There is an old saying that no matter what type of life a person lives, attendance at her/his funeral will depend on the weather. Unfortunately, that saying may have relevance for the Federal Housing Administration today, because no matter how well the FHA is performing in fiscal 2010, the coming actuarial review will depend on predictions about house prices for the next 30 years.
By all measurable standards, the FHA is performing better than many expected and is fulfilling the countercyclical role its founders intended. Its new leadership has implemented a series of changes that have improved credit quality and strengthened lender monitoring and enforcement.
When the private mortgage market collapsed in mid-2007, the FHA stepped in, and it has become the primary financing vehicle for U.S. homebuyers. It is now insuring more purchase loans than Fannie Mae and Freddie Mac combined. Without it, many creditworthy people with credit scores of 620 to 700 would be unable to buy homes and the housing recovery would be even slower.
This increased role has not come at the expense of the FHA's credit quality. Almost 60% of its loans insured in fiscal 2010 have credit scores over 680. The importance of credit scores over 680 is that these loans, even with minimum down payments (3.5%), perform better than loans with credit scores below 680 that have 10% down payments. And loans to borrowers with credit scores below 620 are now less than 4% of the agency's volume.
So it is not surprising that the performance of the FHA's portfolio is improving. Its serious delinquency rate (90-plus days) is at the lowest level of the fiscal year (8.32%). FHA claim payments, while increasing, are running 28% below levels predicted by the FHA's independent actuary. Its cash reserves are still growing and now exceed $33 billion.
The news on the performance of recent originations is even better. The rate of early serious delinquencies in the first six months after loan closing has fallen steadily in every quarter since the beginning of 2008. In fact, for the most recent quarter with available data (the third quarter of 2009), its serious delinquency rate (0.68%) was at least 69% below all four quarters of 2007.
Finally, the FHA's fiscal 2009 actuarial review included a house price forecast for fiscal 2010 that is proving to be overly pessimistic. The fiscal 2009 audit was based on an 8.67% decline in house prices through June 2010 and a 6.5% decline for the entire fiscal year. The latest Federal Housing Finance Agency data, through May 2010, shows the 12-month decline is just 1.2%. The house price forecast in the fiscal 2009 audit reduced the FHA's economic value (capital) by $9.8 billion.
In light of this stellar performance, why would the FHA raise insurance premiums for the second time in less than six months (as it recently announced)? It is a preemptive measure to avoid the negative consequences of a potentially poor actuarial review.
The FHA's annual actuarial review forecasts the performance of its portfolio over the next 30 years projecting the capital remaining in the Mutual Mortgage Insurance Fund after paying claims and other expenses. These audits are inherently dependent on predictions about the future — particularly house prices.
Time will tell about the accuracy of the house price estimates that drive the FHA's fiscal 2010 actuarial review. Hopefully, they will prove more accurate than recent house price estimates. House prices were also forecast to decline 6.69% in fiscal 2008 and, as the fiscal 2009 audit said, "the realized annual national average house price growth rate during FY 2008 was negative 3.66%."
No one can dispute that actuarial reviews are an important component in the assessment of the FHA's financial condition. But, as the above data demonstrates, house price estimates are not infallible and, as a result, actuarial reviews are subject to wide swings in the assessment of the FHA's capital given the uncertainty of the assumptions in the model.
The good news for the FHA is that the review will corroborate the points about the agency's improved credit quality and portfolio performance in the past two years and dispel the myth that the agency has replaced subprime.
It will also have minimal impact on the FHA's current financial capabilities. Since the end of fiscal 2008, the agency's cash reserves have increased 17%, to $33.1 billion. The FHA has sufficient reserves to pay claims for almost three years without considering additional premium income.
What is troubling, however, is the impact of a potentially pessimistic house price forecast on FHA policy in the near future. Despite the agency's improving performance, a decline in its projected capital would likely trigger more program changes that could have adverse consequences for the housing recovery (particularly for many potential first-time homebuyers) and the broader economy. The irony is that actions taken to address any decline in the FHA's capital could exacerbate the tenuous market situation and become a self-fulfilling prophecy. (House prices will fall further because the FHA's actions will reduce demand and make it harder for creditworthy borrowers to get financing.)
The FHA's actuarial review will likely be a tug-of-war between the facts associated with the FHA's improving credit quality and estimates about house prices. While both should be considered in any assessment of the agency's overall financial health, it is important to remember that actuarial reviews are projections about what might happen rather than what is actually happening.