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FHA signals steady MIPs as loan credit quality slides

| November 16, 2018

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The Federal Housing Administration on November 16 released its annual report to Congress on the health of the single-family insurance fund and signaled no plans to change lending programs in ways that might affect the value of Ginnie Mae MBS and CMOs. Past reports have signaled changes in mortgage insurance premiums that significantly affected prepayments. FHA looks likely to hold premiums steady as credit quality in single-family and HECM programs continues to weaken.

The insurance fund strengthened in FY 2018, as the capital ratio increased to 2.76% from 2.18% in 2017. This is above the statutory 2.0% minimum. All of the improvement came from the forward mortgage portfolio, while the HECM portfolio weakened further in 2018.

The FHA looks unlikely to lower annual mortgage insurance premiums

Investors’ primary concern is whether the FHA is planning to reduce annual mortgage insurance premiums or MIPs, which could cause a significant increase in MBS prepayment speeds. The report contains no indication that the FHA is considering lowering MIPs. On the contrary, the FHA reiterates in a footnote that the early 2017 MIP reduction, which the Trump administration rescinded before it became effective, would have harmed the insurance fund. The FHA also notes that the fund would go negative in some historical stress scenarios at current MIP levels, so it would not make sense to lower them. Maintaining MIPs at current levels is consistent with the 2017 annual report and comments made by Secretary Carson earlier this year.

Credit quality is worsening

The report notes two trends that indicate the credit quality of new FHA loans continues to deteriorate. The first is that the average FICO score dropped to 670 in 2018, the lowest level since 2008. The second point is that the average DTI of purchase loans reached 43%, and that nearly 25% of new loans have DTI greater than 50%. Both of these points suggest that 2018 vintage FHA loans might default a bit faster than prior vintages. If so, the resulting faster prepayment speeds could benefit investors in discount Ginnie Mae MBS.

Government-provided down payment assistance loans default more often

The FHA also calls attention to loans with down payment assistance (DPA), which made up over 37% of purchase loans in 2018. This is a sensitive issue for the FHA, since in the past loans with seller-provided DPA defaulted at much higher rates than other FHA loans. Seller-provided DPA is no longer permitted, but borrowers can still borrow money from family members or access various government lending programs (the state housing finance authorities, or HFAs). The FHA notes that loans with DPA default faster than loans without DPA, and that loans with government-provided DPA perform worse than other DPA sources. It is possible the FHA will try to influence the state HFAs to modify their programs to improve credit quality.

The HECM portfolio weakened again

The HECM portion of the insurance fund weakened further—the capital ratio declined to -18.83%. However, the FHA does not indicate that further changes to principal limit factors (PLFs) are forthcoming. Instead, they point to two recent changes that weren’t fully accounted for in the 2018 results:

  • The October 2017 PLF reduction only applied to 52% of loans originated over the last year. September 2018 was the first month in which 100% of HECMs were originated under the October 2017 PLFs.
  • At the end of September the FHA announced new appraisal requirements. When the FHA suspects an appraisal was inflated they can required the lender to get a second appraisal.

Investors in HECM pools are most concerned that the FHA would increase PLFs, which would boost prepayment speeds. However, this seems extremely unlikely while the FHA is monitoring whether the recent PLF reduction sufficiently improved credit quality. It seems more likely that the FHA could decide to lower PLFs again if HECM performance does not improve sufficiently.

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