The blog of the Urban Institute
November 27, 2019

What’s Behind the Dramatic Improvement in the Federal Housing Administration’s MMI Fund?

November 27, 2019

The Federal Housing Administration (FHA) recently released their annual report to Congress, which shows that the capital ratio of the Mutual Mortgage Insurance (MMI) fund was 4.85 percent in fiscal year (FY) 2019, a huge improvement over the 2.76 percent in FY2018. Both the forward portfolio with insurance on $1.2 trillion of mortgages and the reverse mortgage portfolio with insurance on $64 billion showed large improvements.

The MMI fund’s economic net worth for the forward portfolio increased by $19.8 billion in one year, from $46.8 billion to $66.6 billion. As a percentage of insurance in force, the forward portfolio had a capital ratio of 5.44 percent in FY2019, up 1.51 percent from 3.93 percent in FY2018. For comparison, the ratio was 3.33 in FY2017 and 3.11 percent in FY2016.

The dramatic $19.8 billion improvement in FY2019 was driven by two factors:

  • a $10.2 billion reduction in the estimate of the net present value (NPV) of future losses
  • a $9.2 billion improvement in capital resources

Although future revenue estimates remained largely unchanged, we believe that the FHA’s improved handling of defaulted properties has driven this significant improvement in the FHA’s finances.

The $10.2 billion reduction in future losses is expected because of greater use of foreclosure alternatives and less reliance on REO

The FHA is expecting fewer losses on the loans it insures, largely because it has been experiencing fewer losses lately. Last year, insurance claims fell to around 67,400 properties with a loss given default (LGD) of about 41 percent. In other words, the FHA recovered about 59 percent of the money in those 67,400 mortgages.

In contrast, from 2009 to 2018, the LGD fell below 50 percent only once and was often over 60 percent.

The FHA is experiencing fewer losses mostly because it is making greater use of disposition alternatives, such as short sales and claims without conveyance of title, and is less reliant on real-estate-owned (REO) sales. These disposition alternatives are generally preferable for both the borrower and the FHA.

In addition, the loss within the REO and disposition alternative channel has improved. As a result of these changes, LGD has decreased by about a third, from 60 to 40 percent.

Although the FHA has not explained why it expects to see a $10.2 billion improvement in the NPV of future losses, we think this significant improvement reflects a belief that the lower LGD will continue in future years. The estimated NPV of future losses decreased from approximately $43.9 billion to $33.8 billion, or approximately 25 percent, which would indicate that the LGD was not reduced by the full amount reflected in recent performance. 

Although there are other reasons why the NPV of future losses could have improved, none are convincing.

The estimate could be lower because of improving quality, thanks to better-than-expected house price appreciation in 2019 or a better-than-average 2019 book of business. But given that house price appreciation is slowing and the 2019 book has worse credit characteristics than recent books, we doubt this drove the improvement.

Similarly, the FHA may have forecasted higher house price appreciation going forward this year, but given the slowing house market, this is also unlikely a significant driver.

Thus, we believe the biggest driver is the updating of the model based on new evidence on improved LGD.

The $9.2 billion increase in capital resources is primarily a result of profitable new business

The increase in capital resources is largely because of the revenue the FHA brings in each year, minus the claims paid. Revenue is based on the mortgage insurance premium, or 85 basis points (bps), against the $1.2 trillion in insurance in force (about $10 billion) and the upfront fee of 175 bps against the $215 billion in new insurance (about $4 billion), minus the claims paid of approximately $4 billion. The accounting is slightly different because of numerous technical issues, but the simple math approximates the increase in capital resources.

That revenue is greater than claims is not surprising, given the good credit mix in the post–Great Recession books (e.g., strong average credit scores for most years), the almost doubling of the mortgage insurance premium (MIP) since the Great Recession, and the strong house price appreciation of the past seven years. In fact, according to the annual report, the 2019 book of business was profitable even with the worsening of credit attributes and the increase in mortgages with three or more high-risk attributes.

The positive outlook for the FHA’s finances should continue

It is likely the forward fund will continue to improve. Usually, a structural shift, such as changing the disposition channels to rely more on third-party sales, is a modeling change made over years to make sure the trend is sustainable.

In addition, the acute supply shortage is pushing up home prices, particularly at the lower end of the market, which is where the FHA is most active. Prices of less expensive homes in each market are up far more than home prices for the more expensive homes in each market. This further reduces delinquencies and improves recoveries and loss severities.

Given that the forward capital ratio now stands at 5.44 percent, the report addressed the question of how much capital is sufficient. The report suggested that an appropriate target for the capital ratio, after adding back in the NPV of future losses, would be 8.0 percent and that the ratio now stands at 8.2 percent.

If we add in the reverse mortgage program, the MMI is short of its target. However, as we’ve repeatedly stated, home equity conversion mortgages should not be included in the MMI with forward mortgages.

The rate of accumulation of capital reserves is about 75 bps per year in today’s economy. This suggests that the resources are there if the FHA wishes to reduce the MIP.

Although there are pros and cons, we would suggest that a straight cut to the MIP would have a greater effect on improving housing affordability than another popular idea in circulation: eliminating the premium when the mortgage reaches a 78 percent loan-to-value ratio, which typically occurs 9 to 10 years after origination at today’s interest rates.

The improved financial health of the FHA is encouraging, as the forward program is the primary source of mortgages for first-time homeowners. The annual report suggests that this improvement will continue, thanks to fewer losses on all the books of business and the additional economic value from the new book of business.

This gives the FHA the ability to cut the MIP if it chooses to. At the same time, supplementing the annual report with additional loan-level data would allow policymakers to develop additional insights into the adequacy of the capital reserves.

Photo by Andrei Stanescu via Getty Images.

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