In Congressional hearings earlier this year, critics of the Federal Housing Administration argued that the mortgage insurance premium reduction enacted in January has imperiled the program and put the taxpayer in jeopardy.
In contrast to this dire prediction, the facts show that the opposite is happening. Simply put, the FHA is getting stronger, faster.
Critics of the FHA's basic single-family program provide a modern day example of Mark Twain's adage, "don't let the facts get in the way of a good story." They claim the premium reduction will reduce revenue, thereby delaying FHA's financial recovery. They also contend that the actuary's forecasts have repeatedly understated FHA's problems, and argue that the lower premium has only increased risky lending by helping higher income borrowers buy more expensive homes.
The premium reduction is actually increasing the FHA's revenue in two important ways.
First, FHA's volume during fiscal year 2015 is growing much faster than was expected last year. At its current pace, insurance volume for fiscal year 2015 should exceed $200 billion, or be 60% higher than was forecasted last year (prior to the implementation of the premium reduction in January). The FHA's rapidly growing origination volume is generating a significant increase in revenue that will more than offset the financial impact of the premium reduction.
The premium reduction has also sparked an increase in FHA's recapture rate (i.e. percentage of FHA loans that pre-pay and then return as FHA refinances). The recapture rate has doubled since the premium was reduced. An improving recapture rate reduces the threat of excessive portfolio run-off. FHA is retaining performing loans in its portfolio as new originations that will continue to pay the FHA annual premiums (albeit at a lower amount in some cases) and will also be paying a new upfront premium of 1.75% that provides additional revenue.
The critics also maintain that the projections in FHA's actuarial reviews have consistently underestimated potential risks to the fund. While changing economic forecasts have resulted in downward revisions to actuarial projections, the far more important finding is that these revisions are consistently overestimating FHA's actual claims: FHA claim activity has averaged 30% "lower than projected" since FY 2010.
Those who might think that FHA's impending claims are merely backlogged in the foreclosure process, and will eventually be filed, will probably be surprised to learn that the dollar volume of FHA's seriously delinquent loans has fallen 37% from $95 billion in January 2013 to $60 billion in July 2015.
What makes this $35 billion decline in serious delinquencies even more encouraging is that the FHA still has $46 billion in cash reserves to pay claims. Add in the administration's improving loss severity rate (FHA now recovers 50% of the loss when it disposes of a property) and the FHA would still have about $16 billion in capital even if every seriously delinquent loan ended up in foreclosure.
Another reason for optimism is that the FY 2014 Actuarial Review was based on the projection of a "minor housing recession" occurring in FY 2015 – 2016. Had that occurred, the annualized national house price growth rate was forecasted to fall from 6.8% to 0.54% by the fourth quarter of FY 2016.
This pessimistic forecast appears increasingly unlikely since almost halfway through that period, annualized house price appreciation is in the 5-7% range and the CoreLogic forecast for the next 12 months is for appreciation in the 4-5% range.
The impact of the "minor housing recession" forecast in FHA's 2014 Actuarial Review can be seen in the 24% spike in the projected cumulative claim rate for the FY 2015 originations.
It also has a rippling effect through future years as the 30% increase in the FY 2020 claim rate demonstrates. While actuarial reviews certainly have value in managing the FHA program, the limitations of the forecasts on which they are based must also be recognized.
Finally, critics argue that the premium reduction has resulted in higher loan amounts in the program. Leaving aside the fact that it is well-documented in the FHA program that higher-balance loans perform better than lower-balance mortgages, FHA's average home purchase loan in the second quarter of 2015 was $186,000 and only 4% of FHA loans in that quarter were above $400,000. FHA purchase loans below $150,000 during the second quarter also increased 48% compared to a year earlier.
As the preceding data indicates, the premium reduction is accelerating FHA's financial recovery and achievement of the 2% capital ratio. In addition to rising revenue and fewer claims, the historic credit quality of the portfolio and the still-high premiums are very positive indicators for FHA's financial future.
To paraphrase an old trial lawyer's saying, "When the facts are on your side, argue the facts. When the law is on your side, argue the law. When neither is on your side, pound the table." It looks like FHA's critics will be doing a lot of table pounding in the coming years as the facts about the FHA basic single-family program keep getting better.
Brian Chappelle is a founding partner of Potomac Partners in Washington