FHA's Mortgage Insurance Fund Improvement Has Come a Long Way

The Federal Housing Administration (FHA) released its annual Report to Congress several weeks ago, reporting significant improvement in its Mutual Mortgage Insurance (MMI) Fund. Late last week Brian D. Montgomery, FHA Commission and Assistant Secretary of the Department of Housing and Urban Development (HUD), testified regarding the report to a hearing of the House Financial Services Committee.

Montgomery said the MMI's capital ratio increased to 4.84 percent in the 2019 fiscal year (FY2019) from 2.76 percent in FY2018, well above the 2.00 percent statutory minimum. Additionally, MMI Capital was $62.38 billion, an increase of more than $27.52 billion from FY 2018, and perhaps the highest ever.

While attributing a significant portion of the improvement both to the fund and FHA's financial position overall to the favorable economic environment and strong appreciation in home prices, Montgomery said other contributing factors to this progress are the program and policy changes HUD has made in the FHA program to better assess, manage and mitigate risk.

FHA operates the largest mortgage insurance portfolio in the nation, supporting homeownership for more than 8.1 million households, predominantly first-time homebuyers. It also insures loans for multifamily properties that provide affordable housing for American families and hospital and nursing facilities in underserved communities throughout the country. Among the highlights of the past year:

• FHA insured forward mortgages for 990,000 households, of which 616,000 went to first-time homebuyers. It also insured 31,000 Home Equity Conversion Mortgages (HECM), also known as reverse mortgages.

• Minorities represented 36.2 percent of all FHA purchase mortgage borrowers, compared to 19.94 percent in conventional lending channels. FHA mortgages were utilized by 40.58 percent of African American households and 37.61 percent of Hispanic households that purchased homes.

• As of September 30, 2019, FHA had active insurance on more than 8.1 million forward mortgages totaling more than $1.2 trillion in UPB, and HECMs with $64.2 billion in outstanding balances.

While the HECM MMI fund remains negative, capital improved by $7.71 billion, moving from negative $13.63 billion at the end of FY 2018 to negative $5.92 billion at the end of FY 2019.  The HECM capital ratio improved year-over-year from negative 18.83 percent to negative 9.22 percent.  The Commissioner said this demonstrates, in part, the progress FHA has made toward stabilizing the program's financial drain on the MMI Fund.

Since Congress established FHA in 1934 FHA has insured more than 49.5 million single-family homes. Today, the MMI single family mortgage insurance portfolio exceeds $1.29 trillion, and when combined with the commercial insurance portfolio - multifamily at $98.7 billion of unpaid principal balance (UPB) and healthcare facilities at $37.2 billion UPB - FHA manages a more than $1.4 trillion portfolio.

Montgomery said there are current risks to the single-family portfolio that FHA must continue to monitor closely. The number of loans with "extreme risk layering" increased from 2.4 percent to 2.9 percent of endorsements.  This may seem like a small change, he said, but these loans can have a disproportionate impact on overall performance, particularly during economic downcycles.  

"Already FHA is seeing early payment default (EPD) rates creeping up. EPD rates for the FY 2017-19 books of business have more than doubled, to 0.66 percent, from 0.31 percent the FY 2014-16 books. The projected lifetime claim rate for FY 2019 originations, at 9.5 percent, is also higher than any fiscal year since FY 2009, which stands at 12.8 percent," he said.  "Expected lifetime claims rates are rising because of the increase in higher credit risk characteristics in recent originations. Specifically, the emerging risks that lead to these results include a steady increase in debt-to-income ratios over 50 percent, the number of loans with credit scores less than 620, and FHA-insured purchase transaction mortgages with some form of downpayment assistance."

HUD's Housing Finance Reform Plan, submitted to the President in September, proposes a number of recommendations to reduce risks to the MMI Fund, protect taxpayers, and ensure that the agency maintains its focus on lending to underserved populations. Montgomery said all the proposals are important, but he specified five which FHA has prioritized; FHA enforcement; modernizing FHA technology; updating FHA's servicing processes and requirements; improving the financial viability of the HECM program; and strengthening FHA's overall risk management framework.  

