FHA's Finances Improve as Claims on Delinquent Loans Abate

Rising home prices, fewer delinquencies and a dearth of claims by large bank lenders are helping improve the financial health of the Federal Housing Administration.

The FHA continues to benefit from foreclosure delays and a slow process for reimbursing lenders on defaulted loans. Billions of dollars of delinquent FHA-insured loans are held on bank balance sheets. Many loans are either being worked out by lenders or are stuck somewhere in the foreclosure process. While the FHA says it will end up reimbursing lenders for those losses eventually, in the short run, the delays are buying the agency more time to improve its financial condition.

For now, the FHA appears to have plenty of cash in its coffers to pay claims as they come in on delinquent loans. Actual reimbursements to lenders are 49% below what the agency had projected due to "delays in processing foreclosures," the FHA said in its second quarter report to Congress, released last week.

Even though the FHA paid out $21.4 billion in claims in the past four quarters, it had $36.1 billion in cash reserves at the end of its fiscal second quarter, up from $32.3 billion a year earlier.

The quarterly report is important because the FHA has been in the hot seat since November when an independent actuarial report found that projected losses over the next 30 years could put the agency $16 billion in the red, far out of reach of a required 2% capital buffer.

Still the changing nature of the housing market and the FHA's fluctuating finances make it unclear whether the agency will need to tap Treasury in September to shore up its reserves to cover projected losses. The Obama Administration estimated in April that the FHA will need nearly $1 billion to close its funding gap this year.

FHA also showed others signs of a turnaround as home prices improve.

Its serious delinquency rate on loans 90 days or more past due fell below 9% for the first time since September 2011. Rising home prices have improved loss rates on distressed properties. Plus, early-stage delinquencies remain at low levels and the average borrower credit score of 695 is near all-time highs. Currently, more than 50% of FHA loans have credit scores above 680 compared to just 20% in 2007.

FHA insured roughly 32% of all home purchases (excluding refinances) in the second quarter of 2012, up from just 5% in 2006, according to most recent data available.

"This is very encouraging data and the core reason is the influx of great credit quality loans," says Brian Chappelle, a founding partner at consulting firm Potomac Partners LLC, and a former FHA official.

Last week, the agency also streamlined its process for short sales that do not require verification of a borrower's hardship. Borrowers in danger of becoming delinquent now may qualify for a short sale for reasons such as a divorce, death or employment relocation.

FHA also extended indefinitely a forbearance program for unemployed borrowers that requires FHA servicers to suspend or reduce payments for at least 12 months or until the borrower finds a job. The program has been set to expire Aug. 1.

In January, FHA Commissioner Carol Galante proposed a series of changes to shore up the agency's finances including increasing down payments to 5%, from the current 3.5%, for jumbo loans above $625,000, and raising annual mortgage insurance premiums by 10 basis points.

FHA is now collecting the highest premiums in its history — charging a 1.75% upfront and 1.35% annual premium, meaning new borrowers will pay 8.5% of their total loan amount in premiums in the first five years of the loan. Those premiums are used primarily to cover expected losses and fund FHA's reserve.