Is the FHA heading for a bailout?

Jennifer E. Garrett, editor

As published in Scotsman Guide's Residential Edition, September 2012.

Since the first waves of the housing crisis began to hit, the Federal Housing Administration (FHA) has played an increasingly large part in efforts to stabilize the market. In fact, according to data from the U.S. Department of Housing and Urban Development, the FHA’s share of all home-purchase activity was 4.12 percent in fiscal year 2007. As of this past March, it was 16.05 percent, after hitting a high of 19.13 percent in 2010. The FHA currently holds 4.8 million insured single-family mortgages in its portfolio.

“We had an enormous rush into the FHA program when the private market began to exhibit signs of distress,” says Keith T. Gumbinger, vice president at HSH.com, a mortgage-data company. “Low-downpayment mortgages for borrowers with credit scores that weren’t quite up to par vanished from the marketplace — with the exception of the FHA program.”

The FHA’s generous terms for its mortgage-insurance program — credit scores down to 580, downpayments as low as 3.5 percent and loan amounts as high as $729,750 — make the FHA a popular option for many homebuyers with less-than-perfect credit. These borrowers, however, represent significant risk for the FHA in terms of loan defaults and eventual foreclosures.

With FHA delinquencies increasing in recent years, many industry experts are concerned about the agency’s financial stability and wonder: Is the FHA headed for a bailout?

Delinquencies

This past June, the Office of the Comptroller of the Currency (OCC) issued its quarterly report on the mortgage market, with figures on delinquencies for government-guaranteed mortgages, loans from the government-sponsored enterprises (GSEs) and mortgages held by banks and thrifts. Of the three categories of mortgages, government-backed loans performed the worst.

 For government-guaranteed mortgages — the majority of which are FHA-backed loans — the number of loans that were delinquent for 90 days or more increased by 26.6 percent from first-quarter 2011 to this past first quarter. In that same timeframe, 90 days or more delinquencies decreased by 14.7 percent for GSE loans and by 39 percent for bank-held mortgages.

Why is there this discrepancy in performance? According to Andrew Caplin, a professor of economics at New York University, the discrepancy should be expected. “[The FHA] is the only group that’s continued issuing extremely risky loans at a time when it’s known that the economy is extremely fragile and house prices aren’t rising,” he says.

Caplin has appeared before Congress several times to testify about the risks associated with FHA’s book of loans, and he recently co-authored a paper questioning the sustainability of the homeownership that the FHA is creating. In fact, the paper predicts that 90 days or more delinquencies for FHA-backed loans originated from 2007 to 2009 will increase to more than 30 percent within five years.

“There’s no sensible metric by which FHA mortgages are in anything but trouble,” Caplin says.

Gumbinger points out that the FHA was created to serve the low- and moderate-income population and its delinquency rates reflect that. “The FHA has traditionally had, because of the characteristics of its borrowers, higher loss ratios than prime mortgages,” Gumbinger says.

Although logically FHA mortgage-delinquency rates should be expected to be greater than those of prime mortgages, the upward trend still is somewhat disquieting. This past first quarter, the percentage of FHA loans in foreclosure, at 3.83 percent, was the second-highest level in the history of the Mortgage Bankers Association National Delinquency Survey.

Changing standards?

Years of increasing defaults have taken their toll on the FHA’s finances. By Congressional mandate, the agency is supposed to maintain a reserve fund with a 2 percent ratio of fund to loans insured. Because of the need to cover losses on insured mortgages, the reserve fund fell to 0.53 percent in fiscal year 2009. By the end of 2011, the ratio was down to 0.24 percent.

“The FHA is teetering on the edge of insolvency,” Gumbinger says.

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