FHA Insured Mortgages: A Disaster in the Making, Part 2

Includes: KME, PSR, VMBS, XHB
by: Keith Jurow

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Ginnie Mae – Handmaiden of the FHA

The growing exposure of the FHA’s $865 billion insured loan portfolio to delinquencies, defaults and foreclosures is complicated by the fact that most of these loans have been packaged and securitized by approved lenders for the Government National Mortgage Association (Ginnie Mae), a wholly-owned US government corporation.

Ginnie Mae does not originate, buy or sell loans. What this Agency does is guarantee to investors the “timely payment of principal and interest” on mortgage-backed securities (MBS) backed primarily by loans insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA).

Mortgage-backed securities are pools of mortgages used as collateral for the issuance of securities known as pass-through certificates. They are called this because the principal and interest which flows from the underlying mortgages is passed through to the MBS investor. The interest rate on the MBS is lower than that of the underlying loans to allow for servicing fees.

Known in the trade as “Ginnie Maes,” these MBS are not securitized and sold by Ginnie Mae but by lenders who must be approved by both the FHA and Ginnie Mae. They are the only MBS which are backed by the full-faith-and credit of the United States Government. The Ginnie Mae website states that 98% of all FHA insured loans are packaged into Ginnie Mae MBSs.

According to a spokesperson for Ginnie Mae, the issuing lender that is servicing the pool of mortgages in a Ginnie Mae MBS is responsible for making a timely payment of principal and interest from all loans in that MBS to the investors. After a loan has become delinquent for at least 90 days, the lender has the option of buying the loan out of the MBS. It can then begin foreclosure proceedings.

Because it is the issuer/servicer who is responsible for the timely payment of principal and interest of all loans in the Ginnie Mae MBS, the burden of defaults falls on them and on the FHA rather than on Ginnie Mae. As Ginnie Mae phrases the matter on its website, defaults become a problem for Ginnie Mae only if the issuer is insolvent.

FHA-Owned Homes on the Market

In the FHA’s Single Family Operations report for June 2010, it lists “Conveyances” of bank-foreclosed homes to the FHA for which the FHA paid the bank the total unpaid principal balance under its insurance plus allowable expenses. For the current 2010 fiscal year through June 30, the FHA had taken ownership of 72,117 homes from lenders.

An FHA spokesperson updated that number and said that FHA had taken ownership of 77,129 houses through July 31. He pointed out that the FHA had sold 72,563 homes to the public during the current fiscal year. He added that FHA currently had 44,809 homes in its inventory of which 13,323 were listed for sale.

For those of you interested in purchasing an FHA-owned home, the process is not simple. You need to find on the Internet the one firm in each state which is authorized to sell FHA homes. When you do, you may not find many FHA homes for sale. For example, in Fairfield County, Connecticut, which has roughly 800,000 residents, there is one home for sale. That’s right – one.

The Danger Awaiting the FHA in the Near Future

Currently, there are 555,000 FHA-insured homes which are delinquent 90 days or more. This figure has been rising steadily for three years. Loan Performance tracks the cure rate for delinquent mortgages in its massive loan database. The cure rate for seriously delinquent mortgages has plunged to roughly 1%. This means that 99% of these delinquent mortgages are headed for default and then either foreclosure or short sale. The chart below says it all:

(Click to enlarge)

Considering the rate at which FHA mortgages are now becoming delinquent, there will be more than 700,000 seriously delinquent FHA mortgages within a year.

There is no doubt that the FHA Commissioner is determined to prop up the housing market regardless of the fallout. Commissioner Stevens knows that in cities such as San Diego, the market would have totally collapsed without the FHA. Between January and May of 2010, nearly 50% of all purchase mortgages issued in San Diego County were FHA-insured. With an average mortgage of $375,000, these were hardly the first-time buyers that now dominate FHA insurance according to the FHA.

How about Las Vegas? Its housing market is supposed to be searching for a bottom. Yet in May, according to DataQuick, 52% of sales were consummated with FHA-insured loans. Furthermore, 47% of home sales in Las Vegas were cash deals purchased overwhelmingly by investors. Some recovery...

One final mind-boggling figure is the high percentage of “cash-out” FHA refinancings. In FY 2009, the FHA provided nearly 469,000 refinancings which converted a conventional loan into an FHA insured one. In 50% of these refinancings, the FHA authorized the borrower to take cash out. Sounds like the good old days of 2004-2006, doesn’t it?

But this is the post-collapse housing market. How many homeowners have enough equity to be able to take cash out of the new mortgage? My hunch is that there are not very many. Does this look like appraisal inflation and potential fraud to you? By the way, in the current fiscal year the FHA was still approving cash-outs in one-third of all these refinancings.

By the beginning of 2011, US taxpayers will be fully at risk for more than $1 trillion in FHA insured mortgages. Sooner or later, the banks will have to foreclose and convey to the FHA the 550,000 homes that are currently seriously delinquent. These houses will be then be added to the 44,000+ homes now in the FHA’s inventory. Within a year, the number of FHA-insured homes in default or in its inventory could exceed 700,000. What will the FHA do then?

The Agency does have the authority to seek indemnification from large lenders for claims paid on mortgages that were not underwritten according to FHA requirements. It can also seek indemnification for losses incurred because of loans involving fraud or misrepresentation. The FHA Reform Act of 2010, which was passed by the House of Representatives in June, would broaden that authority to cover all FHA lenders.

To do in-depth audits for 6.4 million insured loans as well as for all the lender insurance claims it has processed would be an enormous undertaking. Meanwhile, the defaulted loan numbers keep on climbing. When these homes are finally foreclosed, conveyed to the FHA, and then put up for sale, this will weaken home prices even further.

Disclosure: No positions

Disclaimer: The source of this article is Real Estate Channel. It is reprinted with their permission.

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