As expected, the FHA is having a tough time with its mortgage insurance fund (the Capital Reserve Account), which moved into negative territory this year (about $16bn in the red). The agency simply hasn't been charging enough for insurance on the extremely low down-payment (almost 30x leverage) mortgages it guarantees (see discussion). The media and some politicians have been expecting the agency to tap taxpayer funds in order to recapitalize the insurance fund (in Q3 of 2013). But a recent report from Barclays suggests that it may not have to. Here are some reasons:
1. One of the worst performing components of the FHA's portfolio is made up of seller-funded down-payment mortgages. The agency no longer insures such transactions. However these legacy positions are proving to be painful.
WSJ: - A big chunk of the losses leading to a $16.3 billion shortfall have come from programs that allowed home sellers to fund down payments via nonprofit groups that provided them to buyers as a “gift.” After trying for years, the FHA finally prevailed on Congress to shut down the programs in late 2008, but not before the agency backed billions in risky no-money-down loans as home prices were dropping fast. The Journal looked at the programs in a Page One story just a month before Congress passed a bill that ultimately shut them down.With no additional such mortgages since 2008, this seller-funded portfolio is shrinking in size relative to the whole portfolio and is expected to become less problematic soon.
Seller-funded down-payment assistance loans accounted for just 4% of outstanding loans at the end of September, but they represented 13% of all seriously delinquent mortgages, according to a recently released audit.
2. The fund capitalization calculation does not include the brisk origination business and improved fees the agency has been enjoying recently. In the last two years, the FHA has been steadily increasing its mortgage insurance premiums (MIPs) - something the agency should have done years ago.
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| Source: Barclays Capital |
According to Barclays, these increased fees should put the Capital Reserve Account into positive territory in 2014 in spite of high delinquencies on these low down-payment mortgages. Below is their projection for the fund's capital ratio going forward.
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| Source: Barclays Capital |
3. Since the fund capitalization is measured using actuarial models (similar to the way insurance companies would assess their expected losses), the recent change in assumptions caused large adjustments. In particular the agency adjusted its assumption for loss severity (how much is recovered in case of mortgage default), lowered its projections for house price appreciation, and lowered its interest rate forecast. These model adjustments were obviously necessary, but the change generated a one-time "shock" to capitalization requirement. Which takes us back to the FHA potentially drawing additional funds from the US Treasury. As Barclays points out, "fund appropriations for the FHA are decided in the president’s budget estimate, which uses a different set of economic assumptions". That means that according to the US Treasury's assumptions, the FHA insurance fund may not be as undercapitalized as the FHA reports - and therefore may not need taxpayer support (at this stage). That's government bureaucracy at work.
Barclays: - It is more than likely that the president’s budget estimate will show the MMI fund to be on a stronger fiscal footing than this report states.These three factors indicate that it is not at all certain that the FHA will be forced to ask for taxpayer support in the near future (in spite of its recent troubles).
See this video for more info on the FHA's troubles (from the WSJ's perspective) and the overall issues plaguing the US federal policies on housing:
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