America's Mortgage Conference 2013 FHA Reform Back to Basics 9/10/13

7/29/2019 America's Mortgage Conference 2013 FHA Reform Back to Basics 9/10/13

1/20

ROAD TO FHA REFORM:

Edward Pinto,

Resident Fellow

American Enterprise Institute

September 10, 2013

The views expressed here are those of theauthor alone and do not necessarily representthose of the American Enterprise Institute.

nightmareatfha.com | 1

BACK TO BASICSPRESENTED AT THE 2013 AMERICAN MORTGAGE CONFERENCE

SPONSORED BY THE NORTH CAROLINA BANKERS ASSOCIATION


2/20

FHA LENDING

VA AND FHA DELINQUENCY RATES


RISKIER THAN EVER

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

1946

1949

1952

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

VA serious delinquency

FHA serious delinquency

the FHAs rate averaged197% of the VAs

the FHAs rate averaged96%of the VAsthe FHAs rate averaged118% ofthe VAs

1946-1967

1979-2000

2001-2012

Sources: 1946-1967: John P. Herzog andJames S. Earley, Home Mortgage Delinquency

and Foreclosure (Cambridge, MA: NationalBureau of Economic Research, 1970),www.nber.org/books/herz70-1 and 1979-2012:MBA National Delinquency Survey. All datayear-end, except 2012 data, which is Q2:2012.
http://www.nber.org/books/herz70-1%20and%201979-2012http://www.nber.org/books/herz70-1%20and%201979-2012http://www.nber.org/books/herz70-1%20and%201979-2012http://www.nber.org/books/herz70-1%20and%201979-2012http://www.nber.org/books/herz70-1%20and%201979-2012http://www.nber.org/books/herz70-1%20and%201979-2012http://www.nber.org/books/herz70-1%20and%201979-2012http://www.nber.org/books/herz70-1%20and%201979-2012


3/20

FHA LENDING MAKING

WEIGHTED AVERAGE FAMILY FORECLOSURE CLAIM RATE OF 12.54% FOR


FORECLOSURES COMMONPLACE1975-2011--3.14 MILLION FORECLOSURES AND 1 IN 8 FAMILIES

0%

5%

10%

15%

20%

25%

30%

35%

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000 FHA projected cumulative claim rate-note: annual claim rates do not excludestreamline/FHA-toFHA refinances (rightaxis)FHA adjusted loan count (excludes

streamline/FHA-FHA refi from 1983 on) leftaxis

Sources:

Loan count: HUD PD&R historical data

Projected annual cumulative claim rate andstreamline/FHA-to-FHA refinances: AnnualFHA Actuarial Studies

Number of claims by year = loan count(includes streamline/FHA-to-FHArefinances) x claim rate


4/20

FHA LENDING

MISSION FAILURECOMMON CRITIQUES OF FHA OVER THE YEARS:


Excessive foreclosure rates

Poor property management and disposition

Excessive loan limits

Imprudent appraisal practices

100% guarantee promotes misaligned incentives

Poor underwriting practices impact first time, workingclass and minority borrowers and their communities


5/20

VAS SUPERIOR PERFORMANCE

nightmareatfha.com

Comparison of FHA and VA serious delinquency rates across FICO bands for 2009:

The first (FHA @41-45% DTI) and second bars (VA @41-45% DTI ) for each group show

how VA underwritten loans perform relative to FHA loans in similar FICO bands and

DTIs. The VAs performance across these bands averages about 67% of the FHAs.

The third bar for each group shows the VAs performance for 51-55% DTI, which average

about 80% of FHAs rate for41-45% DTI loans.

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0%

5%

10%

15%

20%

25%

30%

580-599 600-619 620-659 660-679

FHA @41-45% DTI

VA @41-45% DTIVA @51-55% DTI


6/20

FHA VERSUS VA

The VA serves a greater percentage of African American families buying a home than FHA


6%

7%

8%

9%

10%

11%

12%

13%

14%

15%

2004 2005 2006 2007 2008 2009 2010 2011

FHA African American Percentage

VA African American Percentage

Source: Mortgage Bankers Association,derived from Home MortgageDisclosure Act.

