Blog of the Mortgage

HUD Changes and the Future of FHA Business

September 25th, 2009 1:17 PM

It's BFF Friday (Bank Failure Friday). Which bank are you betting on failing? Depository Institution of course.

My Company is doing resoundingly well after tripling its funding capacity by adding two new warehouse facilities in the past week.
Last week Friday HUD sent out a multitude of Mortgagee Letters. But only 3 were of significant importance to our business: you can download each one here:
1. ML 09-28 Appraiser Independence: HUD is moving toward an HVCC type system Beginning on January 1st of 2010. Guess they're concerned with undue influence as well??
2. ML 09-30 Appraisal Validity Periods - HUD is shortening the time that FHA appraisals are valid on an existing Case number. This means that if you take on a declined loan from another lender and you have a new borrower you will only have to wait 121 days (instead of 161 days) to reissue a new appraisal for the subject property. This is GOOD NEWS!
3. ML 09-32 Streamline Refinance Documentation standards changing: AS OF NOVEMBER 18th of this year.
HUD is going to require, income, assets, employment information on their 1003's going forward as well as limiting the amount of closing costs you can roll into the new loan going forward. This could present a problem.

I am forwarding you below a COMPLETE e-mail from our Potomac Partners Group in Washington and their synopsis of this information above as well as what they believe the future of the FHA's direction under David Steven's will be and look like.
Please take a moment to read ALL of this as it very much effects your business going forward.

We have received inquiries from clients concerning the current status of the FHA program, particularly in light of recent press articles raising questions about FHA's fiscal soundness. We are writing this update to provide you w/ our analysis of FHA's financial issues behind these articles and to discuss the general direction of the sweeping changes that we see on the horizon for the FHA program.
FHA's Financial Condition
o  FHA Commissioner has said FHA has sufficient reserves and will not require taxpayer assistance
FHA's Changing Philosophy
o  For the first-time ever, FHA has leadership with industry experience (See New Personnel below)
o  FHA is expected to revamp its risk management and business processes
o  FHA will move toward industry underwriting standards
FHA's New Credit Policies
o  FHA effectively adopted the Home Valuation Code of Conduct and tightened rules on streamline refinances transactions
o  Supervised mortgagees (financial institutions) will be required to submit audited financial statements starting in January 2010
o  Proposed mortgagee eligibility changes could have significant impact (See below)

Overview
Considering the economic problems and the sharp decline in house prices, it is not surprising that FHA's capital ratio will fall below the Congressional target of 2%. FHA has indicated that it is in reasonably good financial shape and will not require any government assistance. However, the decline in the capital ratio does give FHA's opponents on Capitol Hill ammunition to restrict some of FHA activities. The most immediate concern is the extension of the higher mortgage limits. While we are still optimistic that the higher mortgage limits will be extended, it is no longer a "sure thing".
We believe that FHA will be dramatically transformed over the next several years. Under Dave Stevens' (FHA Commissioner) leadership, FHA will be gradually adopting industry principles in many key areas, particularly underwriting policy, risk management and lender relationships (counter-party risk). Accordingly, mortgage lenders should not rely on their experiences with FHA in the past in evaluating how FHA will act in the future. We expect a "seismic" shift in FHA's policies and operations. Quite frankly, we doubt FHA staff realize the magnitude of the changes that are coming.

I. Highlights

Ø FHA's Financial Condition

In last Friday's Washington Post (see #1 at the bottom of this email), FHA "announced" that its capital ratio will fall below the Congressional target of 2%. The capital ratio is important because it is an indicator of FHA's long-term financial health.

In response, FHA also announced on Friday a series of credit policy changes. The Washington Post article follows a September 4th Wall Street Journal story that initially raised concern about FHA's financial condition.

