Their analysis, they say, indicates that FHA couldrnsignificantly lower its premiums, charging a more appropriate fee for risk,rnwhile continuing to build the necessary reserves against losses.  The current high premiums penalize currentrnborrowers for the pricing and performance of earlier loans and for problemsrnexperienced in the so-called reverse mortgage program.  These are the primary causes of FHA’s ongoingrninability to reach the 2 percent reserve ratio, not any deficit in the currentrnloan vintages.  </p

FHA was designed to be self-funding through premiumsrnpaid by mortgage borrowers into the MMI in return for the agencies guarantee ofrntheir loans.  The fund ideally will bernsufficient to cover losses in the event of borrower defaults.  During the housing collapse and subsequentrnrecession projected claims against the fund began to outstrip its projectedrnrevenue so FHA took steps to tighten its standards for guaranteeing loans andrnraised its fees.  </p

Goodman, Bai and Zhu said theirrnanalysis of the 2014 Actuarial Report concludes that MMI’s failure to keep tornthe 2013 projections was driven by “negative revisions to the economicrnvalue of the Home Equity Conversion Mortgage (HECM) book, poor performance ofrnloans made before and during the financial crisis, and a shortfall in revenuesrndriven in part by today’s higher premiums.”</p

There is, however the question ofrnwhether, in a business which continues to improve but at a slower rate thanrnexpected, the agency can afford to lower its premiums even if this would expandrnaccess to credit and avoid in part an adverse selection problem whereinrnborrowers with higher credit scores avoid the high costs of FHA mortgages.  The researchers analyzed the credit mix ofrnFHA’s current and its desired books of business in an attempt to answer thatrnquestion. </p

The researchrnlooked at 90 day delinquency rates under a normal scenario, using the 2001-2002rndefault rate, and a stressed economic scenario based on defaults in 2005 andrn2006.  Defaults in the former periodrnresulted in a 50 percent severity loss by the FHA and the latter in a 65rnpercent loss.  This severity number arernhigh and consistent with those reported by the agency but do not mean that allrnloans that become that delinquent will result in a claim against the fund.  </p

Based on itsrncurrent mix of FHA’s business, losses during normal periods would be 3.8rnpercent and 13.8 percent during periods of stress.  Given the last 100 years of economic historyrnthe study assumes a 0.9 normal to stress ratio leading to expected losses ofrn4.83 percent.   </p

The analysis further assumes that, overrna weighted-average time to repay of six years FHA would collect 1.75 percent inrnan upfront premium and 8.1 percent in annual premiums or 9.85 percent againstrnthe 4.83 percent losses; an expected profit of 5 percent.  If FHA were to insure $135 billion in loansrnin 2015 as it did in 2014 this would lead to a profit of $6.8 billion.   </p

FHA’s medianrnFICO score at origination climbed from around 645 in 2007 to about 700 in 2007rnand is now at 684.  FHA has indicated itrnwishes to move its book of business somewhat lower, to include more 620-680rnFICO borrowers and fewer with scores over 680. rnThis would raise the losses to 5.6 percent resulting in a profit of $5.7rnbillion.  </p

If the FHA’s ultimate goal is to break even eachrnyear, there is room for a significant cut in premiums.   Even if it takes on arngreater number of higher risk borrowers and thus higher losses it could cutrnannual premiums in half, to 0.65 percent, and still break even.  This without even considering the lure of lowerrnpremiums for higher credit score borrowers.  </p

With the affordability of lowerrnpremiums confirmed, the researchers ask to what extent and how quickly newrnborrowers should be required to pay for the performance of older vintage loansrnand for the deficit in the HECM reverse mortgage business.  The MMI fund now stands at $4.8 billion wherernit is mandated to be at $23 billion.  Theyrnnote that maintaining the higher premiums dissuades many potential higherrncredit borrowers from taking FHA loans, leading to less revenue and a morerncostly credit mix.</p

They recommend making up the shortfallrnmore slowly, pricing new business more appropriately for the risk.  “If the FHA lowered the annual premium on thern2015 book to 0.9 percent, it would make $2.0-$3.1 billion, depending on thernloan mix. While that may not be the right number, we believe the wisest coursernof action is some reduction in the insurance premium, with the exact amountrndepending on the FHA’s own internal estimates and policy preferences.”</p

Theyrnconclude that netting $2 to $3 billion this year, rather than the $5.7 to $6.8rnbillion it might make on its current path, depending on how quickly its desiredrnbusiness mix is achieved, is a more appropriate pace that won’t overcharge new borrowers to make uprnfor undercharging in the past.

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