RealEstateEconomyWatch.com

The Federal Housing Administration took the right steps last week to bring the agency’s lending standards in line with private industry practices, but with the loss of its excess reserves, FHA is now essentially running on empty and the jury is out on whether the agency has adequate capital reserves to weather projected losses from defaults and foreclosures, said a noted housing economist who first raised concerns about FHA’s financial condition in an article in Real Estate Economy Watch last June (Can FHA Dodge the Bullet?).

Economist Ann Schnare applauded FHA’s credit policy changes and its plans to hire its first chief risk officer.  “It’s a good thing to tighten up lending practices, and put some real teeth in them. The number of FHA lenders has mushroomed.  Tightening up the requirements on who can originate FHA loans by requiring lenders to be capitalized at a higher level is especially important, because FHA loans have almost no equity and spreading the risk to lenders will reduce FHA’s exposure at this critical time,” she said.

FHA loans, which require only three percent down payment, have become extremely popular.  Over the past two years their market share has grown seven fold, to more than 30 percent of the entire residential mortgage market. 

“During the boom, FHA had a very small market presence but in recent months, FHA has to some degree become the lender of last resort because of its credit policies and low down payment requirements.  That’s not a good place to be when defaults are at record levels,” she said.

The agency’s annual independent actuarial study is being completed and holds the key to whether the $30 billion of capital reserves will be enough to cushion it from losses.  Agency officials anticipate the study to show the capital reserve ratio dropping below the congressionally-mandated threshold of two percent of its loan portfolio.  “Two percent leaves very little margin for error.  If losses don’t work out as projected, the situation could continue to deteriorate,” she said. 

According to the latest quarterly delinquency survey by the Mortgage Bankers Association, during the first quarter, the seasonally adjusted delinquency rate increased from 13.84 percent to 14.42 percent for FHA loans.  The percentage of FHA loans in the foreclosure process increased from 2.76 percent to 2.98 percent.  By contrast one in every 357 U.S. housing units received a foreclosure filing in August, according to RealtyTrac.

Last week many speculated that because of the rising loss rate FHA would have not choice but to seek additional funding from Congress to remain solvent, but last week FHA Commissioner Stevens 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.”