A soon-to-be-released report on the financial condition of the Federal Housing Administration's mortgage insurance fund is likely to provoke demands that the agency make another premium cut.
The report from independent auditors will likely show that FHA remains below its 2% statutory minimum capital ratio, but HUD officials and outside observers still expect it to show major improvement over last year.
Quarterly reports indicate that the insurance fund is benefiting from higher loan endorsements because of the Department of Housing and Urban Development's decision to reduce FHA's mortgage insurance premiums early this year.
"We are hoping with the increased volume that the capital reserve ratio has gone up significantly," HUD Secretary Julian Castro said at an event early this week.
HUD reduced FHA's 1.35% annual mortgage insurance premium by 50-basis points, to 85 points, in January. Since then, FHA endorsements of single-family loans have jumped to 334,400 in the second quarter, up 67% from a quarter earlier.
The "policy has been an unqualified success," Bank of America-Merrill Lynch analysts said in an Oct. 23 report.
Last year's actuarial report showed that the FHA's mortgage fund had an economic value of $4.8 billion, equaling a 0.4% capital ratio relative to loans guaranteed by the agency. The actuaries projected that the fund was on a path to reach a 1.3% capital ratio by Sept. 30 of this year, and 2% a year later.
If the new actuarial report, which is due out early next month, shows that the capital ratio is higher than 1.3%, it would likely spark a debate over whether the FHA needs to further cut mortgage insurance premiums for first-time homebuyers, according to Chris Flanagan, a mortgage securitization analyst with Bank of America-Merrill Lynch.
"An argument can be made that the MIP is too high and there is room to cut," Flanagan said in an interview. "It is still a struggle getting first-time homebuyers into the housing market. There are many people who believe credit conditions are far too tight."
But other analysts said HUD is likely to resist any pressure from industry groups to make another cut.
"We think the 50-basis-point cut had offsetting impacts on the insurance fund, pushing the 2% threshold back slightly, which is why we think FY17 is a realistic estimate," said Isaac Boltansky, an analyst with Compass Point Research & Trading.
If FHA does go for a rate cut, Boltansky said it would likely be a 25-basis-point to 50-basis-point to its upfront premium, not a reduction in its annual premium, which is paid out over the life of the loan.
The annual actuarial report is prepared by independent auditors who look at long-term trends in the mortgage market, interest rates and the economy in making their estimates of the current and future economic value of FHA's single loan portfolio.
According to last year's actuarial report, the housing market should be in a mild recession right now. The auditors also have to factor in the performance of FHA reverse mortgages (known as Home Equity Conversion Mortgage program), which has been a drag on the FHA Mutual Mortgage Insurance Fund.
It is difficult to make predictions about the actuarial report because of the economic assumptions and impact of the reverse mortgage program, observers said.
The reverse mortgage program is a "wildcard," said Brian Chappelle, a mortgage consultant and co-founder of Potomac Partners.
The economic value of the reverse mortgage program dropped from $6.5 billion in fiscal year 2013 to a negative $900 million a year later.
On its own, the FHA's forward mortgage program has been rebounding. It had a negative economic value of $7.9 billion in fiscal year 2013. But a year later, its economic value jumped to a positive $5.9 billion. The last actuarial report projected that the forward program would continue to recover and reach an economic value of $16.2 billion in fiscal 2015. (The auditors do not disclose the capital ratio of the stand-alone FHA forward program — just the capital ratio for the combined FHA forward and reverse mortgage programs.)
On its own, the FHA forward program "should get close to a 2% capital ratio," Chappelle said.
He said all the factors within FHA's control (loan volume, loss severity rate and delinquency rates) have improved substantially over the last year.
For example, the amount of seriously delinquent loans dropped to $55 billion in August, down from $95 billion in January 2013.
If the reverse mortgage program drags down FHA's capital ratio, Chappelle said he is concerned it could take a premium reduction off the table and deprive homeownership opportunities to minorities and low-income borrowers.
"Why should first-time homebuyers be penalized because Congress merged the reverse program into the forward FHA program a few years ago?" he said.
David Stevens, the president and chief executive of the Mortgage Bankers Association, also expects November's actuarial report to show continued improvement.
"I would expect it to be above the 1.3% expectation, but that might be as much as a result of the reverse HECM program as the forward mortgage portfolio," he said.
Stevens, a former FHA commissioner, noted the reverse mortgage portfolio is only one-tenth the size of the forward portfolio. However, it is "extremely volatile and can swing the total capital reserve portfolio significantly."
Meanwhile, Castro has already signaled that he will be cautious in considering any new premium reduction.
"As the fund continues to get stronger," it will allow HUD to consider another premium reduction, Castro said.
Stevens said "FHA would like to build a cushion in the fund, above the 2% minimum level."
"Rates still remain near historic lows and it is my belief that FHA will hold off using this valuable stimulus option until it is clearly needed and not trade away this option too early," he said.
Edward Mills, a policy analyst at FBR Capital markets, said a good report would trigger a renewed debate on a premium cut, but agreed that FHA is unlikely to go in that direction.
"The chances of an annual premium change is extraordinarily low," Mills said in an interview. "If anything is done, I think it will involve the life of loan requirement or the upfront premium."
HUD may also want to avoid the political pushback that would come from any rate reduction. Republican lawmakers argued the January cut was premature because the mortgage fund had no reached its mandatory minimum. If HUD were to make another cut, it would invite more criticism and scrutiny from Capitol Hill.
There are also questions as to whether another premium reduction would result in the same boost the FHA received from the last one. The 50-basis-point premium reduction cut the profitability of each loan, but FHA made it up in volume.
"The question is whether they can do it again," said B of A's Flanagan.
Flanagan's report also points out that an additional FHA annual premium reduction to 55 bps could cut into Fannie Mae and Freddie Mac's market share and hurt the private mortgage insurers' business.
Such a move might force the Federal Housing Finance Agency to reduce the loan fees the two government-sponsored enterprises charge borrowers. It risks "triggering a price war with the GSEs and forcing FHFA's hands," the Oct. 23 report says.
