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HUD Chief Defends FHA Capital Reserves

Senate testimony by HUD Secretary Shaun Donovan

Dec. 6, 2012

By Mortgage Daily staff

While today's low interest rates mean that the Federal Housing Administration's capital reserve ratio is worse than it appears, the secretary of the Department of Housing and Urban Development testified before lawmakers that other factors are offsetting ultra-low mortgages rates that are currently in effect.

In its Annual Report to Congress Fiscal Year 2012 Financial Status FHA Mutual Mortgage Insurance Fund, HUD disclosed that FHA's capital reserve was a negative 1.44 percent. That works out to a negative economic value of $16.3 billion.

But some question the assumptions used to get to that number and suggest it is much worse.

Edward J. Pinto, a resident fellow at the American Enterprise Institute who was scheduled to testify Thursday before the Senate Banking Committee, claims FHA is in worse financial shape that it is willing to let on.

"Given today's low interest rate environment, FHA's negative economic value is -$31 billion, not -$13.5 billion," Pinto said in a note prior to his testimony. "As a result it will be 3 years before, even under the best of circumstances, FHA returns to a positive economic value."

At the hearing, one senator asked HUD Secretary Shaun Donovan about the interest rate assumptions used in determining FHA's capital reserve ratio for its actuarial review. He noted that the interest rates currently in effect are lower than those assumed for projections -- indicating that the actuarial review was overly optimistic. In addition, according to the senator, Federal Reserve policies will likely keep rates low for years to come.

photo of Shaun Donovan
photo of Shaun Donovan testifying on C-SPAN

Donovan acknowledged the negative impact lower rates will have on FHA's position and explained that the projections were made in July.

"So it's accurate that interest rates have dropped further than were built into the primary actuarial view," the HUD chief testified.

But Donovan highlighted two offsetting factors.

The first is home prices -- which he said have performed better than the assumptions used in the actuarial report.

"Based on what we know today, even for this year, the actuarial would be significantly better if it were performed today just on that one variable," he stated.

The second offsetting factor is that the actuarial review assumes that no new FHA business is originated and the portfolio is in runoff mode.

While the report accurately assumes that loans pay off faster during periods of low interest rates, it ignores that around half of those same loans are refinanced through FHA. Congress requires that the report be prepared in a runoff scenario.

"All that being said, we will in the president's budget include the lower interest rates that you describe," Donovan said. "We will also include an updated projection of house prices.

"And at that point, we'll have a clearer picture of how these offsetting factors play."

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