FHA Reserves Sink Further Below Legal Limit Amid Talk of Bailout

An annual audit of the ""Federal Housing Administration's"":http://www.fha.gov (FHA) books has concluded there is a 50-50 chance the government mortgage insurer will need a bailout from taxpayers within the next 12 months.

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""HUD"":http://www.hud.gov released a ""report to Congress"":http://portal.hud.gov/hudportal/documents/huddoc?id=FHAMMIFundAnnRptFY2011.pdf Tuesday on FHA's 2011 fiscal year, which ended September 30. It shows the agency’s cash reserves have fallen to $2.6 billion, down from $4.7 billion at the end of FY 2010.

The decline has pushed FHA’s capital reserve ratio further below the legal limit mandated by Congress. It has deteriorated to 0.24 percent. By federal statute, FHA’s capital reserve ratio should be at a minimum of 2 percent. It was 0.50 percent as of last September.

The capital reserve ratio measures FHA’s cash on hand relative to the number of all outstanding mortgages insured by the federal agency. It’s intended to gauge the amount of cash reserves held by the agency beyond what’s needed to cover projected losses from loan defaults.

FHA’s capital reserve ratio has come in below the congressional requirement of 2 percent for three years now. This latest reading of 0.24 percent is the lowest in the agency’s 77-year history.

HUD’s report on the agency’s deteriorating bottom line comes just as lawmakers are advancing a bill that would

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reinstate higher conforming loan limits for FHA, and most suspect would increase market share for the agency.

An amendment has been approved as part of a broader federal funding bill which would raise FHA loan limits to as much as $729,750 in high-cost markets through 2013. These higher loan limits expired for FHA, as well as the GSEs, on September 30. The bill, which is scheduled for a vote by both congressional chambers later this week, would restore the higher loan limits for FHA, but not for Fannie Mae and Freddie Mac.

As the housing crisis set in and traditional credit lines began to dry up, FHA stepped in. The agency’s market share has jumped from less than 5 percent during the pre-crisis boom to more than 30 percent today. FHA’s active single-family portfolio now stands at more than $1 trillion.

But the same market conditions that have buoyed the agency’s prominence have contributed to large losses, with high levels of loan defaults, declining home prices, and delayed claim resolutions due to lengthening foreclosure timelines.

FHA is the only government agency that is completely self-funded. Although it currently operates at no cost to taxpayers, there is an implicit guarantee that U.S. taxpayers will come to the agency’s aid if needed.

According to FHA’s independent auditors, the principal risk confronting FHA’s balance sheet is a continued decline in home prices into 2012 and even into 2013, which would bring down the value of the current portfolio.

Using scenario projections from Moody’s Analytics, the auditors note that should home prices fall by another 9 percent next year, FHA would need $13 billion from taxpayers to replenish its coffers.

On the other hand, should home prices begin to recover in 2012, with robust growth beginning in 2013, FHA’s would be able to bring its capital reserve ratio above the 2 percent threshold by 2014, all on its own.