Mortgage Financing
FHA's $7 Billion Reestimate Reflects Higher Claims and Changing Loan and Performance Estimates Gao ID: GAO-05-875 September 2, 2005The U.S. Department of Housing and Urban Development (HUD), through its Federal Housing Administration (FHA), provides insurance for private lenders against losses on home mortgages. FHA's largest insurance program is the Mutual Mortgage Insurance Fund (Fund), which currently is self-financed and operates at a profit. FHA submitted a "reestimate" of $7 billion for the credit subsidy and interest for the Fund as of the end of fiscal year 2003, reflecting a reduction in estimated profits. Given this substantial reestimate, Congress asked GAO, among other things, to determine what factors contributed to the $7 billion reestimate and the underlying loan performance variables influencing these factors and to assess how the loan performance variables underlying the reestimate could impact future estimates of new loans.
The $7 billion reestimate was due primarily to an increase in estimated and actual claims over what FHA previously estimated. For example, actual claim activity in fiscal year 2003 exceeded estimated claim activity for 2003--by twice as much in some cases--for the majority of loan cohorts. Prepayments also played a role in the reestimate as they were higher than previous estimates. In fact, actual prepayment activity during 2003 exceeded estimated prepayment activity for all cohorts. Because of the additional claims it paid, upfront premiums it refunded, and the annual premiums it lost, FHA's net cash outflows for the year increased, contributing to the $7 billion adjustment of the Fund's credit subsidy. Several recent events may help explain this increase, including changes to underwriting guidelines, competition from the private sector, and an increase in the use of down payment assistance. FHA has taken some steps to tighten underwriting guidelines and better estimate loan performance, though it is not clear that these steps are sufficient to reverse recent increases in actual and estimated claims and prepayments or help FHA to more reliably predict future claim and prepayment activity. Increases in claim and prepayment activity are likely to continue to add risk to FHA's portfolio.
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Director: Team: Phone:GAO-05-875, Mortgage Financing: FHA's $7 Billion Reestimate Reflects Higher Claims and Changing Loan and Performance Estimates
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Report to the Chairman, Subcommittee on Housing and Community
Opportunity, Committee on Financial Services, House of Representatives:
September 2005:
Mortgage Financing:
FHA's $7 Billion Reestimate Reflects Higher Claims and Changing Loan
Performance Estimates:
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-05-875]:
GAO Highlights:
Highlights of GAO-05-875, a report to the Chairman, Subcommittee on
Housing and Community Opportunity, Committee on Financial Services,
House of Representatives:
Why GAO Did This Study:
The U.S. Department of Housing and Urban Development (HUD), through its
Federal Housing Administration (FHA), provides insurance for private
lenders against losses on home mortgages. FHA‘s largest insurance
program is the Mutual Mortgage Insurance Fund (Fund), which currently
is self-financed and operates at a profit. FHA submitted a ’reestimate“
of $7 billion for the credit subsidy and interest for the Fund as of
the end of fiscal year 2003, reflecting a reduction in estimated
profits. Given this substantial reestimate, you asked GAO, among other
things, to determine what factors contributed to the $7 billion
reestimate and the underlying loan performance variables influencing
these factors and to assess how the loan performance variables
underlying the reestimate could impact future estimates of new loans.
What GAO Found:
The $7 billion reestimate was due primarily to an increase in estimated
and actual claims over what FHA previously estimated. For example,
actual claim activity in fiscal year 2003 exceeded estimated claim
activity for 2003”by twice as much in some cases”for the majority of
loan cohorts. Prepayments also played a role in the reestimate as they
were higher than previous estimates. In fact, actual prepayment
activity during 2003 exceeded estimated prepayment activity for all
cohorts. Because of the additional claims it paid, upfront premiums it
refunded, and the annual premiums it lost, FHA‘s net cash outflows for
the year increased, contributing to the $7 billion adjustment of the
Fund‘s credit subsidy.
Several recent events may help explain this increase, including changes
to underwriting guidelines, competition from the private sector, and an
increase in the use of down payment assistance. FHA has taken some
steps to tighten underwriting guidelines and better estimate loan
performance, though it is not clear that these steps are sufficient to
reverse recent increases in actual and estimated claims and prepayments
or help FHA to more reliably predict future claim and prepayment
activity. Increases in claim and prepayment activity are likely to
continue to add risk to FHA‘s portfolio.
Actual Versus Estimated Claim and Prepayment Rates for FY 2003:
[See PDF for image]
[End of figure]
What GAO Recommends:
To more reliably estimate program costs, the Secretary of HUD should
direct the FHA Commissioner to study and report the impact of variables
that have been found in other studies to influence credit risk. When
changing the definitions of key variables, FHA also should report the
impact such changes would have had on the forecasting ability of its
loan performance models. In written comments, HUD generally agreed with
GAO‘s overall findings.
www.gao.gov/cgi-bin/getrpt?GAO-05-875.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact William B. Shear at (202)
512-8678 or shearw@gao.gov
[End of section]
Contents:
Letter:
Results in Brief:
Background:
The $7 Billion Reestimate Is Significant for Its Size and Direction:
The $7 Billion Reestimate Primarily Reflects Higher-Than-Estimated
Claims:
The Loan Performance Variables Underlying the $7 Billion Reestimate
Will Likely Affect Future Credit Subsidy Estimates, but Are Being
Addressed:
The Loan Performance Variables Underlying the Reestimate Could Affect
Estimates of the Fund's Long-Term Viability:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendixes:
Appendix I: Scope and Methodology:
Appendix II: Data for Figures Used in This Report:
Appendix III: Comments from the Department of Housing and Urban
Development:
Appendix IV: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Annual Credit Subsidy Reestimates For the MMI Fund, Fiscal
Years 2000-2004 (Figure 3):
Table 2: Amount of the 2003 Reestimate Attributed to the 2001-2003
Cohorts, as a Percentage of the Original Loan Amount, For Single-Family
Loan Guarantee Programs (Figure 4):
Table 3: Original Estimated Credit Subsidy Rates and Most Recent
Reestimated Rates for the FHA and VA Loan Guarantee Programs, 1992-2004
Cohorts (Figure 5):
Table 4: Primary Factors Contributing to the Fiscal Year 2003 MMI
Credit Subsidy Reestimate (Figure 6):
Table 5: Change in Future Cash Flow Estimates for the Fund from Fiscal
Year 2002 to Fiscal Year 2003 (Figure 7):
Table 6: Variables Contributing to the $3.9 Billion Change in Estimated
Cash Flows (Figure 8):
Table 7: Increase in Estimated Net Cash Outflows from Removing the Loss
Mitigation Adjustment Factor, 1992-2003 Cohorts (Figure 9):
Table 8: Actual Versus Estimated Conditional Claim Rates for Fiscal
Year 2003, 1993-2003 Cohorts (Figure 10):
Table 9: Actual Versus Estimated Conditional Prepayment Rates for
Fiscal Year 2003, 1993-2003 Cohorts (Figure 10):
Table 10: Amount of FHA Prepayments During Fiscal Years 2000-2004
(Figure 11):
Table 11: Capital Ratio Versus Economic Value of the MMI Fund, Fiscal
Years 2000-2004 (Figure 12):
Table 12: Amortized Insurance-In-Force, Fiscal Years 2000-2004 (Figure
13):
Table 13: Minimum Required Capital Ratio Versus Actual Capital Ratio
(Figure 14):
Figures:
Figure 1: Calculation of Credit Subsidy for the Fund:
Figure 2: Relationship between Actuarial Review and Reestimate:
Figure 3: Annual Credit Subsidy Reestimates for the MMI Fund, Fiscal
Years 2000-2004:
Figure 4: Amount of the 2003 Reestimate Attributed to the 2001-2003
Cohorts, as a Percentage of the Original Loan Amount, for Single-Family
Loan Guarantee Programs:
Figure 5: Original Estimated Credit Subsidy Rates and Most Recent
Reestimated Rates for the FHA and VA Loan Guarantee Programs, 1992-2004
Cohorts:
Figure 6: Primary Factors Contributing to the Fiscal Year 2003 MMI
Credit Subsidy Reestimate:
Figure 7: Change in Future Cash Flow Estimates for the Fund from Fiscal
Year 2002 to Fiscal Year 2003:
Figure 8: Variables Contributing to the $3.9 Billion Change in
Estimated Cash Flows:
Figure 9: Increase in Estimated Cash Outflows from Removing the Loss
Mitigation Adjustment Factor, 1992-2003 Cohorts:
Figure 10: Actual Versus Estimated Conditional Claim and Prepayment
Rates for Fiscal Year 2003, 1993-2003 Cohorts:
Figure 11: Amount of FHA Prepayments during Fiscal Years 2000-2004:
Figure 12: Capital Ratio Versus Economic Value of the MMI Fund, Fiscal
Years 2000-2004:
Figure 13: Amortized Insurance-In-Force, Fiscal Years 2000-2004:
Figure 14: Minimum Required Capital Ratio Versus Actual Capital Ratio:
Abbreviations:
FCRA: Federal Credit Reform Act:
FHA: Federal Housing Administration:
HUD: U.S. Department of Housing and Urban Development:
OMB: U.S. Office of Management and Budget:
USDA: U.S. Department of Agriculture:
VA: U.S. Department of Veterans Affairs:
Letter September 2, 2005:
The Honorable Bob Ney:
Chairman:
Subcommittee on Housing and Community Opportunity:
Committee on Financial Services:
House of Representatives:
Dear Mr. Chairman:
The Department of Housing and Urban Development (HUD), through its
Federal Housing Administration (FHA), provides insurance for single-
family home mortgage loans made by private lenders. During fiscal year
2004, FHA insured 892,591 mortgages, representing $107.7 billion in
single-family mortgage insurance. The insurance program is supported by
the Mutual Mortgage Insurance Fund (Fund), which is financed through
insurance premiums that FHA charges its borrowers.[Footnote 1] FHA's
mortgage insurance program is currently a negative subsidy program,
meaning that the Fund is self-financed and operates at a profit.
