How Risky is the FHA’s Low Down Payment Program?

NAR ResearchJanuary, 2011

ImpetusFHA is required by law to have 2.0% capital

reserve ratioDefaults pushed the capital reserve ratio to

0.5% on September 30th of 2010, down from 0.53% a year earlier

A sharp price decline might push some low-down-payment borrowers underwater

Concern that the government might be forced to support FHA if FHA’s capital reserves are erased

Reason for Concern: 75% increase in high-LTV share since 2007

The elimination of seller assistance does not fully explain this increaseSource: FHA

FHA and the Subprime MarketHistorically, the FHA has focused on extending credit

to the lower end of the credit spectrum

Foreclosure rates on high-LTV, FHA mortgages have increased, but stood at roughly a quarter of the rate for subprime and Alt-A loans as of the 3rd quarter, 2010

FHA is more experienced at vetting high risk borrowers than the private sector.

In recent years, FHA benefited from borrowers with better credit as its market share expanded

FHA Loans Outperform Private Sector Products for Borrowers with Poor Credit

Q1 2007

Q2 2007

Q3 2007

Q4 2007

Q1 2008

Q2 2008

Q3 2008

Q4 2008

Q1 2009

Q2 2009

Q3 2009

Q4 2009

Q1 2010

Q2 2010

Q3 2010

-2%

0%

2%

4%

6%

8%

10%

12%

14%

Purchase FHA 95+ - 100 ALT-A Purchase 95+ - 100Subprime Purchase 95+ - 100

Source: CoreLogic

Credit Scores Have Improved Since 2007

58% of FHA borrowers had a FICO>720 in Q3 2010 versus 19.5% in Q3 2007Source: FHA

FHA Now Competes with Prime LoansThe foreclosure rate on high-LTV, FHA purchase

loans was lower than that for high-LTV, prime mortgages for the past 12 consecutive quarters

The foreclosure rate on high-LTV, FHA purchase loans eased in the 2nd quarter of 2010

The “buyers’ market” and credit crunch allowed borrowers with strong credit to access FHA’s low rates on high LTV loans in greater numbers, which increased the credit quality for FHA’s high LTV loans

High LTV, FHA Outperformed Prime

Q1

2007

Q2

2007

Q3

2007

Q4

2007

Q1

2008

Q2

2008

Q3

2008

Q4

2008

Q1

2009

Q2

2009

Q3

2009

Q4

2009

Q1

2010

Q2

2010

Q3

2010

0.00%0.50%1.00%1.50%2.00%2.50%3.00%3.50%4.00%

Purchase FHA 95+ - 100Prime Purchase Purchase 95+ - 100

Fore

closu

re R

ate

Source: CoreLogic

High LTV Best Performing FHA ProductHigh LTV loans now outperform both low- and

moderate-LTV, FHA products The foreclosure rates on all LTV groups increased

with the end of moratorium in the 1st quarter 2009

Jump in 1st quarter 2009 low-LTV loans was concentrated in the 75% to 80% LTV cohort

Suggests that borrowers who utilize the 3.5% down payment are the least risky to FHA

High-LTV, FHA Mortgages Have the Lowest Foreclosure Rate of all FHA Products

Q1 20

07

Q2 20

07

Q3 20

07

Q4 20

07

Q1 20

08

Q2 20

08

Q3 20

08

Q4 20

08

Q1 20

09

Q2 20

09

Q3 20

09

Q4 20

09

Q1 20

10

Q2 20

10

Q3 20

100.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

FHA Purchase 0 - 80 FHA Purchase 80+ - 95Purchase FHA 95+ - 100

Fore

clo

sure

Rate

Source: CoreLogic

High FICO Preferred High-LTV, FHA Products in the FHA’s Older Book

• Best FICO concentrated in high-LTV loans

• Low FICO concentrated in higher proportion in lower LTVs and SFDPA

LE 90 91-95 96-97 SFDPA850-680 1.7% 1.7% 14.3% 5.0%679-640 1.4% 1.6% 10.1% 5.5%639-620 1.0% 1.0% 5.6% 4.1%619-600 1.0% 1.0% 5.6% 4.1%599-560 1.9% 1.3% 7.8% 7.4%559-500 1.3% 0.7% 3.8% 4.8%499-300 0.2% 0.1% 0.4% 0.6%None 0.6% 0.3% 2.4% 1.6%

