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Actuarial Review of the Federal Housing Administration Mutual Mortgage Insurance Fund Forward Loans for Fiscal Year 2012

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Actuarial Review of the Federal Housing Administration Mutual Mortgage Insurance Fund Forward Loans for Fiscal Year 2012 Actuarial Review of the Federal Housing Administration Mutual Mortgage Insurance Fund Forward Loans for Fiscal Year 2012 November 5, 2012 Prepared for U.S. Department of Housing and Urban Development By Integrated Financial Engineering, Inc. Table of Contents Executive Summary................................................................................................... i I. Introduction.................................................................................................... 1 II. Summary of Findings..................................................................................... 15 III. Current Status of the MMI Fund.................................................................... 29 IV. Characteristics of the Fiscal Year 2012 Insurance Portfolio ......................... 39 V. Fund Performance under Alternative Scenarios ............................................ 55 VI. Summary of Methodology ............................................................................. 65 VII. Qualifications and Limitations....................................................................... 71 VIII. Conclusions.................................................................................................... 73 Appendix A: Econometric Analysis of Mortgage Status Transitions and Terminations Appendix B: Cash Flow Analysis Appendix C: Data for Loan Performance Simulations Appendix D: Economic Forecasts Appendix E: Loss Severity Model Appendix F: FHA Volume Model Appendix G: Stochastic Processes of Economic Variables Appendix H: Econometric Results This Page Left Blank Intentionally FY 2012 Actuarial Review of MMIF Forward Loans Executive Summary Executive Summary The 1990 Cranston-Gonzalez National Affordable Housing Act (NAHA) requires an independent actuarial analysis of the economic net worth and financial soundness of the Federal Housing Administration's (FHA's) Mutual Mortgage Insurance Fund. The Housing and Economic Recovery Act of 2008 (HERA) moved the requirement for an independent actuarial review into 12 USC 1708(a)(4). This report presents the results of our analysis for fiscal year (FY) 2012. HERA also moved several additional programs into the Mutual Mortgage Insurance Fund. One of them, Home Equity Conversion Mortgages (HECMs, which are reverse mortgages) is analyzed separately and is excluded from this Review. In the remainder of this Review, the term “the Fund” refers to the MMI Fund excluding HECMs. The primary purpose of this actuarial review is to estimate the economic value of the Fund, defined as the sum of existing capital resources, total assets less total liabilities of the Fund, plus the net present value of the current books of business, excluding HECMs, and the total insurance-in-force (IIF) of the Fund, excluding HECMs. This year, we used a stochastic method to estimate the net present value (NPV) of future cash flows. In previous Reviews, the net present value of the cash flows was computed along a single, deterministic path of house prices and interest rates. In this year’s Review, instead of a single path, we generated 100 equally likely paths to conduct a Monte Carlo simulation, and computed the net present value of the cash flows for each of them. Then we averaged these 100 numbers to obtain our estimate of the expected NPV of the future cash flows under our simulation procedure. This provides our base case estimates. Based on our stochastic simulation analysis, we estimate that the economic value of the Fund as of the end of FY 2012 is negative $13.48 billion. This represents a $14.67 billion drop from the $1.19 billion estimated economic value as of the end of FY 2011. Because the HECM business is excluded from this analysis, we do not report the capital ratio of the Fund. We project that there is approximately a 5 percent chance that the Fund’s capital resources could turn negative during the next 7 years. We also estimate that under the most pessimistic economic scenario, the economic value could stay negative until at least FY 2019. IFE Group i FY 2012 Actuarial Review of MMIF Forward Loans Executive Summary A. Status of the Fund Exhibit ES-1 reports the estimates of the Fund’s current and future economic value and insurance in force (IIF) using 100 simulated paths and taking the average of the resulting 100 economic values. Both the economic value and the IIF of the Fund are expected to increase each year over the next seven years. Exhibit ES-1: Projected Fund Performance for FYs 2012 to 2019 ($Millions) Economic Economic Volume Investment Unamortize Amortized Value of Fiscal Value of of New Earnings a d Insurance Insurance Each New Year the Fund b b Endorse- on Fund in Force in Force Book of c Business ments Balances 2012 -13,478 1,126,267 1,053,329 11,922 211,737 2013 -2,585 1,223,784 1,136,509 10,987 219,605 -95 2014 4,223 1,291,771 1,186,208 6,845 167,031 -37 2015 11,525 1,317,205 1,194,820 7,222 176,024 80 