Written Testimony of David H. Stevens
Assistant Secretary of Housing - Federal Housing Administration Commissioner
U.S. Department of Housing and Urban Development
"FHA Reforms, Legislative Proposals, and Contributions to the HUD FY 2011 Budget"
Hearing before the Senate Appropriations Subcommittee on Transportation,
Housing and Urban Development, and Related Agencies
Thursday, May 13, 2010
Chairwoman Murray, Ranking Member Bond, and Members of the Subcommittee, thank you for the opportunity to testify today regarding the Federal Housing Administration's (FHA's) recent reforms, legislative proposals, and contributions to the HUD FY 2011 budget request. FHA remains focused on providing access to homeownership, while minimizing the risk to the American taxpayer is of the utmost importance.
Helping Prevent an Economic Catastrophe
As you know, when this Administration took office just over fifteen months ago, the economy was hemorrhaging over 700,000 jobs each month, housing prices were in freefall, residential investment had dropped over forty percent in just eighteen months, and credit was frozen nearly solid. Many respected economic observers warned that a second Great Depression was a real possibility, sparked of course by a crisis in the housing market. Meanwhile, communities across the country-from central cities to newly built suburbs to small town rural America-struggled to cope with neighborhoods devastated by foreclosure, even as their soaring jobless rates and eroding tax base crippled their ability to respond.
As we move beyond the peak of the recent global financial crisis, though there is still a long way to go, it is clear that the nation's housing market has made significant progress toward stability. Through the combination of coordinated efforts by Treasury, HUD, and the Federal Reserve to stabilize the housing market, we are seeing real signs of optimism.
As measured by the widely referenced FHFA index, home prices have significantly stabilized since last April. As recently as January of 2009 house prices had been projected to decline by as much as 5 percent in 2009 by leading major macro-economic forecasters. This housing stabilization is all the more surprising since most forecasters had underestimated the rise in unemployment that has occurred over the past year.
Homeowner equity started to grow again - increasing by over $1 trillion by the end of December, or $13,000 on average for the nation's nearly 75 million homeowners, and helping our economy grow at the fastest rate in six years in the fourth quarter of last year.
And mortgage rates which have been at or near historic lows for more than a year have spurred a refinancing boom that has helped nearly 4 million borrowers in 2009 - freeing up an additional $7 billion annually, some of which will be spent in local economies and businesses, generating additional revenues for our nation's cities, suburbs, and rural communities.
FHA: Facilitating Recovery
While there remains uncertainty about whether this progress will continue at this pace going forward, what is not in doubt is that the FHA has been central to much of this improvement.
Created by President Franklin Roosevelt at a time when two million construction workers were out of work and housing prices had collapsed, the FHA was designed to provide affordable homeownership options to underserved American families and keep our mortgage markets afloat during tough times.
And by insuring almost 30 percent of purchases and 20 percent of refinances in the housing market, FHA is certainly doing so today.
We know the critical role first-time homebuyers are playing in the market, including purchasing REO and vacant properties, helping stabilize home prices and communities alike. More than three-quarters of FHA's purchase-loan borrowers in 2009 were first-time homebuyers, and nearly half of all first-time buyers in the housing market in the second half of last year used FHA loans.
FHA provides mortgage insurance to help lenders reduce their exposure to risk of default. This assistance allows lenders to make capital available to many borrowers who would otherwise have no access to the safe, affordable financing needed to purchase a home.
As access to private capital has contracted in these difficult economic times, borrowers and lenders have flocked to FHA and the ready access it provides to the secondary market through securitization by Ginnie Mae. The increased presence of FHA and others in the housing market, including Fannie Mae and Freddie Mac, has helped support liquidity in the purchase market, helping us ride through these difficult times until private capital returns to its natural levels.
And with 51 percent of African Americans homebuyers and 45 percent of Hispanic families who purchased homes in 20081 using FHA financing, FHA is far and away the leader in helping minorities purchase homes.
FHA has stepped up to fulfill its countercyclical role - to temporarily provide necessary liquidity while also working to bring private capital back to credit markets. Indeed, the FHA has in the past year alone helped more than 800,000 homeowners refinance into stable, affordable fixed-rate mortgages.