In 2001 we reported that the Fund had an economic value, or net worth,
of about $15.8 billion (as of the end of fiscal year 1999) and a
capital ratio of 3.20 percent of the unamortized insurance-in-
force,[Footnote 2] or the initial amount of the mortgages.[Footnote 3]
We noted that the minimum required capital ratio of 2 percent, set by
Congress in 1990, appeared sufficient to withstand moderately severe
economic downturns that could lead to worse-than-expected loan
performance. In 2002, we reported that while loans made during the
1990s were performing much better than loans made in the 1980s,
performance was somewhat weaker for loans originated during the latter
1990s than for those originated earlier in the decade.[Footnote 4] Our
analysis suggested that changes in FHA's underwriting procedures and in
the conventional mortgage market may have increased the overall
riskiness of FHA's portfolio, potentially affecting the Fund's economic
value and its ability to withstand future economic downturns.
Therefore, we cautioned against concluding that the Fund could
withstand specified economic scenarios. In October 2004, FHA estimated
that the Fund had an economic value of about $22 billion and a capital
ratio of 5.5 percent. However, because of the uncertainty of these
measures and recent declines in loan performance, we continue to
believe that caution is warranted.
In recent years, FHA has adjusted its budget estimates to reflect that,
while not requiring subsidy, the performance of FHA-insured loans and
the resulting cash flows were not as strong as previously estimated.
Higher estimated costs caused the program to be less profitable than
previously estimated. Specifically, as of the end of fiscal year 2003,
FHA submitted a "reestimate" of $7 billion for the Fund. Given this
substantial reestimate of program cash flows, you asked us to (1)
assess the significance of the $7 billion reestimate, (2) determine
what factors contributed to the $7 billion reestimate and the
underlying loan performance variables influencing these factors, (3)
assess how the loan performance variables underlying the reestimate
could impact future estimates of new loans, and (4) assess what the
reestimate and the underlying loan performance variables mean for the
long-term viability of the Fund.
To respond to these objectives, we interviewed officials at FHA and
staff from the Office of Management and Budget (OMB). We collected and
analyzed budget data on FHA and comparable loan guarantee programs at
the Department of Veterans Affairs (VA), and Department of Agriculture
(USDA) to determine the significance of FHA's $7 billion credit subsidy
reestimate for the Fund. We interviewed FHA officials and FHA
contractors and collected and analyzed their written information and
data to determine the main factors contributing to the reestimate, the
underlying loan performance variables influencing these factors, and
the likelihood these variables could impact future estimates. We also
analyzed FHA and other data on new loan products and home mortgage
industry trends to assess what the reestimate and underlying loan
performance variables mean for the long-term viability of the Fund.
Details about our scope and methodology appear at the end of this
letter.
We conducted our work from November 2004 through July 2005 in
Washington, D.C., in accordance with generally accepted government
auditing standards.
Results in Brief:
The $7 billion credit subsidy reestimate for the Fund was more than
twice the size of FHA's other recent reestimates and represented a
greater proportion of the Fund's recent cohorts[Footnote 5] than was
the case for the 2003 reestimates for comparable loan guarantee
programs. While the $7 billion reestimate is unusually large, the
upward direction of FHA's recent reestimates in general is of concern
because of the increase in estimated cash outflows they represent.
Also, FHA's current credit subsidy estimates are, with one exception,
higher than the original estimates for all post-1991 cohorts.
Three major factors contributed to the $7 billion reestimate: a change
in the estimated future cash flows of its loans insured through 2003,
the difference between estimated and actual cash flows occurring during
fiscal year 2003, and an interest adjustment. The primary loan
performance variable underlying these factors is unexpectedly high
claims. For example, in 2003 FHA estimated that most cohorts would
experience more claim activity over the course of their 30-year terms
than it estimated in 2002, increasing estimated cash outflows by $2.5
billion. Higher-than-estimated prepayments as well as changing
assumptions about the impact that FHA's loss mitigation efforts could
have on claims are also important variables. For example, the revisions
to loss mitigation assumptions increased estimated cash outflows by
$1.7 billion.
The change in expected claims underlying the $7 billion reestimate will
likely affect credit subsidy estimates for future loan cohorts, but the
effect of prepayments is less certain. Several recent policy changes
and trends may help explain the increase in claims, including changes
to underwriting guidelines, competition from the private sector, and an
increase in the use of down payment assistance. It appears that these
policy changes and trends will continue to impact claims, and thus they
will likely continue to add risk to FHA's portfolio. Prepayment rates
increased significantly prior to the 2003 reestimate, but it is less
likely that the same conditions that caused the surge in prepayments
early in the decade will be repeated. The revisions to loss mitigation
assumptions will also affect future estimates of subsidy by no longer
artificially reducing claims, though the significance may decline. FHA
does not intend to use the same assumption again given its greater
historical experience with loss mitigation.
Because the loan performance variables underlying the $7 billion
reestimate will likely persist to varying degrees, they are also likely
to affect estimates of the Fund's long-term viability. The capital
ratio, a measure of the Fund's long-term viability, has increased in
recent years. However, if the Fund's economic value declines or is
restated at a lower level than previously estimated, because of higher
claims, and if the insurance-in-force remains steady, because of
declining prepayments, then the capital ratio will decline. Whether the
currently estimated 5.5 percent capital ratio or a lower capital ratio
is sufficient depends on the scenarios the Fund is expected to survive
while maintaining the minimum 2 percent reserve. Neither Congress nor
HUD has established criteria to determine how severe a stress the Fund
should be able to withstand.
To more reliably estimate program costs, we recommend that the
Secretary of HUD direct the FHA Commissioner to study and report the
impact on the forecasting ability of its loan performance models of
variables that have been found in other studies to influence credit
risk, such as payment-to-income ratios, credit scores, and the presence
of down payment assistance. We also recommend that when changing the
definitions of key variables, FHA should report the impact of such
changes on the forecasting ability of its loan performance models.
Background:
FHA was established in 1934 under the National Housing Act (P.L. 73-
479) to broaden homeownership, shore up and protect lending
institutions, and stimulate employment in the building industry by
providing mortgage insurance for loans made by private lenders.
Generally, borrowers are required to purchase single-family mortgage
insurance when the value of the mortgage is large relative to the price
of the house. Together, FHA, VA, USDA, and private mortgage insurers
provide virtually all of this insurance. FHA provides insurance for
mortgages that finance the purchase of properties with one to four
housing units, often by low-income, minority, and first-time
homebuyers.
The economic value of the Fund that supports FHA's guarantees depends
on the relative size of cash outflows and inflows over time. Cash flows
out of the Fund from payments associated with claims on defaulted loans
and refunds of up-front premiums on prepaid mortgages.[Footnote 6] To
cover these outflows, FHA receives cash inflows from up-front and
annual insurance premiums from borrowers and net proceeds from
recoveries on defaulted loans. If the Fund were to be exhausted, the
U.S. Treasury would have to cover lenders' claims directly.
The Fund remained relatively healthy from its inception until the 1980s
when claims and losses were substantial, primarily because of high
foreclosure rates in regions experiencing economic stress. These losses
prompted reforms that were enacted as part of the Omnibus Budget
Reconciliation Act of 1990 (P.L. 101-508). The reforms were designed to
place the Fund on an actuarially sound basis and required, among other
things, that it maintain a capital ratio of 2 percent of the insurance-
in-force and that an independent contractor conduct an annual actuarial
review of the Fund to analyze its economic value.
The Federal Credit Reform Act of 1990 (FCRA), enacted as part of the
Omnibus Budget Reconciliation Act of 1990, reformed budgeting methods
for federal credit programs, including FHA's mortgage insurance
program. As a result of FCRA, OMB requires federal credit agencies to
report the actual and estimated lifetime cost to the government of
their programs in their annual budgets. Similarly, federal accounting
standards require agencies to recognize the estimated lifetime costs of
their programs in their financial statements. To determine the expected
cost of credit programs, agencies predict or estimate the future
performance of the programs on a cohort basis. This cost, known as the
subsidy cost, is the net present value[Footnote 7] of estimated
payments the government makes less estimated amounts it receives over
the life of the loan or loan guarantee, excluding administrative costs.
For the Fund, the overall subsidy is currently a negative cost, meaning
that the present value of cash inflows exceeds cash outflows. Outflows
include claims paid on foreclosed properties, refunds of up-front
insurance premiums, and foreclosed property holding costs, while
inflows include insurance premiums and proceeds from the sale of
foreclosed properties, over the life of the loan guarantees (fig. 1).
Figure 1: Calculation of Credit Subsidy for the Fund:
[See PDF for image]
[End of figure]
FCRA established a special budgetary accounting system to record the
budget information necessary to implement credit reform. For loans and
loan guarantees made during or after fiscal year 1992--the effective
date of credit reform--federal agencies use program and financing
accounts to handle credit transactions.[Footnote 8] The program account
is included in budget totals, receives separate appropriations for the
administrative and subsidy costs of a credit program, and records the
budget authority and outlays for these costs. The program account is
used to pay the associated subsidy cost to the financing account when a
direct or guaranteed loan is disbursed. The financing account, which is
nonbudgetary,[Footnote 9] is used to collect the subsidy cost from the
program account, borrow from Treasury to provide financing for loan
disbursements, and record the lifetime cash flows associated with
direct loans or loan guarantees. In 2002, a new capital reserve account
was established for the Mutual Mortgage Insurance Fund to maintain
reserves for the post-1991 cohorts. In 2003 this new account started
earning interest on Treasury investments, collecting negative subsidy
and downward reestimates from the financing account, and paying upward
reestimates.
Agencies are required to reestimate subsidy costs annually to reflect
actual loan performance and expected changes in estimates of future
loan performance. Annual estimates of a program's expected lifetime
subsidy change from year to year. Beyond changes in estimation
methodology, each additional year provides more historical data on loan
performance that may influence estimates of the amount and timing of
future claims and prepayments. Economic assumptions also change from
one year to the next, including assumptions on interest rates,
unemployment, and home prices. Assumptions about the impact of policy
changes also can affect estimates of subsidy costs--for example, by
changing how loans are serviced or the treatment of foreclosed
properties, which potentially influences the timing and amount of
losses.