2016 20,984 1,353,817 1,217,462 9,163 221,233 296 2017 31,352 1,399,213 1,248,114 9,698 231,621 670 2018 42,502 1,436,476 1,269,906 9,988 235,533 1,162 2019 54,251 1,458,771 1,277,260 9,989 242,660 1,760 a All values are as of the end of each fiscal year. The economic value for FYs 2012 through 2019 is equal to the economic value of the Fund at the end of the previous year, plus the current year's interest earned on the previous Fund balance, plus the economic value of the new book of business. b Estimated based on the data extract as of June 30, 2012, our model of new endorsement volumes, and projected loan performance. c Based on our endorsement volume forecast model described in Appendix F. In defining the statutory capital ratio, NAHA stipulates the use of unamortized insurance-in- force as the denominator. However, "unamortized insurance-in-force" is defined in the legislation as "the remaining obligation on outstanding mortgages" – which is generally understood to describe amortized IIF. To allow the flexibility of calculating the capital ratio under either definition, both the unamortized and amortized IIFs are reported in this Review. Following the convention of previous Actuarial Reviews, most of our discussion in this Review focuses on the unamortized IIF. The capital resources of the Fund at the end of FY 2012 were estimated to be $25.57 billion. We simulated the capital resources over the next seven years along the 100 possible future economic IFE Group ii FY 2012 Actuarial Review of MMIF Forward Loans Executive Summary paths of the stochastic simulation. Exhibit ES-2 shows that there is approximately a 5 percent chance that the capital resources may fall to below zero during the next seven years. Exhibit ES-2: Mean and Selected Monte Carlo Percentiles for MMI Capital Resources B. Sources of Change in the Status of the Fund Change in Economic Value from FY 2011 to FY 2012 We estimate that the economic value of the Fund was negative $13.48 billion as of the end of FY 2012, which represents a decrease of $14.67 billion compared to the estimated economic value of $1.19 billion as of the end of FY 2011 reported in last year’s Actuarial Review. Meanwhile, there has been a $56.92 billion increase in the estimated unamortized IIF from $1,069.35 billion to $1,126.27 billion. Current Estimate of FY 2012 Economic Value Compared with the Estimate Presented in the FY 2011 Actuarial Review IFE Group iii FY 2012 Actuarial Review of MMIF Forward Loans Executive Summary Our current estimate of the FY 2012 economic value is $22.83 billion lower than the economic value projected for FY 2012 in the FY 2011 Actuarial Review. Our current estimate of the FY 2018 economic value is $42.50 billion, which is $16.95 billion lower than estimated in the FY 2011 Actuarial Review. The FY 2012 differences are attributed to the following changes, with the magnitude of the change in the estimated FY 2012 economic value for each of the changes shown in parentheses: including the Settlement Fund received from five largest mortgage servicers (+$1.12 billion), using the updated data to estimate origination volume of the FY 2011 to FY 2012 books of business (+$3.26 billion), updating models for predicting loan-status transitions (-$0.75 billion), introducing claim type (conveyances vs. pre-foreclosure sales) prediction model (-$5.04 billion) modifications to the loss severity model to increase precision in stressful environments (- $5.24 billion) updating actual performance in FY 2011-2012 and portfolio composition (+$0.54 billion) updating the interest rate forecast (-$8.03 billion) updating the house price growth rate forecast (-$10.53 billion) updating interest rates used for discounting future cash flows (-$1.07 billion), updating FHA’s new insurance premium schedule for FY 2012 endorsements (+$0.14 billion), adjusting REO claims with the distressed asset securitization program (+1.23 billion), adjusting claims for the large inventory of delayed claims (-$1.24 billion), implementing stochastic interest rate simulation (+$1.67 billion). implementing stochastic house price growth rate simulation (-$0.13 billion), In total, the estimated economic value of the Fund decreased during FY 2012 and is $14.67 billion lower than that of last year. Additional Comments The estimates presented in this Review reflect projections of events more than 30 years into the future. These projections are dependent upon a number of assumptions, including economic trend forecasts by Moody’s Analytics and the assumption that FHA does not change its policies regarding refunds, premiums, distributive shares, underwriting or servicing rules, and administrative expenses. To the extent that these or other assumptions are subject to change, the actual results may vary, perhaps significantly, from our current projections. IFE Group iv FY 2012 Actuarial Review of MMIF Forward Loans Executive Summary Estimation of the variables in the models used for predicting prepayments and claims depends on large amounts of loan-level data, requiring extensive data processing. To complete the Review within the timeframe required by HUD, we used the actual historical loan-level data as of March 31, 2012 provided by HUD.
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