FHA: Another Ticking Time Bomb?

By Shah Gilani

The fundamentals of economic strife based on the disastrous collapse of the U.S. housing market will not get better any time soon. In fact, what’s being pushed through both houses of Congress, even as you read this, is so dangerous that it should be immediately abandoned and revealed for what it is - a ticking time bomb labeled with the initials FHA.

In the past few days alone, the Bernanke Bomb Squad - also known as the U.S. Federal Reserve - was able to defuse two ticking time bombs - Fannie Mae (FNM) and Freddie Mac (FRE) - before the full force of their explosive power could be felt. Fannie and Freddie are now being propped up and will eventually have to be taken over or put into receivership, meaning there ultimately will be damage to deal with.

So, why do I still hear a ticking sound? Because there’s another bomb out there, and it’s getting closer and closer to its point of ignition. Most folks aren’t aware of it, and others who should know better are ignoring it.

The upshot: Most investors are completely oblivious to the danger it poses.

When FHA is Pronounced as "TNT"

This latest threat we’re referring to, of course, is the Federal Housing Administration, more generally known as the FHA.

Congress believes that the FHA is the institution it can count on as the salve that covers the housing gash, and heals it - thereby delivering us from a New Millennium version of the Great Depression. But in reality, the FHA is not only an additional ticking time bomb - it’s one that Congress is packing with additional gunpowder.

The Federal Housing Administration was created as part of the National Housing Act of 1934; in 1965 it became part of the Department of Housing and Urban Development (HUD). In a nutshell, FHA provides insurance - paid for by borrowers - that insures lenders, making certain that interest and principal will be paid on the mortgages that lenders grant to borrowers. FHA insurance and FHA-predicated loans facilitate home buying by low- to middle-income borrowers. When there were eager subprime-mortgage lenders and a plethora of similar lenders bending over backwards to provide mortgages (usually with teaser rates), FHA loans were not in the spotlight.

Legislative Shortfalls Certain to Surface

Within short order, perhaps as soon as next week, the Senate and House versions of their respective housing-recovery-legislation efforts will cross each other and be reconciled. In this politically charged election year, both U.S. political parties and both houses of Congress want to appear both proactive and decisive. The result will be a housing-relief package whose centerpieces are based on Fannie, Freddie and the FHA.

Because of the already-existing burdens of Freddie and Fannie, it’s obvious that further encumbering them with loans from banks - or mortgage companies such as Countrywide Financial Corp. (CFC) - is flat out a bad idea. These are loans, after all, that no one else wants. Ultimately, Freddie and Fannie would take these newly acquired loans, would repackage them as securities, and would end up selling them to themselves, since no one else will buy them.

The centerpiece of the legislation provides $300 billion to the FHA to insure new mortgages for borrowers who are in danger of being foreclosed. This inane and stillborn idea is predicated on a reality that just doesn’t exist.

What will happen is that the legislation will shoehorn borrowers into mortgages that they have no real incentive to repay. In the end, when those dead-end mortgages are abandoned, we the taxpayers will pay to bail out the FHA.

Here’s why the legislation won’t work.

The Top Two Reasons Congress Can’t Win

First, troubled borrowers will have to get lenders to forgive existing loans and take the write-off so that borrowers can refinance with an FHA loan. The trouble here is that lenders just can’t unilaterally decide to forgive the loan. Most of these borrowers have second loans and equity credit lines - usually with more than one lender - and many of these lenders have no incentive to forgive the loans. After all, if the lenders forgive the indebtedness, what will they get?

Exactly nothing - nothing at all.

Another major impediment to this approach is that most of these loans were packaged into "trusts" that issued securities (collateralized mortgage bonds) based on the collective mortgages. The "servicers" of these trusts do not speak for the original lenders, and furthermore have absolutely no incentive to allow individual mortgage holders to opt-out.

If individual mortgage-holders opted out because they could refinance, that would shrink the size of the mortgage pool. Since trust-servicers are compensated based on total size of the pool, where’s their incentive even if they could negotiate on behalf of the underlying lender?  Another idea that was tragically stillborn.

