**Section IV: Characteristics of the Fiscal Year 2007 Book of Business**

This section analyzes the characteristics of the FY 2007 book of
business. The characteristic descriptions include: the analysis of the
volume and composition of loan originations, the comparison of new
purchase versus refinancing, and the distribution of loans by relative
loan size, loan-to-value ratios, and borrower credit scores. This
section also examines and compares the FY 2007 book with previous books
in order to gain insights into how the FY 2007 book is likely to
influence future MMI Fund performance. Because the data used for this
analysis is an extract as of July 31, 2007, the characteristics for the
FY 2007 book reflect only loans originated between October 1, 2006 and
July 31, 2007.

# 

# A. Volume and Share of Mortgage Originations

In FY 2007, FHA is estimated to have insured about \$52.193 billion[^1]
in single-family mortgages through the MMI Fund, bringing the fund's
total unamortized IIF to about \$332.293 billion. Exhibit IV-1 shows the
annual FHA originations counts, for new fully underwritten purchase and
refinance loans and streamline refinancing, for FY 1978 through FY 2007.

**Exhibit IV-1**

![](media/image1.wmf){width="6.467361111111111in"
height="3.317361111111111in"}

Source: FHA data warehouse, July 31, 2007 extract.

Exhibit IV-1 shows that FHA's business volume dropped significantly
during the past four years from its peak in FY 2003. The decline was
particularly significant for streamline refinancing which fell 58.6
percent in FY 2004 from its high in FY 2003, another 51.8 percent drop
from FY 2004 to FY 2005, and attenuating in FY 2006 and FY 2007. In
January 2006, HUD increased the allowable LTV on cash-out refinance
loans from 85 percent to 95 percent. This led to an growth in the fully
underwritten refinance loans in the past two years. Despite this growth,
the total volume of fully underwritten purchase and refinance mortgage
insurance still showed a steady decrease since FY 2002.

Mortgage interest rates had reached a 30-year low during the FY 2003 to
FY 2005 period and remained low until recently. These low mortgage rates
substantially improved housing affordability in the United States.
Although the rapidly rising house prices during the same period
partially offset housing affordability, the highest number of homes sold
in the nation's history took place over this three-year period.
Specifically, the number of homes sold increased from FY 2002 to FY 2005
by about 28 percent. On the other hand, the home-purchase loans endorsed
by FHA dropped by 57 percent during the same period. The same divergence
was observed in dollar terms. The dollar volume of total-market home
sales rose by 66 percent, while the FHA for-purchase endorsement dollar
volume dropped by 55 percent. Exhibit IV-2 shows the mortgage
origination volume and FHA's market share.

The divergent trend between the number of houses sold and number of
home-purchase mortgages FHA endorsed led to the substantial decrease in
FHA's market share in recent years. FHA's share by loan count decreased
from 13.61 percent in FY 2001 to 3.78 percent in FY 2006 and is
estimated to increase slightly to 4.23 percent for FY 2007. When
measured by dollar volume, the estimated FHA market share for FY 2007 is
about 1.99 percent, down from 7.87 percent in FY 2001.

Exhibit IV-2

  ------------ -------------- --------------- --------------- -------------- ------------ ---------------
  **FHA\'s                                                                                
  Market                                                                                  
  Shares of                                                                               
  New                                                                                     
  Insurance                                                                               
  Counts and                                                                              
  Volumes**                                                                               

  **National                                                                              
  Home                                                                                    
  Purchase                                                                                
  Market**                                                                                

  **Fiscal     **Number of                                    **Volume of                 
  Year**       Mortgages                                      Mortgage                    
               Originated**                                   Originated**                

               **(000)**                                      **(billions,                
                                                              current                     
                                                              dollars)**                  

               **FHA^a^**     **Market^b^**   **FHA Share     **FHA**        **Market**   **FHA Share
                                              (%)**                                       (%)**

  1990         742            4,109           18.05           49             519          9.51

  1991         656            3,842           17.09           45             499          9.09

  1992         597            4,123           14.47           43             547          7.77

  1993         639            4,554           14.04           48             613          7.90

  1994         652            4,987           13.07           52             696          7.42

  1995         556            4,845           11.48           45             689          6.46