In accordance with the Omnibus Budget Reconciliation Act of 1990, FHA
contracts with private firms to prepare an annual actuarial
review.[Footnote 10] Figure 2 illustrates the relationship between the
actuarial review and the credit subsidy reestimate. For the review, the
contractors develop econometric loan performance models to estimate
future claim and prepayment activity for the loans FHA insures. The
contractors also develop a cash flow model through which they run the
output of the loan performance models. The actuarial cash flow model
calculates the net present value of future cash flows in and out of the
Fund to estimate its economic net worth and capital ratio. FHA also
uses the actuarial claim and prepayment data with its credit subsidy
cash flow model to estimate the net present value of future cash flows
for the budget and the ending balance of the liability for loan
guarantees in the financial statements. At the end of the fiscal year,
FHA uses a "balances approach" to compare the resources in the
financing account to the liability for loan guarantees.[Footnote 11]
The difference is the credit subsidy reestimate.
Figure 2: Relationship between Actuarial Review and Reestimate:
[See PDF for image]
[End of figure]
In November 1996, FHA implemented a new loss mitigation program that
included a range of options to help homeowners who have defaulted on
their mortgage to either retain their homes or enable FHA to dispose of
them in ways that reduced the costs of foreclosure. The loss mitigation
program has five options: (1) special forbearance, or a repayment
agreement between the lender and borrower to reinstate a loan; (2) loan
modification, which provides borrowers with a permanent reduction in
mortgage payment; (3) partial claim, which enables a borrower to get an
interest-free loan from HUD to bring their mortgage payments up to
date; (4) pre-foreclosure sale, which provides borrowers with a
transition to more affordable housing; and (5) deed-in-lieu of
foreclosure, an alternative to foreclosure whereby a borrower
voluntarily deeds the property to HUD and is released from all mortgage
obligations.
The $7 Billion Reestimate Is Significant for Its Size and Direction:
The $7 billion credit subsidy reestimate for the Fund was more than
twice the size of other recent FHA reestimates and represented a
greater proportion of the Fund's recent cohorts than other 2003
reestimates for comparable loan guarantee programs. Both this unusually
large reestimate and the upward direction of FHA's recent reestimates
are matters for concern. Overall, though the Fund still operates at a
profit, FHA's current reestimated credit subsidy rates are higher than
FHA originally estimated for all but one of the 1992 through 2004
cohorts. In comparison, current reestimated subsidy rates for VA's loan
guarantee program are lower than VA originally estimated for all but
one of the 1992 through 2004 cohorts.
The Reestimate Is Large Compared with Other Recent Reestimates and
Programs:
The $7 billion reestimate FHA reported in its 2003 financial statements
was by far the largest reestimate FHA has made in recent years. As
figure 3 illustrates, it was more than twice the size of any other
reestimate from 2000 through 2004, indicating that FHA's actual and
estimated cash flows have changed substantially.
Figure 3: Annual Credit Subsidy Reestimates for the MMI Fund, Fiscal
Years 2000-2004:
[See PDF for image]
[End of figure]
An alternative way of measuring the magnitude of the reestimate is by
comparing it with reestimates for comparable loan guarantee programs.
FHA's 2003 reestimate was also unusually large compared with
reestimates for the same year for VA's and USDA's single-family loan
guarantee programs.[Footnote 12] FHA reestimates the credit subsidy
separately for each cohort of loans that it insures, totaling the
separate reestimates into one overall reestimate for the fiscal year.
Loans that FHA insured in 2001 through 2003 accounted for $4.5 billion,
or 64 percent, of the total $7 billion reestimate. The $4.5 billion of
the reestimate attributed to these three cohorts of loans equaled 1.22
percent of their combined total endorsements.[Footnote 13] As figure 4
illustrates, this percentage is more than double that of comparable
loan guarantee programs at VA and USDA.
Figure 4: Amount of the 2003 Reestimate Attributed to the 2001-2003
Cohorts, as a Percentage of the Original Loan Amount, for Single-Family
Loan Guarantee Programs:
[See PDF for image]
[End of figure]
FHA's Current Reestimated Subsidy Rates Are Less Favorable Than Its
Original Estimates:
FHA has estimated negative credit subsidies for the Fund since 1992,
when credit reform became effective. However, with one exception,
current reestimated subsidy rates for FHA's loan guarantees are less
favorable than originally estimated. Meanwhile, across the country home
prices have been growing faster and more uniformly since 2000 than they
grew during the 1990s and most of the 1980s. This indicates that very
few borrowers would have seen their home values decline to the point at
which their homes were worth less than their mortgage balances, putting
them at a greater risk of foreclosure and causing subsidy rates to
worsen. In keeping with the trend of increasing home prices, current
reestimated rates for VA's program are more favorable than originally
estimated. As shown in figure 5, the original and current subsidy cost
estimates for FHA's 1992 through 2004 cohorts were negative, meaning
FHA estimated total cash inflows to be greater than outflows over the
life of each cohort. FHA's most recent reestimates indicate that all
but the 1992 cohort will be less profitable than originally estimated,
though FHA is not estimating that these cohorts will have overall
negative cash flows. In comparison, the original subsidy estimates for
VA's 1992 through 2004 cohorts did indicate negative cash flows,
meaning VA estimated that the present value of total cash outflows
would exceed inflows over the life of each cohort. With the exception
of one cohort, VA's reestimated subsidy costs are all lower than
originally estimated, indicating that VA currently estimates that its
cohorts will perform better than originally expected. However, VA
estimates that several cohorts will continue to have overall negative
cash flows.
Figure 5: Original Estimated Credit Subsidy Rates and Most Recent
Reestimated Rates for the FHA and VA Loan Guarantee Programs, 1992-2004
Cohorts:
[See PDF for image]
[End of figure]
The $7 Billion Reestimate Primarily Reflects Higher-Than-Estimated
Claims:
The $7 billion reestimate represents the changes in FHA's estimates of
future loan performance and the change in cash flows stemming from the
difference between estimated and actual loan performance during fiscal
year 2003. These changes primarily reflect the impact of higher-than-
estimated claims, but also reflect the impact of higher-than-estimated
prepayments and a technical change in FHA's calculation of claims. The
reestimate also represents an interest adjustment (fig. 6).
Figure 6: Primary Factors Contributing to the Fiscal Year 2003 MMI
Credit Subsidy Reestimate:
[See PDF for image]
[End of figure]
Three Main Factors Contributed to the Reestimate:
The largest contributing factor--55 percent--was the $3.9 billion
difference between FHA's fiscal year 2003 estimates of the net present
value of future cash flows and the estimates it made one year earlier.
As previously discussed, FHA estimates the value of expected future
cash flows each year by calculating the present value of anticipated
cash outflows, such as claim payments and premium refunds, and
subtracting inflows, such as insurance premiums and proceeds from the
sale of foreclosed properties. In 2002, FHA estimated that the net
present value of future cash flows for the 1992 through 2002 cohorts
was a positive $1.9 billion, meaning that FHA expected cash inflows to
exceed cash outflows on a net present value basis. In 2003, FHA
estimated that the net present value of future cash flows for the 1992
through 2003 cohorts was negative $2 billion, meaning that FHA expected
future cash outflows to exceed future cash inflows.[Footnote 14] As
figure 7 illustrates, the difference between the two estimates is $3.9
billion.
Figure 7: Change in Future Cash Flow Estimates for the Fund from Fiscal
Year 2002 to Fiscal Year 2003:
[See PDF for image]
[End of figure]
The second factor contributing to the $7 billion reestimate--30
percent--was the $2.1 billion difference between estimated and actual
cash flows occurring during fiscal year 2003. This amount indicates
that FHA had $2.1 billion less in cash inflows during 2003 than it had
estimated it would have a year earlier. The final factor contributing
to the reestimate (15 percent) was the $1.1 billion of interest on the
reestimate. OMB guidance requires agencies to calculate an interest
adjustment on the reestimate.[Footnote 15] In FHA's case, the interest
adjustment increased the total reestimate by $1.1 billion.
A Change in Estimated Claims Was the Primary Loan Performance Variable
Behind the $3.9 Billion Change in Estimated Future Cash Flows:
Approximately $2.7 billion (70 percent) of the $3.9 billion net change
in FHA's estimate of future cash flows stems from changes in FHA's
estimates of claims and, to a lesser extent, prepayments (fig. 8). That
is, FHA changed its estimate of future loan performance based on its
observation of actual loan performance during 2003 and revised economic
assumptions. In 2003 FHA estimated that, except for the 1993 and 1994
loan cohorts, all cohorts would experience more claim activity over the
course of their 30-year terms--and thus increase FHA's outflows--than
estimated in 2002. The cash flows associated with these claims
increased estimated cash outflows by $2.5 billion, accounting for 92
percent of the $2.7 billion. Increases in the expected level of
prepayments also affected FHA's estimate of future cash flows. FHA
estimated in 2003 that about half of the cohorts would experience more
prepayment activity than it had estimated in 2002. Because of the
increase in estimated prepayments, FHA expected to collect less premium
income and to pay out premium refunds more often, reducing estimated
cash inflows by about $200 million and accounting for 8 percent of the
$2.7 billion.
Figure 8: Variables Contributing to the $3.9 Billion Change in
Estimated Cash Flows:
[See PDF for image]
[End of figure]
Another major variable that contributed to the $3.9 billion change in
estimated future cash flows was a technical change in FHA's calculation
of claims that increased the reestimate by $1.7 billion. Specifically,
for estimates prepared during fiscal years 2001 and 2002, FHA used a
cash flow assumption--a loss mitigation adjustment factor--to reduce
the claim rates predicted by the actuarial review and used in the
subsidy cash flow model. FHA had been using this factor in the belief
that the historical data used to estimate claim rates did not include
enough years under the loss mitigation program to adequately reflect
the impact of this program--that is, an expected decline in claims.