But it’s the second problem that’s the most worrisome. If borrowers could refinance based on the reduced appraised value of their homes (there’s another issue right there: what appraisals?), they would have to agree to share any appreciation with the federal government.

I’m trying very hard not to laugh. Because it’s really not funny. And here’s why: Because all these folks need help and because the FHA requires down payments of only 3%, those who can refinance actually might do so instead of just walking away - particularly since the FHA allows the down payment to be borrowed, gifted or provided by charitable organizations. (Builders and developers can actually constitute themselves as charitable organizations, believe it or not).

So, banks will hold onto those loans that have decent recovery prospects. More than likely, anything valued at less than 80 cents on the dollar they have already written off - or will, soon - and will then dump those borrowers on the FHA. The FHA will end up with subprime and junk mortgages where the borrowers have "no skin in the game," and no upside incentive. And, as a last laugh, new legislation, already in place, allows the FHA to raise the amount of a loan they can insure from the previous level of $362,790 to a new total of $729,750.

(Special note to lawmakers: Hey folks, it was the extension of credit to borrowers who were unable to afford homes in the first place that got us into this mess).

The FHA is supposed to be revenue neutral. Last year it lost $4.6 billion. Can you see where this is going?

The bottom line: This plan is not a panacea. It is a sea of pain - for the taxpayers, and for the housing market.

Market Notes: Don’t Get "Faked Out"

Don’t be fooled by the "head-fake" rally. The truth is that the congressional efforts being pushed along at breakneck speed to "fix" the U.S. housing disaster are short-sighted and inept, and serve to hide the massive FHA time bomb that’s destined to blow up in our collective face.

Color me unimpressed.

Wednesday’s stock-market rally - and the follow-up advance yesterday (Thursday) do not portend a sea change in momentum and no previous sell-offs would constitute a "capitulation" bottom.

To the contrary, it was what we professional traders call a "dead cat bounce." It was a technical rally based not on fundamentals, but on technicals. Shorts ran for cover, thanks chiefly to newly proposed Securities and Exchange Commission rules that would force short-sellers to actually "locate" shares of stock before they can sell that stock short.

There are massive shorts out there and from time to time such squeezes will result in "head-fake" rallies. The fundamentals have not changed. Keep your eyes on the prize.

Original post

Comments

[CPST1]

Shah, I have a question and hope I can ask it as it should be asked. Given the "bears" covered on FNM, and FRE and likely took new long positions didn't they pull off the bear move of the decade?


I think of FNM and FHE as agencies that are assured through the federal government in the same manner as FHA. The SEC has implemented an emergency ruling that shorts must have a cover.

Technically, I see the (options) calls for either FNM, or, FRE as bottomless whereby new stock can be issued by the government.

You put forth that congress will act in a manner that attempts to balance the mortgage market as a function of its appreciable value despite its present values and then say it is laughable.

I live in Maine and we have the oldest homes anywhere many of which may no longer be worth heating at current fuel cost. In fact, fuel cost on a monthly basis this winter will likely surpass either the cost to rent or pay the mortgage.

We anticipate fuel subsidies to triple from last year which are made available through our states housing department to help us offset the cost of fuel cost. I may well receive $600 this year where last year I received $400, plus, 100 gallons of heating oil from Citizen’s Energy. Thankfully, I have a full tank of oil, and a LIHEAP credit of $700 remaining as I have tried to conserve. I also receive Section 8 existing housing subsidy that pays 2/3 of the rent.

So, why does the government in act a short term (stock) rule and still at the same time plan to issue more stock for the underlying institutions (FHM,FHE)it assures in the first place. Who comes out ahead? If you had $10,0000 to invest where would you put it?


