Could FHA be the next shoe to drop?

From John Burns Real Estate Consulting -- The FHA is a big reason that home prices haven't fallen even further, JBREC states. The FHA's aggressive lending programs have continued throughout the housing downturn, causing its market share of the mortgage industry to grow from 2% in 2005 to 23% today. The FHA is an even larger percentage of the new home mortgage industry, with nearly 25% market share, according to HUD.

The FHA insurance fund, however, is likely running dry. According to a report from mortgage finance experts (click here to read the report), the FHA will not meet its minimum requirement as of its fiscal year-end, which is only 27 days from now. For months, we have been investigating this and reporting our findings to our clients.

While almost all of the experts believe that Congress would support the FHA if necessary (it's currently self-funded), we wonder if FHA officials will be under pressure to continue tightening their lending policies, which currently allow 96.5% mortgages to people with 600 FICO scores. Already, FHA has contracted its own standards to require a 10% down payment for those with credit scores below 500.

Claims against the insurance fund have climbed, with roughly 7% of all FHA-insured loans now delinquent.

Given the FHA's September 30 fiscal year-end, this financial reality will come to light about the same time that other market forces run out of steam:

• Just as the $8,000 tax credit expires.
  
• Just as more of the stalled REO currently held on banks' balance sheets will be coming to market.

The culmination of all these factors means housing could see another leg down later this year or early next year.

Here are key reasons FHA is volatile:

1. Growing Pains: FHA lending has propped up the housing market since credit tightened and seller-funded down payment assistance went away last fall. The staff required to manage and oversee the tremendous growth has had difficulty keeping pace.
2. Subprime Wolves: Thousands of mortgage brokers who focused on the subprime market rebranded themselves by shifting into the FHA-backed business. Approved FHA lenders grew from just over 9,600 at the end of FY07 to nearly 14,000 today, according to HUD.
3. Shifting Distribution: Last November's housing bill increased the size of the loans that the FHA could guarantee. As a result, FHA lending in high-cost states rose rapidly - California, Nevada and even Florida saw their percentage of originations spike. But these are also the states where collateral value has declined the most.
4. No Guard Dog: It's hard to imagine, but the FHA has no Chief Credit Risk Officer, according to several industry experts including Ann Schnare, a leading FHA and mortgage finance expert with Empiris LLC. A HUD source says they are monitoring risk, however, and FHA Commissioner David Stearns expressed his personal concern in a USA Today article this week.

For more information visit John Burns Real Estate Consulting.