At the same time FHA has taken steps to reverse falling home prices, it has also worked to help families keep their homes, deploying its loss mitigation tools to assist a half million families at risk of foreclosure.
Not only is FHA ensuring the availability of financing for responsible first time home purchasers, it is also helping elderly homeowners borrow money against the equity of their homes through the Home Equity Conversion Mortgage (HECM). This program has grown steadily in recent years, to a volume of $30.2 billion in FY 2009.
And finally, FHA is playing an important role in protecting homeowners and helping prospective homeowners make informed decisions. It is providing counseling to homeowners to help them avoid falling into unsustainable loans. And it is fighting mortgage fraud vigorously on all fronts, having taken enforcement actions on more than six times as many lenders since FY 2009 than those over the FY 2000-2008 period combined.
The central role of housing in the U.S. economy demands that federal agencies involved in housing policymaking rethink and restructure programs and policies to support housing as a stable component of the economy, and not as a vehicle for over-exuberant and risky investing.
With that in mind, the President's Budget for 2011 represents a careful, calibrated balancing of FHA's three key responsibilities: 1) providing homeownership opportunities to responsible borrowers, 2) supporting the housing market during difficult economic times and 3) ensuring the health of the FHA Mutual Mortgage Insurance (MMI) fund.
With this Budget, HUD is projecting that FHA will continue to play a prominent role in the mortgage market in fiscal year 2011. Accordingly, it requests a combined mortgage insurance commitment limitation of $420 billion in fiscal year 2011 for new FHA loan commitments for the Mutual Mortgage Insurance (MMI) and General and Special Risk Insurance (GI/SRI) funds. The proposed total includes $400 billion under the MMI Fund, which supports insurance of single family forward home mortgages and reverse mortgages under HECM; and $20 billion under the GI/SRI Fund, which supports multifamily rental and an assortment of special purpose insurance programs for hospitals, nursing homes, and Title I lending. The budget requests a direct loan limitation of $50 million for the MMI fund and $20 million for the GI/SRI fund to facilitate the sale of HUD-owned properties acquired through insurance claims to or for use by low- and moderate-income families.
The Budget also includes $88 million for the Housing Counseling Assistance program, which is the only dedicated source of Federal funding for the full spectrum of housing counseling services. With these funds we also plan to continue our work to expand the number of languages in which counseling is available. In addition, the budget continues FHA's Mortgage Fraud initiative ($20 million) launched in fiscal year 2010 as well as implementation of sweeping reforms to the Real Estate Settlement and Procedures Act (RESPA) which began in January 2010 and the Secure and Fair Enforcement (SAFE) for Mortgage Licensing Act beginning in June 2010.
Rebuilding FHA's Capital Reserves
As important as FHA is at this moment to our nation's economy, FHA has not been immune to the hard times for the housing sector. Late last year, we reported to Congress that FHA's secondary reserves had fallen below the required two percent level - to 0.53 percent of the total insurance-in-force. However, when combined with reserves held in the Financing Account, FHA reported with its FY 2009 actuarial review that it holds more than 4.5 percent of total insurance-in-force in reserves - $31 billion set aside specifically to cover losses over the next 30 years.
As such, the independent actuary concluded that FHA's reserves will remain positive under all but the most catastrophic economic scenarios.
Further, while its Capital Reserve Account has decreased too quickly, FHA is not ?the next subprime? as some have suggested.
Subprime delinquencies are 240 percent higher than FHA's for a reason - subprime loans had much weaker underwriting standards than FHA. While others participated in investor-owned markets or were exposed to exotic mortgages such as option-ARMs and interest-only loans, and while some tolerated lax underwriting standards, FHA stuck to the basics during the housing boom: 30-year, fixed rate traditional loan products with standard underwriting requirements. Unlike subprime lenders, FHA requires that borrowers demonstrate they can pay their mortgage by verifying their income and employment.
All of that said, Madam Chairwoman, we've learned from recent history that the market is fragile, and we have to plan for the unexpected. That uncertainty is complicated by an organization we inherited that, to be honest, was simply not properly managing or monitoring its risk.