The U.S. Securities and Exchange Commission issued an emergency order on Tuesday placing restrictions on the short selling of shares of certain major financial firms. The SEC's order will require that anyone effecting a short sale in these securities arrange beforehand to borrow the securities and deliver them at settlement. The order takes effect Monday, July 21, and will terminate at the end of July 29. The SEC said the order may be extended, but for no more than 30 calendar days in total duration. ---- The agency identified the following securities affected by its order: ----- Shorting Curbs -- BNP Paribas Securities Corp (BNPQY.PK) -- Bank of America Corp (BAC) -- Barclays PLC (BCS) -- Citigroup Inc (C) -- Credit Suisse Group (CS) -- Daiwa Securities Group Inc (DSECY) -- Deutsche Bank Group AG (DB) -- Allianz SE (AZ) -- Goldman Sachs Group Inc (GS) -- Royal Bank ADS (RBS) -- HSBC Holdings Plc ADS (HBC) -- JPMorgan Chase & Co (JPM) -- Lehman Brothers Holdings Inc (LEH) -- Merrill Lynch & Co Inc (MER) -- Mizuho Financial Group Inc -- Morgan Stanley (MS) -- UBS AG (UBS) -- Freddie Mac (FRE) -- Fannie Mae (FNM) --

[ASG]

Why is it that every one of these type stories - that trumpet the dangers of Freddie, Fannie - here the FHA - or even ones like Countrywide and IndyMac etc never bother to talk about teh details

All we hear is how much risk there is - how poorly they are supposedly doing - how likely they are to fail and/or need rescue

Yet - none of these predictions are supported by facts.

The strength of Fannie. Freddie, FHA and even IndyMac and Countrywide are in the underlying assets - the loans themselves.

So just how are these loan portfolios doing?

Even a nominal effort at research yields the broad facts.

Fannie Mae has appx $5 trillion in mortgages - appx 1/2 of all mortgages in the US - some are claiming they don't have enough capital - but once again these claims are the result of "fair value" accounting of their assets - which means pricing them at liquidation value - irregardless of the real value

Yet the delinquency rate on the FNMA portfolio - the 90 day late rate - is just 1.15% as of March 2008 ... the foreclosure rate is usually a bit less than half of the delinquency rate

tinyurl.com/FNMA-FC-RA...

So on ALL FNMA Loans almost 99% are not delinquent


FNMA Loan breakdown Q1 2008:

tinyurl.com/FNMA-LoanD...

A tiny fraction of all FNMA loans are subprime - and just over 10% are ALT-A ....

A total of 93% of all new business in Q1 2008 was fixed rate loans - and a total of 89% of all mortgages in their portfolio are fixed rate loans

Estimated average Loan to Value is 62% (38% down payment/equity)

Estimated average FICO score - 721 (generally considered in the very good to excellent range)

Fannie Mae Delinquency Rates Q1 2008 (only appx 50% will actually end up foreclosed):

tinyurl.com/FNMA-Delin...

In Q1 2008 just 1.15% of all loans were 90+ days delinquent - appx 50% of these will end up foreclosures

Majority of delinquencies are in CA, AZ, FL and NV ...

90+ day delinq rates on ALT-A was 2.96% in Q1 200 vs 2.15% in Q1 2007

90+ day delinq rates on Subprime was 7.42% in Q1 200 vs 5.76% in Q1 2007

Many of these higher risk loans were originated in 2007 and prior - with our tightened standards newly acquired loans will have lower credit risk

The delinquency rate overall is just over 1% - just under 99% of all FNMA loans are NOT delinquent - are performing as agreed

Fannie Mae Q1 2008 Foreclosure stats:

tinyurl.com/FNMA-FCsta...

AZ, CA, FL, and NV accounted for 17% of foreclosures in Q1 2008 vs 4% in Q1 2007

The Midwest accounted for 36% of foreclosures in Q1 2008 vs 44% of the foreclosures in Q1 2007

ALT-A loans accounted for 29% of foreclosures in Q1 2008 vs 17% of the foreclosures in Q1 2007

Total foreclosed homes rate was 0.1% of all mortages in Q1 2008 and Q1 2007

Out of ALL Fannie Mae loans 99.9% are not foreclosed on ....

