Why now is not the time for FHA premium cuts
In its latest annual report to Congress, November 2020, the Federal Housing Administration (FHA) published its “capital ratio”, a measure of capital reserves relative to the insurance in force held within the Mutual Mortgage Insurance Fund (MMI Fund). The figure, which stands at 6.1%, was the highest capital ratio recorded since 2007 and the sixth consecutive year above the 2% minimum mandated by Congress.
The same report found that the FHA had accumulated capital reserves amounting to $ 78.9 billion – perhaps the highest on record and just $ 15.6 billion less than the amount the FHA analysts believe it is necessary to maintain the ability to pay mortgage insurance claims as a result of adverse credit. event similar to the 2008 financial crisis.
In light of the improved capital position of the MMI Fund, mortgage industry trade groups and other stakeholders have sharply called on the FHA to reduce its mortgage insurance premiums (PMI) which are paid by borrowers. to insure the credit risk of single-family term and reverse mortgages. .
The timing of a premium reduction, however, in the current environment is in our view premature and HUD Secretary Fudge made the right decision with the March 30 announcement: “We have no short-term plan to change the FHA mortgage insurance premium. pricing. “
Although the Fund’s position has strengthened in recent years and continues to do so, largely thanks to a robust housing market fueled by low inventories, low interest rates and strong appreciation in house prices, there are many reasons to act with caution and continue to prepare for the unexpected.
As lenders adjust to changing risk perspectives and perhaps even improved compliance regulations, they need to be able to react in real time and make the necessary changes quickly. Leveraging technology can help.
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The FY2020 annual report highlighted several data points of concern: The FHA continues to deal with over 1 million borrowers on COVID-19 mortgage forbearance, with more than 10% of those in abstention for a year.
At the end of fiscal 2020, serious delinquencies in the term portfolio (over 90 days past due) amounted to $ 158 billion, an increase of $ 117 billion from fiscal 2019. This is an all-time high, even surpassing the previous high of $ 105 billion in 2012.
The number of these loans to be cured is uncertain and will depend on how many will be able to resume making mortgage payments or make other loss mitigation options available, including the use of a partial claim. As such, the total cost to FHA is unknown at this time and may not be clear for a few years.
As an example, seller-funded installment loans that prevailed in the early 2000s had a negative impact of $ 16.5 billion on the FHA fund in fiscal 2016 despite the end of the program in September 2008, based on an independent actuarial review.
In addition, the high risk attributes of the loans held in the term portfolio have been on the rise for years. In fact, the presence of loans with two or more indicators of higher credit risk, called risk layers, has been increasing since 2014. The early performance of loans with such layers of risk is about three times worse than that of mortgages without it, and like we could. you expect, the percentage of loans with prepayment defaults has dramatically worsened for mortgages over the past few years. Projected lifetime claim rates for recent creations are at the highest level since 2009.
While it is tempting to consider reducing premiums at a time when many people in our country are struggling economically, it is vitally important to understand the sensitivity of the MMI fund to macroeconomic performance and the assumptions built into the forecasting models that have been shown to change dramatically, most notably the appreciation of house prices.
The MMI Fund’s calculations are such that a modest 1% reduction in property price appreciation lowers FHA reserves by 1.30 percentage points ($ 16.9 billion). To illustrate how quickly the underlying assumptions can change, consider the period just before and after the “Great Recession” when the MMI Fund’s capital ratio was 7% in fiscal 2007.
By 2008, the capital ratio had fallen to 3.2%, and by 2012 it had fallen into negative territory, -1.4%, requiring a drawdown of $ 1.7 billion from the US Treasury in 2013.
Applying a stress test to the FY2020 portfolio similar to the conditions produced by the Great Recession would actually wipe out the current capital of the MMI Fund entirely, resulting in a capital ratio of -0.63%.
Managing the capital position of the MMI Fund requires discipline that goes well beyond meeting or exceeding a minimum capital ratio at any given time.
Prudent management of capital requires that the FHA protect the MMI Fund and the US taxpayer from future economic shocks and establish realistic benchmarks for capital reserves. Recent history has shown that it was well above the 2% mandated by Congress.
The impact of seemingly small reductions in PMI must be understood. Assuming the FHA insures 1 million new mortgages per year, the average for recent years, a reduction in the PMI of 25 basis points (or 1/4 of 1%) would reduce annual revenues by about $ 500 million. dollars in the first year of renewal only and would trigger a recalculation of future income, reducing income.
The FHA must also consider the macroeconomic environment in which it operates, as well as the dynamic market effects of the PMI structure on the Fund. In the current environment, a reduction in premiums, for example, is likely to trigger a series of refinancings, further reducing revenue, a key component of the FHA’s claims-paying ability, across the portfolio for a period of time. period of tension.
Taking measures that facilitate increased portfolio prepayments when the borrowers’ end result in COVID-19 forbearance is unknown could have the effect of a “one-two punch” when these rate refinancings. lower premiums further erode FHA capital.
While any savings for FHA borrowers are welcome, it is important to note that the current FHA PMI structure already offers borrowers lower credit costs compared to GSEs, primarily Fannie Mae and Freddie mac. GSEs and FHAs work differently in terms of mortgage liquidity, but you can make a general comparison between them in terms of the ultimate costs to the borrower.
Over the life of the loan, FHA mortgage insurance provides similar coverage to private mortgage insurance with improved credit and GSE guarantee fees, but at a lower cost. A typical FHA borrower with a credit score of 665 would save over $ 10,000 in credit charges in the first seven years of mortgage life compared to the same loan secured by private mortgage insurance and a GSE.
The FHA, a government agency, is largely self-sufficient. He has a fervent obligation to manage the Fund on behalf of the American people in a way that supports its mission, which includes helping low-to-moderate income (LMI), minority and first-time buyers, as well as old people.
Additionally, the FHA plays an important role within the larger housing finance ecosystem, with the need to both pay claims and have greater capacity if and when the private market is unable or unwilling to. lend without FHA support. This is especially important for how LMI borrowers and the elderly cope in times of economic crisis.
The point is that the MMI Fund is capitalized by PMI paid by the borrower and investments in US Treasuries. The FHA must pay for claims and other expenses, including the costs of preserving ownership of this same fund. In its 87 year history, the FHA has needed to lean on its authority with the Treasury only once, which should be a point of pride and motivation for those who manage it. It is not in the interests of the program, of homebuyers, of the housing market, or of the economy to reproduce, nor should the government facilitate the shift in market share of private capital. Policies should not be adopted that place the Fund in this position.
Fortunately, the housing market appears to have rolled strong in 2021 and is expected to remain so, even if this was unexpected in 2020 during the early days of the pandemic.
Due to its unique mission of serving LMI borrowers, however, it is reasonable for the FHA to expect significant future losses to the MMI Fund due to the current pandemic crisis and heightened concern if the appreciation real estate prices are stagnant or reversed.
The ongoing global pandemic, protracted unemployment and house price volatility present a potential for significant stress on the MMI Fund, especially as the current opt-out flexibilities are unwinding and beyond. In a crowded market, the combination of these risk variables creates a potentially unfavorable scenario for the FHA.
Until the impact of these and other macroeconomic stress conditions is better understood, the PMI should not be reduced as it could lead to future exposure for the taxpayer if the capital ratio were not sufficient. to absorb impacts. The HUD secretary made the right decision.
This column does not necessarily reflect the opinion of the editorial staff of HousingWire and its owners.
To contact the authors of this story:
Brian Montgomery at [email protected]
To contact the editor responsible for this story:
Sarah Wheeler at [email protected]