Origination Views

Where the FHA Stands

By David H. Stevens

Mr. Stevens, assistant secretary for housing/Federal Housing Administration commissioner for the U.S. Department of Housing and Urban Development, testified before the U.S. House Financial Services Committee's subcommittee on housing and community opportunity in October 2009 on the soundness of the FHA. The following are excerpts from his remarks.

As you know, the FHA is playing a critical role in the housing market and our economy right now - insuring a third of the home-purchase mortgage market and 80% of its purchase loans are for first-time homebuyers.

But as you also know, FHA recently announced that our independent, non-governmental actuarial review is expected to predict that FHA's capital reserve ratio will fall below 2%. There has been considerable confusion about what this announcement means.

And so I welcome this opportunity to clarify our situation and discuss the proactive steps being taken to ensure that FHA remains financially sound so that we can continue to support and revive the housing market.

Let me simply state at the outset that based on current projections, absent any catastrophic home price decline, FHA will not need to ask Congress and the American taxpayer for extraordinary assistance - we will not need a bailout.

FHA only insures owner-occupied residences and has never insured exotic subprime, Alt-A, or "no-doc" mortgages. FHA has also never wavered from requiring full documentation of employment and income when underwriting new home purchases. This responsible approach has allowed us to limit losses during this economic crisis and fulfill our mission of providing safe opportunities for homeownership to those who can afford a home.

FHA does not resemble private financial institutions, including mortgage lenders or investment banks like Countrywide Financial or Bear Stearns, to which FHA has been compared inaccurately by those who do not understand FHA's business model. FHA does not have a leverage ratio as it does not hold debt on its balance sheet. FHA is financed from mortgage insurance premiums paid to FHA in exchange for providing mortgage insurance. FHA holds reserves in its financing and capital reserve accounts. Balances in these accounts represent the net sum of premiums collected from borrowers minus any insurance claims that FHA pays to lenders, e.g., in the event that a homeowner defaults on their FHA-insured loan. FHA only insures those loans that meet FHA's underwriting criteria, as described earlier. By providing mortgage insurance to lenders on these loans, FHA provides protection to lenders against the risk of default, which expands liquidity in the market and has enabled homeownership opportunities to be expanded to a broader population.

The private financial institutions to which FHA is most similar are private mortgage insurers (PMIs) who also offer mortgage insurance to private lenders to protect them from the risk of default by a borrower. FHA has recently experienced significant swings in its market share as FHA largely plays a countercyclical role to ensure critical liquidity remains in the mortgage market when private mortgage insurers decide to or are forced to insure fewer loans. Much attention has been paid to recent statistics showing that FHA is currently insuring more than 25% of new home mortgages, a significant increase from approximately 3% in 2006.

This increased market share is largely the result of market pullback by PMIs from providing new mortgage insurance as they are capital-constrained from paying claims and reserving funds for large expected losses on their historical portfolio. FHA is partially filling the void left by PMIs.

FHA has not loosened its underwriting standards and in fact has experienced a significant improvement in credit quality of newly insured borrowers, from an average FICO score of 633 two years ago to 693 today.

A report released by the Federal Reserve Oct. 1 states: "Beginning in the early part of 2008, PMI companies started limiting their issuance of PMI insurance and raising prices because of rising claims and binding capital restrictions in certain states. As a consequence, Fannie Mae and Freddie Mac substantially reduced their purchases of loans with loan-to-value ratios (LTV) above 80%, which by statute require PMI (or other credit enhancement). Both GSEs [Fannie Mae and Freddie Mac] also raised their credit guarantee fees for such loans at this time as well."

These actions taken by PMIs and GSEs in reaction to losses on their historical portfolios have led to FHA-insured loans becoming relatively cheaper and more accessible to borrowers, compared to PMI-insured loans than they were during the boom. FHA's increased market share is a result of this countercyclical market dynamic and not in itself a reflection of the riskiness or lack thereof of newly insured loans.

In fiscal year 2008, FHA insured over 1.1 million single-family loans - almost triple what was insured the year before. In fiscal year 2009, FHA insured approximately 2 million loans. FHA anticipates that it will continue to insure a significant volume of mortgages in fiscal year 2010 as it continues to play an important role in the housing.

Today, FHA is critical to the recovery of the housing market for both existing and new homeowners. FHA's single-family purchase-loan portfolio is currently 80% first-time homebuyers, of which 27% are minorities. FHA provides opportunities for first-time homebuyers who have good credit histories but may not have a large downpayment to purchase homes, which has a stabilizing effect on home values. Equally as important, over 49% of the loans insured by FHA in fiscal year 2009 have been refinances, thereby helping existing homeowners to move into safe, fixed-rate loans, with historically low interest rates. These refinances have, on average, saved homeowners between $100-$200 per month on their housing expenses.