The Federal Housing Administration is making tough choices to help shore up the government program from weaker loans made in years past. A mortgage industry veteran is at the helm shaping the policy changes.
Mortgage Banking
January 2010
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By Robert Stowe England
David H. Stevens was sworn in as assistant secretary for housing at the Department of Housiing and Urban Development (HUD) and commissioner of the Federal Housing Administration on July 15, 2009, and is responsible for overseeing the $600 billion FHA mortgage insurance portfolio and HUD's multifamily subsidized housing program. The commissioner oversees HUD's regulatory responsbilities under the Real Estate Settlement Procedures Act (RESPA).
Prior to his appointment, Stevens was president and chief executive officer of the Long & Foster Companies, Inc., in Chantilly, Virginia. Further, he has an extensive background in mortgage finance. He served as executive vice president and national wholesale manager at Wells Fargo Home Mortgage in Des Moines, Iowa, and was a senior vice president in single-family business at Freddie Mac. Stevens spent 16 years at World Savings Bank, where he began his career. He is a graduate of the University of Colorado at Boulder.
Mortgage Banking caught up with Stevens at his office in the HUD building in southwest Washington, D.C., recently, where this interview was conducted.
Q: There are some who have taken to referring to the FHA lending program as “the new subprime.” How do you respond to those comments and is there any truth to that assessment?
A: I think those who refer to it as the new subprime are creating an unnecessary and irrational judgment about the FHA program. Nothing could be further from the fact. Where subprime was characterized by extremely low credit quality, adjustable mortgages, 2/28s with a fairly significant payment increase in the early period, limited or sometimes no income documentation or otherwise . . . the FHA portfolio is very different. It’s 100 percent 30-year, fully amortized fixed-rate. It’s [a] 100 percent fully [documented] mortgage portfolio. It’s a primary residence-only [mortgage portfolio]. No second homes, no investor properties, and the average credit score has risen to near 700.
An FHA loan is for shelter. The fact it’s owner-occupied, and you look at the average loan size, these loans are not for speculation or investment. And much of the subprime and alt-A product was originated either for speculative purposes or originated with no documentation or originated using variable-rate loans that didn’t amortize at all or had significant spikes in either the rate, payment or both within their early period.
FHA was only . . . at 2 1/2 percent of the mortgage market in 2007, while subprime and alt-A combined were near 50 percent of the market. This reflects the fact that FHA didn’t compete with those kinds of programs for a reason. It’s a pretty boring product--fully documented, 30-year fixed, owner-occupied, primary residence.
Q: What power will the new chief risk officer who came on board in late October actually have to make changes in FHA program rules, such as underwriting rules, adjusting net-worth requirements and setting loan-to-value [LVT] rerquirements?
A: I announced I wanted to bring in a new risk officer when I was confirmed, and I’m happy to say he is hired and on board. And his name is Robert Ryan, Bob for short. Bob comes with a wealth of experience from Freddie Mac, where he [performed] a variety of roles in risk-management functions for 27 years. He’s extraordinarily capable. He is a direct report to me. He will have broad authority in my organization around identifying risks in the portfolio, creating new policy recommendations, and since it’s a brand-new position for FHA--they’ve never had a risk officer before--we’ll be creating an organization beneath him to support his work.
Again, some risk changes we will be able to implement quickly, if they are allowable by mortgagee letter. Some risk-management changes will feed into the approval process through rule-making. And some will require legislation. To that end, he will work broadly within HUD and the government to help make the right policy changes going forward.
The one thing I would add [is that, as] he reports to me, he’ll be solely focused on risk--while both the secretary and I will be looking at those risk recommendations with a broader view on impacts to the housing finance system, underserved communities and some of the more traditional roles of FHA.
Q: What has been the impact on FHA of the seller-assisted down-payment loans that began in 2000 and were banned by Congress after 2008? How many more dollars of insurance claims do you estimate will come from those loans in total?
A: It’s forecasted right now that the total net claim expectation in future years as a result of the seller-funded DPA [(down-payment-assistance) loans] would be over $10 billion--$10.4 [billion].
Q: That was one of the key reasons FHA’s capital ratio fell from 3 percent [in 2008] to 0.53 percent [for 2009] and below the congressionally required 2 percent level?
