FHA Reserves At All Time Low. Audit Sees Finances Recovering in 2012
The Federal Housing Administration (FHA) has sustained significant losses and its capital reserve ratio has fallen below the threshold mandated by Congress, however, there is no reason to think that these reserves will fall below zero and, in fact, are already showing signs of recovery.
These are the principal findings of the annual independent actuarial study of the agency released this morning at a press briefing conducted by Housing and Urban Development Secretary Shaun Donovan and FHA Commissioner David H. Stevens.
The study shows that FHA's reserves have fallen to 0.53 percent of total insurance in force this year, significantly below the two percent level it is required by Congress to maintain. One year ago the ratio was 3 percent, the decrease is attributable to the difficult conditions in the housing market and losses from loans made before 2009.
The capital reserve ratio measures reserves held in excess of those needed to cover projected losses over the next 30 years. The 0.53 percent ratio represents the funds held in the Capital Reserve Account. These funds are in addition to funds in the Financing Account which are designated to pay for losses on existing loans. The combined total of reserves in these two accounts is $31 billion or more than 4.5 percent of total insurance-in-force.
The report cites the FHA response to the many demands placed on it during the current housing crisis. As private sources of mortgage money have dried up, FHA has more and more been pushed into guaranteeing loans and other actions to facilitate the market's recovery. In the second quarter of 2009 FHA has guaranteed nearly 50 percent of all mortgages issued to first-time home borrowers. This segment of the market represents 80 percent of the loans guaranteed by the agency this year.
At the same time, the agency is experiencing elevated levels of stress. Fiscal year 2005 to 2007 books-of-business have particularly suffered from the results of income and job loss and significant home-price declines. The FY 2007 book is especially "showing to-date claim-rate experience that puts it on a par with FHA's worst-ever books from the early 1980s." But the report states that because of FHA's historically prudent lending, the stress on its portfolio does not equate with the stress on conventional market portfolios.
As the level of activity has increased in response to the crisis, the agency has tightened its lending standards. It has halted the seller-financed down payment assistance program, increased oversight of lenders, tightened underwriting standards on streamline refinances, and is considering other "prudent measures" to increase loan quality. Among measurable results the average credit score of borrowers has increased to 693 compared to 633 two years ago. Other improvements have been a drop in the average mortgage debt ratio from 26.11 percent in 2007 to 24.24 today and an improvement in average total debt ratios from 39.27 to 36.85.
Because of these improvements, the report states that loans insured since January 2009 should provide net positive revenues for the FHA.
The audit report likens the stress today to that experienced by FHA prior to 1990 when an audit determined that the agency, while solvent, could not expect to meet its obligations going forward. "The primary difference today is that the just-completed actuarial studies show that FHA's capital reserve ratio will not dip below zero under most of the economic scenarios considered. Under most of these scenarios, premium rates are sufficient to pay for claims on new books of business, contribute toward the ongoing costs of expected claims on the older books, and then to start rebuilding capital in just a few years."
Most of the scenarios run as part of the study found that the fund could regain a two percent net capital ratio as early as FY 2012. FHA's capital resources have grown from $27.2 billion at the start of the year to $30.7 billion today for an overall capital-resource ratio of 4.5 percent. This increase in capital resources is primarily due to premium revenues collected on new insurance written this year. FHA now collects an upfront premium as well as a monthly premium on this insurance and FY 2009 was a record year for new insurance commitments.
At the same time the estimated amount of earmarked loss reserves necessary to cover expected net losses on future cash flows has increased from 14.3 billion last year to 27.1 billion. As a result FHA needs to reserve an additional $12.8 billion for future losses. With these funds reserved the net capital position of the fund falls to $3.6 billion or a net capital ratio of 0.53 percent.
Looking at the out-years for the period of FY 2009 to 2016 the report projects that business currently outstanding will drain a significant portion of capital resources over the next five years. The extent to which new business will replace these funds will determine the health of the reserves during that period. The base level scenario run by the audit shows that the fund will experience net outflows for the next two years after which capital resources are expected to begin to rise, yielding a low point in the capital resource ratio of 2.16 percent predicted for the end of FY 2011.
A number of sensitivity analyses were run as part of the audit, showing the response of the capital ratios to scenarios including a Deeper Housing Recession, Higher Loss Severity Rates, and Downward Interest Rate Shock.
At a press briefing accompanying the release of the report Secretary Donovan said, "FHA is playing a critical role in restoring health to the housing market by helping working families access mortgage financing when private capital is tight. This is a temporary role which FHA has played in previous economic downturns. The Administration is committed to ensuring that the FHA steps back as private capital returns to the market. With this temporary increased role comes increased risk and responsibility. That's why we are committed to closely monitoring market behavior patterns and economic risks so that we are prepared to enact reforms that ensure the FHA's financial health moving forward."
In an effort to manage risk and anticipating future problems FHA is using models showing more extreme circumstances than those envisioned in the actuarial study including one scenario that projects the reserves dropping into negative territory. As a response to this modeling FHA Commissioner David Stevens earlier announced a set of credit policy changes that become effective on January 1. At that time FHA will:
- Require submission of audited financial statements by supervised mortgagees
- Modify procedures for streamline refinance transactions
- Require appraiser independence in loan origination
- Modify appraisal validity period
- Enable appraisal portability
The agency also hopes to modify mortgagee approval and participation in FHA loan origination and increase net worth requirements for mortgagees
In addition, the agency announced it has named Robert Ryan as its new Chief Risk Officer to oversee its risk mitigation efforts. This is a new position within the agency.
John A. Courson, President and CEO of the Mortgage Bankers Association (MBA) today issued the following statement in response to the Federal Housing Administration's (FHA) announcement of its fiscal health and financial outlook.
"Today's announcement is a major wakeup call for FHA and the lending community, but no reason to panic. The two percent reserve requirement was established in order to ensure that FHA could stand the stress of a major housing and mortgage market event. It is safe to say that FHA is facing that type of event today.
"We are encouraged by the corrective actions FHA has already announced and has begun implementing - the elimination of seller-funded down payments and the recent program changes to help it better manage its risk - that should help FHA come out of the current housing crisis positioned to continue its mission promoting more affordable mortgage credit for borrowers.
"MBA and its members, who originate the vast majority of all FHA loans, have long been leading efforts in Washington to give FHA the tools it needs to best serve its mission. That is why we are continuing to encourage Congress to appropriate the critical funding that FHA needs to hire and maintain staff and update its technology."
Former FHA Commissioner Brian Montgomery, writing on his blog last month, stated, "There has never been a point in our nation's history that better illustrates exactly why FHA and Ginnie Mae exist. During these uncertain economic times, their counter-cyclical role of ensuring adequate mortgage activity and liquidity has been necessary and vital.
Montgomery pointed to the FHA's role in allowing nearly one million subprime/Alt-A borrowers to refinance into 30-year FRMs and financing nearly 2 million first-time buyers. He noted that FHA had gone from providing 3 percent of the nation's lending activity to nearly 25 percent virtually overnight. READ MORE