FHA single family loans amounts to an eye popping 63 percent of the market.

Statement Of Kenneth M. Donohue Inspector General Department of Housing and Urban Development

The Department’s primary challenge is to find ways to improve housing and to expand opportunities for families seeking to improve their quality of life. HUD does this through a variety of housing and community development programs aimed at helping Americans nationwide obtain affordable housing. These programs, which include Federal Housing Administration (FHA) mortgage insurance for Single-Family and Multifamily properties, are funded through a $45+ billion annual budget and, in the case of FHA, through mortgage insurance premiums. Recently, the Department also received over $13 billion in the American Recovery and Reinvestment Act funding for various programs to stimulate the economy. This is in addition to the almost $4 billion received for the Neighborhood Stabilization Program in July 2008.

The last two years have seen enormous and damaging developments in the mortgage market: the dissolution of the subprime and Alt-A loan markets; dramatic drops in housing prices in most areas of the country; a concomitant rise in default and foreclosures; financial insecurity in the mortgage-backed securities markets represented by the government takeover of Fannie Mae and Freddie Mac; the collapse of credit markets; and, as a primary vehicle to address these issues, an urgent reliance on the FHA to bolster the mortgage market. As the Mortgage Asset Research Institute has stated, the unprecedented onslaught of financial losses, reputational damages, and rehabilitative public policies will forever reshape the mortgage industry.

While there are other programs at HUD that are being utilized in a significant way to help stimulate the economy (i.e., billions of dollars in new funding to Community Development Block Grants, to increased Public Housing assistance, etc.), which are also vulnerable to fraudulent and abusive activities, the primary focus of this testimony is on the salient issues facing the FHA program due to the mortgage crisis and to an increased reliance on our Department to potentially resolve matters at this critical juncture. The current degree of FHA predominance in the market is unparalleled.

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The Housing and Economic Recovery Act (HERA) passed last summer, created a new Hope for Homeowners program to enable FHA to refinance the mortgages of at-risk borrowers. While activity to date has been very limited, the FHA was authorized to guarantee $300 billion in new loans to help prevent an estimated 400,000 homeowners from foreclosure. The Congress recently passed and the President signed legislation to revise this program in order to increase participation. The Secretary recently testified, however, that these estimates will not likely be reached. Nevertheless, these changes, and others, to remedy a dysfunctional mortgage market are likely to increase the challenges to the OIG. While the goal to help homeowners in distress is important, relaxing qualification requirements for borrowers and lenders may create a situation that could be exploited by fraud perpetrators to take advantage of desperate homeowners, at risk-lenders, and the FHA insurance fund. The HERA legislation also authorized changes to the FHA’s Home Equity Conversion Mortgage (HECM) program that will enable more seniors to tap into their home’s equity and obtain higher payouts which raises new oversight concerns for this agency.

As we turn to today’s environment, the volume of Single-Family FHA-insured loans has enlarged in Fiscal Year 2008 by tripling from $59 billion in Fiscal Year 2007 to over $180 billion in Fiscal Year 2008. The latest figures from Single-Family market comparisons from the first quarter of Fiscal Year 2009 show that FHA’s total endorsements have increased from 24% of the market the year before to 63% of the market which includes both home sales and refinances. FHA’s home sales’ market share (excluding refinances) has increased from approximately 6% to close to 20% during this time period. Many potential homeowner loans may not have come to the agency yet as some of the new initiatives are still taking hold and the industry is flushing out its options and possibly posturing for more favorable terms.

FHA will be challenged to handle its expanded workload or new programs that require the agency to take on riskier loans than it historically has had in its portfolio. The surge in FHA loans is likely to overtax the oversight resources of the FHA, making careful and comprehensive lender monitoring difficult. In addition, our experience in prior high FHA volume periods (such as from 1997-2001) shows that the program was vulnerable to exploitation by fraud schemes, most notoriously flipping activities, that undercut the integrity of the program.

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The OIG has initiated investigations of Ginnie Mae MBS fraud. In one recent case, the two former corporate officers of a Michigan financial company were convicted of defrauding Ginnie Mae by retaining the funds obtained from terminated and/or paid-off loans. The defendants failed to disclose to Ginnie Mae that the loans were terminated, while one of the defendants utilized the funds from the paid-off loans to invest in the stock market and to make fraudulent monthly payments to Ginnie Mae on the loans that were previously paid-off in order to conceal the fraud. The fraud began during July of 1998 and continued until October of 2007, resulting in a loss of approximately $20,000,000. Further, a recent audit of the Ginnie Mae program has found that it did not ensure that mortgage-backed securities pools were FHA insured within a reasonable period after pool issuance. Without proper corrective actions, the gap in the MBS program policies and procedures will continue to make Ginnie Mae susceptible to program risks including fraud.

OIG Observations
The results of the latest actuarial study, though now somewhat dated, show that HUD has sustained significant losses in its Single-Family program making a once fairly robust program’s reserves smaller. The study shows that FHA’s fund to cover losses on the mortgages it insures are contracting. As of September 30, 2008 the fund’s economic value was an estimated $12.9 billion, an almost 40 percent drop from over $21 billion a year ago. The $12.9 billion economic value represents 3 percent of the mortgages insured by the FHA. Although above the 2 percent ratio required by law, it is well below the 6.4 percent ratio from September 30, 2007. Moreover, these latest projections used macroeconomic forecast data as of June 2008 and are profoundly sensitive to the accuracy of those forecasts. If more pessimistic assumptions are factored in, the ratio could dip below 2 percent in succeeding years requiring an increase in premiums or Congressional appropriation intervention to make up the shortfall.

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A significant problem facing FHA, and the lenders it works with, is the fallout from decreasing home values. This increases the risk of default, abandonment and foreclosure, and makes it correspondingly difficult for FHA to resell the properties. About 7 percent of FHA loans are currently in default (i.e., more than 90 days non-payment status, foreclosure or bankruptcy). The Mortgage Bankers Association reports a 30-day + delinquency rate for FHA loans of over 13 percent. A major concern is that even as FHA endorsement levels meet or exceed previous peaks in its program history, FHA defaults have already exceeded previous years. The Secretary recently testified that he is sending SWAT teams in to try to head off the ramifications from early defaults on the FHA fund.

This, however, reinforces the importance for FHA approved lenders to maintain solid underwriting standards and quality control processes in order to withstand severe adverse economic conditions. Another extensive problem confronting FHA has been its inability to upgrade and replace legacy (developed in the 1970s and 1980s) application systems that had been previously scheduled to be integrated. The FHA systems environment remains at risk and must evolve to keep up with its new demands. Add to that an escalation in the properties owned and managed by FHA and the overall picture becomes more complicated.

Increased Risks to FHA:
Until recently, FHA’s market share remained quite low as conventional subprime loans were heavily marketed by lenders. The tightening credit market has increased FHA’s position as a loan insurer and, with that, is coming an increase in lender/brokers seeking to do business with the federal program and an overall concern regarding some of these loan originators. For example, we currently have under investigation, for alleged inappropriate activities, several FHA lenders who were also lenders in the subprime market. The movement towards HUD is already underway as reflected in recent statistics. FHA approval of new lenders increased 525% in a two-year period. For example, as of the end of Fiscal Year 2008, FHA had over 3300 approved lenders as compared to 997 at the end of Fiscal Year 2007 for an increase of 330%. If you compare the FY 2008 totals (over 3300) to the FY 2006 totals (692) it is a 525% increase. Lender approvals for the first half of FY 2009 currently total about 1600.