At the end of Q1 2008 Fannie Mae had $2.723 trillion in mortgages on their books and $2.625 trillion in mortgage guarantees on their books - total appx $5.35 trillion .... up from 2007 which saw $2.65 trillion in loans and $2.55 trillion in guarantees for a total of $5.2 trillion

Fannie Mae has $4.53 billion - out of $5.35 trillion in total loans in foreclosed homes on their books a total actual foreclsoure rate of 0.085% of current book

... and they will recover appx 60 - 65% of that $4.53 billion as these properties are sold - leaving a net loss of appx $1.812 billion - or appx 0.034% of the total $5.35 trillion current book

Total "non-accruing&quo... (delinquent) loans are appx $8.723 billion - which makes the delinquency vs foreclosed rate on the $4.53 billion equal to appx 51.9%

Yep that portfolio is in terrible shape ....

Net interest income for Q1 2008 was $1.69 billion ... net guarntee income Q1 200 8 was $1.752 billion

Total income/loss before taxes was a loss of $5.113 billion for Q1 2008 however $4.377 billion of this was a "paper" mark to market "fair value" accounting loss - and there was another $3.073 billion provision for credit losses in Q1 2008 in this $5.113 billion Q1 loss

The $5.113 billion Q1 2008 loss provided a tax benefit of $2.928 billion - which reduced the net loss to $2.186 billion after taxes

According to one report:

"As of March 31, 2008, Fannie Mae had $42.7 billion in core capital, which represented a $5.1 billion surplus over the requirements of its regulator ... If we add together their statutory surplus, current loss reserve and estimated revenues, total “claims paying resources” for FNM are $56-92 billion ... If we tax effect these numbers, we see that FNM can sustain losses of $85-141 billion over 3-5 years

What is happening is that Fannie and Freddie are required, by accounting rule, to record paper losses because the immediate trading value of the assets on their books -- and in this case assets means mortgage loans that it holds--are going down. It probably has no intention of selling those now, so that is a somewhat theoretical problem. But that's what the accounting rules require, and as a result, it must record a "loss" for those on its quarterly income statement. That loss is then deducted from the value of shareholder equity on its balance sheet, thereby reducing the "capital" it has to serve as a cushion against further losses. That's basically what all the fuss is about."

Total losses in Q1 2008 = $2.186 billion (or which $4.377 billion was a paper mark to market loss which will come back as profit as the financial markets stabilize) ... and total reserves and surplus etc $56-$92 billion ...

Yep - they are in terrible shape all right ....

-steady and increasing revenue

-increasing market share with limited competition
loss reserves sufficient to handle years of losses at
current levels

-billions in unencumbered loans they can borrow
against

-improving loan credit quality on new loans
very small exposure to riskier subprime and ALT-A
loans

-far below "market" delinquency and foreclosure rates

FHA's numbers are even better than Fannie's in most metrics - the loans in their portfolios have some of the lowest default rates of all loans according to MBA's numbers

Yet we constantly hear from "traders" like this one how terrible these institutions are doing - and never with a review of the real details - the status of the assets....

Why is that?

What are all these commentators afraid of?

Perhaps an interesting "tell" is the strong interest the SEC has in the whole "shorts" situation ....

[il]

According to HUD data entp.hud.gov/sfnw/publ..., the default rate on FHA loans is 17%.

Which is not at all surprising given the nature of the loans.

[Stockguy456]

Politics is the 2nd oldest profession but it is very much like the 1st oldest profession!

video.google.com/video...

[Whisper OnThe Wind]

Go away stockguy, you're becoming redundant by posting this same statement (and website) on more than one column. Since you're the one stumping for attention, you must be among the 1st oldest profession?

[jimmy46]

Knowledgeable sellers and buyers have always avoided FHA.

They take forever to make a decision.

They lowball the appraisal so the seller has to cut the price
from what was agreed upon.

Most sellers refuse to take FHA financing for these reasons.

[ASG]

The link is bad as is the alleged 17% default rate on FHA mortgages above.

FHA Serious Delinquency Rates for Q1 2008 were 5.59% down from 6% Q4 2007.

FHA Foreclosure starts were 0.87% for Q1 2008 down from 0.91% Q4 2007.

And FHA completed foreclosures (inventory rate) was flat at 2.4% Q1 2008 vs 2.34% Q4 2007.