  1996         688            5,289           13.00           58             784          7.43

  1997         753            5,467           13.77           66             854          7.73

  1998         790            6,084           12.99           71             1004         7.12

  1999         911            6,463           14.09           89             1124         7.96

  2000         858            6,335           13.55           89             1157         7.71

  2001         872            6,405           13.61           96             1221         7.87

  2002         808            6,615           12.22           94             1356         6.93

  2003         657            7,148           9.19            80             1578         5.08

  2004         506            7,901           6.41            63             1914         3.27

  2005         346            8,454           4.09            43             2247         1.89

  2006         302            7,979           3.78            39             2201         1.75

  2007^c^      296            6998            4.23            39             1949         1.99
  ------------ -------------- --------------- --------------- -------------- ------------ ---------------

Sources: Existing Home Sales are from the National Association of
Realtors; FHA numbers are from HUD.

^a^ Home purchase loans endorsed by FHA under either the General
Insurance Fund or the MMI Fund.

^b^ Total number of home sales in the nation.

^c^ FY 2007 numbers are the annual size estimated as of May 2007.

Looking at the longer history shown in Exhibit IV-2, during the decade
of 1992 to 2002, FHA's market share remained stable at around 13 percent
of the market in terms of the number of loans insured. Because of the
smaller size of FHA-insured loans, FHA's market share by dollar volume
was around 8 percent during the same time period. This relationship had
been stable regardless of the total market volume and macroeconomic
conditions.

The high rate of house price appreciation may have contributed to the
decrease in FHA market share. It is also very likely that the reduction
in FHA market share is a result of the expansion of subprime lending
during the past several years. The subprime mortgage market expanded
rapidly during the last housing boom when the annual house price growth
rate reached its peak in FY 2004 and FY 2005. Many lenders relaxed their
underwriting criteria and designed creative products to qualify
borrowers with impaired credit histories, low downpayments, and high
payment ratios. As FHA maintained its underwriting standards throughout
the mortgage-demand boom during the last three years, it suffered a loss
in market share, especially in refinance loans and adjustable rate
mortgages.

According to OFHEO's 2007 Q2 HPI, the housing market has slowed down
significantly during FYs 2006 and 2007. The house-price growth rate in
FY 2006 fell to 6.1 percent, and the annualized growth rates were
further lowered to 2.2 and 0.3 percent during the first and second
quarters of 2007. The cooling down of the housing market is consistent
with Global Insight's forecast back in 2006 but appears to be more
severe. Global Insight has revised its forecast downward accordingly. In
its August 2007 forecast, Global Insight forecasts that the OFHEO
national average house price index would drop by 2.14 percent during FY
2007, and another 1.17 percent during FY 2008. The housing market
slowdown will have a negative impact on FHA claim rates during the next
few years. However, as there is an extremely high concentration of
recent FHA books in the relatively safer 30-year FRM product, we do not
anticipate that default rates for FHA loans will approach current
default rates in the subprime market.

In the rest of this section, we examine FHA's business concentration
pattern to determine if there exist adverse quality indicators that were
not incorporated into the actuarial models applied in the FY 2007
Actuarial Review.

**B. Originations by Location**

FHA insures loans in all regions of the U.S., but about half of FHA's
total dollar volume is concentrated in only ten states. Exhibit IV-3
illustrates the percent of FHA's total dollar volume originated in these
ten states over FYs 2003 through 2007. The table includes the top 10
States during FY 2007 plus California.

Exhibit IV-3

  --------------------- ---------- ---------- ---------- ---------- ----------
  **Percentage of FHA                                               
  Dollar volume                                                     
  Originated Between FY                                             
  2003 and FY 2007**                                                

                                                                    

  **State**^a^          **2003**   **2004**   **2005**   **2006**   **2007**

  Texas                 9.27       11.42      13.53      12.56      11.19

  Georgia               4.24       5.33       6.22       6.11       6.05

  Ohio                  3.40       3.81       4.24       4.90       4.62

  Florida               4.78       5.28       4.34       3.91       4.59

  New Jersey            3.65       4.05       3.99       3.58       4.40

  Illinois              5.00       4.78       4.40       4.08       4.24

  Michigan              3.01       3.33       3.83       3.82       3.81

  Colorado              5.53       4.99       4.59       3.74       3.49

  New York              3.00       3.56       2.88       3.33       3.46

  N. Carolina           2.76       2.88       3.53       3.46       3.24

  California^b^         8.89       5.19       2.33       1.52       1.74

  **% of Total**        44.64      49.43      51.55      49.49      49.09
  --------------------- ---------- ---------- ---------- ---------- ----------

Source: FHA data warehouse, July 31, 2007 extract.

