That is, an  agency may suffer losses due to weaknesses or uncertainties in the work  of its counterparties, which include lenders and appraisers for FHA and  issuers for Ginnie Mae. The Fund’s Financial Condition Has Continued to Worsen, Increasing the Possibility That FHA Will Require Additional Funds

The Fund’s capital ratio dropped sharply in 2008 and fell below the  statutory minimum in 2009, when economic and market developments  created conditions that simultaneously reduced the Fund’s economic  value (the numerator of the ratio) and increased the insurance-in-force  (the denominator of the ratio). 1). Higher-than-expected declines in house  values contributed to both higher defaults and claims and higher loss- on-claim than anticipated in 2010. 2). At the same time, the Fund’s condition has worsened from a budgetary  perspective. 3). FHA’s Current Methodology for Assessing the Fund’s Condition Does Not Fully Account for Future Economic Volatility

As we reported in September 2010, FHA and its actuarial review  contractor enhanced their methods for assessing the Fund’s financial  condition but still were addressing other methodological issues that could  affect the reliability of estimates of the capital ratio. However, the current methodology is significantly limited by its reliance on  a single economic forecast to produce the estimate of the capital ratio that  is used to determine if the Fund is meeting the 2 percent capital reserve  requirement. This approach does not fully account for the variability in  future house prices and interest rates that the Fund may face. FHA’s loan volume grew  significantly from 2006 to 2010. To provide  assistance to the Office of Risk Management (one of the offices within the  Office of Risk Management and Regulatory Affairs) in developing a risk- management strategy and organizational structure and establishing risk- management policies and processes, FHA hired a consultant to produce  a comprehensive report and recommend best practices for its operation.According to FHA officials, FHA plans to adopt the consultant’s  recommendation to establish an enterprise risk committee to address  overall risk to the organization and a second tier of committees to address  program and operational risks. While the consultant  recommended that FHA integrate risk assessment and reporting  throughout the organization, currently the Office of Single Family  Housing’s quality control activities and the Office of Risk Management’s  activities remain separate efforts. More specifically, without an integrated risk-assessment  strategy, certain risks may not be fully addressed at the operational level  in a way that minimizes risk to the insurance programs; without annual  reassessments of its risks, the Office of Single Family Housing lacks  assurance that its quality control efforts address all its risks; and without  ongoing mechanisms in place to anticipate and address new or emerging  risks, FHA lacks a systematic approach to help the agency identify,  analyze, and formulate timely plans to respond most effectively to  changed conditions and risks. While FHA has taken some steps to address succession planning, these  steps have been limited. Department of Housing and Urban Development, Succession Management Plan, Fiscal  Year 2006-2009, (Washington, D.C.: September 2006). Ginnie Mae Has Undertaken Efforts to Improve Risk Management, but Many Remain to Be Implemented

Ginnie Mae has taken steps to better manage operational and  counterparty risks and has several initiatives planned or under way. GAO  and others have identified limited staff, substantial reliance on  contractors, and the need for modernized information systems as risks  that Ginnie Mae may face. Ginnie Mae’s counterparty risk would stem  from the failure of issuers of Ginnie Mae-guaranteed MBS to provide  investors with monthly principal and interest payments. It  will be important for Ginnie Mae to complete its initiatives related to  operational and counterparty risk as soon as practicable. Ginnie Mae Has Not Yet Implemented Certain Practices for Modeling Costs and Revenues

In developing inputs and procedures for the model used to forecast costs  and revenues, Ginnie Mae did not consider certain practices identified in  Federal Accounting Standards Advisory Board (FASAB) guidance for  preparing cost estimates of federal credit programs. Ginnie Mae has not  developed estimates based on the best available data, performed  sensitivity analyses to determine which assumptions have the greatest  impact on the model, or documented why it used management  assumptions rather than available data. By not fully implementing  practices in FASAB guidance that we believe represent sound internal  controls for models, Ginnie Mae’s model may not be using critical data  that could affect the agency’s ability to provide well-informed budgetary  cost estimates and financial statements. Ginnie Mae has indicated that it plans to implement all of our  recommendations but has not provided a specific timeline. In addition,  Ginnie Mae agreed with our observation about the importance of  completing ongoing and planned initiatives for enhancing its risk- management processes, as soon as practicable, to improve operations.
Why GAO Did This Study

