The Federal Housing Administration (FHA) has released its Annual Report to Congress on the Status of the Mutual Mortgage Insurance Fund (MMI Fund or “the Fund”), the agency’s fiscal year actuarial review, and once again the Fund showed an improved financial position for FHA over the prior year.
Despite headwinds for the U.S. economy, with October wholesale prices rising 8.6% year-over-year, tied for the highest ever, along with the deceleration of real GDP in Q3, a strong housing market and robust home price appreciation have boosted MMI Fund Capital to over $100 billion, increasing from last year by $21.5 billion. The capital ratio of the Fund improved to 8.03%, a 1.93 percentage point improvement over 2020, which was the highest level since 2007. Both MMI Fund Capital and MMI Fund Capital Ratio are at historic highs.
This is welcome news for FHA, especially given the fate of 660,000 FHA borrowers who are seriously delinquent (nearly 400,000 still in COVID-19 forbearance plans) remains uncertain. Many of those borrowers have and will use FHA’s home retention tools available to them and hopefully have a soft landing as they return full-time to the workforce.
Borrowers unable to find employment potentially face an uncertain road ahead, since a successful home retention outcome is increasingly more difficult without full-time employment that provides a stable income source.
A key question accompanying the strengthened financial position of FHA for HUD leadership will be what happens to FHA mortgage insurance premiums (MIP).
Earlier this year, Secretary Marcia Fudge planted a flag when she said FHA premium cuts were not on the table. With the improvement in the Fund’s position once again, there is sure to be increased pressure from some FHA stakeholders to lower premiums in the name of relief to borrowers.
While Secretary Fudge is focused on increasing affordability of FHA financing, she is also looking to expand financing “for small-dollar mortgages in low-cost markets” and “expanded homebuyer assistance,” to “create opportunities for homeownership to a greater number of well-qualified borrowers of modest means.”
As Secretary Fudge and FHA balances these important goals, it is necessary to unpack for a moment the significance of the premiums FHA collects and the claims it later pays.
As the MMI Fund Report points out, FHA’s MMI Capital is in part a buffer “against adverse shocks and financial events during uncertain times.” FHA Capital held in excess of minimum requirements is “designed to reduce adverse impacts due to the procyclical nature of lending.”
Like any insurance company in the private market, FHA must hold this “capital at risk” to pay claims in the event that the premiums collected are not sufficient to cover them.
Indeed, managing the capital position of the MMI Fund is a core risk management responsibility for FHA, undertaken proactively and with an eye toward continuing to build strength for the future.
FHA’s prudent management of the capital position of the Fund should take into consideration numerous factors including the health of the economy, home price appreciation, credit risk already on the books (and its expected performance over time), and the amount of excess capital necessary to meet unexpected losses.
The Annual Report makes it clear: “Because the MMI Fund Capital Ratio is so closely tied to Home Price Appreciation (HPA), the assessment of FHA’s financial health represented by the ratio can change materially and quickly with changes in both actual and projected home values.” Further, HPA is a lagging indicator that clarifies or confirms a trend over time. By the time HPA data confirms a downward trend, it has already negatively impacted MMI Capital.
“[M]odels driven by industry-wide HPA assumptions,” the report concludes, “are not necessarily indicative of the outcomes for this distinct population of mortgages, resulting in further uncertainty regarding the impact to the MMI Fund as the economy continues its recovery from the pandemic. The size of the seriously delinquent portfolio further magnifies the uncertain future MMI Fund performance.”
Indeed, the continued strength in the housing market through the COVID-19 pandemic and resulting strong nationwide home price appreciation has materially impacted the capital ratio in a positive way.
Nevertheless, for FHA to put itself in a position to best serve low- to moderate-income borrowers who will be most affected should private markets constrict (which history has shown sometimes do), it must be prepared to weather adverse events such as those experienced during the Great Recession in the 2008-2012 period, or the COVID-19 stress being experienced currently, with the ultimate cost not yet known.
Any consideration for reducing MIP should also consider the cost to other goals set by FHA that make use of, or deploy existing excess capital, such as further investing in affordable housing consistent with Administration goals.
Given that the extent of the cost of higher, COVID-driven delinquencies is not yet known, a decision to reduce MIP should, in our view, be deferred indefinitely.
Once FHA determines MMI Capital is sufficient to cover expected losses and still maintain an industry-standard buffer, should it have excess capital beyond that amount, the common urge has been to return it to taxpayers/borrowers in the form of MIP reductions.
As we wrote in April of this year, the impact of seemingly small MIP reductions should be understood before setting that course. Take into consideration that if FHA insures 1 million new mortgages a year, the average in recent years, a MIP reduction of 25 basis points (or 1/4th of 1%) would shrink annual revenue by approximately $500 million in the first renewal year alone and trigger a re-calculation of future, reduced revenues while lowering overall mortgage payments by an average of $31 per month (using an assumption of a $150,000 loan amount with down payment less than 5% and financed for 30 years).
As FHA considers the current macroeconomic environment in which it is operating, as well as the dynamic market effects of MIP structure on the Fund, a premium reduction, for example, is likely to trigger a round of refinances, further reducing revenues, a key component of the FHAs claims-paying capacity, across the broader portfolio during a time of stress. Further, an accelerated prepayment environment harms investors in Ginnie Mae securities as their expected investment returns are negatively impacted. FHA is encouraged to consider any change to MIP in a broad sense to ensure it also understands and evaluates both the direct cost and also the “ripple effect” of an MIP reduction to HUD and the entire mortgage market.
Taking actions that facilitate increased portfolio prepayments and reduced securities value when the ultimate outcome of borrowers in COVID-19 forbearance is unknown might have a compounding impact when those lower premium rate refinances erode FHA’s capital foundation even further.
FHA should consider all options that help to expand opportunities for low- to moderate-income homebuyers by deploying some of the excess capital into new programs, products, or underwriting policies that furthers the Administration’s desire to increase credit availability to low- and moderate-income borrowers, first-time homebuyers, and minority borrowers.
The capital deployment can come in the form of additional claims-paying capabilities to support expanding lending to borrowers currently unable to qualify. Examples of this may include increasing the incentives and therefore the volume of manufactured housing (key to expanding affordable housing stock), working with state and local governments on policies and programs needed to increase lending to targeted income groups, and responsibly expanding use of government down-payment assistance programs that improve opportunities for first-time homebuyers.
The continued improvement in the FHA’s capital position is welcome news for the agency’s ability to fulfill its mission and continues to be a source of strength to the housing market and to millions of potential homebuyers. We believe staying the course on premiums would continue to be prudent, given the risks and uncertainty.
Editor's note: The opinions expressed in this piece are those of the authors and do not necessarily reflect those of their employer or any clients.