A provision of the Housing and Economic Recovery Act of 2008 moved, starting in 2009, new Home Equity Conversion Mortgages from the General Insurance Fund to the Mutual Mortgage Insurance Fund, which houses the Federal Housing Administration's basic mortgage insurance program.
The HECM program, with its wide swings in capital as a result of economic forecasts, can result in misleading conclusions about the solvency of the MMI Fund — positively or negatively. The FHA forward mortgage program is too important to the housing market to have its financial analysis clouded by a program with a totally different mission and risk factors. It is time to move the reverse program back out of the MMI Fund.
In fiscal year 2009, the reverse mortgage program was projected to contribute $12 billion to the Fund in FY 2014 according to the independent actuary. Instead, the reverse program has become a $1.2 billion drain on the MMI Fund and is expected to continue to be a detriment until FY 2019 according to the latest actuarial review.
Why should the financial health of the HECM program matter to the families who rely on FHA financing to purchase a home and the premiums that they pay for this insurance?
One only had to watch the recent House Financial Services Committee hearing during which Republican members hammered Department of Housing and Urban Development Secretary Julian Castro for lowering the annual premium to see the adverse impact HECM is having on the forward program.
The FHA appears in bad shape because it's still a few years away from reaching the 2% capital ratio, and required a $1.7 billion bailout in 2013. Both of those situations are attributable not to lax requirements of the forward program but to having its finances tied to those of the HECM program.
This makes it easier to argue that requirements FHA loans should be tightened, which would restrict access to families relying on FHA financing to purchase a home.
Of course, the principal culprit is the fluctuation in HECM's projected finances. A quick review of the facts explains why. First, the HECM program was the sole reason why FHA required the $1.7 billion bailout in FY 2013. The forward mortgage program had a $3.4 billion surplus after covering all anticipated future claims according to then FHA Commissioner Carol Galante's testimony before the same House Committee on October 29, 2013.
In defense of the HECM program, its actuarial reviews are extremely sensitive to home price forecasts and the interest rates used for discounting future cash flows. Just how sensitive was demonstrated in the FY 2014 review when the MMI Fund took a negative $5.8 billion adjustment as a result of the impact of interest rate volatility on the HECM program.
The HECM program also has a negative impact on FHA's capital ratio. In addition to the negative $1.2 billion economic value for the HECM portion of the Fund in the FY 2014 Actuarial Review, it was necessary, in May 2013, to transfer $4.2 billion from the MMI Fund to the HECM financing account ($770 million was repaid in 2014). If HECM loans were excluded from the Fund, FHA's long-standing homeownership program would have $9.3 billion in reserve (instead of $4.8 billion) after paying all anticipated claims and have a capital ratio of .87% (instead of .41%) as of September 2014.
Looking to 2015, the news for FHA's forward program is even more encouraging. When you add in the $10.2 billion projected economic value of the FY 2015 book of business, FHA's capital ratio would be approximately 1.85% at the end of this fiscal year. In fact, in a January 2015 paper titled "A Case for Lower FHA Premiums," Mark Zandi, Moody's Analytics Chief Economist, and Cristian Deritis, Senior Director, Consumer Credit Analytics, forecasted that the Fund "would get back to 2% by mid-2015" if the reverse mortgage program was excluded.
Supporting their assessment is widespread improvement in all of FHA's key metrics for the forward program including credit quality, loan performance and loss severity. For example, the median credit score for every quarter since 2009 is over 690. Historically, FHA's average credit scores per quarter were generally below 650 and bottomed out at 626 in 2007 Q4.
The impact of the improved credit quality is demonstrated by the following two statistics. First, in Congressional testimony in March 2010, FHA officials underscored the importance of good credit scores when they testified that loans with credit scores above 680 with low down payments perform better than loans with credit scores between 620-679 with 10% down payments. In addition, these high credit score books since 2009 are now 86% of FHA's portfolio (dollar volume) according to the FY 2014 Actuarial Review.
Because of the outstanding credit quality of FHA's recent books, FHA loan performance has improved steadily. The administration's total capital resources to pay claims have also increased 63% since FY 2008 from $28.2 billion to $46 billion at the end of FY 2014. Finally, recovery rates have improved 62% since 2009.
The FHA forward loan program has helped millions of families finance homes and is poised to thrive if untangled from HECM in the MMI. FHA's ability to serve these families should not be affected by issues associated with the HECM program.
Brian Chappelle is a founding partner of Potomac Partners in Washington.