	Background

		FHA’s Role and Insured Portfolio

FHA’s single-family mortgage insurance programs insure private lenders  against losses from borrower defaults on mortgages that meet FHA  criteria for properties with one to four housing units. In fiscal year 2016, FHA  insured roughly 1.3 million single-family mortgages with total initial  balances of approximately $260 billion. Budgetary review. Budgetary and Actuarial Assessments of the Fund Serve Different but Complementary Functions

		Supplemental Funding Is Determined by Budgetary Assessments, and Actuarial Reviews Provide Complementary Information

FHA assessments performed as part of the MMI Fund’s annual budgetary  review—specifically, the credit subsidy estimates and reestimates  discussed previously—determine the fund’s financing account and capital  reserve account balances. In contrast, the actuarial reviews do not directly determine the need for  additional budget authority; rather, they are used to assess whether the  MMI Fund is in compliance with the requirement to maintain at least a 2  percent capital ratio. For example, in its fiscal year 2015  report to Congress, FHA discussed the amount of additional capital that  would have been needed for the forward mortgage portfolio to achieve a  2 percent capital ratio and withstand losses in the event of an economic  downturn similar to the last economic crisis. However, the MMI  Fund’s capital requirement is not consistent with the element on including  accountability mechanisms. Unexpected Losses and Specified Risk Thresholds

The MMI Fund’s capital requirement is partially consistent with the  framework element of being able to cover unexpected losses and being  based on a specified risk threshold, such as an adverse economic  scenario that the entity would be expected to withstand. FHA Has Not Conducted Fund-Wide Stress Tests or Specified the Objectives of Its Tests

Stress testing practices for the MMI Fund are consistent with two of the  five elements in our stress testing framework—that stress testing  methods and results be transparent and stress testing scenarios capture  relevant risks. Without  specific objectives for its stress testing, FHA has limited assurance that its  stress tests are targeted to risk-management needs and that its reporting  to Congress provides consistent information on the MMI Fund’s ability to  withstand adverse conditions. Joint Capital Assessment Has Advantages and Disadvantages

		Advantages of Including Reverse Mortgages in the Fund’s Capital Requirement Include Greater Transparency

Beginning with the 2009 loan cohort, HERA placed new HECMs (FHA- insured reverse mortgages) in the MMI Fund, while previous HECMs  remained in the General and Special Risk Insurance Fund. However, if the HECM  portfolio was required to independently meet a minimum capital ratio, the  volatility of the portfolio’s economic value could make it difficult for FHA to  consistently meet the requirement without targeting a capital level  substantially above the minimum requirement. As with a separate  HECM capital requirement, this option would help ensure that the  financial condition of future loan cohorts in the forward mortgage portfolio  is not masked by a combined capital ratio. Specifically,  the statutory 2 percent capital requirement does not specify the economic  conditions the fund would be expected to withstand. By  analyzing and reporting stress test results on a fund-wide basis and  defining the specific objectives of its stress tests, FHA would better  understand the capital position of the MMI Fund as a whole under  stressful conditions and have greater assurance that its stress testing  methods and scenarios are targeted to risk-management needs. GAO staff who made key contributions to this  report are listed in appendix V.

Appendix I: Objectives, Scope, and Methodology

Our objectives were to examine (1) the types of information actuarial  reviews and other assessments provide about the Mutual Mortgage  Insurance Fund’s (MMI Fund) financial condition, including its ability to  remain self-sufficient; (2) the extent to which the capital requirement and  stress testing practices for the MMI Fund are consistent with principles  and practices underlying those of other financial institutions; and (3) key  advantages and disadvantages of including both forward and Home  Equity Conversion Mortgages (HECM) in the MMI Fund’s capital  assessment. We determined the extent to which the actuarial, budgetary, and financial  accounting reviews contained information pertinent to assessing the MMI  Fund’s financial condition, such as the amount of funds needed and  available to cover expected net future costs on outstanding insurance, the  amount of funds available to cover unexpected losses, and the projected  performance of the MMI Fund under alternative economic scenarios. Capital Requirements and Stress Tests

