Managing Risk To The FHA’s Insurance Fund

WORD ON THE STREET: While the Federal Housing Administration's (FHA) Mutual Mortgage Insurance (MMI) Fund has remained positive, we are keenly aware of the importance of remaining vigilant to the risks the agency faces and will continue to take the actions necessary to protect the fund and taxpayers.

Indeed, such vigilance has been the hallmark of the current administration. Having taken office in the midst of the greatest recession since the Great Depression and faced with a housing market in crisis, this administration acted immediately to strengthen the FHA and protect its insurance funds by instituting the most sweeping reforms to credit policy, risk management, lender enforcement, and consumer protection in FHA history.

First, beginning in 2010, the FHA raised its mortgage insurance premiums three times – actions that were made possible, in part, as a result of legislation passed by Congress. As we have frequently said, the FHA greatly appreciates the key role that was played by this committee in that effort. Thanks to those actions, the FHA's current premium levels are the highest they have ever been in the agency's history.

The new annual mortgage insurance premium structure alone led to an increase in the fiscal year 2011 economic value of the MMI Fund of $1.37 billion. It should also be noted that due to today's historically low interest rates, the FHA has been able to strengthen the MMI Fund through its premium increases without jeopardizing housing affordability.

Continuing our progress, last year, the FHA implemented a two-step credit-score policy for FHA borrowers. Those with credit scores below 580 are now required to contribute a minimum down payment of 10%. Only those with stronger credit scores are eligible for FHA-insured mortgages with the minimum 3.5% down payment.

In addition, a final rule will soon be published that outlines changes to the FHA's requirements regarding seller concessions. Allowable seller concessions will be reduced and are never to exceed actual closing costs. These changes will accord with industry norms regarding seller concessions and better protect the MMI Fund from risks associated with inflated appraisal values.

The FHA has also made significant changes to the Home Equity Conversion Mortgage (HECM) program. In September 2010, the FHA introduced the HECM Saver product as a second option for reverse-mortgage borrowers. The HECM Saver offers significantly reduced up-front loan closing costs for mortgagors who wish to borrow less than the maximum amount available under a standard HECM loan.

In addition, the FHA adjusted the principal limit factors used to determine the maximum claim amount for HECM loans to ensure that HECM Standard could be self-supporting. Finally, the FHA provided guidance for lenders regarding the treatment of tax-and-insurance defaults by HECM borrowers. These policy measures have significantly strengthened the HECM program so that it can continue to provide important financial options for seniors without posing unnecessary risks to the MMI Fund.

Changes have also been made to the condominium program, including the introduction of a project re-approval and recertification process for FHA-approved condominium projects, as well as a comprehensive revision of the FHA's Condominium Project Approval and Processing Guide. These changes ensure the compliance of condominium projects with the FHA requirements while updating those policies to better accord with industry trends and norms.

The U.S. Department of Housing and Urban Development (HUD) also made changes to its loss mitigation requirements to increase the use of trial-payment periods prior to a mortgagee's executing of a loan modification or partial claim action to cure a default. Trial-payment plans are expected to reduce redefault rates on loan modifications and partial claims, and thereby reduce costs to the FHA insurance fund.

Lender oversight and enforcement

Just as significant as the changes made to the FHA's loan programs has been the strengthening of its oversight and enforcement for FHA-approved lenders. Starting with heightened approval requirements for lenders, the FHA is ensuring that it partners with stable and responsible lenders, and that HUD's limited oversight resources are focused appropriately on the entities that pose the greatest potential threat to the FHA's insurance funds.

Indeed, as a result of the FHA's heightened oversight of lenders, over the past three fiscal years, HUD has withdrawn the approval of over 1,600 lenders to participate in FHA programs, while protecting the fund through indemnifications and required repayments of improperly originated loans, and the imposition of more than $10 million in civil money penalties and administrative payments.

Additionally, the FHA has made substantial changes to its targeting and execution of loan file reviews. Utilizing risk-based targeting that employs a wider array of potential risk factors than has been used previously, the FHA has enhanced its ability to identify the lenders and loans that most warrant closer inspection by HUD. In so doing, the FHA is better able to prevent unwarranted risks to the MMI Fund.

Integral to the long-term sustainability of the MMI Fund is a culture of decision-making at HUD that emphasizes the importance of risk management. An effort that began with this administration is the development of the Office of Risk Management and Regulatory Affairs (ORMRA) within the Office of Housing. This new office provides for a central focus on risk tolerance, risk exposure and risk management for each of the various FHA program areas. The complete establishment and integration of the office within the FHA are top priorities for HUD. While there is still work to be done to fully establish a comprehensive risk-management framework, significant progress has already been made.

Over the past fiscal year, ORMRA has hired over 15 new employees. These hires bring with them a diverse background in risk management, covering all of the FHA's core lines of insurance business. Following the transition of the first deputy assistant secretary for ORMRA, Bob Ryan, to a new role as special advisor to the HUD secretary, a senior advisor for risk has recently joined the FHA to provide continued leadership and expertise in risk management.

The risk management office has become a significant part of the business operations within the FHA. As partners to each business line and program area, the risk managers are involved in a wide array of policy and operational decision-making processes. On a monthly basis, formal meetings are held between ORMRA and each of the business lines to discuss emerging risks, recent trends and policy updates.

In addition, ORMRA provides substantial capacity for risk monitoring and reporting, and for general portfolio analysis. Over the next fiscal year, ORMRA has plans to further enhance its analytical capabilities with a variety of new tools.

It should also be noted that the Government Accountability Office (GAO) conducted an audit titled "Federal Housing Administration: Improvements Needed in Risk Assessment and Human Capital Management," which examined the integration of ORMRA activities with the FHA operations, as well as the FHA's broader workforce planning mechanisms.

The GAO report found that, in general, HUD was making significant progress in its incorporation of risk management activities and the assessment and development of its human capital. HUD agreed with the audit's recommendations to continue these activities and felt that the audit provided helpful analysis of the current state with regard to risk management and human capital development within the FHA. The FHA was already at work to implement many of the GAO's recommendations prior to the start of the audit and will utilize the audit in its continued efforts to manage risk and human capital.

Leveraging technology

In addition to the steps HUD has taken to strengthen the MMI Fund via policy, process and organizational changes, the department is also engaged in a large-scale effort to acquire and employ a modern financial services information technology environment to better manage and mitigate counterparty risk across all of the FHA's insurance programs.

The FHA Transformation Initiative will enable risk detection and fraud prevention by capturing critical data points at the front end of the loan life cycle, and by leveraging risk and fraud tools, rules-based technology and transactional controls to minimize exposure to the FHA's insurance funds.

These tools will enable the FHA to leverage 21st century information technology systems to manage risk at all points of the loan life cycle. For example, the FHA Transformation Initiative will automate the application process for FHA lender approval, and will provide enhanced data validation capabilities for the evaluation of lender applications.

In addition, the initiative will provide risk-analytics mechanisms to identify and manage risk-based exceptions for inbound endorsements and appraisals, thus permitting the FHA to address these concerns at the loan level. Finally, the initiative will provide the FHA with comprehensive portfolio-analysis tools by which it can identify and evaluate current and emerging risk trends in order to more effectively take appropriate action to avoid or mitigate risks to the MMI Fund.

Shaun Donovan is the secretary of the U.S. Department of Housing and Urban Development. This article was adapted from written testimony Donovan provided to the House Financial Services Committee for a Dec. 1 hearing titled "Perspectives on the Health of the FHA Single-family Insurance Fund." To read Donovan's full testimony, click here.

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