FHA Reserves At All Time Low. Audit Sees Finances Recovering in 2012

by devteam November 12th, 2009 | Share

The Federal Housing Administration (FHA) has sustained significant lossesrnand its capital reserve ratio has fallen below the threshold mandated byrnCongress, however, there is no reason to think that these reserves will fallrnbelow zero and, in fact, are already showing signs of recovery.

These are the principal findings of the annual independent actuarialrnstudy of the agency released this morning at a press briefing conducted byrnHousing and Urban Development Secretary Shaun Donovan and FHA CommissionerrnDavid H. Stevens.    

The study shows that FHA's reserves have fallen to 0.53 percent ofrntotal insurance in force this year, significantly below the two percent level itrnis required by Congress to maintain.  Onernyear ago the ratio was 3 percent, the decrease is attributable to therndifficult conditions in the housing market and losses from loans made beforern2009.

The capital reserve ratio measures reserves held in excess of thosernneeded to cover projected losses over the next 30 years.  The 0.53 percent ratio represents the fundsrnheld in the Capital Reserve Account. rnThese funds are in addition to funds in the Financing Account which arerndesignated to pay for losses on existing loans. rnThe combined total of  reserves in these two accounts is $31 billion or more than 4.5rnpercent of total insurance-in-force.

The report cites the FHA response to the many demands placed on itrnduring the current housing crisis.  Asrnprivate sources of mortgage money have dried up, FHA has more and more beenrnpushed into guaranteeing loans and other actions to facilitate the market'srnrecovery.  In the second quarter of 2009rnFHA has guaranteed nearly 50 percent of all mortgages issued to first-time homernborrowers.  This segment of the market representsrn80 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-businessrnhave particularly suffered from the results of income and job loss andrnsignificant home-price declines.  The FYrn2007 book is especially “showing to-date claim-rate experience that puts it onrna par with FHA's worst-ever books from the early 1980s.” But the report statesrnthat because of FHA's historically prudent lending, the stress on its portfoliorndoes not equate with the stress on conventional market portfolios.

As the level of activity has increased in response to the crisis, thernagency has tightened its lending standards. rnIt has halted the seller-financed down payment assistance program,rnincreased oversight of lenders, tightened underwriting standards on streamlinernrefinances, and is considering other “prudent measures” to increase loanrnquality.  Among measurable results thernaverage credit score of borrowers has increased to 693 compared to 633 twornyears ago.  Other improvements have beenrna drop in the average mortgage debt ratio from 26.11 percent in 2007 to 24.24rntoday and an improvement in average total debt ratios from 39.27 to 36.85.

Because of these improvements, the report states that loans insured sincernJanuary 2009 should provide net positive revenues for the FHA.

The audit report likens the stress today to that experienced by FHA priorrnto 1990 when an audit determined that the agency, while solvent, could notrnexpect to meet its obligations going forward. rn”The primary difference today is that the just-completed actuarial studiesrnshow that FHA's capital reserve ratio will not dip below zero under most of therneconomic scenarios considered.  Underrnmost of these scenarios, premium rates are sufficient to pay for claims on newrnbooks of business, contribute toward the ongoing costs of expected claims onrnthe 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 fundrncould regain a two percent net capital ratio as early as FY 2012.  FHA's capital resources have grown from $27.2rnbillion at the start of the year to $30.7 billion today for an overallrncapital-resource ratio of 4.5 percent. rnThis increase in capital resources is primarily due to premium revenuesrncollected on new insurance written this year. rnFHA now collects an upfront premium as well as a monthly premium on thisrninsurance and FY 2009 was a record year for new insurance commitments.

At the same time the estimated amount of earmarked loss reservesrnnecessary to cover expected net losses on future cash flows has increased fromrn14.3 billion last year to 27.1 billion. rnAs a result FHA needs to reserve an additional $12.8 billion for futurernlosses.  With these funds reserved thernnet capital position of the fund falls to $3.6 billion or a net capital ratiornof 0.53 percent.

Looking at the out-years for the period of FY 2009 to 2016 the reportrnprojects that business currently outstanding will drain a significant portionrnof capital resources over the next five years. rnThe extent to which new business will replace these funds will determinernthe health of the reserves during that period. rnThe base level scenario run by the audit shows that the fund willrnexperience net outflows for the next two years after which capital resourcesrnare expected to begin to rise, yielding a low point in the capital resourcernratio of 2.16 percent predicted for the end of FY 2011.

A number of sensitivity analyses were run as part of the audit, showingrnthe response of the capital ratios to scenarios including a Deeper HousingrnRecession, Higher Loss Severity Rates, and Downward Interest Rate Shock.

At a press briefing accompanying the release of the report Secretary Donovanrnsaid, “FHA is playing a critical role in restoring health to the housing marketrnby helping working families access mortgage financing when private capital isrntight. This is a temporary role which FHA has played in previous economicrndownturns. The Administration is committed to ensuring that the FHA steps backrnas private capital returns to the market. With this temporary increased rolerncomes increased risk and responsibility. That's why we are committed to closelyrnmonitoring market behavior patterns and economic risks so that we are preparedrnto enact reforms that ensure the FHA's financial health moving forward.”

In an effort to manage risk and anticipating future problems FHA isrnusing models showing more extreme circumstances than those envisioned in thernactuarial study including one scenario that projects the reserves dropping intornnegative territory.  As a response tornthis modeling FHA Commissioner David Stevens earlier announced a set of creditrnpolicy changes that become effective on January 1.  At that time FHA will:

  • Require submission of audited financial statements by supervisedrnmortgagees
  • 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 inrnFHA loan origination and increase net worth requirements for mortgagees

In addition, the agency announced it has named RobertrnRyan 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'srnhistory that better illustrates exactly why FHA and Ginnie Mae exist.rnDuring these uncertain economic times, their counter-cyclical role of ensuringrnadequate mortgage activity and liquidity has been necessary and vital.

Montgomery pointed to the FHA's role in allowingrnnearly one million subprime/Alt-A borrowers to refinance into 30-year FRMs andrnfinancing nearly 2 million first-time buyers. rnHe noted that FHA had gone from providing 3 percent of the nation'srnlending activity to nearly 25 percent virtually overnight. READ MORE

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About the Author


Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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