Let’s Continue To Protect FHA For The Long Term

Each November HUD releases it’s FHA Actuarial Report to Congress. This is a congressional mandate based on a history of FHA finding itself under capitalized risking draws from its “permanent and indefinite” authority as provided to draw funds from the Treasury should it have insufficient reserves in place to cover forecasted losses on it’s book of business. This years 2018 independent Actuarial Report on the health of the MMI fund continues to affirm my concern that we stay committed to not weaken the fund despite calls from some to reduce premiums or modify the premium structure.

As a former FHA Commissioner, I excitedly await these releases each year having walked into that role in 2009 when the fund was already destined for trouble. As a matter of fact, and to remember this history, I testified to to this concern in my confirmation hearing in front of the Senate Banking Committee in April of 2009 and asserted what we all knew – that the MMI fund was in trouble, “FHA has not been immune to the adverse conditions of this market. Default rates and foreclosures exceed prior estimates.“, was one of my statements to this point.

To be clear, the FHA is unlike any private or other government sponsored provider of credit. It is a massive insurance company that guarantees reimbursement to GNMA MBS investors for the full value of loss associated with an FHA default. This guaranty is backed behind loans that have higher risk characteristics than loans backed by the GSE’s. FHA loans combine higher debt to income ratios, lower credit scores, and higher loan to values than their other government sponsored counterparts. And as you can see by the report issued by Isaac Boltansky of Compass Analytics it is trending worse. As shown below, the trend in both credit score and DTI in the FHA portfolio is weakening:

FHA is unique and important in the single family housing market in other aspects. It serves minorities and first time homebuyers in manner unmatched by any other credit provided in the US. It is the largest provider of reverse mortgages for seniors in the nation. And lenders that help distribute FHA loans across the nation are dominated by non-bank, independent mortgage bankers, primarily because the major bank lenders have backed away from the program due to concerns related to indemnification risk that may obligate them to severe financial penalties in the event of default, a subject that I have been vocal about for years.

The MMI fund also backs the far riskier reverse mortgage program (HECM), a product that has whip-sawed the reserves significantly over the years and in this years report reflects its ongoing concern to taxpayers as shown in Isaac’s analysis comparing the forward and reverse books.

In short, the concentration of credit attributes in the FHA portfolio contain more risk factors across the spectrum than loans created by Fannie Mae or Freddie Mac or most other private lenders. The good news is that this year the actuarial shows that the capital reserves continue to grow above the base minimum of the 2% legislated floor, standing at 2.76%. But risk remains and we have learned through history that the reserves held today still may underestimate the true loss exposure in a nationwide recession. In an economy with virtually full employment, low interest rates, and stable house prices, it would be ludicrous to forget the realities of economic cycles as we have seen in the past. Yes, FHA has rebuilt its financial resources. But holding 3.89% in capital resources on it’s massive $1.26 trillion portfolio is minimal on a risk adjusted basis.

Recently some of my industry colleagues have called for either an outright reduction in premium or an elimination of the lifetime premium. I oppose either move at this juncture. In fact, as commissioner I made several moves to protect the fund including raising premiums with congressional support, establishing a credit score minimum, and installing life of loan MIP, and would argue against moves to the alternative until we see more improvements in the HECM program and understand the economic cycle we may be facing in the years forward.

I installed the life of loan MIP for one key reason. FHA, unlike the MI elimination policy in the GSE program, still remains on the hook for losses even if the premium is cancelled. Just as you pay for auto, health, or other insurance as long as you are under its protection, FHA needs to do the same. In 2009 after home prices dropped nationally over 20% and in some regions between 30%-40%, we found that we were obligated to pay for losses on homes where the MIP was not being collected due to previous elimination based on equity, and yet many of these homes were not underwater due to the price corrections in the recession. Because there is always risk in HPI forecasting it was our view that a premium must be paid as long as the insurance is in place. Not only does this add significant economic value to the fund, it protects the integrity of its administrators to make certain that appropriate premiums are applied to all insured borrowers. While some might argue adverse selection in interest rate rallies or periods of property value appreciation for better qualified borrowers who refinance out of the program, I would argue that the math does not offset the down side forecast risk to home prices as projected in any actuarial.

Look, I am not saying that FHA should never consider reducing premiums. But keep in mind that all net earnings are booked as reserves for future losses and without getting into the confusing explanations of federal budgeting and spending, these reserves are critical to keep FHA well supported during down markets. We are in the best credit cycle seen in decades. We have had low interest rates, record low unemployment, and nearing a decade of home price gains. FHA has insured the best credit books perhaps ever seen its history. But the HECM program remains a huge problem and we have not tested mortgage performance in a down cycle yet. With both credit and LTV drift, some counter parties facing potential capital and liquidity concerns, and many forecasting a weakening economy in the next couple of years, this is the time to remain vigilant and continue to build the reserves until there us unanimous confidence in this ability to withstand a negative cycle.

I applaud the fortitude of my friend FHA Commissioner Brian Montgomery in holding back on any MIP changes and I would suggest that most former commissioners would have a similar view. All stakeholders in housing and mortgage finance need to protect FHA from future scrutiny due to short sighted acts that could jeopardize its long term role in serving homeownership. Let’s protect the FHA.