A: Yes. As a matter of fact, without the seller-funded down-payment-assistance loans in the portfolio, our capital reserve would be over the 2 percent legislative-mandated capital reserve ratio.
Q: Will insurance premiums be going up and, if so, by how much?
A: First of all, we haven’t come to any specific conclusions. We’re looking at every option. We’re balancing two things. One is the role of FHA in this fragile housing market--the role we play in the absence of capital in particular for the low-down-payment borrower with good credit and full documentation. And we’re balancing that with the goal of getting the capital reserve back over 2 percent. And so mortgage insurance premiums are one option of a variety of things we are looking closely at.
We are also considering raising the up-front premium, as well as raising the annual premium – or raising both. Currently, the upfront premium is 1.75 percent, below the statutory maximum of 3 percent. We are requesting authority from Congress to raise annual premiums, as this is one of the most effective ways of raising capital for the fund with the least impact per borrower.
Q: So, no decisions have been made among those options?
A: Right. No decisions have been made.
Q: When do you expect to decide?
A: We expect to provide detailed public guidance for changes we intend to make by the end of January.
Q: Another thing that FHA could do to improve its future financial position would be to increase the level of the down payment. Is that something you’re considering?
A: Everything is being considered. Obviously when you look at it prospectively for future portfolio performance, there’s a limited number of things you can look at. You can look at things like premium, you can look at credit quality or credit scores, you can look at down payment, and you can look at the institutions to make sure they are manufacturing the right quality of loans.
As for credit scores, we are looking at raising the minimum FICO scores for new FHA borrowers and are currently analyzing what this floor should be, as well as the relationship between FICO scores and down payments.
We are also looking at whether or not to raise the up-front cash that a borrower has to bring to the table in an FHA-backed loan to make sure FHA borrowers have more skin in the game and a stronger equity position in their loans. We’re analyzing several options for doing this.
The interesting thing about the FHA portfolio, which I’ve come to appreciate more and more in the few months I’ve been here, is that, unlike a lot of other experimental programs of the past decade--subprime and others that only had a few years [of performance history] behind them--this portfolio goes back many decades, doing similar down-payment, full-doc, 30-year fixed-rate mortgages. And the thing we [could do to] most greatly impact the capital would actually be looking more closely at the loans in the portfolio right now and getting those to cure. Because that’s what’s really draining the capital.
The future book, the 2009 book, has actually had a positive impact on the overall capital ratio. We are looking at the prospective terms, but we’re also looking at the things we can do within the existing portfolio.
Q: In terms of curing the loans in the existing portfolio, does that involve refinancing some of them?
A: Or, actually to make sure they were underwritten and created under our guidelines.
Q: Would that mean checking to see if they involved fraud?
A: Fraud would be a consideration, and just general misrepresentations. Make sure they are underwritten according to the guidelines with the right ratios. One of the things that has been coming in there was a period where lenders may have taken advantage of some of FHA’s programs.
Q: And if you find they have, what can you do about it?
A: There are a variety of things that we can potentially do, and we’re researching it very carefully now [for remedies] that are within the legal boundaries of FHA.
Q: Can you require people to repurchase the loans?
A: Generally, repurchase is a limited option. But indemnification [is one option], and there are other options that can be utilized. For example, we are asking Congress for authority to hold lenders responsible for their fraud or misrepresentations by indemnifying the FHA fund. We are also asking Congress to give us authority to hold lenders accountable nationally for their performance, with a Lender’s Scorecard that will summarize the performance of lenders who do business with FHA.
Q: Lender indemnification could reduce your losses going forward?
A: Yes. And again, we’re not going out of vengeance. Most lenders originated loans responsibly and if there were some that didn’t, we want to make sure we hold them accountable.
Q: Does Congress have to approve any plans you have to raise the capital reserve ratio from 0.53 percent to 2 percent?
A: Yes, so it varies. Some can be done externally just by improving the economy. In many scenarios, if home prices just recover on sort of a normalized path and if FHA were to continue to do what it’s doing, you can theoretically get the capital up on its own. The changes we’re studying above and beyond that, some can be done by mortgagee letter [and] some require regulatory authority, which would be rule-making, with comment period. And some need actual legislation to change. It depends which policy you’re working on. For each policy, we’ve actually mapped out a path in terms of what each one would have to go through.