However, FHA officials stated that in fiscal year 2003 FHA removed the
factor because the historical loan performance data, which by then
included more years of experience with the loss mitigation program,
sufficiently reflected the program's impact. In addition, FHA noted
that its actuarial review was underestimating claims, making it
counterproductive to use a loss mitigation adjustment factor that
further reduced the actuarial claim predictions. Removing the loss
mitigation adjustment factor from the 2003 subsidy cash flow model
increased the reestimate by a total of $1.7 billion, with the greatest
increase related to loans made in the most recent years (fig. 9).
Figure 9: Increase in Estimated Cash Outflows from Removing the Loss
Mitigation Adjustment Factor, 1992-2003 Cohorts:
[See PDF for image]
[End of figure]
The above increases in estimated cash outflows are offset by the
estimated additional cash inflows from new loans that FHA insured in
2003. Specifically, FHA estimated that for loans originating during
2003, future inflows would exceed future outflows by $1 billion.
Several other factors had much smaller positive or negative impacts on
future cash flows. The net impact of these other factors contributed
$500 million to the reestimate.
Higher-Than-Estimated Claims and Prepayments Contributed to the $2.1
Billion Difference between Estimated and Actual Cash Flows Occurring
during 2003:
The remaining part of the $7 billion--$2.1 billion--represents the
difference between estimated and actual cash flows occurring during
fiscal year 2003. Certain elements of the difference relate to the 1992
through 2002 cohorts, including $330 million in underestimated claims
and recoveries on claims and $1 billion in overestimated net fees
(insurance premium receipts less premium refunds). The remaining $700
million relates to cash flow differences associated with the 2003
cohort.
Our analysis of loan performance data found that claims and prepayments
occurring during 2003 exceeded FHA's estimates. As figure 10
illustrates, actual claim activity in fiscal year 2003 exceeded
estimated claim activity for 2003--by twice as much in some cases--for
the majority of loan cohorts. For example, FHA estimated that about 1.6
percent of all the loans it insured in 2000 that were in the portfolio
at the beginning of 2003 would result in a claim during 2003. However,
4 percent of such loans actually ended in a claim in 2003. Actual
prepayment activity exceeded estimated prepayment activity for all loan
cohorts. For example, FHA estimated that 14 percent of all the loans it
insured in 2001 that were still in the portfolio at the beginning of
2003 would prepay during 2003. However, more than 40 percent of such
loans actually prepaid during 2003. Because of the additional claims it
paid, up-front premiums it refunded, and the annual premiums it lost,
FHA's cash inflows for the year declined and resulted in a $2.1 billion
upward adjustment of the Fund's credit subsidy.
Figure 10: Actual Versus Estimated Conditional Claim and Prepayment
Rates for Fiscal Year 2003, 1993-2003 Cohorts:
[See PDF for image]
Note: The 2003 estimate data are from the 2002 actuarial review. The
2003 actual data are from the 2004 actuarial review.
[End of figure]
The Loan Performance Variables Underlying the $7 Billion Reestimate
Will Likely Affect Future Credit Subsidy Estimates, but Are Being
Addressed:
The events behind the change in expected claims underlying the $7
billion reestimate will likely continue to affect future credit subsidy
estimates, though prepayments may have a smaller effect. The one-time
modeling change caused by removing the loss mitigation adjustment
factor should also continue to have an effect on future estimates,
though its significance may decline.
Higher Claims Will Likely Continue, but FHA Is Taking Steps to Improve
Its Estimates:
As we have seen, the $7 billion reestimate was largely due to higher-
than-estimated claims. Several recent events may help explain this
increase, including changes to underwriting guidelines, competition
from the private sector, and an increase in the use of down payment
assistance. FHA has taken some steps to tighten underwriting and to
better estimate claims, but it is not clear that these steps will be
sufficient to reverse recent increases in claims or significantly
improve future estimates of claims.
According to FHA, revised underwriting guidelines issued in 1995
represented significant changes that would enhance home-buying
opportunities for a substantial number of borrowers. These changes made
it easier for borrowers to qualify for loans and for higher loan
amounts. In previous work, we noted that these underwriting changes may
partly explain the higher claim rates of the late 1990s.[Footnote 16]
FHA officials told us that since making these changes, FHA's share of
first-time homebuyers has increased by more than 30 percent, and its
share of minority homebuyers has increased by 40 percent. FHA officials
noted that these borrowers are more susceptible to changes in economic
conditions and, thus, may be more likely to default on their mortgages.
The officials also noted that, while this change in the composition of
their borrowers had resulted in a one-time increase in claims, claims
have leveled off and should remain steady at the new level.
To evaluate the impact of the underwriting changes, FHA introduced a
simple variable into its annual actuarial models that captures whether
or not a loan was made after fiscal year 1995. This variable is
intended to capture the one-time impact of the 1995 underwriting
changes, not to capture any adverse trends that might result from
changes that accrue over time, such as increasing competition from the
private sector or the growing prevalence of down payment assistance. If
there are adverse trends, as opposed to only one-time changes, the
model will not fully capture them and, therefore, will likely
underestimate future claims. For example, if loans with down payment
assistance have higher claims and if this category of loans grows over
time, then the claim model will consistently underestimate claims and
the model's error will worsen with time.
In 2002, we reported that the performance of loans insured during the
late 1990s was weaker than the performance of loans originated earlier
in the decade. We noted then that increased competition and changes in
the conventional mortgage market could result in FHA's insuring
relatively more loans that carried greater risk. These issues continue
to be significant. In recent years, private mortgage insurers and
conventional mortgage lenders have increasingly offered products that
compete with FHA for homebuyers who are borrowing more than 95 percent
of the value of their home. In addition, automated underwriting systems
and credit-scoring analytic software are believed to be able to more
effectively distinguish low-risk loans for expedited processing. If, by
selectively offering these low down payment loans to better risk
borrowers, conventional mortgage lenders and private mortgage insurers
were able to attract lower-risk borrowers that would have traditionally
sought FHA-insured loans, recent FHA-insured loans with down payments
of less than 5 percent may be more risky on average than they have been
historically.
A growing trend that has raised some concerns and may increase claims
is the use of seller-funded down payment assistance for mortgages
insured by FHA. FHA requires borrowers to make a 3 percent contribution
toward the purchase of the property, but that contribution can come
indirectly through borrowers' relatives or nonprofit organizations.
Although FHA does not permit down payment funds to come directly or
indirectly from sellers, it does permit nonprofits that receive
contributions from sellers to provide down payment assistance to
homebuyers. Many conventional mortgage products also permit down
payment funds to come from sources other than the borrower; however,
the terms of these mortgage products generally stipulate that such
funds cannot come either directly or indirectly from an interested or
seller-related party. A HUD Office of the Inspector General evaluation
of FHA-insured loans found that loans with down payment assistance from
seller-funded nonprofits had a greater risk of default and that the
percentage of FHA-insured loans with down payment assistance from
seller-funded nonprofits was growing at an increasing rate. As of July
2005, FHA had not revised its policies regarding acceptable sources of
down payment assistance or imposed additional underwriting requirements
on borrowers who obtained down payment assistance from seller-funded
nonprofits. At your request, we are currently conducting a study on
down payment assistance and evaluating the performance of these loans.
A program assessment jointly prepared by OMB and FHA and included with
the 2006 President's Budget noted that FHA's loan performance model is
neither accurate nor reliable because it consistently under predicts
claims. For the 2004 actuarial review, FHA worked with a new contractor
to redesign and respecify its loan performance models. FHA continues to
work on improving its new models so that it can more accurately and
reliably predict claims and prepayments. Several factors distinguish
the new models from those used previously. First, the new models use
quarterly data, while the previous models used annual data. In
addition, the new models explicitly address the time lag in claims and
the implications of the time lag for prepayments,[Footnote 17] and
allow for a closer correspondence between the actual and predicted time
pattern of claim and prepayment rates. These changes may improve the
models' ability to predict the number and timing of claims and
prepayments. Nonetheless, for the 2004 actuarial review FHA had to
adjust model estimates of claims that will occur in fiscal years 2004
through 2006 for all loan cohorts. By the third quarter of fiscal year
2004, while FHA was preparing the 2004 actuarial review, FHA realized
that actual claims for the year were outpacing the amount of estimated
claims based on data from the first half of 2004 and earlier. FHA and
its contractors assumed this difference was caused by a temporary
deviation and adjusted the model's projected claim rates to match the
recorded claim counts. Specifically, FHA applied a claim rate
multiplier to increase estimated claim rates by 50 percent for all
cohorts for fiscal years 2004 and 2005 and by 25 percent for fiscal
year 2006. Because FHA was responding to what it believed to be a
temporary deviation, it did not apply the multiplier to any years after
2006.
The new models also eliminated some explanatory variables, such as
unemployment rates and payment-to-income ratios, and altered the
definitions of other key variables. For example, the previous models
assumed that borrowers who passed up profitable refinancing
opportunities would experience permanently higher claim rates--
sometimes referred to as burnout--while the new models assume that
higher claim rates are a temporary phenomenon that will last only 2
years. In addition, neither model incorporates certain variables that
have been found to be important in assessing credit risk, such as
credit scores and the source of down payments. FHA officials are
researching these variables currently. FHA officials told us they will
not be including credit scores for the 2005 actuarial review, though
they are considering ways to account for credit scores in the 2006
actuarial model. For the 2005 model, FHA made adjustments for the
source of down payments by adjusting the loan-to-value ratio for seller-
funded down payment assistance. On balance, it is not clear that these
changes to the actuarial models will permit FHA to more reliably
estimate claim (or prepayment) activity. In fact, the $7 billion
reestimate was followed a year later with an upward reestimate of $2.3
billion for fiscal year 2004.
Prepayments Had a Smaller Impact on the $7 Billion Reestimate and Their
Impact on Future Credit Subsidy Estimates Is Uncertain:
While claims may have been the largest driver behind the reestimate,
prepayments also had an impact. As we discussed above, FHA experienced
a significant increase in prepayment activity from 2001 through 2004.
As figure 11 illustrates, between 2000 and 2001, the dollar amount of
prepayments more than doubled, rising from $37 billion to $82 billion.
