Congressional Budget Office September 12, 2014 Modeling The - PowerPoint PPT Presentation

Congressional Budget Office September 12, 2014 Modeling The Budgetary Cost of FHA’s Single Family Mortgage Insurance Presentation for the Inaugural Conference of the Center for Finance and Policy, Massachusetts Institute of Technology Francesca Castelli, formerly of CBO; Gabriel Ehrlich, Damien Moore, and Jeffrey Perry, all of CBO This presentation provides information from Modeling the Budgetary Costs of FHA's Single Family Mortgage Insurance , Working Paper 2014-05 (Congressional Budget Office, September 2014), www.cbo.gov/publication/45711.

Overview ■ The Federal Housing A dministration ’s (FHA’s) single-family mortgage insurance program ■ Budgetary costs and the capital reserve account ■ CBO’s statistical modeling and cost projections C O N G R E S S I O N A L B U D G E T O F F I C E 1

FHA’s Single Family Mortgage Insurance Program ■ The program facilitates access to mortgage credit for borrowers with – Low down payments – Limited or poor credit histories ■ FHA guarantees mortgages against default ■ Borrower pays up-front and annual fees ■ Estimated $1.2 trillion of insurance is in force at the end of fiscal year 2014 (HUD 2013a) C O N G R E S S I O N A L B U D G E T O F F I C E 2

FHA Share of Purchase Loan Originations Percentage of Total Market 35 30 25 20 15 10 5 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 C O N G R E S S I O N A L B U D G E T O F F I C E 3

FHA and National Average Serious Delinquency Rates Percentage of Outstanding Loans 10 9 8 7 FHA 6 5 4 3 2 National Average 1 0 2002 2003 2004 2005 2007 2008 2009 2010 2012 2013 C O N G R E S S I O N A L B U D G E T O F F I C E 4

Capital Reserve Ratio of the Mutual Mortgage Insurance Fund, Excluding Home Equity Conversion Mortgages Percent 8 7 6 5 4 3 2 1 0 -1 -2 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 C O N G R E S S I O N A L B U D G E T O F F I C E 5

Budgetary Treatment of Federal Credit Programs: Key Concepts ■ Credit reform subsidy ■ Fair-value subsidy ■ Capital reserve account C O N G R E S S I O N A L B U D G E T O F F I C E 6

Budgetary Treatment of Federal Credit Programs ■ Federal Credit Reform Act (FCRA) of 1990 ■ In each year, the federal budget deficit reflects – Estimates of lifetime costs (credit reform subsidies) of new mortgage guarantees in that year – Reestimates of costs (subsidy reestimates) of previously issued mortgage guarantees ■ Credit reform subsidies are present value calculations that use a Treasury rate to discount cash flows C O N G R E S S I O N A L B U D G E T O F F I C E 7

Credit Reform Subsidy Calculation (Illustration) ■ FHA fee: 175 basis points (bps) up front, 135 bps annually ■ Expected insurance claims: 70 bps annually ■ Annual cash outflow (in basis points): Year 0 1 2 . . . −175 −135 −135 . . . Fees Claims 70 70 . . . _____________ _____________ _____________ −175 Net Cash Flow -65 -65 . . . Discounted at −175 plus −455 equals −630, or −6.3% credit reform subsidy Treasury Rates C O N G R E S S I O N A L B U D G E T O F F I C E 8

Fair-Value Subsidies ■ Private mortgage insurers charge annual mortgage insurance premiums – Generally exceed FHA’s fees – Significantly higher than expected losses ■ Private insurers’ fees in excess of losses – Administrative costs – Return on capital (Investors demand a higher return than Treasury rates to compensate them for market risks.) ■ For FHA – Administrative costs are accounted for outside of subsidies – Market risks are not accounted for in the budget – Taxpayers (and beneficiaries of federal programs) bear market risks associated with FHA’s guarantees C O N G R E S S I O N A L B U D G E T O F F I C E 9

Fair-Value Subsidy Calculation (Illustration) ■ Same cash flows as in the FCRA illustration, but they include a risk premium for credit loss exposure of 115 bps per annum. ■ Annual cash outflow and risk premium charge (in basis points): Year 0 1 2 . . . −175 −135 −135 Fees . . . Claims 70 70 . . . 115 115 Risk Premium ____________ ____________ ____________ −175 Net Cost 50 50 . . . Discounted at −175 plus 300 equals 125, or 1.25% fair-value subsidy Treasury Rates C O N G R E S S I O N A L B U D G E T O F F I C E 10