Q: Have any of the details of those policies been revealed?
A: Well, we know what is within the limits and not within the limits, for example, on premiums. We know what can be done by simply a mortgagee letter versus legislation.
Q: Can a premium increase be done by a mortgagee letter?
A: The upfront premium is [changeable by mortgagee letter]. The upfront premium can be raised, but the monthly premium--that is legislatively capped, for example. I don’t want to infer that we’re planning to raise them. We’re only going to do it if it improves quality and performance, as well as capital. You know, we can’t make up in future books [what is going to be lost on] the deals that are in the 2006, the 2007 and the 2008 books [of business]. We just can’t change those portfolios by future improvements. We’re not going to ask future buyers to pay for what was done incorrectly in those past book years.
We’ve already made a number of substantive changes just in my first weeks on the job that are actually going to help. Changing the streamlined refinance program [is one of them.] Streamline refinances perform about 2 1/2 times worse than a full-doc refinance. And so, you know, that one change in the program, which I enacted in my first month on the job [and went into effect Jan. 1, 2010], will have an impact. So then, we’ve already made some minor changes. What we’ve been doing on the counterparty risk [is] eliminating some of the bad players in the portfolio--Taylor, Bean & Whitaker was the most public of those, but
there have been a variety of other institutions we’ve shut down in [the last several] months.
Q: Taylor, Bean & Whitaker is one of two major companies FHA has disciplined and sanctioned. The other is Lend America. Are there others in the works? What is the signal you’re trying to send to the mortgage industry with these actions?
A: First of all, yes [there is going to be an increase in enforcement] definitely under my regime. Taylor, Bean & Whitaker was an action that we took [during my]second week on the job. We’ve taken several actions since then. We have a new set of risk metrics, and we looked at what we call counterparty risk. We looked at institutional outliers on a monthly basis. And we’re looking very closely at those that are not originating to the standards expected by the FHA program. For those, we will take steps.
So, for the majority of lenders that originate with integrity to the quality expectations of FHA, they shouldn’t have worries. But we are working to make sure that those who are approved to have the FHA eagle don’t ultimately cost the taxpayer for lack of oversight. The actions we can take vary depending on the nature of their violation. It can include anything from simple indemnification to penalties. We can do legal action and suspension, and ultimately termination. It just depends on the nature of their violations.
There’s a Mortgagee Review Board and I chair that, and we have more frequent meetings scheduled than took place in past years. And it’s the Mortgagee Review Board that takes action on specific institutions, and we review every single [action against an] institution as a board so there’s no one off, nothing haphazard. Everything is reviewed through the board. It’s not the place we want to be, but the one thing I clearly identified coming into the job was, in order to keep FHA strong for the lending community going forward, I believe it’s my job to make sure it’s managed appropriately and safely, and otherwise the program itself could be at risk.
Q: And then we would have virtually no lenders in this space.
A: That’s right. That’s one of the things about the down payment. I mean, you can raise the down payment, but then you’ll potentially stall the recovery of some fragile communities that depend on FHA. A family with a job, with the spouse or both spouses having a job, good credit, ability to pay for a home and who want to have ownership, a 3 1/2 percent down payment on a $200,000 home is $7,000 roughly. If you raised it a significant level, you can just slow their ability to buy their dream home, even though they can afford it. And the question is, is that ultimately beneficial to FHA and the taxpayer? And that’s what we’re considering.
Q: The annual report on the financial status of the FHA Mutual Mortgage Insurance Fund [MMIF] that HUD sent to Congress said that the 2007 book of FHA loans is showing a claims rate to date that puts it on par with FHA’s worst-ever books in the early 1980s. What are the characteristics of the loans in the book of business that are making it perform so badly?
A: There are several things. First is the seller-funded down-payment-assistance loans [that] are in the book broadly. Second is the average credit score of that portfolio is lower than it is today. The average credit score of 2007 was about 630, roughly, while the average credit score for the entire portfolio today is approximately 690. And most importantly, during the peak of 2007, if you look at the portfolio, the percentage of below-620 [borrowers] approaches almost 50 percent of the portfolio. And toward the end of 2009, the percentage of loans below 620 is turning into low single digits of our portfolio.