Prepayments reached a total of $190 billion in 2003 and decreased
slightly to $123 billion in 2004.
Figure 11: Amount of FHA Prepayments during Fiscal Years 2000-2004:
[See PDF for image]
[End of figure]
FHA experienced surges of prepayment activity in the mid-1980s and
early 1990s. All three of these time periods coincided with periods of
declining interest rates, though the rates of prepayment are highest in
2003, when mortgage interest rates reached a 30-year low. As of July
2005, mortgage interest rates had declined even further from their 2004
level, though by a much smaller amount compared with the 2002-2003
decline. Because it is difficult to project future interest rates, it
is difficult to project their impact on future prepayment activity. As
we noted previously, house prices have risen faster in the first part
of the decade than they did in the 1990s or most of the 1980s. Rapid
appreciation in housing prices permits borrowers to refinance using
conventional loans, however, it is uncertain that the upward trend in
appreciation will continue.
One-time Removal of Loss Mitigation Factor Should Continue to Affect
Future Estimates:
The removal of the loss mitigation adjustment factor also had a notable
impact, affecting the cash flow model's calculation of claims and thus
contributing $1.7 billion to the reestimate. FHA does not intend to use
this adjustment again given its greater historical experience with loss
mitigation. That is, FHA expects that the historical data on which loan
performance estimates are based will include and reflect more years of
experience with the loss mitigation program. However, this change in
the assumptions used in estimating loan performance will affect the
estimated subsidy costs of new cohorts because estimates of future
cohorts will not include the loss mitigation adjustment factor, though
the significance of no longer making this adjustment may decline over
time. That is, as FHA estimates of loan performance include more
historical experience with loss mitigation, any positive effect loss
mitigation may have would be reflected in the loan performance
variables.
Recent Policy Changes May Affect Claims and Prepayments:
In recent years, FHA has introduced several policy changes that may
affect claim activity. Since 2000, FHA has loosened some underwriting
procedures to encourage homeownership. For example, FHA increased the
amount of the mortgage payment it will permit relative to borrower
income. Specifically, in April 2005, FHA increased its maximum payment-
to-income ratio from 29 percent to 31 percent and its debt-to-income
ratio from 41 percent to 43 percent.[Footnote 18] By increasing these
qualifying ratios, FHA could offer mortgage insurance to borrowers who
would not have otherwise been approved for a loan. However, borrowers
who devote more of their income to their mortgage payments could have
trouble meeting their payments if they encounter financial trouble. FHA
made these changes in response to recent federal tax cuts, which
increased potential borrowers' buying power. Therefore, FHA noted, the
changes should broaden eligibility without increasing the risk of
default.
FHA has also taken steps to tighten some underwriting guidelines. For
example, in 2000 it changed its policies on gift transfers and the
types of assets that may be considered for cash reserves. FHA now
requires more documentation for gift transfers to ensure that the funds
are applied toward the borrower's down payment and come from sources
with no interest in the sale of the property. However, in a recent
review of FHA's new mortgage loan products, we found that FHA does
permit nonprofits that receive contributions from sellers to provide
down payment assistance to borrowers.[Footnote 19] FHA also now
requires lenders to ensure that borrowers' assets, such as retirement
accounts, can be easily converted into cash before applying them toward
cash reserves. This policy change requires that lenders account for any
applicable taxes or withdrawal penalties that borrowers may incur when
converting their assets to cash, potentially reducing the amount of
cash available to these borrowers. In early 2004 FHA introduced the
Technology Open to Approved Lenders Mortgage Scorecard. This tool is
used in conjunction with automated underwriting systems to evaluate the
credit risk of borrowers who apply for FHA insured loans. The
introduction of the new mortgage scorecard may help FHA and lenders
more efficiently and effectively identify and evaluate credit risk and,
therefore, may help reduce claims.
FHA has taken measures to enhance the effectiveness of its loss
mitigation program. In 2002, FHA modified some of its loss mitigation
options to give lenders more flexibility to assist borrowers who are
unable to make their monthly payments, help avoid or reduce the time
and expense of the foreclosure process, and enable borrowers to obtain
credit again in the future. FHA believes that the introduction of loss
mitigation and changes made since the program's implementation should
reduce losses it incurs when borrowers default on their loans. FHA also
introduced the Accelerated Claim Disposition demonstration program in
2002 (referred to as the "601" program) to streamline the claim and
property disposition processes with the goal of reducing losses to the
Fund.
FHA has also made some recent policy changes that may affect prepayment
activity. For example, FHA changed its up-front mortgage insurance
premium rules for mortgages endorsed after December 2004. In the past,
FHA refunded a percentage of the up-front premium to borrowers when
they prepaid their loans, typically by refinancing or selling their
homes. Borrowers were entitled to this refund even when they refinanced
outside of FHA. For new loans guaranteed after December 2004, FHA will
no longer refund a percentage of the up-front premium to borrowers who
refinance their mortgages outside of FHA. FHA also shortened the refund
schedule of the up-front premium from 5 to 3 years. These changes could
encourage borrowers to refinance their mortgage with another FHA-
insured loan, while reducing the amount of refunds that FHA pays to
borrowers who refinance or sell their homes. However, these changes may
also discourage some borrowers from choosing to finance their home
purchases with an FHA-insured mortgage. FHA predicts that the changes
to its up-front premium rules will increase cash flows by about $168
million annually.
The Loan Performance Variables Underlying the Reestimate Could Affect
Estimates of the Fund's Long-Term Viability:
The effect of recent trends on the loan performance variables
underlying the $7 billion reestimate will likely persist to varying
degrees and therefore affect estimates of the Fund's long-term
viability. The capital ratio, a measure of the Fund's long-term
viability, has increased in recent years. However, should the economic
value decline or be restated as lower than previously estimated (due to
higher-than-estimated claims), and should the insurance-in-force remain
steady (due to declining prepayments), then the capital ratio will
decline. Whether the currently estimated 5.5 percent capital ratio or a
lower capital ratio is sufficient to meet federal requirements depends
on what conditions the Fund is expected to survive while maintaining
the minimum 2 percent reserve. Neither the Congress nor HUD has
established criteria to determine how severe of a stress the Fund
should be able to withstand.
The Fund is required to maintain a minimum capital ratio (a measure of
its long-term viability) of 2 percent of the insurance-in-force. As
figure 12 illustrates, the Fund's capital ratio has been well above 3
percent and rising since fiscal year 2000. The economic value of the
Fund--the sum of existing capital plus the net present value of
expected future cash flows from existing cohorts--has also been rising
for a number of years, though it declined in fiscal year 2004. However,
the Fund's insurance-in-force declined 20 percent between 2002 and 2004
in response to increased claim and prepayment activity during those
years and a decline in new loan originations. As the capital ratio is
the Fund's economic value divided by its insurance-in-force, the
capital ratio only increased because the decrease in the insurance-in-
force was proportionately larger than the decrease in the economic
value of the Fund.
Figure 12: Capital Ratio Versus Economic Value of the MMI Fund, Fiscal
Years 2000-2004:
[See PDF for image]
[End of figure]
If the economic value declines or is restated at a lower level than
previously estimated and if the insurance-in-force does not decline
(for example, due to substantial prepayments), then the capital ratio
will decline. As we noted, the events that help explain the increase in
claims underlying the $7 billion reestimate--such as changes in
underwriting guidelines, competition from the private sector, and an
increase in the use of down payment assistance--do not appear to be one-
time events and likely will continue to add risk to FHA's portfolio.
For example, the borrowers FHA has attracted since introducing its 1995
underwriting changes are more susceptible to economic downturns and,
therefore, more likely to default on their mortgages. Further, despite
HUD's Office of the Inspector General finding that loans with down
payment assistance from seller-funded nonprofits have a greater risk of
default, the percentage of FHA- insured loans with down payment
assistance from seller-funded nonprofits is growing at an increasing
rate.
FHA has introduced several policy changes that may help reduce claim
activity, such as requiring lenders to ensure that borrowers' assets
can be easily converted into cash before applying them toward cash
reserves and introducing the TOTAL Mortgage Scorecard to evaluate the
credit risk of borrowers who apply for FHA-insured loans. Despite these
changes, it seems likely that FHA's higher level of claims will
continue. Higher claim rates imply a lower estimated economic value of
the Fund.
While prepayment rates increased significantly in the early part of the
decade, it is less likely that the same conditions that caused the
surge in prepayments will be repeated, reducing the impact that
prepayments may have on reducing the insurance-in-force. As we noted
above, the three surges of prepayment activity that FHA experienced
coincided with periods of declining interest rates. The rates of
prepayment were highest in 2003, when mortgage interest rates reached a
30-year low. As figure 13 illustrates, the Fund's amortized insurance-
in-force also declined in fiscal years 2003 and 2004 as prepaying
borrowers left the portfolio. Mortgage interest rates have been even
lower in the spring and early summer of 2005. Even if prepayments slow,
should claim activity continue to be higher and FHA be unable to
compete for new borrowers, the Fund's insurance-in-force may shrink.
But if the net effect is that the size of the portfolio stabilizes or
declines only slightly, higher claim activity could result in a lower
capital ratio.
Figure 13: Amortized Insurance-In-Force, Fiscal Years 2000-2004:
[See PDF for image]
[End of figure]
The long-term viability of the Fund depends on both the impact that the
underlying change in loan performance may have on the capital ratio and
the conditions or scenarios under which Congress expects the Fund to
maintain its 2 percent minimum reserve. A lower capital ratio would
mean that the Fund is less able to withstand adverse economic
conditions. As figure 14 illustrates, the Fund's capital ratio has been
well above the 2 percent minimum and rising since fiscal year 2000. But
whether the currently estimated 5.5 percent capital ratio or a lower
capital ratio is sufficient depends on what conditions the Fund is
expected to survive while maintaining the minimum 2 percent reserve.