AFRICAN AMERICAN LOAN GUARANTEE PERCENTAGES


7/20

HARMING WORKING-CLASS


FAMILIES AND COMMUNIITIES

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Atlanta,

GA

Baltimore,

MD

Birmingham,

AL

Buffalo,

NY

Chicago,

IL

Cincinnati,

OH

Cleveland,

OH

Columbus,OH

Dallas,TX

Detroit,

MI

Indianapolis,

IN

LosAngeles,CA

Memphis,

TN

Miami,FL

Newark,

NJ

NYC,

Bronx

NYC,

Brooklyn

NYC,

Queens

Philadelphia,

PA

Richmond,

VA

Rochester,NY

Syracuse,

NY

Trenton,

NJ

Washington,

DC

Projected

ForeclosureRate

FHA Loan Projected Foreclosure Rate

Low-Income Zip Code vs. Middle-Income Zip Code Areas

(21 cities plus 3 New York boroughs)

Low Income Rate

Middle Income Rate

From a recent study

where 19 of 22 cities

had higher FHA

projected foreclosure

rates in low-income zip

codes than in middle-

income zip codes.

Replicates the National

Training and Information

Centers 2002 study

for the same 22 cities.

That study found 21 of22 cities had higher

FHA loan default rates

in low-income census

tracts than in middle-

income census tracts.


8/20

HARMING MINORITY


FAMILIES AND COMMUNIITIESFrom a recent studywhere 19 of 22 cities

had higher FHA

projected foreclosure

rates in minority zip

codes than in white zip

codes.

Replicates the National

Training and Information

Centers 2002 study

for the same 22 cities.

That study found 19 of22 cities had higher

FHA loan default rates

in minority census

tracts than in white

census tracts.

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Atlanta,

GA

Baltimore,

MD

Birmingham,

AL

Buffalo,

NY

Chicago,

IL

Cincinnati,

OH

Cleveland,

OH

Columbus,OH

Dallas,TX

Detroit,

MI

Indianapolis,

IN

LosAngeles,CA

Memphis,

TN

Miami,FL

Newark,

NJ

NYC,

Bronx

NYC,

Brooklyn

NYC,

Queens

Philadelphia,

PA

Richmond,

VA

Rochester,NY

Syracuse,

NY

Trenton,

NJ

Washington,

DC

Projected

ForeclosureRate

FHA Loan Projected Foreclosure Rate

Minority Zip Code vs. White Zip Code Areas

(21 cities plus 3 New York boroughs)

Minority Rate

White Rate


9/20

FORECLOSURE CRISIS:

nightmareatfha.com

In Chicago, the highest foreclosure rates and percentage of loanswith FICOS greater than 660 are concentrated in working-class zipswhere incomes and home prices are below area median

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QUADRANT OF DOOM


10/20

DISPROPORTIONATE IMPACT ON

nightmareatfha.com| 10

WORKING-CLASS COMMUNIITIESFrom a study showingthat an FHA borrowerliving in a zip code in thefourth quartile (thosewith a mean Equifax

Risk Score of 519 to673) had an average 45percent higher likelihoodof being 90+ daysdelinquent compared toa borrower with thesame risk characteristics(measured across 245risk buckets) living in azip code in the firstquartile (with meanEquifax Risk Scores of721 to 826).


11/20

DISPROPORTIONATE IMPACT ON


WORKING-CLASS COMMUNIITIESLoans to FHA borrowers inzip codes with a higherfraud risk score (FRS)perform worse than loans inzips with a lower FRS, evenwhen borrower risk factors

such as FICO score, downpayment, and DTI ratio areheld constant. An FHAborrower in a zip code in the4th quartile (the 25% of thezips with the highest FRS),

on average, had a 31%higher likelihood of being90+ days delinquentcompared to a borrowerwith the same risk factorsliving in a zip in the 1stquartile (the 25% of the zips

with the lowest FRS).

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

90+Rate

Neural Net Predicted 90+ Rate By Risk Bucket

1st & 4th Interthinx Risk Index Quartiles

Neural Net Predicted 1st Quartile 90+ Rate

Neural Net Predicted 4th Quartile 90+ Rate


12/20

NEEDY FAMILIES NEED

nightmareatfha.com

Step back from markets that can be betterserved by the private sector.

Concentrate on low- and moderate-incomehomebuyers who truly need help purchasingtheir first home.

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FHAS FULL ATTENTION


13/20

STOP FINANCING FAILURE


FHAs average one-in-eight Family Claim Rate (FCR) masked much higher familyfailure rates in many working-class and minority neighborhoods.

The FHAs current credit box for 580-679 FICO borrowers yields a weightedaverage FCR of 18%.