Overview of FHA's Audit:

FHA is required by law to have an independent audit performed every year. An audit is important because it assesses the future financial condition of the FHA program at a particular point in time. Therefore, an audit projects the status of the fund after paying all anticipated claims and expenses associated with the run-off of the existing portfolio. The capital ratio reflects the reserves available to address unanticipated losses. Consequently, two key factors in the audit analysis are 1) economic projections (e.g. house price estimates) going forward and 2) program factors (i.e. loan characteristics of the existing portfolio).

In 1990, Congress established a 2% capital ratio target for the FHA fund. In other words, FHA should have 2% of its portfolio in reserves after paying all anticipated claims and expenses.

FHA has signaled in the Washington Post article that the audit will conclude that the capital ratio will fall below 2% for FY 2009. However, FHA also indicates that the fund will remain "positive" and, in fact, will return above the 2% capital ratio target in the next several years even if no changes are made. The primary cause for the improving credit ratio will be stabilizing house prices. Once the economy (and house prices) recover, the capital ratio will increase accordingly.

Key Points

While the FY 2009 audit should be published in mid-late October, FHA has made several encouraging statements about the financial status of the fund.

First, FHA Commissioner Stevens underscored that FHA reserves are adequate to cover future losses and no bailout is necessary. He said:
"To be clear, the fund's reserves are sufficient to cover our future losses, so the FHA will not require
taxpayer assistance or new Congressional action."

Mr. Stevens also said that:
"We are not going to need a special subsidy or special funding of any kind."

He also added that it will not be necessary to raise mortgage insurance premiums.

FHA's Current Cash Reserves Are Strong

FHA has $30 billion in current cash reserves to pay claims. At their present claim rate, we estimate FHA could pay claims for 50 months without considering any premium income from existing or new originations.

More detailed information about the audit and the implications of the FY 2009 capital ratio falling below the Congressionally mandated 2% target are provided in the Details Section below.

P2 (Potomac Partners) Assessment

FHA, like every other financial institution, will not be immune from the impact of further house price depreciation. To fulfill its public purpose, FHA cannot avoid this economic risk. FHA's challenge and responsibility is to balance this risk with prudent credit management.

By acting quickly last week (and with more changes likely), FHA is attempting to mitigate the most significant risk from the capital ratio falling below 2% (i.e. political). FHA's opponents on Capitol Hill will attempt to use the decline in the capital ratio as justification for opposing further expansion of the FHA program. The most immediate threat would be to the proposal to extend the higher mortgage limits for another year. While we still believe the higher limits will be extended, the odds of this happening have decreased but are still better than 50/50.

Ø FHA's Changing Philosophy and Direction

We expect there will be a sea change in FHA policy and operational requirements in the coming months. The announcements last Friday are just the beginning of a dramatic overhaul of the FHA program. While the industry will not agree with every change, there should be significant improvement over the way FHA has conducted business.

With a new FHA Commissioner (and an incoming Deputy Assistant Secretary and Chief Risk Officer) that have extensive industry experience, we expect FHA to completely revamp all aspects of its business. In light of the financial concerns, underwriting policy, risk management processes and counterparty responsibilities are at the top of the list for review.   The upshot is that FHA will be a dramatically different agency in the coming months and years.

While it will not happen overnight, here are the kind of changes we expect:

1) Underwriting Changes

On a longer term basis, we expect FHA will develop their own automated underwriting system. In the interim, we expect FHA will tighten underwriting standards in its TOTAL Scorecard.   In addition, based on in-depth analysis of FHA performance data, we expect FHA to target poor performing products and tighten policies accordingly bringing FHA guidelines more in line with industry standards.   For example, Dave Stevens has mentioned problems with "manual underwrites". Further changes on refinance transactions also seem inevitable in light of the continued poor performance of these loans in the Neighborhood Watch database. Refinances (5.27%) are now performing 100 basis points worse than existing home purchase loans (4.20%). As recently as June 2008, refinances were performing 100 bps better.

