DEC 18, 2012 4:21pm ET

Mortgage Reform 2013: Watching the FHA

DEC 18, 2012 4:21pm ET
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As the national debate about government-sponsored enterprise reform heats up, some analysts caution the potential political and regulatory changes expected in 2013 may not have a meaningful impact on the mortgage market overall. 

The future performance of the Federal Housing Administration is yet another concern for 2013.

According to Keefe, Bruyette & Woods analysts, the 2012 FHA annual audit report findings showing the agency is facing a “significant capital shortfall” has refocused attention on the FHA and its future role in the housing market.

The 2013 mortgage industry debate most likely will be driven by concerns about how the FHA, the nation’s most “significant source of support for the mortgage and housing market,” will do business in the future.

While its role “will diminish over time,” write KBW analysts in a yearend mortgage market overview report, given how important the FHA still is in supporting the housing market, no “meaningful action” is expected, at least in the near future. 

Also, thanks to the fact that the GSEs are currently profitable, the Federal Housing Finance Agency is not expected to achieve “any meaningful progress on GSE reform.”

The FHA debate on the other hand unavoidably revolves around how to manage FHA credit risk and preserve economically sound capital ratios.

The 2012 FHA annual audit report released in November shows FHA’s capital ratio decreased to -1.44% from 0.24% in fiscal 2011 and 0.50% in 2010—even though the FHA has a minimum capital requirement of 2%—indicating a shortfall of $38.9 billion. 

Analysts expect “only minor changes” to the current FHA program since a much less active FHA has the potential to negatively impact “the nascent housing recovery.”  

Nonetheless, judging from current data the future direction of the FHA as a less significant generator of mortgages, has already started to materialize. 

By the end of the third quarter of 2012 the FHA accounted for 13% of national mortgage volume, down from a peak of 30% in 4Q08, yet “well above pre-crisis levels,” analysts note.

Data show the FHA’s share as a percent of total originations and mortgage debt outstanding as the FHA’s share of the purchase market is higher than its share of the refinance market: In fiscal year 2012, FHA insured 1.18 million loans valued at $213 billion.

However, over 733,000 of these mortgages were purchase loans that represent 61.9% of all purchases.

It matters because the FHA borrower “has historically been of weaker credit than the prime conforming borrower.”

The average FICO score for FHA borrowers declined slightly in fiscal 2012 to 698 from 701 in 2011. Quarterly data since 2008 show, “although credit scores are up materially, they still remain low relative to the prime conforming market,” analysts wrote reminding everyone that the days when the FHA provided mortgages for weaker borrowers with 3.5% downpayments and 96.5% LTVs may never come back. Furthermore, as the FHA has taken steps to reduce its share, and as private mortgage insurance has experienced a modest recovery” after a sharp decline during the crisis, FHA market share has already declined from its peak in late 2008.

At the end of fiscal 2012 (ending September 2012), the FHA had approximately $1.1 trillion of insurance in force.

Yet, arguably, the current FHA book of business poses less default risk. Following a legacy of weaker borrowers with higher levels of delinquency and foreclosure rates that historically have sustained FHA losses at levels “well above losses on the conforming sector,” analysts note, FHA credit performance has improved.

For example, as of 3Q12, the serious delinquency rate on FHA insured loans (including foreclosure inventory) was 8.54%, down from 9% in 2Q12; this compared to 4.69% at 3Q12 for prime loans.

After three years, 2009 vintages are on average performing more than two times better than 2006-08 vintages—even though the 2006-09 vintages continue to see worsening serious delinquency rates over time. 

According to the annual report expected MMI fund related losses from the 2007 and 2008 books are $6.4 billion and $13.2 billion, respectively. Meanwhile, analysts find, because of the termination of the Seller-Funded Downpayment Assistance Loans, the 2009 FHA book of business “could perform somewhat better than older books.” 

The financial condition of the FHA however, remains an industry wide concern.

Annual audits of FHA’s economic net worth and the financial soundness of its Mutual Mortgage Insurance fund worries analysts. (As a rule they estimate the economic value of MMI based on the sum of current capital resources plus the net present value of the books of business. Plus, they calculate the projected capital ratio dividing the economic value by the total insurance in force.)

FHA started taking actions to strengthen the financial position of the fund during 2012. In the 2012 annual report it “announced several new actions to help strengthen the financial position of the MMI fund,” to be implemented in 2013.

Going forward the FHA plans to increase the annual MIP by an additional 10 bps, as a way “to help reduce the FHA market share in the primary MI market,” analysts note.

The FHA is also focusing on real estate owned foreclosure alternatives “as a means to reduce loss severities on defaulted loans,” through streamlining the FHA short-sale policy and ramping up loan sales through its Distressed Asset Stabilization Program.

Actions to manage risk and protect the fund include calls for congressional action from various entities including HUD.