The MBA Q1 2008 Nat'l Delinquency Survey shows:

DELINQUENCIES:

The seasonally adjusted delinquency rate increased 47 basis points for prime loans (from 3.24 percent to 3.71 percent) and 148 basis points for subprime loans (from 17.31 percent to 18.79 percent). The delinquency rate decreased 33 basis points for FHA loans (from 13.05 percent to 12.72 percent) and increased 73 basis points for VA loans (from 6.49 percent to 7.22 percent).

But delinquencies are not the important measure - REO's - actual foreclosures are:

FORECLOSURES:

The foreclosure inventory rate increased 26 basis points for prime loans (from 0.96 percent to 1.22 percent), and increased 209 basis points for subprime loans (from 8.65 percent to 10.74 percent). FHA loans saw a six basis point increase in foreclosure inventory rate (from 2.34 percent to 2.4 percent), while the foreclosure inventory rate for VA loans increased 12 basis points (from 1.12 percent to 1.24 percent).

Foreclosure Starts also shows a decline for FHA loans in Q1 2008:

FC STARTS:

The seasonally adjusted foreclosure starts rate increased 13 basis points for prime loans (from 0.41 percent to 0.54 percent), 62 basis points for subprime loans (from 3.44 percent to 4.06 percent), and 11 basis points for VA loans (from 0.39 percent to 0.5 percent). The foreclosure starts rate decreased four basis points for FHA loans (from 0.91 percent to 0.87 percent).

And last - the Serious Delinquency Rate - which is a foreteller for filings and foreclosures is also down for FHA.

SERIOUS DELINQ:

Compared with last quarter, the seriously delinquent rate increased for all loan types, except FHA loans. The rate increased 32 basis points for prime loans (from 1.67 percent to 1.99 percent), increased 198 basis points for subprime loans (from 14.44 to 16.42 percent), increased five basis points for VA loans (from 2.83 percent to 2.88 percent) and decreased 41 basis points for FHA loans (from 6 percent to 5.59 percent).

FHA loans represent 8% of US loans outstanding and 7% of foreclsoures started. Subprime loans (fixed and ARM) are 12% of all US loans but represent 50% of foreclosure starts

Even the subprime loans don't have a 17% delinquency rate.

www.mortgagebankers.or...

[texasgolfer]

in a sellers market with available creative financing, the seller may not opt for FHA financing due to time and cost. However, in a buyers market with restricted financing most sellers will do what is necessary to sell and cut their loss or stop the bleeding. Remember most buyers are not realtors looking to flip and are smart enough to get the price down. If the seller refuses to understand the current nature of the market, then classify them as prospective sellers, because they won't sell.

[il]

> The link is bad as is the alleged 17% default rate on FHA mortgages above.

Sorry, the correct link is https://entp.hud.gov/s...

Under "Servicing" menu one can get access to the number of FHA loans outstanding broken down by the loan standing per lender. The data can be downloaded to Excel with the link at the bottom of the page. Total loans in default / total loans in active portfolio = 17%.

The largest lender (WFC) has 171,726 loans in default out of 1,066,040 total loans in portfolio. The default rate of 16%. The loans of 3 or more months delinquent are 6.64% of the portfolio.

The data as of June 30, 2008.

[il]

Hmm, the seekingalpha's URL munging "feature" is truly amazing. Neighborhod Watch link, take number 3: tinyurl.com/hud-fha

[ASG]

The link you provided shows out of a total of 261 FHA Servicers the following:

3,896,389 Total loans outstanding
313,405 30 days delinquent = 8.04%
113,387 60 days delinquent = 2.91%
242,749 90 days delinquent = 6.23%

56,876 Actual Foreclosures = 1.51% of total mortgages

Just 8.79% of delinquent loans end up foreclosed

And the more realistic number - just 24.25% of loans 90 days delinquent end up foreclosed

FHA loans still have a very low foreclosure rate and a low 90 day default rate ... the "total delinquent" number is essentially meaningless - the 60+90 day delinquencies are 9.14% - again, and falling

More importantly the metric shown above, that these rates are falling - decreasing - shows the absolute fallacy of the claims such as this article alleges - that FHA (or Fannie or Freddie or even IndyMac) are "ticking time bombs"

These claims are simply ludicrous and are rarely backed up by actual research or apparently even any understanding of the real portfolio quality numbers

[il]

> 3,896,389 Total loans outstanding
> 313,405 30 days delinquent = 8.04%
> 113,387 60 days delinquent = 2.91%
> 242,749 90 days delinquent = 6.23%

Apparently, there is no disagreement with 17% default rate for loans guaranteed by FHA.