FCRA versus Fair-Value Accounting ■ Fair-value accounting provides a more comprehensive measure of cost than FCRA accounting ■ Disadvantages of FCRA Accounting – Budgetary savings provide incentive to expand credit programs – Makes economically equivalent alternatives to credit programs appear to be more costly ■ Disadvantages of Fair-Value Accounting – Risk premium is not a cash cost – Cost of market risk is excluded from the estimates of many non-credit programs, for example, unemployment insurance C O N G R E S S I O N A L B U D G E T O F F I C E 11

The Capital Reserve Account ■ Part of the system of accounts used to reconcile subsidies with cash flows ■ Can be calculated as the sum of estimated subsidy savings on outstanding cohorts plus accumulated interest ■ Often cited as a measure of program solvency, but FCRA programs have permanent authority to draw funds to pay claims as needed ■ FHA is required to maintain a 2% ratio of capital reserve balance to insurance-in-force (but has not done so since 2009) ■ The balance does not represent resources that can be used to offset future spending C O N G R E S S I O N A L B U D G E T O F F I C E 12

CBO’s Statistical Modeling ■ Used to project cash flows for FCRA and fair-value calculations ■ Estimated from loan performance records from 1992 through 2009 – Loan characteristics at origination plus quarterly performance data ■ Statistical models follow existing literature – Multinomial logit model for default and prepayment probabilities – Linear regression for loss given default C O N G R E S S I O N A L B U D G E T O F F I C E 13

Statistical Modeling Variables ■ Borrower credit scores (after 2004) ■ Interest rates ■ Home equity ■ State unemployment ■ Outside source of down payment ■ Geographic location ■ Age of loan ■ Loan amount C O N G R E S S I O N A L B U D G E T O F F I C E 14

Macroeconomic Projections Ten-Year Treasury Note Rate One-Year Treasury Note Rate Percentage Points Percentage Points 18 18 16 16 Mean 14 14 12 12 95th Percentile 10 10 8 8 6 6 4 4 2 2 5th Percentile 0 0 Log Federal Housing Finance Authority Unemployment Rate Purchase-Only House Price Index 1991q1 = 100, Log of Index Level Percentage Points 7 12 6 10 5 8 4 6 3 4 2 2 1 0 0 1953 1965 1978 1990 2003 2015 2028 2040 1953 1965 1978 1990 2003 2015 2028 2040 C O N G R E S S I O N A L B U D G E T O F F I C E 15

Projections of Lifetime Claim Rates Percent of Mortgages 40 Projected 35 Actual (Through 2013) 95th Percentile 30 25 5th Percentile 20 15 10 5 0 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 C O N G R E S S I O N A L B U D G E T O F F I C E 16

Projections of Lifetime Prepayment Rates Percent of Mortgages 100 95th Percentile 90 80 5th Percentile 70 60 Projected 50 Actual (Through 2013) 40 30 20 10 0 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 C O N G R E S S I O N A L B U D G E T O F F I C E 17

Projections of Loss Given Default Percent of Unpaid Balances 80 70 95th Percentile 60 50 40 5th Percentile 30 20 10 0 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 C O N G R E S S I O N A L B U D G E T O F F I C E 18

Estimated FCRA Subsidy Rates Percentage Points 14 12 10 95th Percentile 8 6 5th Percentile 4 2 0 -2 -4 -6 -8 -10 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 C O N G R E S S I O N A L B U D G E T O F F I C E 19

CBO’s Projections for the Capital Reserve Billions of Dollars Congressional Budget Office Office of Management 5th Percentile— 95th Percentile— and Budget Mean Better Outcome Worse Outcome Capital Reserve Contribution, −28.0 1992 to 2013 cohorts 3.3 3.1 25.7 Total Subsidy Savings, 2014 and 2015 cohorts 22.3 16.4 23.7 8.3 C O N G R E S S I O N A L B U D G E T O F F I C E 20

Projected Fair-Value Subsidy Rates for Purchase Loans for the 2014 Cohort, by FICO Score and Original Loan-to-Value Ratio Percent Borrower's FICO Score Loan-to-Value 500 to 560 to 600 to 640 to 660 to 680 to 720 and Ratio 559 599 639 659 679 719 Above Less Than 80 3.9 2.3 2.0 1.2 1.2 0.8 0.3 80 to 90 5.8 4.4 3.7 2.4 2.5 1.8 0.8 90 to 95 2.9 3.5 3.9 2.1 2.4 1.5 0.4 95 to 97 n.a. 2.7 2.2 0.2 0.5 -0.4 -1.4 97 and Above n.a. 3.1 2.8 0.5 0.7 -0.3 -1.2 Note: n.a. = not applicable. C O N G R E S S I O N A L B U D G E T O F F I C E 21

Future Modeling Improvements ■ Incorporate more recent performance data (after 2009) ■ Use better information on FHA’s streamline refinances ■ Improve risk premium estimates ■ Find additional ways to quantify uncertainty C O N G R E S S I O N A L B U D G E T O F F I C E 22