^a^ States are sorted according to their share of FY 2007 origination
volume in the MMI Fund.

^b^ California had been one of the top 10 States in FHA's business up to
FY 2004. It was ranked 19^th^ in 2005, 23^rd^ in 2006, and 21^st^ in
2007, respectively.

This year New York appears for the first time in the top-ten list. We
also see that California continued to contribute a low percentage share
to FHA's business volume, while Texas has maintained the top percentage
share of over 11 percent. The rapid growth in California house prices
during the past several years has pushed more home mortgages over the
FHA loan-size limit.

The historical house price growth rates at the MSA level are captured by
our econometric model through the probability of negative equity
variable, and the geographical concentration of the MMI Fund and the
historical house price growth rates in the various locations have been
reflected in the actuarial simulation model.

**C. Originations by Mortgage Type**

Exhibit IV-4 shows that historically the 30-year FRM has comprised most
of FHA's single-family business. This pattern began to change in the
early 1990s when FHA began insuring the adjustable-rate mortgage (ARM)
and the streamline-refinancing mortgage (SR). Gradually, ARM and SR
mortgages took on a bigger share of annual loan originations. For the
next few years, the 30-year FRM share decreased, with FYs 1993, 1994 and
2003 recording the lowest shares. An opposite trend has emerged as
market interest rates recently stabilized. From FY 2005 to FY 2007,
30-year FRMs increased from 69.54 percent to 91.38 percent while 30‑year
SRs dropped from 16.31 percent to 5.82 percent. At the same time, the
ARM share of the portfolio (including both ARMs and ARM SRs) also shrank
dramatically from 11.52 percent in FY 2005 down to 2.86 in FY 2006, and
finally to 1.42 percent in FY 2007. As ARMs are more vulnerable to
economic downturns, the smaller concentration in ARMs of the most recent
two books of business will help the performance of the MMI portfolio
during the next few years. Meanwhile, 15-year FRMs and 15-year SRs
continue to be minor product types in the total MMI Fund portfolio.

The dynamics of the MMI Fund product type concentrations is captured by
our econometric models with six separate models fitted to the historical
performance of the individual product types.

Exhibit IV-4

  --------------- ------------- ------------- ---------- ---------------- ------------- ----------
  **FHA-Insured                                                                         
  Originations By                                                                       
  Mortgage Type**                                                                       

  **(Percentage                                                                         
  of FHA-Insured                                                                        
  Mortgages by                                                                          
  Dollar                                                                                
  Volume)**                                                                             

                  **Purchase                             **Streamline                   
                  Mortgages**                            Refinancings**                 

  **Fiscal**      **30-Year**   **15-Year**   **ARMs**   **30-Year**      **15-Year**   **ARM
                                                                                        SRs**

  **Year**                                                                              

                  **FRMs**      **FRMs**                 **SRs**          **SRs**       

  1978            99.91         0.09          n/a        0.00             n/a           n/a

  1979            99.94         0.06          n/a        0.00             n/a           n/a

  1980            99.90         0.10          n/a        0.00             n/a           n/a

  1981            99.84         0.15          n/a        0.00             n/a           n/a

  1982            99.62         0.38          n/a        0.00             n/a           n/a

  1983            93.71         6.28          n/a        0.01             0.00          n/a

  1984            94.28         5.68          0.01       0.02             0.01          n/a

  1985            92.00         7.75          0.14       0.08             0.03          n/a

  1986            88.93         8.07          0.74       1.90             0.36          0.00

  1987            80.44         4.97          1.47       11.22            1.84          0.06

  1988            86.30         3.59          4.98       4.64             0.45          0.04

  1989            92.95         2.69          1.52       2.64             0.19          0.00