To assess the extent to which the MMI Fund’s capital requirement and  FHA’s stress testing approach are consistent with principles underlying  such requirements for other financial institutions, we developed two  evaluative frameworks and assessed requirements and practices for the  MMI Fund against them.
Why GAO Did This Study

FHA insures private lenders against losses from defaults on single-family mortgages. According to independent actuarial reviews, in fiscal years 2009–2014, FHA's MMI Fund (which insures $1.2 trillion in single-family traditional and reverse mortgages) did not meet its statutory 2 percent capital requirement. Also, a budgetary review determined that the fund required $1.69 billion in supplemental funds in fiscal year 2013.
GAO was asked to examine issues concerning the MMI Fund's capital requirement and actuarial reviews. This report examines the types of information provided by assessments of the fund's financial condition, FHA's capital requirement and stress testing practices, and trade-offs associated with including reverse mortgages in the fund's capital assessment.
GAO analyzed actuarial and budgetary assessments of the MMI Fund. GAO reviewed financial institution and regulatory capital and stress testing principles to develop an evaluative framework and applied it to FHA. GAO also interviewed federal and mortgage industry officials.

What GAO Found

The Federal Housing Administration's (FHA) budgetary reviews of the Mutual Mortgage Insurance Fund (MMI Fund) assess whether it needs more budget authority to cover expected future costs, and independent actuarial reviews provide complementary information on the fund's finances. FHA uses the actuarial reviews to assess whether the MMI Fund's capital ratio (economic value divided by insurance obligations) meets the 2 percent requirement and how fund components would perform under alternative economic scenarios. While the actuarial assessment does not directly determine the need for additional budget authority, it evaluates the fund's ability to absorb unexpected losses and may prompt changes in FHA policies and insurance premiums.
Capital requirements and stress testing practices—tools for managing financial risks—for the MMI Fund are not consistent with all elements of a framework GAO developed to help assess these tools in the context of FHA's single-family mortgage insurance programs. In accordance with the framework, FHA's capital assessments and stress tests are transparent and incorporate a number of relevant risk factors. However, areas of inconsistency include the following:
Scenario-based requirement . The statutory capital requirement is intended to help ensure the fund can absorb unexpected losses but is not based on a specified risk threshold, such as an adverse economic scenario the fund would be expected to withstand without requiring supplemental funds.
Accountability mechanisms . The capital requirement also does not include accountability mechanisms, such as a set of steps FHA would have to take if the capital ratio again fell below the 2 percent minimum.
Fund-wide stress tests . FHA has conducted separate stress tests—projections of financial condition under adverse scenarios—of its forward (traditional) and reverse mortgage (loans against home equity available to seniors) portfolios, but has not performed tests on a fund-wide basis.
Stress test objectives . FHA has not defined specific objectives for its stress tests such as determining the amount of additional capital, if any, that would be needed to withstand conditions similar to the last housing crisis.
Strengthening FHA's capital requirement and stress testing practices could help ensure that the MMI Fund is able to withstand economic downturns and that stress test results are as relevant and useful as possible for risk management.
Including reverse mortgages in the fund's capital assessment has advantages and disadvantages. Unlike for stress tests, FHA jointly assesses forward and reverse mortgages to calculate a combined capital ratio. Subjecting the reverse mortgage portfolio to capital assessment has made its financial condition more transparent. But, the portfolio's sensitivity to changes in economic assumptions makes the combined ratio more unpredictable. Alternative approaches also pose trade-offs. For example, a separate reverse mortgage capital requirement may help ensure the financial transparency of both portfolios, but requiring FHA to hold more capital to account for the volatility of the reverse mortgage portfolio could compel FHA to raise insurance premiums or lower borrowing limits.

What GAO Recommends

Congress should consider specifying the economic conditions the MMI Fund would be expected to withstand without supplemental funds, and FHA should conduct stress tests on a fund-wide basis and specify the objectives of its stress tests. GAO also continues to maintain that Congress should incorporate accountability mechanisms into FHA's capital requirement (as stated in GAO-13-722 ). FHA agreed with GAO's recommendations.