Credit and risk controls were antiquated. Enforcement was weak. And our personnel resources and IT systems were inadequate.
Little of this may have been obvious when FHA's market share was 3 percent as recently as 2006. But when our mortgage markets collapsed, and homebuyers increasingly turned to the FHA for help, the potential consequences of these lapses in risk management became very clear.
Reforms to Date
From my first day as FHA Commissioner, I began a thorough review of our loan practices and organizational capacity and gaps. We have already taken several steps within our existing authority to shore up the FHA and continue to improve our operations to ensure that taxpayers are not put at risk.
In addition to steeply increasing lender enforcement, we've strengthened credit and risk controls - toughening requirements on our Streamlined Refinance program, made several improvements to the appraisal process, and published a final rule in the Federal Register on April 20 to increase net worth requirements for all FHA lenders.
Long overdue, FHA hired its first Chief Risk Officer, Robert Ryan, to provide the most comprehensive and thorough risk assessment in the organization's history - and ensure that the assumptions going into our modeling reflect the most current economic conditions.
In addition, with Congress' help, we are working to increase staffing and technical capacity and upgrade our technology systems - and though we still have a long way to go, we delivered FHA's first comprehensive technology transformation plan to Congress in September. We have continued to make progress on both fronts. We recently issued and received several responses to a Request for Information to begin upgrading our risk and fraud tools and we delivered a FHA Staffing Report to Congress, which outlines our significant progress towards hiring the 118 FTEs that we thank Congress for appropriating to FHA in FY 2010, along with details on an aggressive training and human capital development plan that includes managerial and technical skill building training as well as on-the-job mentoring.
Under the Obama Administration, FHA has significantly increased its lender enforcement activities to protect the MMI Fund, consumers, and address a number of bad actors that were previously not held accountable.
Since July 1, 2009, the Mortgagee Review Board (MRB) has investigated 365 cases, resulting in withdrawal of approval for 354 lenders and suspension of an additional 6 lenders. The number of cases that have been investigated by the MRB since July 2009 are greater than those investigated in the years 2002-2008 combined2. We take our responsibility to oversee lenders with the utmost seriousness. I would also like to emphasize that FHA's intent is to protect the Fund through a commitment to lender enforcement, but FHA in no way intends to punish responsible lenders. We are working closely with lenders to identify best practices and share them among the lending community, proactively identify problem situations and identify means to improve performance, to the benefit of lenders, consumers, and the FHA.
January Policy Announcements and Legislative Requests
On January 20th of this year, I proposed taking the following steps to mitigate risk and augment the MMI Fund's capital reserves: increase the mortgage insurance premium (MIP); impose a firm floor on allowable credit scores, and further tighten the minimum credit score required for borrowers with low down payments; reduce the maximum permissible seller concession to match the industry norm; and implement a series of significant measures aimed at increasing lender responsibility and enforcement. Thank you for the opportunity to explain these policies in more detail.
I would like to be clear that many of these reforms were long overdue as FHA did not respond effectively to changes in the marketplace that happened during the housing boom and the subsequent decline - inaction was and is not an option. In addition to the Congressional mandate to take action to bring FHA's capital reserves back up above 2%, FHA also has a responsibility to protect consumers from irresponsible lending practices, protect the taxpayer from excessive claims on the MMI fund, and facilitate the return of private capital to the mortgage market. We take these responsibilities seriously, as evidenced by the series of policies that we have already enacted and those that we request Congressional authority to enact.
FHA conducted an exhaustive review of loan performance in its portfolio and a thorough policy development process to ensure that these policy changes balance three guiding principles: 1) improve FHA loan performance and capital reserves, 2) continue to support the broader housing market and recovery, and 3) preserve FHA's role in providing homeownership opportunities to responsible underserved borrowers. Each one of our policy changes fulfills these three priorities. Additionally, FHA evaluated several dozen other policy options which ultimately were not chosen as they did not strike the appropriate balance. With these factors, in mind, FHA has proposed a series of balanced policy proposals that fulfill our responsibility to the American taxpayer and recognizes the important role that FHA is currently playing in the recovery of the housing market.