Figure 14: Minimum Required Capital Ratio Versus Actual Capital Ratio:
[See PDF for image]
[End of figure]
Because economic downturns put downward pressure on house prices and
incomes, they can stress FHA's ability to meet its obligations. Thus,
it is reasonable that measures of the financial soundness of the Fund
would be based on tests of the Fund's ability to withstand recent
recessions or regional economic downturns. The 2004 actuarial review
examines four stress scenarios, none of which are particularly severe.
Three of the 4 stress tests examine one source of stress at a time,
while one examines two stresses simultaneously. A severe stress test
would examine the possibility of multiple stresses occurring
simultaneously, such as a decrease in house prices coupled with a
decrease in recoveries on the sale of foreclosed homes and an increase
in the dispersion of house price changes across multiple regions.
Neither Congress nor HUD has established criteria to determine how
severe a stress the Fund should be able to withstand. While the Fund
continues to maintain a capital ratio above the required minimum, we
have recommended in the past that HUD develop criteria that specify the
economic conditions the Fund should be able to withstand and the
capital ratios currently consistent with those criteria. We also
recommended that the annual actuarial analysis give more attention to
tests of the Fund's ability to withstand appropriate stresses. Finally,
we recommended that HUD develop better tools for assessing the impact
that policy changes may have on the volume and riskiness of the loans
that FHA insures.[Footnote 20]
Conclusions:
There are two important ways that FHA can manage risks to the Fund and
its ability to withstand economic downturns. First, FHA needs to be
able to reliably estimate program costs. To do so, FHA needs to
understand the factors that influence loan performance and, considering
this information, accurately estimate future claims and prepayments and
the resulting cash flows. Without better estimates of loan performance,
FHA cannot reasonably estimate the economic net worth of the Fund or
its capital ratio. Second, even if FHA can better estimate program
costs, it still needs to know what conditions the Fund is expected to
endure while maintaining the minimum 2 percent capital reserve.
Recommendations for Executive Action:
To more reliably estimate program costs, the Secretary of HUD should
direct the FHA Commissioner to study and report in the annual actuarial
review the impact of variables that have been found in other studies to
influence credit risk, such as payment-to-income ratios, credit scores,
and the presence of down payment assistance, on the forecasting ability
of the loan performance models used in FHA's actuarial reviews of the
Fund. FHA also should report in its annual actuarial review the impact
of any changes it makes to key variables, such as the burnout variable,
on the forecasting ability of the loan performance models.
Agency Comments and Our Evaluation:
We provided HUD, VA, and OMB with a draft of this report for their
review and comment. We received written comments from HUD, which are
reprinted in appendix III. We also received technical comments from
HUD, which have been incorporated where appropriate. VA and OMB did not
have comments on the draft.
HUD stated that it agrees with GAO's overall finding that higher than
projected claims were a significant variable underlying the $7 billion
reestimate, and that its 1995 underwriting changes help explain the
increase in claims. HUD also agreed with our description of the steps
it has taken to better estimate claims in its recent actuarial reviews.
HUD raised a concern that our first recommendation would require FHA to
direct its actuarial contractor to include certain variables in its
loan performance models, and that this would compromise the requirement
for an independent actuarial study of the Fund. In response, we
recommend instead that FHA study and report in the annual actuarial
review the impact of such variables on the forecasting ability of the
loan performance models. HUD further noted that its contractor is
actively considering the specific variables that we had recommended FHA
include in its annual actuarial review.
In response to our second recommendation that FHA report in its
actuarial review the impact of any changes it makes to key variables on
the forecasting ability of its loan performance models, HUD noted that
the actuarial reviews and appendices contain full documentation of the
models and justifications for the selection of the included variables
and their definitions. However, we found, for example, that the 2004
actuarial review did not fully document or justify the change in the
definition of the burnout variable. Specifically, the 2004 actuarial
review contained only a short statement regarding this change, with no
accompanying analysis of its impact on the forecasting ability of FHA's
loan performance models. We therefore continue to recommend that the
annual actuarial review include analyses of the impact of changes made
to key variables on the forecasting ability of the loan performance
models.
As agreed with your office, unless you publicly announce the contents
of this report earlier, we plan no further distribution until 30 days
from the report date. At that time, we will send copies of this report
to interested Members of Congress and congressional committees. We will
also send copies to the Secretary of Housing and Urban Development and
Director of the Office of Management and Budget and make copies
available to others upon request. In addition, this report will be
available at no charge on the GAO Web site at [Hyperlink,
http://www.gao.gov].
If you or your staff have any questions about this report, please
contact me at (202) 512-8678 or shearw@gao.gov. Contact points for our
offices of Congressional Relations and Public Affairs may be found on
the last page of this report. GAO staff who made key contributions to
this report are listed in appendix IV.
Sincerely yours,
Signed by:
William B. Shear:
Director, Financial Markets and Community Investment:
[End of section]
Appendixes:
Appendix I: Scope and Methodology:
To assess the significance of the $7 billion reestimate, we interviewed
officials at the Department of Housing and Urban Development's (HUD)
Federal Housing Administration (FHA) and Office of the Inspector
General (OIG) and staff from the Office of Management and Budget (OMB).
We reviewed the fiscal year 2000-2004 audited financial statements for
FHA to compare the size and direction of MMI reestimates over time. We
analyzed data from the fiscal year 2005-2006 Federal Credit Supplements
to compare the size and direction of reestimates, by cohort, among
comparable loan guarantee programs at FHA, the Department of Veterans
Affairs, and Department of Agriculture.
To determine what factors contributed to the $7 billion reestimate and
the underlying loan performance variables influencing these factors, we
collected and analyzed supporting documentation for the reestimate,
including analyses prepared by FHA and work papers prepared by FHA's
financial statement auditor. We collected and analyzed the fiscal year
2000-2004 actuarial reviews of the MMI Fund and related loan
performance data to examine trends in loan performance and consider the
impact that model changes may have had on estimated subsidy costs. We
collected and analyzed fiscal year 2002-2003 credit subsidy cash flow
models used to calculate the reestimates for those years, to consider
the impact of loan performance on cash flows. We supplemented this
analysis by interviewing the 2003 financial statement auditors, OMB
staff, officials in the OIG, FHA staff, FHA contractors that assist in
the preparation of the reestimate, and the 2004 actuarial review
contractors for background information to verify our findings on the
factors and underlying loan performance variables.
To assess the control procedures governing the loan performance data we
collected, we reviewed the findings of our previous studies in which we
assessed the reliability of data for FHA-insured loans that came from
the same source as the data used in this report. While the data in
these previous reports covered a limited number of loan cohorts, the
control activities we reviewed apply to all cohorts. In 2004 we
assessed the reliability of a random sample of FHA-insured loans from
the 1996-1999 cohorts, comparing seven elements of the paper loan file
to the electronic file to determine if they matched, and found no
material errors. We also reviewed several years' worth of FHA financial
statement audits and found no known or suspected problems with the
relevant FHA information systems. From these steps, we concluded these
data were sufficiently reliable for our analyses.[Footnote 21] In 2005
we obtained loan performance data on FHA-insured loans from the 1992,
1994, and 1996 cohorts. To verify this data, we met with FHA staff
involved in generating the sample data set and discussed data quality
procedures with appropriate FHA staff. FHA officials indicated that
their data systems contain data entry checks and that data submitted by
lenders were reviewed by FHA. As part of its annual financial statement
audit, FHA's data system was audited by external auditors, and no major
issues concerning data quality were raised. Based on these discussions,
we determined that the FHA data were sufficiently reliable for our
analyses.[Footnote 22]
To assess how the loan performance variables underlying the reestimate
could impact future estimates of new loans, we interviewed FHA
officials and the contractors for the 2004 actuarial review regarding
the causes of the loan performance variables and their impact on future
estimates. We also discussed recent and planned changes to the loan
performance models that may affect FHA's future estimates. We reviewed
recent policy changes that may impact loan performance variables by
analyzing relevant policy changes discussed in recent actuarial reviews
and mortgagee letters issued by FHA through the HUD Web site.
To assess what the reestimate and its underlying loan performance
variables mean for the long-term viability of the Fund, we analyzed FHA
and other data on new loan products and home mortgage industry trends.
We reviewed prior GAO reports describing changes in the home mortgage
market and FHA loan performance and used professional judgment to opine
on whether earlier concerns for the viability of the Fund persist.
[End of section]
Appendix II: Data for Figures Used in This Report:
Table 1: Annual Credit Subsidy Reestimates For the MMI Fund, Fiscal
Years 2000-2004 (Figure 3):
Dollars in millions:
Fiscal year: 2000;
Credit subsidy reestimate: $3,350.
Fiscal year: 2001;
Credit subsidy reestimate: -$1,687.
Fiscal year: 2002;
Credit subsidy reestimate: $1,526.
Fiscal year: 2003;
Credit subsidy reestimate: $7,029.
Fiscal year: 2004;
Credit subsidy reestimate: $2,340.
Source: GAO analysis of FHA data.
[End of table]
Table 2: Amount of the 2003 Reestimate Attributed to the 2001-2003
Cohorts, as a Percentage of the Original Loan Amount, For Single-Family
Loan Guarantee Programs (Figure 4):
Agencies: FHA;
Current reestimate as a percentage of total disbursements: 1.22%.
Agencies: VA;
Current reestimate as a percentage of total disbursements: 0.46%.
Agencies: USDA;
Current reestimate as a percentage of total disbursements: 0.50%.
Source: GAO analysis of Federal Credit Supplements, fiscal years 2005
and 2006.
[End of table]
Table 3: Original Estimated Credit Subsidy Rates and Most Recent
Reestimated Rates for the FHA and VA Loan Guarantee Programs, 1992-2004
Cohorts (Figure 5):
Cohort: FHA:
Cohort: 1992;
Original subsidy rate (MMI): -2.60%;
Fiscal year 2005 reestimate rate (MMI): -3.03%.
Cohort: 1993;
Original subsidy rate (MMI): -2.70%;
Fiscal year 2005 reestimate rate (MMI): -2.55%.
Cohort: 1994;
Original subsidy rate (MMI): -2.79%;
Fiscal year 2005 reestimate rate (MMI): -1.58%.
