The Federal Housing Administration (FHA) has become a far larger player in the housing industry since the housing downturn began, capturing a third of mortgage transactions compared to just 2.5% of transactions two years ago.
This has home builders not only paying more attention to the programs offered by the FHA, but it has the industry targeting the FHA borrower in both marketing and product.
"Most of our builders are targeting entry-level buyers with less expensive product, and they're using FHA much, much more," said Eric Landry, Morningstar's associate director for industrial sector research and homebuilders.
On March 16, Meg Burns, director of the FHA's Office of Single Family Program Development, spoke with Citi Equity Research analyst Josh Levin during an investor call to discuss the increasing role of the government mortgage insurance company.
Burns brought conference call listeners up to date on the role the FHA plays, yet emphasized the importance of the role private mortgage insurance companies have albeit with some changes in regulation.
"I feel strongly that they are needed in the mortgage market and hope they can sustain themselves," Burns said. "I think there needs to be changes to the regulator side of business for them to succeed."
Delving further into regulations, Burns noted that she may not be the best to speak of exact changes, as she herself is a government employee, but she pointed to some mainstream opinions on what needs to be done.
"Regulatory changes need to be a more uniform set of regulations that are applicable across the board," she said. "The mismatch today of regulation, that was problematic. The feds are looking more at the product and the borrowers' capacity to pay, which was not the case over the past couple of years. So a switchback to that alone will help the private mortgage companies."
Levin, in his takeaway note March 16, noted that the "FHA does not utilize risk-based pricing. All borrowers pay the same amount of mortgage insurance regardless of individual credit risk. FHA has explored using risk-based pricing, but such mechanisms have proven unpopular with Congress. Burns thinks it is unlikely that Congress will tighten borrower qualification standards."
He also noted that Burns has more of an optimistic take on the current loan modification programs that are being touted by the Administration, due to the more standardized approach being taken.
Burns added that the FHA's role is to support private lending and to bolster the private mortgage sector, not to be a competitor. And while the presence of FHA, which was created in 1934, has made its way into more and more mortgages these days, it is not always the better option to the government-sponsored enterprises (GSEs).
"GSE-backed mortgages are normally cheaper, but today that's not the case," she said. "When things are functioning normally, FHA is not cheaper."
While FHA mortgages are the only game in town in markets such as California, Burns pointed out that in markets that are still somewhat stable and there is still equity in deals, GSEs are the better option.
And with the cyclical downturn the market is in, Burns said the FHA has had an uptick in lenders applying to become FHA-approved, and builders, with the focus on smaller homes and first-time buyers, are marketing the FHA loans since they call for 3.5% down as opposed to the higher down payments other lenders are looking for.
But with the increase of applications to gain FHA borrowers, the government entity has seen a "degradation in quality of applications," Burns said.
"The reject rate is substantially higher today," she said, because "lenders have to submit certain types of documents to prove they have the net worth, and they have to submit audited financial statements. But most importantly, they have to submit a quality control plan to demonstrate to the FHA that they actually have a monitoring plan in place that is applicable to the FHA product. The No. 1 reason [some of the applications are] rejected is because they submit [a plan] that is insufficient."
And speaking to the pessimistic views and insinuations that FHA loans are going to create the next subprime market, Burns rejected the notion, explaining that the entity is self-funded by the mortgage insurance premium collections from borrowers and the requirements of lenders to verify income and employment of borrowers. And in regards to recent reports of an increase in defaults on FHA loans, Burns said that the absolute number of defaults has gone up, but the rate of defaults has gone down and "they represent less than 1% of the business."