FHA Audit Shows Credit Quality Improvement, HECM Liability Increase

The latest independent audit of the Federal Housing Administration shows the agency experienced better than anticipated credit quality of borrowers and an improved house price appreciation forecast in the short term.

The audit, prepared by Clifton Gunderson, estimates the liability for the Mutual Mortgage Insurance (MMI) decreased from $28,456 million at the end of fiscal year 2009 to $26,035 million at the end of fiscal year 2010.

While the short term price appreciation helps the MMI fund, the long term housing price appreciation forecast for HECM properties didn’t turn out as well.  According to the report, FHA has insured 650,591 reverse mortgages (HECM) with a maximum claim amount of $144 billion since the beginning of the program.

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Of these 650,591 HECM loans, 510,144 loans with a maximum claim amount of $119 billion are still active. As of September 30, 2010, the insurance-in-force (the outstanding balance of active loans) was $73 billion.  The HECM liability for fiscal years 1992-2008 increased from $4.753 billion at the end of fiscal year 2009 to $8.692 billion at the end of fiscal year 2010.

“The increase in the liability is primarily due to a less optimistic house price appreciation forecast for HECM properties in the long term and new estimates of current and future tax and insurance default cases,” said the report.

“The HECM liability is driven more by long term house price appreciations forecasts than short term forecasts. The drop in the long term forecast results in lower recoveries from future HECM assigned assets and the new estimates of current and future tax and insurance default cases increases the unpaid balance of these loans which increases the liability.”

According to Michael McCully, Partner at New View Advisors, the data found in the audit was expected.

“The magnitude of loss comes as no surprise, we warned of an $8 billion loss for the old cohorts in our blog,” he said to RMD in an email.  “This new data justifies FHA’s Principal Limit Factor reductions and other program modifications for fiscal years 2010 and 2011.”

After benefiting from nearly two decades of home price appreciation, the recent changes made to the program will “mitigate FHA’s future losses, assuming no additional material home price depreciation,” he said.

Even with the lower principal limits, McCully believes that senior homeowners continue to receive generous benefits from the HECM program.  However, the company remains concerned that slow prepayments could translate into higher crossover loss and the impact of taxes and insurance defaults.

To view the report, see here.