  1990            93.09         2.77          0.80       3.09             0.25          0.00

  1991            88.20         3.14          4.43       3.63             0.57          0.04

  1992            66.79         2.51          16.35      10.84            2.17          1.34

  1993            45.78         2.25          12.14      29.96            7.75          2.13

  1994            42.49         1.81          16.97      27.95            8.06          2.72

  1995            65.10         1.28          29.25      2.78             0.94          0.65

  1996            61.09         1.29          25.42      8.65             1.72          1.83

  1997            57.18         1.10          35.06      3.62             0.69          2.35

  1998            65.56         1.16          11.93      17.78            1.39          2.18

  1999            73.57         1.13          4.24       18.34            1.74          0.98

  2000            85.36         0.71          11.04      2.06             0.26          0.57

  2001            75.84         0.94          2.08       19.77            0.65          0.73

  2002            66.96         1.21          6.05       21.11            1.57          3.09

  2003            51.42         1.34          3.89       36.95            3.12          3.29

  2004            63.62         1.36          8.70       19.53            2.43          4.36

  2005            69.54         1.26          8.67       16.31            1.37          2.85

  2006            88.65         1.35          2.65       6.66             0.48          0.21

  2007^a^         91.38         1.26          1.34       5.82             0.12          0.08
  --------------- ------------- ------------- ---------- ---------------- ------------- ----------

Source: FHA data warehouse, July 31, 2007 extract.

^a^ Based on partial year data.

**D. Initial Loan-to-Value Distributions**

Based on previous econometric studies of mortgage behavior, a borrower's
equity position in the mortgaged house is one of the most important
drivers of default behavior. The larger the equity position a borrower
has, the greater the incentive to avoid default on the loan. The initial
LTV is an inverse measure of the borrower's equity at the origination
date. Exhibit IV-5 shows the distribution of mortgage originations by
initial LTV categories.

Exhibit IV-5

  ---------------- ---------- ---------- ---------- ---------- ---------- ----------
  **Distribution                                                          
  of Originations                                                         
  by Initial LTV                                                          
  Category**                                                              

  **(Percentage of                                                        
  Fully                                                                   
  Underwritten                                                            
  FHA-Insured                                                             
  Mortgages by                                                            
  Dollar Volume)**                                                        

  Books of         Unknown    ≤ 80%      \> 80%     \> 90%     ≥ 95%      ≥ 97%

  Business         LTV                   ≤ 90%      \< 95%     \< 97%     

  1978             18.07      4.89       12.38      29.49      28.91      6.26

  1979             19.76      7.10       16.55      31.05      22.51      3.03

  1980             11.45      12.75      27.86      26.04      19.83      2.07

  1981             26.96      11.87      26.88      17.70      15.44      1.15

  1982             16.54      19.14      26.68      20.73      16.07      0.83

  1983             20.42      19.04      24.39      20.22      14.68      1.25

  1984             2.78       16.19      26.17      24.27      23.56      7.03

  1985             1.11       16.19      31.22      25.26      23.57      2.64

  1986             0.56       18.26      30.33      25.32      22.53      3.00

  1987             0.18       15.57      27.26      27.57      26.29      3.13

  1988             0.13       8.01       19.72      33.07      34.37      4.71

  1989             8.93       6.78       16.86      30.95      32.06      4.42

  1990             11.93      6.15       16.19      29.84      31.49      4.40

  1991             1.79       5.59       15.74      28.09      31.68      17.11

  1992             1.76       4.39       13.99      27.84      38.45      13.57

  1993             0.31       3.65       12.85      25.34      33.13      24.73

  1994             0.24       3.46       11.70      24.12      33.09      27.40

  1995             0.07       2.75       10.36      24.30      34.47      28.05

  1996             0.03       2.84       11.10      25.35      34.87      25.81

  1997             0.01       3.26       11.43      26.01      34.85      24.45

  1998             0.01       3.55       12.23      26.31      35.00      22.91

  1999             0.00       3.17       9.10       13.16      30.73      43.84

  2000             0.00       2.34       6.23       6.59       32.76      52.07

  2001             0.00       3.27       7.56       5.90       26.27      57.00

  2002             0.00       3.88       8.09       5.67       25.39      56.96

  2003             0.00       5.47       9.61       5.92       25.36      53.63

  2004             0.01       5.56       9.17       5.88       25.00      54.38

  2005             0.01       5.79       9.22       5.71       23.75      55.52

  2006             0.01       6.81       10.06      9.56       24.23      49.33

  2007^a^          0.01       7.52       11.52      12.99      25.70      42.27
  ---------------- ---------- ---------- ---------- ---------- ---------- ----------

Source: FHA data warehouse, July 31, 2007 extract

^a^: Based on partial year data.

