FHA Insured Mortgages, a Disaster in the Making?

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In a previous REAL ESTATE CHANNEL article, I pointed out that there were two main props supporting the housing market now.  We examined the first one in detail - the banks withholding most foreclosed homes from the market. 

The second prop is even more important -- the soaring percentage of home mortgages that are insured by the Federal Housing Administration (FHA).  Let's take an in-depth look at the FHA.

A Little History

The Federal Housing Administration (FHA) was created by Congress in 1934 to enable lower income families to purchase homes that they would otherwise not have been able to afford.  Remember, this was only a year after the banking system totally collapsed and roughly 4,000 banks had permanently shut their doors.  To encourage reluctant banks to write mortgages, the FHA was authorized to provide insurance for mortgage loans backed by the full-faith-and-credit of the United States.

FHA Insured Loans Saved the Housing Market from Collapse

During the housing bubble years of 2004-2006, the FHA played no role in supporting the boom.  When the market finally seized up in the spring of 2007, the FHA made a determined effort to keep mortgage lending from completely drying up.  The chart below puts this into perspective.


As of June 2010, the FHA had 6.4 million insured loans in force.  Three and one-half million of them were put in place during FY 2008-2009.  The total dollar amount of FHA insurance in place through June was $865 billion.  At the current rate of insured loan originations, the total of insured loans in force will exceed $1 trillion within six months.

FHA Underwriting Standards

Although the FHA was essentially a non-factor in facilitating the housing boom, its standards for providing mortgage insurance have been extremely lax to say the least. 

During his appearance before the House of Representatives this past March, the FHA Commissioner, David Stevens, submitted detailed written testimony which pointed out that 6.2% of the entire insured loan portfolio had been issued to homebuyers with FICO scores below 500.  Really.  That is roughly 360,000 insured loans which were provided to owners with FICO scores less than 500.  Keep in mind that the accepted standard for subprime mortgages during the bubble years was a FICO score lower than 620.  More than 37% of these loans are now at least 60 days delinquent, in foreclosure, or in bankruptcy.

Compounding the problem, between 2001 and 2008 the FHA provided a program known as seller-funded downpayment assistance (SFDP).  It allowed non-profit consumer advocacy groups to "donate" the 3.5% down payment to low-income buyers seeking an FHA insured loan.  The seller was often a home builder who "contributed" the funds to the non-profit which passed it on to the buyer.

The program was riddled with fraud.  Many of the non-profits were really tools of the builders.  To cover their costs, the builders simply jacked up the price of the home.  In 2006, the Commissioner of the IRS called these mortgages "scams" which "damage the image of honest, legitimate charities."  After mounting criticism, the program was finally ended in 2008.  The FHA actuarial report issued in 2009 calculated that the program had cost the Agency nearly $10 billion in losses. 
    
Mortgage Modification Efforts

According to the written testimony submitted by Commissioner Stevens referred to earlier, the FHA assisted 450,000 families in keeping their homes out of foreclosure in FY 2009.  For the first quarter of the current fiscal year, the Agency assisted another 122,000 families.

Unfortunately, the Mortgage Metrics Report issued jointly by the Office of Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) for the first quarter of 2010 revealed that 67% of these modified FHA mortgages were in default again within twelve months.

In spite of these increasing mortgage modification efforts, the number of seriously delinquent FHA mortgages (delinquent 90+ days) climbed to 555,000 in May 2010 according to HUD's Neighborhood Watch database.

Protecting the FHA's Capital Reserve Account

Because of the skyrocketing loan delinquencies and defaults, the FHA decided to take actions to protect its Capital Reserve Account.  As the chart below shows, it had fallen below the required minimum of 2% by 2009.



In his March Congressional testimony mentioned earlier, Commissioner Stevens cited several steps the Agency was taking to shore up the Capital Reserve Account.  First, he pointed out that it had cracked down on 354 FHA lenders by withdrawing their approval status. 

This action was necessary because mortgage fraud had reared its ugly head again.  The number of FHA-approved lenders had doubled between 2007 and 2009, but the Agency had neither the staff nor the resources to adequately police them.  Evidence of widespread fraud had been uncovered by the Washington Post in early 2009.  It reported that 9,200 loans insured by the FDA between 2007 and 2009 had gone into default after no more than one mortgage payment had been made.
  
To protect the Agency's Capital Reserve Account, the Commissioner was increasing the upfront insurance premium from 1.5% of the amount borrowed to 2.25%.  He also planned to raise the recurring annual premium from 0.5% to 0.9% for loans with loan-to-value (LTV) ratios above 95%.  After the Reserve Account was restored to its 2% minimum, he planned to actually lower the upfront insurance premium to 1%.  The Commissioner noted that these changes would have little impact on how much an applicant needed to expend up front because the up front premium was usually rolled into the amount borrowed.

Commissioner Stevens also stated that he was planning to create a two-tier FICO requirement.  To obtain a loan that required only the minimum 3.5% down payment, an applicant would need a FICO score of at least 580.  Those with scores of 500-579 would be required to make a minimum down payment of 10%.  Applicants with FICO scores less than 500 would be ineligible for an FHA loan guarantee.

With regard to a proposal that the minimum down payment be raised to 5%, Stevens rejected the idea because it would "adversely impact the housing market recovery."

Ginnie Mae - Handmaiden of the FHA

The growing exposure of the FHA's $865 billion insured loan portfolio to delinquencies, defaults and foreclosures is complicated by the fact that most of these loans have been packaged and securitized by approved lenders for the Government National Mortgage Association (Ginnie Mae), a wholly-owned U.S. government corporation. 

