, Fannie Mae and FHA.”