In recent years, two components of HUD—FHA and Ginnie Mae—have played a major role in the single-family mortgage market. FHA insures lenders against losses from mortgage defaults. Ginnie Mae guarantees the timely payment of principal and interest for securities backed by federally insured or guaranteed mortgages. Due partly to the contraction of other mortgage market segments, FHA's and Ginnie Mae's business volumes have risen sharply. This growth highlights the need for these entities to properly manage financial risks while meeting the housing needs of borrowers.
This testimony discusses (1) changes in the financial condition of FHA's insurance fund, the budgetary implications of these changes, and how FHA evaluates the fund's financial condition; (2) steps FHA has taken to assess and manage risks; and (3) steps Ginnie Mae has taken to manage risks and estimate costs and revenues.
This testimony draws from GAO reports on FHA's oversight capacity (GAO-12-15), the financial condition of FHA's insurance fund (GAO-10-827R), and Ginnie Mae's risk management (GAO-12-49). GAO also reviewed updated information on the fund's condition as of September 30, 2011.

What GAO Found

For the third consecutive year, the Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA) reported that the capital ratio for the Mutual Mortgage Insurance Fund—the ratio of the fund's economic value to insurance obligations—has not met the 2 percent statutory minimum. FHA cites declines in the fund's economic value due to higher-than-expected defaults, claims, and losses. At the same time, the other component of the ratio, insurance obligations, grew rapidly. The fund's condition also worsened from a budgetary perspective, with balances in the fund's capital reserve account reaching new lows. If the account were depleted, FHA would require more funds to help cover costs on insurance issued to date. FHA has indicated that it will narrowly avoid this scenario in fiscal year 2012. FHA enhanced methods for assessing the fund's financial condition but has not fully addressed GAO's 2010 recommendation for improving the reliability of its estimates. It relies on a single economic forecast, which does not fully account for variability in future house prices and interest rates. The approach GAO recommended would simulate numerous economic paths for house prices and interest rates would improve the reliability of its capital ratio estimates.
FHA has taken or plans steps to better assess and manage risk. It created a risk office in 2010 and hired a consultant to recommend best practices. FHA plans to establish committees to evaluate risks at enterprise-wide and programmatic levels. It began a quality control initiative for single-family housing, in which program and field offices assess and report on risks, and enhanced lender and appraiser reviews. While FHA's consultant recommended integrating risk assessments, the quality control and risk office activities currently remain separate efforts. Also, since 2009, the Office of Single Family Housing has not updated assessments annually in accordance with HUD guidance. Without integrated and updated risk assessments that identify emerging risks, FHA lacks assurance it has identified all its risks. GAO recommended integrating quality control and risk office activities and updating assessments annually.
GAO and others have identified limited staff, substantial reliance on contractors, and the need for modernized information systems as risks that the Government National Mortgage Association (Ginnie Mae) may face. Ginnie Mae has several planned initiatives to enhance its risk-management processes related to gaps in resources, contracts, and issuers, but these plans have not been fully implemented. It will be important for Ginnie Mae to complete these initiatives as soon as practicable to enhance its operations. Also, in developing inputs and procedures for the model used to forecast costs and revenues, the agency did not consider certain practices identified in guidance for preparing cost estimates of federal credit programs. Ginnie Mae has not developed estimates based on the best available data, performed sensitivity analyses to determine which assumptions have the greatest impact on the model, or documented why it used management assumptions rather than available data. By not fully implementing certain practices, which GAO believes represent sound internal controls for models, Ginnie Mae's model may not use critical data that could affect the agency's ability to provide well-informed budgetary cost estimates and financial statements. GAO recommended that Ginnie Mae adopt these practices.

What GAO Recommends

GAO previously recommended that FHA and Ginnie Mae take additional steps to improve their risk management. FHA and Ginnie Mae agreed with these recommendations and said they had efforts under way to implement them.