Heres How Well Push FHA Back into the Black
While FHA has enacted substantial reforms under the current administration, this year’s actuarial review makes clear that loans made prior to and at the outset of the recent crisis continue to weigh heavily on the health of the MMI Fund. Therefore, building upon the significant efforts already undertaken to protect and preserve the MMI Fund, FHA is implementing a series of additional actions to continue improving the fund’s trajectory over both the short and long term. Using the actuary’s model, collectively, these changes are projected to provide billions of economic value for the MMI Fund in FY 2013.
The changes made since 2009 to FHA’s lender oversight, credit policies and premium pricing have yielded substantial improvements in the quality of new loans endorsed by FHA. But significant opportunity remains to reduce the impact on the fund of poorly performing legacy loans severely impacted by the recession, and to provide greater assistance for distressed borrowers as they seek to recover and find meaningful assistance in dealing with their delinquent loans. With a majority of FHA’s projected losses attributable to loans insured from 2007-2009, FHA will take several additional steps to maximize recovery in the areas of loss mitigation and asset management.
The actuary projects nearly $60 billion in claims costs for FHA from seriously delinquent loans that will go to claim by the end of FY 2014, largely arising from loans insured between 2007 and 2009. As a result, reducing the severity of losses derived from these loans will exert a demonstrable positive impact to fund performance over the next few years. Throughout the past fiscal year, FHA has been executing on an overall asset management strategy aimed at ramping up REO alternatives. REO alternatives (primarily short sales) comprised about 15%-20% of total dispositions since 2010, yielding average loss severities about 20% lower than REO. In recent months, as noted, FHA also unveiled its Distressed Asset Stabilization Program, another REO alternative that improves fund performance. These and other actions have had a measurable effect, as loss severities have already fallen by 9% in the last year A further reduction in loss severities will further improve fund performance.
FHA issued a Mortgagee Letter on Nov. 16 that established revised standards for repayment plans, standard modifications, and FHA-HAMP loss mitigation products, which are expected better assist distressed borrowers and reduce losses to the fund from foreclosures. FHA loss mitigation policies will be geared towards greater payment relief for borrowers, targeting payment reductions of at least 20% for FHA-HAMP modifications, which will result in more sustainable payment outcomes for borrowers over the long term.
This approach will yield lower claim costs for FHA while also reducing prepayment speeds for insured loans, both of which will positively impact the MMI Fund.
Although FHA is deeply committed to providing loss mitigation alternatives to borrowers which permit them to retain their homes, home retention is simply not an option for some borrowers. For these borrowers, preforeclosure sales (short sales) offer an opportunity to transition out of their homes. This enables both FHA and the borrowers to avoid the costs and damages of the foreclosure process. FHA will introduce a streamlined preforeclosure sale policy which removes certain barriers for borrowers in obtaining a short sale on their FHA-insured mortgage. This change is expected to increase the number of defaulted loans that end in short sales rather than foreclosures. Because losses from short-sales are substantially lower than from the traditional FHA REO process, the shift of greater numbers of distressed homeowners to short-sale dispositions rather than foreclosures will yield better results for the MMI Fund while allowing distressed borrowers to start anew without having to go through the difficult and costly foreclosure process.
FHA is conducting a pilot whereby properties secured by nonperforming FHA-insured loans are offered for sale by the lender who has completed the foreclosure process. At a reserve price slightly below the outstanding unpaid principal balance of the loan, the properties are sold to third-party purchasers without ever being conveyed to FHA. This method of disposing of these properties may yield lower losses for the MMI Fund than selling them through FHA’s normal REO disposition process, as carrying costs associated with preserving, managing and marketing an REO property were eliminated.
In addition to the policy and programmatic changes outlined above, FHA will also take several innovative and proactive steps to increase utilization of loss mitigation options and reduce unnecessary asset disposition losses. First, beginning in 2013, FHA will launch a large-scale proactive marketing campaign to promote modification and short-sale strategies for delinquent borrowers. This effort is expected to increase utilization of these programs, which will permit more borrowers to become aware of and take advantage of these opportunities, while reducing foreclosures and decreasing associated losses for FHA. In addition, FHA will also pursue more creative strategies to dispose of REO properties in geographies where traditional asset disposition methods yield net negative recoveries for FHA. This approach will both save money for FHA on unnecessary losses as well as contribute to community stabilization initiatives in cities hit hard by the recession.
While much has been done under the current administration to improve the performance and revenue of new FHA endorsements, we believe it is vital to take additional steps to strengthen new books to ensure the long-term health of the MMI Fund.
Under a policy change made in 2001, FHA has been cancelling required mortgage insurance premiums on loans for which the outstanding principal balance reaches less than 78% of the original principal balance. However, FHA remains responsible for insuring 100% of the unpaid principal balance of a loan for the entire life of the loan, such loan life often extending far beyond the cessation of MIP payments. As written, the timing of MIP cancellation is directly tied to the contract mortgage rate, not to the actual loan LTV. The current policy was put in place at a time when it was assumed that home price values would not decline, but today we know that LTV measured by appraised value in a declining market can mean that actual LTVs are far lower than amortized mortgage LTV, resulting in higher losses for FHA on defaulted loans. Analyses conducted by FHA’s Office of Risk Management projects lost revenue of approximately $10 billion in the 2010-2012 vintages as a result of the current cancellation policy. The same analyses also suggest that 10%-12% of all claims losses will occur after MIP cancellation. Therefore, beginning with new loans endorsed after the policy change becomes effective later in FY 2013, FHA plans to once again collect premiums based upon the unpaid principal balance of FHA loans for the entire period during which they are insured, permitting FHA to retain significant revenue that is currently being forfeited prematurely.
We are very grateful for the flexibility Congress granted us in 2010 to adjust FHA’s premium pricing. And we have utilized that flexibility three times already. This fiscal year, we plan to use it once again as, consistent with FHA’s continued efforts to balance its countercyclical role in the nation’s mortgage market with its responsibility to manage the fund, FHA plans to increase annual mortgage insurance premiums by an additional 10 basis points. While the new loans being made today are profitable to FHA and we do not want to over-burden or constrict access to credit as the housing market continues to mend, we also must ensure that we are rebuilding adequate reserves for the future and phasing out of our countercyclical role by reducing FHA’s footprint in the marketplace and helping to facilitate the return of private capital.