As Exhibit IV-5 indicates, the distribution among initial LTV categories
shifted after 1999. About 42.27 percent of the mortgages originated in
FY 2007 have LTV ratios of 97 percent or more. This is a 13
percentage-point reduction from FY 2005, when over 55.5 percent of that
book of business is concentrated in this highest LTV category. On the
other hand, there is a clear increase in the concentration in LTVs less
than 95 percent. The shift in the LTV concentration is partially due to
the increase of the fully underwritten refinance loans, whose maximum
allowable LTV is 95 percent, during the past two years. The highest LTV
allowed on these loans are 95 percent. This recent shift in LTV
concentration will also help the MMI Fund portfolio in weathering the
current housing market slowdown.

The LTV concentration of individual books of business affects our
econometric models in two respects. First, it serves as the starting
position for updating the probability of the negative equity variable.
Second, the initial LTV itself is also included in the model to capture
potential behavioral differences among borrowers self-selected into
different initial LTV categories.

**E. Borrower Credit History Distributions**

Credit score data were collected through two different channels. The
first channel includes the credit scores collected for a sample of FHA
applications in FY 1992, 1994, and 1996, and subsequently updated for
loan applications in FY 1997 through 2003. This set of score data is
particularly useful because these loans have existed for multiple years
and provide valuable claim and prepayment historical performance
records. The limitation of this data source is that it only involves a
limited sample of FHA loans. In addition, because the sample was
collected for policy research purposes, it was a choice-based sample.
For example, there was over-sampling of early-default loans in the
1997-2003 application years.

Since May 2004, all lenders originating loans for FHA insurance are
required to report borrower credit scores directly to HUD if they choose
to order them as part of the underwriting process. Nevertheless, all
loans going through the TOTAL scorecard will have credit scores ordered
electronically by the affiliated AUS. This is the second source of
credit score data. As there are no exceptions to this requirement, the
credit scores collected through this channel are considered to be
comprehensive and unbiased. However, these loans are typically too new
to generate significant numbers of claim and prepayment events for use
in econometric modeling.

Exhibit IV-6 shows the distributions of fully underwritten FHA mortgage
loans by borrower credit score categories and origination years. For
loans originated in FY 2007, the median FICO score is approximately 640,
the level below which a loan is generally regarded as a subprime
mortgage. About 15 percent of the loans have FICO scores above 680.
Referring to statistical results presented in Appendix A, loans that
lack credit scores exhibit claim and prepayment patterns similar to the
loans with about 580 FICO scores. The lack of credit scores is suspected
to include primarily borrowers for which there was not sufficient
information in their credit file to allow computation of a score.
Including these loans that lack credit history, about one-fifth of the
loans originated in FY 2007 are expected to perform worse than loans
with a 580 FICO score. The distribution among credit score categories
remained stable in general during the past three years, when the data
were obtained directly from lenders.

Due to the over-sampling of early-default loans, there is a particularly
high concentration of loans in the lowest credit score category (FICO ≤
539) during the FY 1997 to 2004 period. The original choice-based
sampling scheme was not available, so it was not possible to compare the
credit score distributions between the two data channels.

As the amount of credit score information collected via the new channel
increases and as the loans with scores age further, the ability to
differentiate loan credit quality by borrower credit history will
continue to improve.