Restructuring FHA Mortgage Insurance Premiums
First, insurance revenues from single family loan guarantees will grow by increasing the upfront premium to 225 basis points across all FHA forward product types (purchase, conventional to FHA refinances, and FHA to FHA refinances). The upfront premium increase was implemented by mortgagee letter issued on January 21, 2010 and became fully effective in the market for all applications received on or after April 5, 2010. I would like to thank Congress for providing FHA with the flexibility to increase the upfront premium to a maximum of 300 basis points through passage of the Housing and Economic Recovery Act (HERA) in 2008. While we have not chosen to increase the upfront premium to the maximum, this flexibility has enabled FHA to take immediate action to begin rebuilding our capital reserves. Similarly, we request flexibility in our legislative proposal to increase the annual premium to 150 basis points although we have not proposed to increase the annual premium to that level in our FY 2011 budget proposal.
As noted in the proposed budget, while HUD is moving to increase the upfront premium to 225 basis points we are ultimately planning to reduce that premium to 100 basis points, offset by a proposed increase in the annual premium to 85 basis points for loans with loan-to-value ratios (LTV) up to and including 95% and to 90 basis points for LTVs above 95%.
This change to the annual premium will require legislative authority. We are extremely grateful that the House Financial Services Committee recently passed HR 5072 - the FHA Reform Act of 2010 - which provides this authority as well as several other provisions to further strengthen FHA. This legislation is now awaiting passage by the full House of Representatives. Given the importance of these issues to FHA's ability to facilitate our housing recovery while protecting the taxpayer, we hope that the Senate will similarly move to pass this legislation as expeditiously as possible.
We believe this new premium structure is sound policy - more in line with GSE and private mortgage insurers' pricing, and is intended to facilitate the return of private capital to the mortgage market.3 Indeed, if these changes are adopted during the current fiscal year, the estimated value to the MMI fund would be approximately $300 million per month, which would replenish FHA's capital reserves even faster than if this authority was provided through the annual appropriations process.
This restructuring of FHA's mortgage insurance premiums will accomplish two very important goals: 1) increase the homeowner's equity in each mortgage transaction and reduce the risk to the FHA fund, and 2) facilitate the return of private capital to the mortgage market.
Increasing Equity in FHA Loans
As stated earlier, if granted legislative authority to increase the annual mortgage insurance premium, FHA proposes to reduce the upfront mortgage insurance premium from 225 basis points to 100 basis points. Borrowers typically finance the upfront mortgage insurance premium in their loan balance, increasing the effective loan-to-value and reducing the amount of equity in their home. The reduction of the upfront premium will lower the loan balance as well as add an additional 125 basis points of equity to each loan purchase.
Facilitating the Return of Private Capital to the Mortgage Market
As noted, the elevated role FHA is currently playing in the market is temporary. In addition to being more equitable for borrowers and generating more receipts for FHA, this change to the FHA premium structure brings FHA's pricing more in-line with the private mortgage insurance industry and enables more robust private competition. In fact, in response to FHA's announced policy changes, MGIC, the largest U.S. private mortgage insurer, announced on February 23rd that it would be adopting a new pricing scale.4
Updating Credit Score / Downpayment Guidelines
FHA is also proposing a ?two-step? FICO floor for FHA purchase borrowers, which would reduce both the claim rate on new insurance as well as the loss rate experienced on those claims. Purchase borrowers with FICO scores of 580 and above would be required to make a minimum 3.5% down payment; and those with FICO scores between 500-579 would be required to make a minimum down payment of 10%. Applicants below 500 would be ineligible for insurance. FHA plans to publish the two-step FICO proposal in the Federal Register soon, with implementation planned later this fiscal year.
Careful analysis of the existing FHA loan portfolio shows a clear performance difference between loans that were made below the proposed FICO/LTV guidelines. Loans below the guidelines are currently more than four times as likely to be seriously delinquent than loans above the guidelines. Loans below the guidelines demonstrate a seriously delinquent rate of 31.1%, while loans above the guidelines currently demonstrate a seriously delinquent rate of 7.6%. Of the total FHA loan portfolio, approximately 6% of loans fall under the proposed guidelines; however, due to improved quality of recent FHA loans, only 1.5% of loans endorsed in FY2009 would be excluded under the proposed guidelines.