Share of Total Book 9.1% 7.7% 50.0% 33.1%% FICO>639 by LTV 34.1% 42.9% 48.8% 31.7%

Purchase Loan Composition in 2007

Source: FHA

Credit Quality Improved; Majority of FHA’s Total Book is Now High-FICO, High-LTV

• High FICO share improved in all LTV ranges

• 83.9% of high LTV had a FICO greater than 639

• 58.7% of the FHA total lending was for high LTV loans with a FICO greater than 639 in 2010 versus 24.4% in 2007

Source: FHA

Housing Without high LTV FHA Loans5.156 million existing home sales in CY 2009

12.0% or 618,070 were FHA loans with LTV between 96% and 98%

Implies a 12.6% decline in median home price if high LTV eliminated

Share of FHA loans with 96% to 98% LTVs rose from 58.1% in 2009 to an average of 68.7% for Q1 through Q3 of 2010

Impact of eliminating high LTV, FHA in 2010 would be greater than 12.0% of EHS in 2010 (roughly 15.0% for Q1 through Q3)

Loss of high LTV from the FHA’s portfolio would have dropped $5.67b from the FHA’s economic value in FY 2010 and forced the FHA to borrow $2.029b from the government

Other Sources of the Strain on FHARisk from borrowers with lower credit

magnified by economic decline

Shift in focus of FHA lendingHAMPLend to broader market

Seller assisted down payment program

Expanded lending:mitigates improved books?raises risk to tax payers?

Employment Issues Account for Nearly 50% of Delinquencies

• Excess obligation was primary issues in 2007

• Income and unemployment primary reason after 2008

• Income falling as a reason for delinquency as of Q3 2010

No source of private sector data to use for comparisonSource: FHA

Expanded Role for FHA in the Housing Market?Foreclosure rate on FHA refinance loans jumps in the 3rd

quarter of 2009 after new initiative FHA-HAMP – August 2009 Allows underwater borrowers to refinance into FHA loans

Defers up to 30% of remaining principal Pays up to 12-months of arrearage Reduces PITI to 31%

Foreclosure rate on FHA REFIs surpassed purchase in the 4th quarter of 2009

FHA endorsed 871,096 refinances in calendar year 2009

The spread widened in the 1st through 3rd quarters of 2010, but FHA’s REFI volume fell dramatically

Foreclosure Rate on High LTV, FHA REFI Loans Above the Rate on Purchase

Source: CoreLogic

Q1

2007

Q2

2007

Q3

2007

Q4

2007

Q1

2008

Q2

2008

Q3

2008

Q4

2008

Q1

2009

Q2

2009

Q3

2009

Q4

2009

Q1

2010

Q2

2010

Q3

2010

-60

-40

-20

0

20

40

60

80

-3%

-2%

-1%

0%

1%

2%

3%

4%

FHA Purchase 95+ - 100 FHA Refi 95+ - 100Spread (Left Axis)

Sp

read

: B

asi

s P

oin

ts

Fore

clo

sure

Rate

Legacy of Seller-Funded Down Payment Assistance

• Nearly 500,000 loans from SFDPA still on FHA books; 145,000 more were refinanced into new FHA loans

• Account for 17% of total FHA loans

• 34% of SFDPA loans on books are in delinquency; 12% of refinanced SFDPA loans in delinquency

• SFDPA loans accounted for $6.1 billion in losses to date: FHA anticipates $7.5 billion in losses in FY 2011 and FY 2012

• Excluding these losses implies a reserve ratio of 1.67% in 2011 versus the FHA’s current projection of 0.99%

Does the Expansion of FHA Hide Improvements or Expand Risk to Tax Payers?

• ENW increased from $3.641b in FY 2009 to $4.657b in 2010, an increase of 28%

• IF rose 36% over the same period

• FHA’s review suggests that strong credit in the expanded 2009 and 2010 books added to ENW and offset lower credit quality in older vintages

• Furthermore, the total number of loans rose (and potential claims), but average loan risk for the portfolio fell and newer vintages are paying

Source: FHA

Source: FHA