Is FHA Next?

Investor's Business Daily has an article that will raise some eyebrows for the mortgage market.

Skyrocketing growth in loans from the Federal Housing Administration and Ginnie Mae have helped support the mortgage market — but could leave taxpayers on the hook for massive new losses.

FHA-insured loans have more than tripled from 530,000 in fiscal year 2007 to 1.7 million thus far in 2009. The Government National Mortgage Association, which securitizes FHA loans, has boosted its mortgage-related issuance to $287 billion from $85 billion.

Yet during that same period, the FHA's loan delinquency rate has climbed to 14.4% in Q2 from 12.6% two years earlier.

Now, everything in the article is perfectly natural and not necessarily alarming. The meteoric rise in FHA loans is to be expected. During the height of the mortgage boom, there were so many alternatives to FHA that it lost a lot of favor. FHA has significantly higher up front costs and it has a built in mortgage insurance on all loans. Furthermore, FHA has no stated loans. As such, when there was a plethora of loan options, there was usually plenty of more favorable alternatives to FHA.

Remember, 2003-2007 were the years of overbuying. Yet, FHA had no stated loans. In fact, FHA has fairly strict debt to income requirements. Often, the requirement wouldn't allow any more than a total DTI of 37%, though there were exceptions. So, during the boom, FHA naturally lost favor.

Now, there's no more sub prime. There's no more Alt A. There's no more stated. In fact, all there is is Fannie/Freddie and FHA. So, is any surprised that in the last two years FHA's loan volumes have exploded? Of course, they have.

It's true that FHA allows for very high loan to value. In fact, you can buy a property with less than 3% down. At this point, FHA is the only outlet for high ltv loans. FHA still has strict debt to income requirements. It's credit requirements are less than that of Fannie/Freddie but it does require fairly good credit. Here's the thing that's of most concern.

Adding to the concern, the FHA's fund to cover losses has dropped to a projected 3% of insured loans. That's a leverage ratio of 33-to-1, the level banking giant Bear Stearns was at before it failed.

All FHA loans have something called Mortgage Insurance Premium. Up front, FHA receives 1.5% of the loan from the borrower. Then, it receives .5% yearly split month over month as part of the mortgage. This is used as an insurance policy to protect banks on loans that go bad. So, right now, FHA has $3 in the MIP accounts for every $100 worth of loans.

Now, the article compares that to Bear Strearns, but that's awfully misleading. Bear Stearns was leveraging something totally different. They would make investments in MBS and other things. They would put down a $1 and borrow $30 more. This isn't quite the same thing.

This is probably less than FHA would want, but that's also to be expected when there's suddenly an explosion in new loans. Between, the 1.5% up front and another .5% over the first year, FHA only collects 2% in MIP premiums in the first year. So, if there's an explosion of new loans, as has happened, then this leverage ratio will go down. Yet, as FHA starts to hold on to these loans long term that ratio will go up.

There is also some inside mortgage baseball that's important. Last month, Taylor Bean and Whitaker went out of business. They were the third largest FHA lender in the country. They were also known for taking a lot of the "junk FHA" loans. So, the more aggressive FHA loans no longer have an outlet. I was concerned about FHA last summer when Hope for Homeowners passed. This was essentially a pseudo loan modification program in FHA. Yet, this program has been a total failure and only a handful of loans have been under it.

FHA has all the potential problems that all mortgages have. The dropping real estate prices causes an alarming number of FHA loans to go underwater. Rising unemployment means more and more FHA borrowers have no jobs. The high ltv is its own problem, but FHA counters that with strict dti limits. We should be concerned about FHA like we should be concerned about any part of the mortgage market. Yet, I don't see anything yet to sound extra alarms.