The report, required by Congress, estimates that the agency will have completely exhausted its capital reserves.
FHA is required to keep a capital reserve balance of two percent of the value of its mortgage insurance business – currently valued at $1.1 trillion. However, the actuarial report released Friday showed that that balance will be -1.44 percent, meaning that the FHA will not have sufficient fund to cover future losses.
The report also showed that the FHA continues to operate at a loss, failing to earn enough in premium revenue to offset losses from its insurance business.
If FHA were a private company, it would effectively be insolvent and could face a government takeover or bailout like insurance giant AIG did in 2008. However, FHA has unlimited authority to draw funds from the Treasury, so if it needs to, it can simply bail itself out – something that has never happened in the agency’s 78-year history.
No decision has been made yet on whether or not FHA will use its bailout authority. That decision won’t be made until President Obama drafts his 2013 budget next year.
To return the agency to fiscal solvency, the administration may decide to increase the fees FHA charges lenders to insure loans, increasing its premium revenue in an attempt to keep its capital reserves out of the red.
Last year, FHA’s capital reserve ratio stood at 0.24 percent as the agency posted a net worth of just $2.6 billion despite insuring $1.1 trillion in home loans.
FHA does not make home loans directly. It insures banks and other lenders against losses, allowing them to take as little as a 3.5 percent down payment.
In the report, the auditors pointed to three factors driving FHA’s deteriorating financial conditions: losses stemming from FHA’s expansion during the housing crisis, continued low interest rates, and changes to how the actuary estimates losses on FHA’s business.
The first factor is relatively straightforward. During and immediately after the housing crisis, FHA became the lender of last resort for lower-income and first-time buyers as banks all but shut down home mortgage lending. Because this expansion by the FHA took place during a prolonged economic downturn, the loans insured by FHA during this time period show a much higher rate of default than loans made afterwards.
The second factor harms FHA’s financial conditions because low interest rates make refinancing mortgages more attractive to borrowers, reducing FHA’s revenue from the premiums it collects because when borrowers refinance, they repay their old FHA-insured mortgages. Secondly, borrowers who cannot refinance – usually because they owe more than the home is worth – are more likely to default, forcing the FHA to pay out an insurance claim.
The third factor is simply a change in how the FHA actuary accounts for losses, particularly from short-sales – when a bank sells a home in lieu of foreclosure in an effort to recoup some of the value of the loan. This accounting change led to a negative revision of about $10.2 billion to FHA’s net worth. Another modeling change is that the house-price forecast used to value FHA’s business showed lower growth in housing prices than was predicted last year, causing the actuary to reduce the estimate of the agency’s net worth because it forecast that house prices – and therefore the loan values FHA insures – to increase more slowly, leading to lower than expected premium revenues.