Not only has the average FICO® score gone up, but the percentage below the 620 number has dropped significantly. So we’re getting not only a broad-based improvement, we’re also getting a real uptick on the low end of the loan portfolio.
The other thing that’s changed that is significant is that borrower’s payment ratio has dropped precipitously in 2009 to almost about 24 percent. So, the average bottom ratio, the amount of someone’s gross monthly income taken up by their total mortgage payment, is down to about 24 percent. So, we’re insuring the best credit quality and the best ability to repay than we have ever done in FHA’s history.
In 2007, it was just the opposite. Our average credit score dipped to its lowest period in 2007. So, it has a big impact. And I think a lot of [the problem loans were insured] when the subprime market collapsed and the alt-A market collapsed, particularly for the third and fourth quarters of 2007.
There was, on the margin, some migration over to FHA during that period. And I’m not sure everybody saw it. We saw it outside. I saw it in the private sector, where I was, but I’m not sure it was clearly identified here. And we [saw] a significant drop in credit quality during that period of time. But that’s been very much corrected by a variety of actions.
Q: Has the default rate peaked for those 2007 mortgages?
A: If you look at the audit. . . , the way we hold for reserves and [the way] we look at claim rates, we are not like a bank. We look at claim rates over a 30-year term on the portfolio. Most banks under a Basel standard will look at loan-loss expectations for the next year or two years. We are not in the peak default years yet. And I actually expect those books to start going to peak default years around the year three--mid- to end of year three, and [into] year four of their duration.
So, in 2010 and 2011 you should see those defaults peak out on those particular loans in the 2007 book year. So, when people see the number, they shouldn’t be surprised. But we have factored that into our overall forecast for all default rates, and that’s what we have reserved for. We reserve for 30 years of default losses, not just a couple of years.
Q: The House Financial Services Committee has passed out financial regulation overhaul legislation that would create a new Consumer Financial Protection Agency. Will FHA lenders be affected by that legislation? Are there provisions in that legislation you would like to see modified or ones that are missing that you would like to see added?
A: We’re very supportive of the creation of the Consumer Financial Protection Agency. We think it will be helpful in insuring that there is an industry-wide, nationwide oversight against abusive practices that can affect consumers.
Q: On Sept. 18, HUD announced a sweeping set of changes designed to shore up the credit quality of the FHA loan program going forward. Which of those changes has triggered the most blowback from the industry?
A: So far, the industry’s been relatively supportive of all of the changes. There is some concern over the changes to how we will manage and work with mortgage brokers by a segment of the industry. That is in comment period right now, and it’s going to rule-making. But I anticipate that those will move forward.
Q: What specific steps can FHA take that will go the farthest in helping to improve the quality of FHA loans that are originated?
A: In that particular set of changes, the change in refinance policy will have the single greatest impact.
Q: Making it full-doc?
A: Making it full-doc. And we have clear performance data that show that streamlined refinances do not perform as well as a full-doc refinance. So that’ll improve quality prospectively, without question. I think changes to appraisal policy will help us become more conforming to the rest of the industry. I am always concerned when a policy around the making of a loan can create adverse selection. And the way we changed our policy will actually put us in a leadership position in improving and raising quality.
Q: Specifically, how will changes in the appraisal and other policy changes work?
A: The way the previous appraisal [policy] worked, none of the items in the Home Valuation Code of Conduct were in our appraisal policy, so we implemented some of the arm’s-length requirements between who orders the appraisal and who completes the appraisal to take the influence from commissioned salespeople out of the process. But we also clearly state that we don’t require the use of an AMC [appraisal management company] in the policy. And we expect the appraiser to be paid fairly, according to the standard pay in the area. We also emphasize the need to hire people with local knowledge in our new policy.
The other thing that we changed is the way we assign case numbers and how long they are locked in for. We used to lock case numbers to the property for a six-month time frame. That created exposure to FHA should property values move in that period of time. We could assign a case number for six months and property values [could] decline 10 percent over the next six months, and we would have a value sitting out there that’s too high. And then, likewise, it can benefit the market as prices go up. That six-month lock provided exposure to FHA for adverse selection, particularly in a declining market, and there are lenders who might take advantage of that.