**Exhibit IV-6**

  ---------------- --------- -------- -------- -------- -------- -------- -------------
  **Distribution                                                          
  of Originations                                                         
  by Credit Score                                                         
  Category^a^**                                                           

  **(Percentage of                                                        
  Fully                                                                   
  Underwritten                                                            
  FHA-Insured                                                             
  Mortgages by                                                            
  Dollar Volume)**                                                        

  Books of         Lack of   \> 300   \> 540   \> 580   \> 620   \> 680   Credit\
                   Credit                                                 Score Not

  Business         History   ≤ 539    ≤ 579    ≤ 619    ≤ 679    ≤ 850    Collected

  1992             4.48      0.10     0.38     1.07     3.59     3.17     87.22

  1993             4.59      0.12     0.40     0.96     2.97     2.47     88.48

  1994             3.87      0.11     0.49     1.44     4.22     3.06     86.81

  1995             3.38      0.16     0.51     1.15     2.68     1.77     90.35

  1996             4.17      0.35     1.19     3.06     7.03     4.29     79.90

  1997             2.45      0.91     1.76     3.60     6.30     2.98     82.01

  1998             1.82      1.19     2.21     4.44     7.56     3.12     79.66

  1999             1.72      1.13     2.29     4.57     7.59     2.88     79.81

  2000             1.88      1.65     2.70     4.48     6.62     2.39     80.27

  2001             1.35      1.38     2.51     4.20     6.24     2.26     82.05

  2002             1.34      1.55     2.72     4.59     6.94     2.64     80.22

  2003             1.47      1.72     3.24     5.53     8.54     3.24     76.25

  2004^c^          3.23      1.76     4.06     8.19     14.11    5.88     62.77

  2005^b^          6.83      3.68     10.45    22.82    40.02    16.20    0.00

  2006^b^          5.67      3.52     9.92     22.76    41.35    16.79    0.00

  2007^b^          5.08      4.43     11.12    24.35    39.98    15.05    0.00
  ---------------- --------- -------- -------- -------- -------- -------- -------------

^a^ Most FICO score data are obtained from the previous HUD special data
collection project. Problematic loans were over-sampled during the years
1997 to part of 2004.

^b^ Starting May 2004, lenders are required to report FICO data directly
to HUD.

^c^ Mixture of the above two sources of data.

**F. Initial Loan Size Distributions**

One of our model's explanatory variables is the relative loan-size. This
variable is identified by comparing the size of a particular loan with
the average loan size of all other FHA-insured loans originated in the
same period and within the same state. Existing literature indicates
that using *relative* loan size categories eliminates the upward bias
that occurs when classifying loans in higher-cost areas using *absolute*
loan-size categories. The upper limits for our relative loan size
categories are based on breakpoints determined by a percentage of the
average loan amount in each state.

Exhibit IV-7 shows the percentage of new originations within each
relative loan-size category. Overall, the FY 2007 book of business is
similar to other recent books of business. Over the years, the largest
loan size category (\> 140 percent of the average loan size) has been
gradually increasing. Most of this increase corresponds to a decrease in
the share of loans in the 80-100 percent and 120-140 percent relative
loan size categories.

FHA experience indicates that larger loans tend to perform better in two
respects compared with smaller loans in the same geographical area, all
else being equal. Larger loans incur claims at a lower rate, and in
those cases where a claim occurs, loss severity tends to be lower. The
loss severity rate is defined as the claim amount not recovered through
the sale of the conveyed property or mortgage note as a percent of the
unpaid principal balance. Houses securing larger FHA loans tend to fall
into the average house price range for their surrounding areas. Since
this market is relatively liquid and there is a relatively large number
of these similar-quality homes in the area, the house price volatility
of these houses tends to be relatively smaller in comparison to the
house-price volatility of extremely low- and high-priced houses. With
similar initial LTVs, higher priced houses will be associated with
larger loan amounts. In addition, because a large portion of claim costs
are fixed and do not vary with regard to loan or property value, larger
loans are generally accompanied by lower loss-severity rates.