Cohort: 1995;
Original subsidy rate (MMI): -1.95%;
Fiscal year 2005 reestimate rate (MMI): -0.44%.
Cohort: 1996;
Original subsidy rate (MMI): -2.77%;
Fiscal year 2005 reestimate rate (MMI): -0.85%.
Cohort: 1997;
Original subsidy rate (MMI): -2.88%;
Fiscal year 2005 reestimate rate (MMI): -1.10%.
Cohort: 1998;
Original subsidy rate (MMI): -2.99%;
Fiscal year 2005 reestimate rate (MMI): -1.74%.
Cohort: 1999;
Original subsidy rate (MMI): -2.62%;
Fiscal year 2005 reestimate rate (MMI): -1.95%.
Cohort: 2000;
Original subsidy rate (MMI): -1.99%;
Fiscal year 2005 reestimate rate (MMI): -0.55%.
Cohort: 2001;
Original subsidy rate (MMI): -2.15%;
Fiscal year 2005 reestimate rate (MMI): -0.94%.
Cohort: 2002;
Original subsidy rate (MMI): -2.07%;
Fiscal year 2005 reestimate rate (MMI): -1.07%.
Cohort: 2003;
Original subsidy rate (MMI): -2.53%;
Fiscal year 2005 reestimate rate (MMI): -1.53%.
Cohort: 2004;
Original subsidy rate (MMI): -2.47%;
Fiscal year 2005 reestimate rate (MMI): -1.61%.
Cohort: 2005;
Original subsidy rate (MMI): -1.82%.
Cohort: 2006;
Original subsidy rate (MMI): -1.70%.
Cohort: VA:
Cohort: 1992;
Original subsidy rate (MMI): 2.19%;
Fiscal year 2005 reestimate rate (MMI): 1.72%.
Cohort: 1993;
Original subsidy rate (MMI): 2.33%;
Fiscal year 2005 reestimate rate (MMI): 0.31%.
Cohort: 1994;
Original subsidy rate (MMI): 1.36%;
Fiscal year 2005 reestimate rate (MMI): -0.02%.
Cohort: 1995;
Original subsidy rate (MMI): 1.18%;
Fiscal year 2005 reestimate rate (MMI): -0.13%.
Cohort: 1996;
Original subsidy rate (MMI): 1.56%;
Fiscal year 2005 reestimate rate (MMI): 0%.
Cohort: 1997;
Original subsidy rate (MMI): 0.74%;
Fiscal year 2005 reestimate rate (MMI): -0.25%.
Cohort: 1998;
Original subsidy rate (MMI): 0.49%;
Fiscal year 2005 reestimate rate (MMI): 0.01%.
Cohort: 1999;
Original subsidy rate (MMI): 0.45%;
Fiscal year 2005 reestimate rate (MMI): 0.01%.
Cohort: 2000;
Original subsidy rate (MMI): 0.68%;
Fiscal year 2005 reestimate rate (MMI): -0.25%.
Cohort: 2001;
Original subsidy rate (MMI): 0.29%;
Fiscal year 2005 reestimate rate (MMI): 0.35%.
Cohort: 2002;
Original subsidy rate (MMI): 0.39%;
Fiscal year 2005 reestimate rate (MMI): 0.27%.
Cohort: 2003;
Original subsidy rate (MMI): 0.81%;
Fiscal year 2005 reestimate rate (MMI): 0.44%.
Cohort: 2004;
Original subsidy rate (MMI): 0.50%;
Fiscal year 2005 reestimate rate (MMI): -0.07%.
Cohort: 2005;
Original subsidy rate (MMI): -0.32%.
Cohort: 2006;
Original subsidy rate (MMI): -0.32%.
Source: GAO analysis of Federal Credit Supplements, fiscal years 2005
and 2006.
[End of table]
Table 4: Primary Factors Contributing to the Fiscal Year 2003 MMI
Credit Subsidy Reestimate (Figure 6):
Dollars in billions.
Difference between estimated and actual cash flows for FY 2003: $2.1;
Change in estimated future cashflows: $3.9;
Interest on adjustment: $1.1.
Source: GAO analysis of FHA data.
[End of table]
Table 5: Change in Future Cash Flow Estimates for the Fund from Fiscal
Year 2002 to Fiscal Year 2003 (Figure 7):
Dollars in millions.
Fiscal year: 2002;
Amount: $1,864.
Fiscal year: 2003;
Amount: -$2,008.
Source: GAO analysis of FHA financial statements, fiscal years 2002-
Fiscal year: 2003.
[End of table]
Table 6: Variables Contributing to the $3.9 Billion Change in Estimated
Cash Flows (Figure 8):
Dollars in billions.
Loans originating in 2003: $1.0;
Other: -$0.5;
Removal of loss mitigation adjustment: -$1.7;
Change in conditional claim and prepayment rates: -$2.7.
Source: GAO analysis of FHA data.
[End of table]
Table 7: Increase in Estimated Net Cash Outflows from Removing the Loss
Mitigation Adjustment Factor, 1992-2003 Cohorts (Figure 9):
Dollars in thousands.
Fiscal year: 1992;
Impact: $10,979.
Fiscal year: 1993;
Impact: $24,126.
Fiscal year: 1994;
Impact: $32,926.
Fiscal year: 1995;
Impact: $21,632.
Fiscal year: 1996;
Impact: $40,131.
Fiscal year: 1997;
Impact: $52,666.
Fiscal year: 1998;
Impact: $108,630.
Fiscal year: 1999;
Impact: $151,683.
Fiscal year: 2000;
Impact: $142,118.
Fiscal year: 2001;
Impact: $349,441.
Fiscal year: 2002;
Impact: $451,067.
Fiscal year: 2003;
Impact: $339,110.
Source: GAO analysis of FHA data.
[End of table]
Table 8: Actual Versus Estimated Conditional Claim Rates for Fiscal
Year 2003, 1993-2003 Cohorts (Figure 10):
Cohort: 1993;
Estimated claims: 0.60%;
Actual claims: 0.48%.
Cohort: 1994;
Estimated claims: 0.58%;
Actual claims: 0.53%.
Cohort: 1995;
Estimated claims: 0.96%;
Actual claims: 1.71%.
Cohort: 1996;
Estimated claims: 0.93%;
Actual claims: 1.69%.
Cohort: 1997;
Estimated claims: 1.08%;
Actual claims: 2.29%.
Cohort: 1998;
Estimated claims: 0.95%;
Actual claims: 1.75%.
Cohort: 1999;
Estimated claims: 0.92%;
Actual claims: 1.93%.
Cohort: 2000;
Estimated claims: 1.58%;
Actual claims: 4.03%.
Cohort: 2001;
Estimated claims: 0.87%;
Actual claims: 1.96%.
Cohort: 2002;
Estimated claims: 0.32%;
Actual claims: 0.50%.
Cohort: 2003;
Estimated claims: 0.01%;
Actual claims: 0.01%.
Source: GAO analysis of FHA data.
[End of table]
Table 9: Actual Versus Estimated Conditional Prepayment Rates for
Fiscal Year 2003, 1993-2003 Cohorts (Figure 10):
Cohort: 1993;
Estimated prepayments: 17.10%;
Actual prepayments: 34.33%.
Cohort: 1994;
Estimated prepayments: 16.32%;
Actual prepayments: 32.13%.
Cohort: 1995;
Estimated prepayments: 17.33%;
Actual prepayments: 29.91%.
Cohort: 1996;
Estimated prepayments: 17.58%;
Actual prepayments: 32.45%.
Cohort: 1997;
Estimated prepayments: 18.20%;
Actual prepayments: 31.33%.
Cohort: 1998;
Estimated prepayments: 17.36%;
Actual prepayments: 36.54%.
Cohort: 1999;
Estimated prepayments: 16.58%;
Actual prepayments: 35.80%.
Cohort: 2000;
Estimated prepayments: 22.73%;
Actual prepayments: 34.67%.
Cohort: 2001;
Estimated prepayments: 14.37%;
Actual prepayments: 41.63%.
Cohort: 2002;
Estimated prepayments: 7.78%;
Actual prepayments: 33.81%.
Cohort: 2003;
Estimated prepayments: 1.12%;
Actual prepayments: 7.00%.
Source: GAO analysis of FHA data.
[End of table]
Table 10: Amount of FHA Prepayments During Fiscal Years 2000-2004
(Figure 11):
Dollars in millions.
Fiscal year: 2000;
Prepayment: $37,576.
Fiscal year: 2001;
Prepayment: $82,260.
Fiscal year: 2002;
Prepayment: $121,154.
Fiscal year: 2003;
Prepayment: $190,370.
Fiscal year: 2004;
Prepayment: $123,029.
Source: GAO analysis of FHA data.
[End of table]
Table 11: Capital Ratio Versus Economic Value of the MMI Fund, Fiscal
Years 2000-2004 (Figure 12):
Dollars in millions.
Fiscal year: 2000;
Economic value: $16,962;
Capital ratio: 3.51%.
Fiscal year: 2001;
Economic value: $18,510;
Capital ratio: 3.75%.
Fiscal year: 2002;
Economic value: $22,636;
Capital ratio: 4.52%.
Fiscal year: 2003;
Economic value: $22,736;
Capital ratio: 5.21%.
Fiscal year: 2004;
Economic value: $21,977;
Capital ratio: 5.53%.
Source: GAO analysis of FHA data.
[End of table]
Table 12: Amortized Insurance-In-Force, Fiscal Years 2000-2004 (Figure
13):
Dollars in millions.
Fiscal year: 2000;
Amortized insurance in force: $449,867.
Fiscal year: 2001;
Amortized insurance in force: $459,305.
Fiscal year: 2002;
Amortized insurance in force: $466,598.
Fiscal year: 2003;
Amortized insurance in force: $406,619.
Fiscal year: 2004;
Amortized insurance in force: $372,373.
Source: GAO analysis of FHA data.
[End of table]
Table 13: Minimum Required Capital Ratio Versus Actual Capital Ratio
(Figure 14):
Fiscal year: 2000;
Capital ratio: 3.51%;
Required minimum capital ratio: 0.02%.