Q: The industry is having a lot of trouble trying to comply with the new RESPA rules slated to take effect this month. What is HUD doing to accommodate those concerns?
A: I understand the concern from the industry. I’m from the industry, and I’ve met with every industry group possible. The first meetings around this RESPA rule were [held] around 2005. HUD worked for a couple of years crafting the rule and went through a couple of hearing processes, comment periods, and the rule finally was approved in 2008, giving the industry 14 months to implement.
While I understand there are some questions that still need to be answered, we are still answering today questions from the old RESPA rule that’s been in existence for many, many years. I’ve gone through the forms, and I think the RESPA rule is an improvement. And what we have done to give the industry some protection as they implement the new rule [is], we have announced that for the first 120 days of 2010, we will not actively enforce the new RESPA rule for any institution operating in good faith to implement the rule. That will allow some time for people to see how it operationalizes in the industry while keeping the rule in effect.
Q: What has been the role of the first-time homebuyer credit for FHA?
A: About 50 percent of FHA’s total loans in 2009 were purchase transactions. So that’s roughly 1 million loans. Of that, 80 percent were first-time homeowners. Now, what percentage of those needed the first-time homeowner tax credit to purchase? I don’t have a specific answer for that. But I would say [having the tax credit] is a significant step toward getting the housing market back on track. The first-time buyer buys someone else’s home and causes [the seller] to move, too. And so we believe that that has definitely created momentum in the market, if nothing else.
Q: What effect will the existing homebuyer tax credit have?
A: We have not measured exactly what the impact will be of that portion of the homebuyer credit. There’s no doubt it will have impact on the margin. It should help home sales going forward. We’re just coming off several consecutive months of increased home sales and not only increased month over month, but [in October] it was an increase year-over-year.
Q: In an op-ed in the Wall Street Journal Nov. 23, Robert C. Pozen, chairman of MFS Investment Management of Boston, charges that with the $8,000 tax credit, many new homeowners whose mortgages are insured by the FHA can buy a house “without putting any of their own money at risk.” He charges that such homeowners are much more likely to default and that because so many of these loans are insured by the FHA that “the FHA will probably need a taxpayer bailout.” How do you respond to this charge?
A: The FHA program requires the borrower to have verifiable, seasoned, liquid, assets for the 3.5% down payment. The tax credit can ultimately be received through application for refund from the IRS, but that does not interfere with the requirement to have saved the down payment and used those funds for the home purchase. The fact that borrowers who save the money, regardless as to whether they get a tax refund down the road, distinguishes them from borrowers who never had to save a penny. We do not think borrower behavior will result in adverse outcomes due to getting a tax credit months later. The discipline to save the down payment is what is critical to reflecting performance versus not saving at all. Performance on the 2009 portfolio, the only year the tax credit has been applicable, is good and the average credit score and other borrower characteristics reflect that.
Q: The tax credit has worked well?
A: The one thing that seems clear is that the policies of the Obama administration are clearly having a positive effect on the housing market. What we need to focus on now is to gain enough confidence in the U.S. housing finance system so that private capital will come back in and replace this role that the government is playing so strongly right now.
Q: So if the FHA is not needed quite as much as it is now, it will be a good thing?
A: Absolutely. In fact, we forecast and are planning for its eventual return to its more normalized place in the market and not run at the current share level it has today. However, we don’t expect that to happen in the near term in 2010. So, today FHA plays really the most critical role it has played in its history--bringing the housing market back on track.
Q: Finally, what does your background in realty and mortgage finance bring to your job as FHA commissioner?
A: I think the advantage of having me here at this time is that for the first time in many years, they brought in an FHA commissioner with specific mortgage experience. And I know everything from point of sale to the secondary market. I’ve played senior roles in all areas. So, when we’re facing such a critical time, I think my knowledge is helping make the changes necessary to ensure that FHA remains strong for the long term. And I know the secretary counts on that as he makes some of the difficult decisions about what needs to be done to keep FHA strong.
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