> FHA loans still have a very low foreclosure rate and a low 90 day default rate ... the "total delinquent" number is essentially meaningless - the 60+90 day delinquencies are 9.14% - again, and falling

It is not clear where the observation of "60+90 day delinquencies falling" is coming from. The MBA article implies that in Q1 08 the "seriously delinquent" rate for FHA loans was 5.59% vs. 6% in Q4 07. Vs. 6.23% 90+ days late in Q2 08. Of course, quarter-to-quarter comparison is of a little statistical significance. I seriously doubt that year-over-year default rate is showing a decrease.

As for the total default rate being "essentially meaningless"...
Prices continuing to plummet. Homeowners on FHA loans having virtually no skin in the game (little or no down payment). It is only rational for them to stop paying. 30 day late loans are certainly going to carry over to more serious defaults in the near future.

[ASG]

prices do not "continue to plummet" - isolated markets continue to see price drops - the OFHEO (Fannie Mae "parent") covers almost 300 markets vs Case Schiller and show a nominal year over year decrease when you look at all markets

Even Case Schiller's founder has recently indicated price drops are more and more isolated and leveling or reaching a bottom

Further - the OFHEO also reports a 5 year price performance along with year to year - and across all 300 markets the price performance over 5 years is (from memory) still something like a 41% gain

It would be then the loans the last 2 years that would be the issue with foreclosures and delinquencies - it is these loans affected by the price decrease - yet the FHA numbers show the FHA foreclosure claims rate on loans less than 2 years old is just 0.24% - compared with 1.94% for loans 5 years old or older

And as to year to year changes in the FHA portfolio - that info was in the link I provided from the MBA Natl Deliq Report:


Change from last year (first quarter of 2007):

The FHA foreclosure inventory rate increased 21 basis points (0.21%) - so the actual foreclosures are up a whopping 2/10ths of 1 percent year over year - to 1.94% of all FHA loans

The seasonally adjusted foreclosure starts rate for FHA loans decreased three basis points (0.03%) - essentially unchanged from the first quarter of 2007 - so new foreclosures are also essentially unchanged year to year

On a year-over-year basis, the seriously delinquent rate increased 33 basis points (0.33%) for FHA loans - another increase - of a whopping 1/3 of 1% - again essentially flat year over year

And to review - the changes from 4th Quarter 2007:

The seasonally adjusted delinquency rate decreased 33 basis points for FHA loans (from 13.05 percent to 12.72 percent)

The foreclosure inventory rate (completed foreclosures) for FHA loans saw a 6 basis point (0.06%) increase in foreclosure inventory rate (from 2.34 percent to 2.4 percent)

The seasonally adjusted foreclosure starts rate decreased four basis points (0.04%) for FHA loans (from 0.91 percent to 0.87 percent)

The seriously delinquent rate, the non-seasonally adjusted percentage of loans that are 90 days or more delinquent, or in the process of foreclosure, increased for all loan types, except FHA loans. The rate decreased 41 basis points (0.41%) for FHA loans (from 6 percent to 5.59 percent).



The data is clear - on a year to year basis FHA loans foreclsoure stats are essentially unchanged - and on a quarter to quarter basis they are trending down

More importantly FHA loans are performing well within the parameters priced into and expected for the portfolio - with more than 99% of loans NOT foreclosed upon and more thn 94% NOT seriously delinquent.

And again these numbers are trending down.

Despite that - like with Fannie Mae and their similar numbers - a large number of people are still making silly claims as with this story - which ignore the actual facts - the performance of the underlying assets - and predicting massive failures

[ASG]

And FHA borrowers have never had to have any significant "skin" in the game - downpayments have been 3% or less for years and yet the FHA portfolio has repeatedly had some of the smallest losses of all loans