2) Risk Management

FHA always had the tools to better manage the risk in the FHA program.   They now will have the "will" (i.e. leadership). We expect FHA will target their post-endorsement reviews to early delinquencies (e.g. 60 day) in the first six months. The result of these better targeted reviews will be more timely information on product performance and possible problems requiring policy changes. These reviews will also inevitably increase the number of loan indemnifications that lenders may receive from HUD as reviews will be targeted to poor performing loans.

3) Counterparty Responsibilities

It seems very likely that FHA will be increasing lender accountability in the coming months. Some likely changes are:

Implementation of Credit Watch for wholesalers

We expect FHA to implement Credit Watch for wholesalers by the end of FY 2009. It will likely be effective for the first quarter of 2010. Based on the way that FHA implemented Credit Watch for retail, each wholesaler's early default rate will be compared to the field office average and those with compare ratios ( probably above 300% to start) will be precluded from doing any FHA wholesale business in the particular HUD field office jurisdiction.

Higher net worth requirements

FHA, in its upcoming proposed rule, is expected to increase net worth requirements to $1 million dollars in 2010. It is possible that FHA will pursue further increases (above the $1 million base amount) through a tiered approach (i.e. higher net worth for higher volume).

Increased Indemnification risk

We believe there will be increased indemnification risk in the FHA program.   FHA's improved risk management review process will likely better identify underwriting errors and other administrative errors that affect the loan risk. Hopefully, FHA will target indemnifications to cases in which substantive errors occurred rather than for "technical fouls" that had no impact on the loan performance. We do not believe that FHA will be changing its philosophy in any way to hold lenders accountable for default issues (i.e. job loss, family, health, etc.) over which the lender had no control.

Ø FHA's New Credit Policy Changes: Impact of FHA's Proposed Mortgagee Eligibility Change

We believe the FHA proposal to stop approving loan correspondents in the FHA program is arguably the most significant announced change.
In the press release, FHA said "Correspondents (mortgage brokers) will continue to be able to originate FHA insured loans through their relationships with approved mortgagees; however they will no longer receive independent FHA approval for origination eligibility." In other words, FHA Direct Endorsement lenders will be able to underwrite and close loans that were obtained from non approved mortgage brokers, community banks, etc. Of course, the Direct Endorsement lender will be responsible for the origination process on these loans. In effect, these loans are likely to be treated like retail loans from a liability perspective.

As you know, FHA Commissioner Dave Stevens is a former Freddie Mac executive. It appears that FHA will be adopting some Freddie Mac business principles. One of the GSE guidelines, of course, is to hold the seller servicer responsible for the actions of the originator. The FHA proposal, in effect, would be substituting the Direct Endorsement lender for the GSE seller-servicer. We would expect the DE lender would have to underwrite and close the loan in its name.

FHA's primary reasons for taking this action are: 1) FHA does not have the resources to conduct a thorough review of all applicants and their current process for mortgage brokers is cursory at best and 2) the minimal net worth ($63,000) provided little protection for the Government's risk in the event of an indemnification request.

The implications of this change are far-reaching in the FHA program. Once you permit FHA approved lenders to take applications from any source that meets State and other Federal guidelines (e.g. RESPA), it could render FHA's other lender approval requirements outdated and unnecessary (i.e. branch lending areas, direct lending, principal-agent restrictions, etc.). We expect FHA will be reengineering its lender approval and monitoring process.

Timeline for Implementation

To implement this change, FHA must go through the rulemaking process. We expect the proposed rule to be published in the next several weeks and there will likely be a 30 day period comment period. While changes are possible as a result of comments, the apparent goal is to have a final rule published by the end of the year so current loan correspondents will not have to be recertified in 2010.

Potomac Partners
Washington D.C. 20008

Have a great week!

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Have a great Summer Selling season.

You'll need the following links to download these forms:

Education Station
Government Loan Programs

Remember to Go out and have fun!

Posted by Raoul Badde on September 25th, 2009 1:17 PMPost a Comment (0)