Loan Performance Based on Proposed Updated Credit Score / Downpayment Guidelines
Two Step Rule
||Seriously Delinquent (90-Day+)|
Source: US Department of HUD/FHA; February 2010.
If implemented, in combination with the proposed mortgage insurance premium structure, the updated FICO/LTV guidelines are projected to result in the $4.1 billion in additional offsetting FHA receipts as reflected in the President's Budget.
Minimum Downpayment for FHA Loans
Some have suggested that FHA raise the minimum required downpayment to 5% across the board and also remove the option of financing the upfront insurance premium into the loan balance for all transactions as a means to increase homeowner equity. We share the goal of increasing equity in home purchase transactions, but determined after extensive evaluation that such a proposal would adversely impact the housing market recovery.
To determine the impact of requiring a minimum 5% downpayment for all transactions, FHA evaluated the loan files of a large sample of past endorsements to identify the number of borrowers who had sufficient assets at time of loan application to contribute the additional 1.5% of equity at closing. As illustrated in the table below, such a policy change would reduce the volume of loans endorsed by FHA by more than 40%, while only contributing $500 million in additional budget receipts. This translates to more than 300,000 fewer first-time homebuyers and would have significant negative impacts on the broader housing market - potentially forestalling the recovery of the housing market and potentially leading to a double-dip in housing prices by significantly curtailing demand. In contrast, the combination of policy changes proposed by FHA in the FY 2011 budget would contribute an additional $4.1 billion in additional receipts to FHA while having a much more moderate impact on the broader housing market.
Impact of FY 2011 Policy Options on FHA Receipts and Loan Volume
||FHA Receipts ($ Billions)
||FHA Loan Endorsements ($ Billions)
|Baseline without policy changes
|Minimum 5% downpayment for all transactions
|FY2011 Budget Proposal with all proposed policy changes
Source: US Department of HUD/FHA; February 2010.
Furthermore, downpayment alone is not the only factor that influences loan performance. The combination of downpayment and FICO score is a much better predictor of loan performance than just one of those components alone. For instance, loans with a loan-to-value (LTV) above 95% and a FICO score above 580 perform better than loans with LTV below 95% and a FICO score below 580, while loans with a LTV above 95% and a FICO score below 580 perform significantly worse than all other groups, as illustrated below.
FHA Single Family Insured Loan Claim Rates
Relative Experience by Loan-to-Value and Credit Score Values4
Ratios of each Combination's Claim Rate
to that of the Lowest Risk Cell5
|?Loan-to-Value Ratio Ranges
||Credit Score Ranges6
|Up to 90%||2.6||2.5||1.9||1.0
|90.1 - 95%||5.9||4.7||3.8||1.7
Source: US Department of HUD/FHA; March 2010.
It is for these reasons, rooted in a thorough review of actual FHA loan performance data, that FHA has decided to reduce the upfront mortgage insurance premium, which is financed into the loan balance in the vast majority of transactions, and increase the annual mortgage insurance premium, which is paid over time and not financed into the loan balance, which is more aligned with the premium structure of private mortgage insurance companies.
In particular, we have proposed to permit loans to borrowers with FICO scores above 580 with a minimum 3.5% downpayment and loans to borrowers with FICO scores between 500 to 579 with a minimum 10% downpayment. It is also worth noting that these downpayment guidelines are minimums and many borrowers do in fact have significantly lower LTVs - in the fourth quarter of FY 2009, more than 21% of endorsed loans had a LTV lower than 90%.
Reducing Seller Concessions
We are also proposing a third policy measure to reduce the maximum permissible seller concession from its current 6 percent level to 3 percent, which is in line with industry norms. The current level exposes the FHA to excess risk by creating incentives to inflate appraised value. As seen in the table below, FHA's experience shows that loans with high levels of seller concessions are significantly more likely to go to claim. Experience to-date on loans insured from FY 2003 to FY 2008 suggests that claim rates on high-concession loans are 50 percent higher or more than those on low-concession loans.