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How FHA Can Improve Capital Position

Government reports make recommendations

Oct. 23, 2013

By Mortgage Daily staff

A pair of government reports offer recommendations that could help the Federal Housing Administration improve its capital position and avoid future shortfalls. One possibility is a stronger, more autonomous FHA structure, while another is to adopt some financial reporting practices used by private mortgage insurance companies.

While FHA has raised mortgage insurance premiums and tightened its underwriting requirements in recent years, more can be done to improve its long-term viability.

Among the changes FHA has made to its guidelines was to establish a minimum credit score for loan applicants.

But a report from the Government Accountability Office, FEDERAL HOUSING ADMINISTRATION: Analysis of Options for Modifying Its Products, Market Presence, and Powers, says that mortgage market observers say more can be done.

The study was conducted because of FHA's weakened financial condition; it hasn't met its 2 percent statutory minimum capital ratio since 2009 and now requires a federal infusion.

Among the potential changes are revising underwriting standards to focus on residual income, increasing downpayment requirements and reducing allowable seller concessions.

But the report acknowledged that such changes could prompt some of the best-quality FHA borrowers to choose competing alternatives -- leaving higher-risk borrower in their place.

One possibility that would help reduce FHA's market share is a limit on maximum borrower income.

Another possibility is to lower FHA's loan limits, which range from $271,050 to $729,750 for one-unit properties. The current limits, which were established during the housing crisis, are considered too high by some. In some cases, FHA's limits are higher than Fannie Mae's and Freddie Mac's.

The GAO said that lowering M.I. coverage to less than 100 percent of the loan amount or employing risk-sharing agreements could reduce FHA's market presence -- though such moves could limit the availability or increase the cost of credit to some borrowers. Risk-sharing would require careful consideration about the terms, pricing and incentives as well as counterparty government oversight.

"Finally, these options might also affect FHA's ability to respond to changing market conditions," the report stated.

Changes in FHA's structure and powers that bring it more in line with other government corporations, increase its autonomy and enhance its enforcement powers could enhance its flexibility and capacity to manage risk. It would also give FHA greater authority to change program requirements and invest in staff and technology.

"FHA and other observers have also argued that FHA needs greater power to change loan products or loan features without a lengthy rulemaking process and additional information technology resources -- resources for which FHA must currently compete within HUD," the GAO said. "Expanding FHA's operational and managerial powers would give the agency more flexibility, and increasing its enforcement powers would allow it to more effectively oversee lenders."

However, the GAO cautioned that any expansion of FHA's authority might need to be limited and complimented by heightened transparency requirements, including for the rulemaking process.

But even if FHA's organizational structure or authority doesn't change, the agency can do more to enhance program efficiency and effectiveness and protect taxpayers.

Recommendations made by the GAO are aimed at improving FHA's loss mitigation efforts, management of real-estate owned inventories, risk assessment, human capital management and information technology systems.

FHA has responded by taking steps like developing a plan for conducting an inaugural risk assessment and creating a workforce analysis and succession plan.

The report noted that FHA reform is clouded by efforts to further regulate housing finance and by the uncertain resolution of Fannie and Freddie.

"Partly for this reason, GAO identified modernization of the federal role in housing finance as a high-risk area in early 2013," the report stated. "Any changes to the federal tools that support housing finance should be made in concert and with full recognition of the interdependence among FHA, the enterprises, and federal regulation."

A second GAO report, FHA MORTGAGE INSURANCE: Applicability of Industry Requirements Is Limited, but Certain Features Could Enhance Oversight, was also prompted by FHA's capital deficiencies.

The second report acknowledged differences in reserve and capital requirements between FHA's Mutual Mortgage Insurance Fund and private mortgage insurers as a result of the distinct environments in which FHA and the private insurers operate.

While private insurers are required to establish a reserve for estimated losses expected in the near term on delinquent loans, FHA is required to reserve for the present value of estimated losses for all outstanding loans net of anticipated revenues. While capital requirements are expressed as comparisons of risk to capital for both FHA and private insurers, the calculations measure risk and capital differently.

But both FHA and private mortgage insurance companies have struggled to maintain capital requirements over the past few years.

There are some features of the private regulatory framework that could be used to enhance oversight of FHA's MMIF.

For instance, FHA could separately report the MMIF's unearned premium reserve and contingency reserve.

"FHA's liability for loan guarantees combines 30-year estimates of future claims, premiums, and recoveries into a single number, as required, and does not disclose the timing of each type of cash flow," the GAO stated. "Disclosing the timing of specific cash flows would help illustrate the extent to which estimates of claims payments, premiums, and recoveries in the liability for loan guarantees are concentrated in the near term or longer term and therefore more or less certain.

"Such disclosure could enhance congressional oversight of FHA and would be consistent with reporting practices of other federal programs and federal internal control guidance for communicating externally about an agency's risks."

Remediation plans to restore capital to required levels and additional reporting that apply to private insurers could be applied to FHA in a move to increase accountability.

Although FHA last year provided Congress with a set of planned actions to address its capital shortfall, it had not done so previously. Had it provided a capital restoration plan at the point when the capital ratio fell below the required level, prompt action would have been ensured for FHA.

Current pending legislation includes these type of requirements and would be consistent with requirements Congress has enacted for the Federal Deposit Insurance Corp. and certain financial institutions.

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