Ginnie Mae does not originate, buy or sell loans.  What this Agency does is guarantee to investors the "timely payment of principal and interest" on mortgage-backed securities (MBS) backed primarily by loans insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA).

Mortgage-backed securities are pools of mortgages used as collateral for the issuance of securities known as pass-through certificates.  They are called this because the principal and interest which flows from the underlying mortgages is passed through to the MBS investor.  The interest rate on the MBS is lower than that of the underlying loans to allow for servicing fees.

Known in the trade as "Ginnie Maes," these MBS are not securitized and sold by Ginnie Mae but by lenders who must be approved by both the FHA and Ginnie Mae.  They are the only MBS which are backed by the full-faith-and credit of the United States Government.  The Ginnie Mae website states that 98% of all FHA insured loans are packaged into Ginnie Mae MBSs.

According to a spokesperson for Ginnie Mae, the issuing lender that is servicing the pool of mortgages in a Ginnie Mae MBS is responsible for making a timely payment of principal and interest from all loans in that MBS to the investors.  After a loan has become delinquent for at least 90 days, the lender has the option of buying the loan out of the MBS.  It can then begin foreclosure proceedings.

Because it is the issuer/servicer who is responsible for the timely payment of principal and interest of all loans in the Ginnie Mae MBS, the burden of defaults falls on them and on the FHA rather than on Ginnie Mae.  As Ginnie Mae phrases the matter on its website, defaults become a problem for Ginnie Mae only if the issuer is insolvent.
 
FHA-Owned Homes on the Market

In the FHA's Single Family Operations report for June 2010, it lists "Conveyances" of bank-foreclosed homes to the FHA for which the FHA paid the bank the total unpaid principal balance under its insurance plus allowable expenses.  For the current 2010 fiscal year through June 30, the FHA had taken ownership of 72,117 homes from lenders. 

An FHA spokesperson updated that number and said that FHA had taken ownership of 77,129 houses through July 31.   He pointed out that the FHA had sold 72,563 homes to the public during the current fiscal year.  He added that FHA currently had 44,809 homes in its inventory of which 13,323 were listed for sale. 

For those of you interested in purchasing an FHA-owned home, the process is not simple.  You need to find on the Internet the one firm in each state which is authorized to sell FHA homes.  When you do, you may not find many FHA homes for sale.  For example, in Fairfield County, Connecticut, which has roughly 800,000 residents, there is one home for sale.  That's right - one.

The Danger Awaiting the FHA In the Near Future

Currently, there are 555,000 FHA-insured homes which are delinquent 90 days or more.  This figure has been rising steadily for three years.  Loan Performance tracks the cure rate for delinquent mortgages in its massive loan database.  The cure rate for seriously delinquent mortgages has plunged to roughly 1%.  This means that 99% of these delinquent mortgages are headed for default and then either foreclosure or short sale.  The chart below says it all.



Considering the rate at which FHA mortgages are now becoming delinquent, there will be more than 700,000 seriously delinquent FHA mortgages within a year. 

There is no doubt that the FHA Commissioner is determined to prop up the housing market regardless of the fallout.  Commissioner Stevens knows that in cities such as San Diego, the market would have totally collapsed without the FHA.  Between January and May of 2010, nearly 50% of all purchase mortgages issued in San Diego County were FHA-insured.  With an average mortgage of $375,000, these were hardly the first-time buyers that now dominate FHA insurance according to the FHA.

How about Las Vegas?  Its housing market is supposed to be searching for a bottom.  Yet in May, according to DataQuick, 52% of sales were consummated with FHA-insured loans.  Furthermore, 47% of home sales in Las Vegas were cash deals purchased overwhelmingly by investors.  Some recovery!

One final mind-boggling figure is the high percentage of "cash-out" FHA refinancings.  In FY 2009, the FHA provided nearly 469,000 refinancings which converted a conventional loan into an FHA insured one.  In 50% of these refinancings, the FHA authorized the borrower to take cash out.  Sounds like the good old days of 2004-2006, doesn't it?

But this is the post-collapse housing market.  How many homeowners have enough equity to be able to take cash out of the new mortgage?  My hunch is that there are not very many.  Does this look like appraisal inflation and potential fraud to you?  By the way, in the current fiscal year the FHA was still approving cash-outs in one-third of all these refinancings.

By the beginning of 2011, U.S. taxpayers will be fully at risk for more than $1 trillion in FHA insured mortgages.  Sooner or later, the banks will have to foreclose and convey to the FHA the 550,000 homes that are currently seriously delinquent.  These houses will be then be added to the 44,000+ homes now in the FHA's inventory.  Within a year, the number of FHA-insured homes in default or in its inventory could exceed 700,000.  What will the FHA do then?

The Agency does have the authority to seek indemnification from large lenders for claims paid on mortgages that were not underwritten according to FHA requirements.  It can also seek indemnification for losses incurred because of loans involving fraud or misrepresentation.  The FHA Reform Act of 2010, which was passed by the House of Representatives in June, would broaden that authority to cover all FHA lenders.

To do in-depth audits for 6.4 million insured loans as well as for all the lender insurance claims it has processed would be an enormous undertaking.  Meanwhile, the defaulted loan numbers keep on climbing.  When these homes are finally foreclosed, conveyed to the FHA, and then put up for sale, this will weaken home prices even further.

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