Fiscal year: 2001;
Capital ratio: 3.75%;
Required minimum capital ratio: 0.02%.
Fiscal year: 2002;
Capital ratio: 4.52%;
Required minimum capital ratio: 0.02%.
Fiscal year: 2003;
Capital ratio: 5.21%;
Required minimum capital ratio: 0.02%.
Fiscal year: 2004;
Capital ratio: 5.53%;
Required minimum capital ratio: 0.02%.
Source: GAO analysis of FHA data.
[End of table]
[End of section]
Appendix III: Comments from the Department of Housing and Urban
Development:
U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT:
WASHINGTON, D.C. 20410-8000:
OFFICE OF THE ASSISTANT SECRETARY FOR HOUSING-FEDERAL HOUSING
COMMISSIONER:
AUG 15 2005:
Mr. William B. Shear:
Director:
Financial Markets and Community Investments:
United Sates Government Accountability Office:
Washington, D. C. 20548:
Dear Mr. Shear:
The Department of Housing and Urban Development (HUD) appreciates the
opportunity to address the Government Accountability Office (GAO) draft
report entitled "FHA's $7 Billion Reestimate Reflects Higher Claims and
Higher Loan Performance Estimates" (GAO-05-875).
The Department agrees with GAO's overall finding that higher than
projected claims were a significant factor that resulted in a $7
billion credit subsidy re-estimate for the Mutual Mortgage Insurance
Fund in FY 2003. FHA became aware that models developed by its
independent actuarial review contractor were under-predicting claims
for post-1995 books of business in early 2003. In FY 1995, FHA had
implemented underwriting changes intended to expand the proportion of
its insured borrowers who were first-time and minority homebuyers.
These changes were successful, and FHA's share of first-time homebuyers
increased from 60 percent to 80 percent and its share of minority
homebuyers increased from 20 to 35 percent. Changing the composition of
FHA borrowers, however, also reduced the effectiveness of FHA's
existing models for predicting claims. In 2003, FHA worked with the
contractor to include a simple indicator variable to capture the impact
of these underwriting changes. The inclusion of this new variable in
the FY 2003 actuarial review appropriately increased the predicted
future claims on all post-1995 books of business and was the principal
reason for the $7 billion re-estimate.
For the FY 2004 actuarial review, FHA selected a new contractor that
was tasked with developing new models that would more accurately
predict claims in the short-as well as the long-run. The contractor
made a number of technical improvements to the econometric methodology
used to model FHA conditional claim and prepayment rates. These changes
resulted in more credible predictions of ultimate claim and prepayment
rates, but still under-predicted claims for the most immediate
termination years. This limitation was corrected in the FY 2004
actuarial review with the contractor's decision to use a one-time claim
adjustment factor. For FY 2005, FHA has continued to work with the
contractor to further refine the specifications of the conditional
claim and prepayment models.
In its report, GAO recommends "the Secretary of HUD should direct the
FHA Commissioner to include in FHA's loan performance models additional
variables that have been found in other studies to influence credit
risk, such as payment-to-income ratios, credit scores, and the presence
of down payment assistance." While HUD can ask the independent
contractor to consider certain variables, it cannot direct the
contractor to do so, since that would violate the statutory requirement
for an independent actuarial study of the MMI Fund. Selection of
variables for FHA's conditional claim and prepayment models is
determined by economic theory and by statistical tests that measure the
accuracy of the models' predictions. Mandating the inclusion of
variables could actually weaken rather than strengthen the models'
predictiveness.
With regard to its specific recommendations to consider inclusion of
credit scores, to acknowledge the presence of down payment assistance,
and to reconsider the specification of the burnout factor, FHA informed
GAO that FHA's actuarial contractor has these actions under active
consideration. With regard to its general recommendation, "whenever
making changes to the definitions of key variables FHA should determine
whether and to what extent revisions of these definitions may have
improved the forecasting ability of the loan performance models used in
FHA's actuarial reviews of the Fund," FHA refers GAO to the actuarial
review itself and its appendices that contain full documentation of the
models and justifications for the selection of the included variables
and their definitions.
Thank you for the opportunity to review the GAO report. FHA and its
contractor are motivated by the desire to implement state-of-the-art
models that meet the highest standards of technical performance. FHA
believes that recent modeling improvements have reduced the likelihood
of future sizable MMIF credit subsidy re-estimates.
Sincerely,
Signed by:
Brian D. Montgomery:
Assistant Secretary for Housing-Federal Housing Commissioner:
[End of section]
Appendix IV: GAO Contact and Staff Acknowledgments:
GAO Contact:
William B. Shear (202) 512-8678:
Staff Acknowledgments:
In addition to the above, Mathew Scirč, Assistant Director, Anne Cangi,
Marcia Carlsen, Emily Chalmers, Austin Kelly, Mamesho Macaulay, Marc
Molino, and Katherine Trimble made key contributions to this report.
(250223):
FOOTNOTES
[1] FHA also provides mortgage insurance for certain single-family
programs, such as condominiums and home equity conversion mortgages,
through its General and Special Risk Insurance Fund. The single-family
mortgage insurance programs supported by the General and Special Risk
Insurance Fund represented about 13 percent of all single-family
mortgages that FHA insured in 2004. The remaining 87 percent were
insured through the Mutual Mortgage Insurance Fund.
[2] The Omnibus Budget Reconciliation Act of 1990 defined the capital
ratio as the ratio of the Fund's capital, or economic net worth
(economic value), to its unamortized insurance-in-force. However, the
act defined unamortized insurance-in-force as the remaining obligation
on outstanding mortgages--a definition generally understood to apply to
amortized insurance-in-force. HUD has calculated the capital ratio
using unamortized insurance-in-force as it is generally understood--
which is the initial amount of mortgages.
[3] See Mortgage Financing: FHA's Fund Has Grown, but Options for
Drawing on the Fund Have Uncertain Outcomes, GAO-01-460 (Washington,
D.C.: Feb. 28, 2001).
[4] See Mortgage Financing: Changes in the Performance of FHA-Insured
Loans, GAO-02-773 (Washington, D.C.: July 10, 2002).
[5] A cohort includes those direct loans or loan guarantees of a
program for which a subsidy appropriation is provided in a given year
even if the loans are not disbursed until subsequent years.
[6] FHA refunds a portion of the up-front premium based on the time
elapsed since the loan was originated and when a borrower prepays or
refinances their loan.
[7] Present value is the worth of the future stream of cash inflows and
outflows, as if they had occurred immediately. In calculating present
value, prevailing interest rates provide the basis for converting
future amounts into their "money now" equivalents. Net present value is
the present value of estimated future cash inflows minus the present
value of estimated future cash outflows.
[8] Liquidating accounts were established to handle credit transactions
on a cash basis for pre-credit reform loans and loan guarantees.
[9] Nonbudgetary accounts may appear in the budget document for
informational purposes but are not included in the budget totals for
budget authority or budget outlays.
[10] From 1989 to 1998, Price Waterhouse (PricewaterhouseCoopers as of
1998) performed the actuarial review; from 1999 to 2003, Deloitte &
Touche performed the review; in 2004, Technical Analysis Center, Inc.,
was awarded the contract.
[11] Current OMB guidance allows agencies to use either the
"traditional approach" or the "balances approach" to reestimate costs.
The traditional approach uses both actual past and estimated future
cash flows to calculate a revised expected cost. Then the amount of the
reestimate is based on the change in the expected cost. HUD uses the
balances approach, which compares the net resources (cash, other
assets, and liabilities) in the financing account to the total
estimated future cash flows. Both approaches yield simular results.
Figure 2 illustrates the balances approach.
[12] Because the age composition of these programs' portfolios may
differ, we selected only the three most recent cohorts for our
analysis. These three cohorts represented the majority of FHA's loan
portfolio in 2003.
[13] Figure 4 is based on data from the fiscal year 2006 Federal Credit
Supplements, which reports $369 billion in Fund loans endorsed
(guaranteed) to date for the fiscal year 2001-2003 cohorts. According
to the Federal Credit Supplement, 100 percent of Fund loan guarantees
are endorsed in the first year.
[14] Lifetime cash flow estimates continued to be positive, primarily
because of positive cash flows occurring earlier in the life of the
cohort.
[15] Circular No. A-11, Part 5: Federal Credit Programs, Office of
Management and Budget, June 2002.
[16] See Mortgage Financing: Changes in the Performance of FHA-Insured
Loans, GAO-02-773 (Washington, D.C.: July 10, 2002).
[17] A loan may be seriously delinquent for several quarters before
that delinquency is resolved. Because it is difficult for a borrower
with a delinquent loan to obtain a new loan in order to refinance,
several quarters may pass during which time a loan has a high
probability of resulting in a claim, because it is delinquent, and has
a low probability of resulting in a prepayment, because the borrower
cannot refinance using conventional channels.
[18] The payment-to-income ratio, also referred to as the housing-
expense-to-income ratio, examines a borrower's expected monthly housing
expenses as a percentage of the borrower's monthly income. The debt-to-
income ratio looks at a borrower's expected monthly housing expenses
plus long-term debt as a percentage of the borrower's monthly income.
FHA limits the monthly mortgage payment to no more than 31 percent of
monthly gross income (before taxes) and limits the mortgage payment
combined with other debts to no more than 43 percent of income.
[19] See Mortgage Financing: Actions Needed to Help FHA Manage Risks
from New Mortgage Loan Products, GAO-05-194 (Washington, D.C.: Feb. 11,
2005).
[20] See Mortgage Financing: FHA's Fund Has Grown, but Options for
Drawing on the Fund Have Uncertain Outcomes, GAO-01-460 (Washington,
D.C.: Feb. 28, 2001).
[21] See Home Inspections: Many Buyers Benefit from Inspections, but
Mandating Their Use Is Questionable, GAO-04-462 (Washington, D.C.:
April 30, 2004).
[22] See Mortgage Financing: Actions Needed to Help FHA Manage Risks
from New Mortgage Loan Products, GAO-05-194 (Washington, D.C.: Feb. 11,
2005).
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