BofAML: FHA probably won't require bailout

by JUSTIN T. HILLEY

Home prices will most likely decline a little more than 2% next year, suggesting the Federal Housing Administration will not require a Treasury bailout, according to analysts at Bank of America Merrill Lynch. Some folks in Washington and academia claim a bailout is inevitable.

Analysts noted the FHA's estimation that a 4% to 5% decline in home prices by the end of 2012 could force it to empty its insurance fund, which the agency uses to pay lenders when a borrower defaults. The FHA has the authority to raise premiums to guard against a draining of the fund and worries that it will need a bailout.

JP Morgan Chase (JPM: 30.70 -3.73%) analysts recently said if existing home sales fail to reach the 5.5 million level next year, the nation could be looking at another 5% decline in home prices in 2012. Overall, by the end of 2011, home prices will drop 3% this year and are expected to fall another 1.6% in 2012, according to Chase.

The FHA doubts a bailout will occur.

"The simplest way around a potential bailout would be to increase revenues into the (insurance) fund through an increase in mortgage insurance premiums," BofAML analysts said. "Further increases could easily be justified while the overall performance of the book is in the red."

The Department of Housing and Urban Development earlier this month revealed that it is considering increasing premiums on FHA-insured mortgages after weeks of FHA official denials. The increase would further reduce prepayment speeds as FHA borrowers face a decreased incentive to refinance.

In November, the FHA released its annual report to Congress on the state of the fund. The report stated the fund's capital ratio, a measure of its ability to pay future claims, will rise above the federally mandated minimum of 2% by 2014. The ratio now sits at 0.24%.   "Although the long-term forecast is positive, the fund remains susceptible to risk if housing continues to slide," analysts said.

Credit performance of FHA-backed loans mirrors the results seen in agency pools, they said, and fundamentals are stronger for new loans than for those originated a few years back. For example, the average credit score of newly issued Ginnie Mae-backed loans is now more than 700, and early payment default rates have dropped below 0.4% after topping out north of 2% with pre-2009 borrowers.

Ginnie Mae guarantees the timely payment of principal and interest to investors who own residential mortgage-backed securities backed by pools of FHA-insured loans.

The improved credit performance has impacted FHA's bottom line, as well. The value of its guarantee book, which reached negative 9% of the underlying loan value in 2007, now stands at more than 5% of loan volume.

Despite the recent improvement, payouts to cover losses outpaced the revenue from insurance premiums and property liquidations in 2011, taking the excess reserves down by $2 billion and below the statutory minimum of 2%.