FCRs range from 26% (580-599 FICO scores) to 13% (660-679 FICOscores).

The deleterious effects resulting from such high failure rates can be avoided by atwo-step process designed to achieve FCRs of 7.5% on 580-679 FICO creditscore loans:

Implement the general process improvements designed to align incentives.

Balance down payment, loan term, FICO, and debt-to-income (DTI).

These steps would drop FHAs overall rate more than in half to 5-6 percent.


14/20

ALIGNMENT OF INCENTIVES

Contributes greatly to the VAs success: Combines public sector mission of benefiting the

veteran backed by public sector guarantee.

Alignment of financial interests:

25% guaranty limit aligns originator, servicer, issuer and Ginniewith the VA and homeowner

Doing it right from start to finish is in everyones interest

Allows the VA to address issues within this rationalizedstructure, rather than responding with ad hoc solutions

Origination, securitization, servicing Utilizes processes to reduce risk and fraud

The lack of properly aligned incentives helps explainswhy, notwithstanding the magnitude and persistency ofFHAs problems, efforts at reform have failed.

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15/20

VAS ABILITY TO PAY PRACTICES

nightmareatfha.com

VA requires underwriters to identify and verify income availableto meet:

The mortgage payment

Other shelter expenses (includes utilities and maintenance)

Debts and obligations (includes job related expenses such as child care)

Family living expenses

Residual income needs

The resulting debt-to-income ratio (DTI) is secondary toresidual income as an underwriting factor.

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16/20

APPRAISER PANELS

nightmareatfha.com

Alignment of incentives: Panel selected based on experience and geographical competence (VA)

Size: 4500 (VA) vs. 55,000 (FHA). VA did 40% of the FHAs volume (2012)- Reopening of local panel based on need, additions based on competence (VA)- 2012: goal of increasing VA panel size from 4600 to 5800 , now at 5200

Assignment based on rotation (VA) vs. lender selection (FHA)

Quality control (VA)- VA staff appraisers or designated lenders- Minimum of 10% of work is field reviewed

Two benefits of appraiser panels merit special mention: Appraiser independence takes away a tool from unscrupulous parties. Appraiser independence results in greater identification of needed property

repairs and shortcomings.

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17/20

VAs 25% COVERAGE

nightmareatfha.com

VA pays up to an average of 25%, averaging 25% while FHApays up to 100% of the claim amount, averaging 63%.

FHAs loss rate is an estimated 5 times the VAs (2 times the

incidence and 2.5 times the severity).

The VA charges 1/3 FHAs premium (present value basis).

VA Issuers absorb 1.6 times the overall loss rate comparedto FHA issuers for the same fee.

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18/20

VAS 25% COVERAGE

nightmareatfha.com

Did not deter ability to play a countercyclical role. VAs volume tripled from 2007 to 2009.

In 2009 the VAs median FICO score was 705, similar to the FHAsmedian of 694.

Did not deter ability to serve underserved borrowers in asustainable manner. In 2005, 43% of the VAs originations had a FICO between 600-679,

virtually identical to FHAs 44%.

VA has experienced substantially lower serious delinquencyrates than the FHA for decades and are currently half theFHA rate (2001-2012).

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19/20

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In July 2010, FHA Commissioner Stevens proposed eliminating seller

concessions >3%.

FHA allows up to a 6% seller concession vs. 3% for conventional market:

The incidence of concessions and the average concession is highest forloans 3%, default rate 1.9 times that of loans where 0%(1/3 of FHA loans below $180,000 have a 0% concession.

When concession is >3%, default rate 1.3 times that of loans where >0%and 3% subject working class families and

neighborhoods to needless foreclosure risk.

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REDUCE SELLER CONCESSIONS


20/20

nightmareatfha.com

Reduce coverage below 100 percent (Section 234 of theProtecting American Taxpayers and Homeowners Act of 2013(PATH));

Advise consumer as to foreclosure risk based applicants riskprofile (Section 236 of PATH);

Limit seller concessions to 3 percent (Section 263 of PATH);

Utilize residual income test (Section 267 of PATH);

Reinstitute vetted appraisal panels with rotational assignment; Introduce countercyclical stress test and LTV ratios; and

Underwrite for risk.

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WORKING CLASS COMMUNITIES

DESERVE COMMON SENSE REFORM

America's Mortgage Conference 2013 FHA Reform Back to Basics 9/10/13

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