Rapid growth in Federal Housing Administration loan guarantees may be a byproduct not only of the demise of subprime lending, but higher loan limits and the limited capacity of private mortgage insurers, a Federal Reserve analysis of data collected from mortgage lenders and other sources reveals.
The Federal Reserve report, released Wednesday, suggests that most of the the growth in FHA lending has been in lending to borrowers with higher credit scores, which could bode well for future claims against the FHA insurance fund.
On Jan. 1, the Department of Housing and Urban Development will tighten credit standards on FHA loans and implement new rules for appraisals, saying the capital reserve ratio of the FHA insurance fund is expected to fall below statutory minimums (see story).
The announcment of those changes followed the passage of legislation that’s intended to help FHA combat fraud and lax underwriting by hiring additional staff and upgrading its technology — a move prompted by fears that increased demand for FHA-backed loans is taxing the FHA’s capabilities to oversee lenders.
With the collapse of the secondary market for "private label" mortgage-backed securities in late 2007, subprime loan originations plummeted 88 percent from 2007 to 2008, to $23 billion, according to figures compiled by Inside Mortgage Finance. By the end of 2008, FHA’s share of home purchase and refinance mortgages was about 30 percent, up from less than 6 percent in 2007.
That — along with the fact that many loan originators who once specialized in subprime have moved into the FHA arena — has prompted some observers to dub FHA "the new subprime."
But the Federal Reserve’s annual analysis of data collected under the Home Mortgage Disclosure Act of 1975 (HMDA) shows more than half of the purchase loans FHA insured in 2008 were to prime borrowers, up from 30 percent in 2007. Prime prime borrowers accounted for more than 60 percent of the increase in guarantees of home purchase loans, the study said.
The report also showed borrowers who take out FHA loans may be particularly vulnerable to falling home prices and unemployment because they have very little equity in their homes.
The share of FHA home-purchase loans with loan-to-value ratios exceeding 95 percent fell by about 5 percentage points from 2007 to 2008, to 67.4 percent. But the median LTV on these loans remained above 97 percent.
That gives borrowers who lose their jobs or experience home-value declines little leeway to sell or refinance their home in the event they face foreclosure.
Although many borrowers who might have taken out a subprime loan in the past now have nowhere to turn to but FHA-backed loans, Fannie Mae and Freddie Mac — which have tougher underwriting standards — have also seen their market share grow from 28 percent in 2006 to 48 percent in 2008. …CONTINUED
The numbers crunched by Fed staffers suggest that increased loan limits have as much to do with FHA’s rapid growth as the collapse of the market for private-label mortgage-backed securities that funded subprime lending.
The decline of private-label securitizations was well under way by 2007, but FHA and VA lending did not surge until 2008, the report notes.
Two other factors — congressionally mandated increases in loan limits for FHA, Fannie Mae and Freddie Mac, and problems faced by private mortgage insurers — also appear to have played a role.
Before lawmakers boosted loan limits in high-cost markets to as much as $729,750 in March 2008, FHA’s loan limit had been $271,050 in most areas of the country. The "conforming loan limit" for Fannie and Freddie was $417,000.
The loan-limit increases boosted FHA purchase loan guarantees by an estimated 7.4 percent in 2008, the report said, and refinancings by 8.9 percent.
Fannie and Freddie took longer to implement the higher limits and actually began giving up much of the market share they had picked up when secondary mortgage markets shut down in 2007, the report said.
While FHA loan guarantee programs once required down payments of as little as 3 percent (the minimum has been raised to 3.5 percent), borrowers putting down less than 20 percent need to obtain private mortgage insurance in order for their loan to be eligible for purchase or guarantee by Fannie or Freddie.
In early 2008, private mortgage insurers, faced with rising claims and strict capital requirements, started raising prices and issuing fewer policies. Fannie and Freddie "substantially reduced their purchases of loans" requiring private mortgage insurance, and also raised their own fees on such loans, the report said.
The increase in FHA’s home-purchase and refinance market shares accelerated just as Fannie and Freddie’s market share began falling in early 2008, the report said.
In other words, FHA was not only attracting homebuyers with poor credit scores who once would have relied on subprime lenders, but prime borrowers taking out loans previously considered "jumbo," or too big for Fannie and Freddie.
The Fed study analyzed a more limited set of data collected by Lender Processing Services Inc. that showed the FHA share of home-purchase loans with loan-to-value ratios in excess of 80 percent rose sharply in 2008, from just over 20 percent to about 70 percent.
At the same time, Fannie and Freddie’s share of loans in which borrowers put down less than 20 percent fell from more than 50 percent to 20 percent during 2008.
The report found further evidence that subprime lending has largely gone away rather than moved into FHA. …CONTINUED
The percentage of all loans made in 2008 classified as "higher cost" — a typical feature of subprime loans — fell from 28.7 percent in 2006 to 18.3 percent in 2007. Last year, just 11.6 percent of loans were classified as higher-priced, the report said.
Independent mortgage companies, which originated 45.7 percent of higher cost loans in 2006, accounted for just 18.5 percent of those loans in 2008.
By comparison, banks and other depository institutions made 61.6 percent of higher cost mortgage loans in 2008, up from 26.8 percent in 2006.
But because far fewer such loans were being made, higher cost loans only made up 5.6 percent of mortgages made by banks and depository institutions last year, down from 14.7 percent in 2006.
After adjusting for anomalies in the interest rate environment, the Fed report concluded that the percentage of higher-cost loans guaranteed by FHA was virtually unchanged from 2007 (2.1 percent) and 2008 (2.3 percent).
That doesn’t say as much about the credit risk posed by FHA borrowers as it might seem to, the report warned. While subprime lenders attempted to account for risk by charging higher interest rates, most of the risk of default on insured loans is supposed to be covered by insurance premiums.
Because Congress has placed a moratorium on risk-based pricing of FHA insurance premiums, "pricing on FHA loans may not be particularly sensitive to the loan’s credit risk," the report said.
Nevertheless, improvement in FHA FICO scores suggests that growth in FHA-backed lending in 2008 "has predominantly involved loans with lower risk characteristics than in 2007," the report said.
In 2007, the median FICO score of an FHA home-purchase loan was approximately 625, the report said, citing the more limited LPS data set. The share of FHA home-purchase loans to prime borrowers with FICO scores greater than 660 grew from 30 percent in 2007 to more than 50 percent in 2008, the report said.
The credit quality of FHA’s portfolio may also have benefited from the refinancing boom at the tail end of 2008, coinciding with a sharp decline in mortgage rates. A large number of high-credit-quality borrowers refinanced prime mortgages in order to take advantage of relatively low mortgage rates.
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