HUD staff has been working to provide clarity to FHA lenders on regulatory expectations, for example, their concerns about uncertain and unanticipated False Claims Act liability which has led many depository lenders to largely withdraw from FHA lending. In October HUD and the Department of Justice (DOJ) signed a Memorandum of Understanding (MOU) concerning the process of deciding when to pursue a claim under the False Claims Act which provides clear guidance on its use.

HUD is also in the process of revising FHA's annual and loan-level certifications in order to clarify the requirements for compliance by lenders and has substantially revised FHA's Defect Taxonomy, the document that outlines FHA's method of identifying defects at the loan level.

FHA is actively developing a single technology platform with baseline architecture that includes an end-to-end re-alignment of FHA's single family's IT systems. When complete, this platform will provide lenders with a single portal to conduct business from loan application through claims processing and allow for electronic submission and management of documents.   

Another priority is on reducing the burden of servicing FHA loans, aligning servicing requirements with the government sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, and ensuring FHA's loss mitigation options protect taxpayers and promote sustainable home ownership.  A recent Mortgagee Letter updates FHA's loss mitigation options in major disaster areas and FHA's "Disaster Standalone Partial Claim" will now be a standard mortgage relief option available for all survivors of major disaster. Within the larger umbrella of "loss mitigation," FHA is working to streamline its application process for loan modifications and the options available to borrowers to better align them with the GSEs.

FHA is also working to reduce burdens in the conveyance process. These conveyance policies can have a direct impact on participation by lenders and therefore a significant impact on access to FHA products by our traditional borrowers.

While the reverse mortgage program's financial footing is significantly more stable today, it is still far below HUD's objectives. FHA recently made permanent its HECM collateral risk assessment policy first announced in 2018. This policy requires a second appraisal when FHA determines that the first appraisal needs additional support. It is expected that there will be a $200 million reduction in insured volume/risk exposure from this requirement. There has also been new guidance for clarifying and streamlining service responsibilities in assigning HECMs related to non-borrowing spouses, as well as to the heirs of the last surviving HECM borrower

As regards to the whole portfolio, FHA made changes to its Technology Open to Approved Lenders (TOTAL) Mortgage Scorecard to better account for emerging default risk indicators. TOTAL is an evaluation tool that assesses a borrower's credit history and application information. To address concerns associated with the increase in the concentration of mortgages with high DTI ratios, these adjustments to TOTAL will require more mortgages with a combination of higher-risk characteristics to undergo a manual underwriting process which subjects applications to greater scrutiny.

To address the 250 percent growth in cash-out refinances from FY 2013 to FY 2018, and to better manage this risk, FHA has reduced its maximum LTV and combined LTV (CLTV) percentages for cash-out refinance mortgages from 85 percent to 80 percent. This new policy aligns with the GSEs' LTV policies.  

The Commissioner said one of his concerns since his first term as Commissioner during the Bush Administration is the need to radically modernize FHA's information technology structure.  Its single-family business currently runs off 15 different systems, some of which are more than 40 years old and uses an antiquated programming language developed more than a half century ago. Frequent system failures and other technology service breaks result in costly delays, increase FHA risk exposure, as well as that of FHA-approved lenders and other program participants.  While Congress appropriated $20 million to modernize the single-family technology systems in FY 2019 and another $20 million is in appropriations bills for FY 2020, FHA ultimately will need $80-$90 million.   

The Commissioner also presented information from the report on FHA activities in financing multifamily housing programs, noting that its Office of Multifamily Housing currently provides oversight on a combined portfolio serving 2.6 million insured and assisted rental households for a total of 30,206 properties.  The majority of the assisted units include Project Based Section 8 and HUD's Section 811 and 202 properties serving extremely low- and very low- income seniors and people with disabilities.

Montgomery also reported on a new demonstration program announced last summer to help set new national standards for the physical inspection of real estate and touched on activities on the part of the Offices of Healthcare Programs, Housing Counseling, and Manufactured Housing.