**Exhibit IV-**7

  ---------------- ---------- ---------- ----------- ------------ ------------ ----------
  **Distribution                                                               
  of Originations                                                              
  by Relative                                                                  
  Loan-Size                                                                    
  Category**                                                                   

  **(Percentage of                                                             
  FHA-Insured                                                                  
  Mortgages by                                                                 
  Dollar Volume)**                                                             

  **Book of        **0-60% of **60-80%   **80-100%   **100-120%   **120-140%   **\>140%
  Business**       Average    of Average of Average  of Average   of Average   of Average
                   Loan       Loan       Loan Size** Loan Size**  Loan Size**  Loan
                   Size**     Size**                                           Size**

                                                                               

                                                                               

  1978             3.53       12.16      25.12       27.31        21.56        10.32

  1979             3.30       11.12      24.33       30.98        21.79        8.48

  1980             3.50       10.69      23.45       33.64        19.85        8.87

  1981             4.07       11.05      23.47       29.60        19.49        12.31

  1982             4.90       11.30      21.39       27.75        20.78        13.88

  1983             4.16       11.48      22.36       28.26        22.24        11.50

  1984             4.30       11.71      22.27       28.22        21.29        12.21

  1985             4.27       11.62      21.91       28.39        23.75        10.06

  1986             3.60       11.48      23.01       30.17        23.98        7.76

  1987             3.51       11.78      23.14       29.51        23.88        8.16

  1988             4.22       12.18      21.71       28.58        21.36        11.94

  1989             4.51       12.37      21.40       26.23        21.28        14.21

  1990             4.79       12.64      21.42       25.59        18.93        16.63

  1991             4.80       12.55      21.39       24.33        21.40        15.53

  1992             4.43       12.35      21.97       25.62        21.60        14.03

  1993             3.92       12.31      23.16       26.89        20.90        12.82

  1994             4.33       12.81      22.34       24.93        20.31        15.28

  1995             4.74       12.98      20.93       24.59        20.85        15.90

  1996             4.56       12.87      21.01       25.27        21.54        14.74

  1997             4.63       12.92      20.49       25.78        21.67        14.50

  1998             4.29       12.53      21.14       27.71        21.53        12.79

  1999             4.63       12.94      21.45       25.82        19.08        16.08

  2000             5.27       12.82      20.80       23.98        18.93        18.19

  2001             4.93       12.31      22.02       24.85        19.11        16.78

  2002             5.14       12.29      21.72       24.52        18.88        17.46

  2003             5.08       12.22      21.80       25.09        18.85        16.96

  2004             5.89       12.46      20.10       22.97        18.77        19.80

  2005             5.88       12.76      19.57       22.75        18.84        20.19

  2006             5.91       13.17      19.29       22.63        18.22        20.78

  2007^a^          5.97       13.04      19.45       22.64        17.96        20.94
  ---------------- ---------- ---------- ----------- ------------ ------------ ----------

Source: FHA data warehouse, July 31, 2007 extract

^a^: Based on partial year data.

Exhibit IV-8 provides a detailed breakdown of average loan sizes by
relative loan-size category.

**Exhibit IV-**8

  ------------ ---------- ---------- ----------- ------------ ------------ ----------
  **Average                                                                
  Loan Size by                                                             
  Relative                                                                 
  Loan-Size                                                                
  Category                                                                 
  (\$)**                                                                   

  **Books of   **0-60% of **60-80%   **80-100%   **100-120%   **120-140%   **\>140%
  Business**   Average    of Average of Average  of Average   of Average   of Average
               Loan       Loan       Loan Size** Loan Size**  Loan Size**  Loan
               Size**     Size**                                           Size**

  1978         16,471     24,133     31,030      37,511       45,919       48,769

  1979         18,759     28,091     36,749      45,573       52,103       54,367

  1980         20,427     30,766     40,507      50,452       56,326       60,788

  1981         21,630     33,050     43,938      53,932       60,784       68,269

  1982         22,484     34,121     45,165      55,587       64,470       71,728

  1983         25,161     37,142     48,451      59,297       68,798       76,377

  1984         25,879     38,581     51,013      62,994       72,510       78,989

  1985         28,069     41,754     55,205      68,138       79,415       83,603

  1986         29,857     43,556     56,584      69,924       80,836       86,007

  1987         30,501     43,639     56,555      69,984       81,180       86,562

  1988         29,393     42,257     55,080      69,456       79,570       85,961

  1989         30,081     43,627     56,658      71,003       82,270       90,737

  1990         31,839     45,965     59,911      74,427       84,880       98,441

  1991         32,971     47,807     62,089      76,631       90,813       100,461

  1992         34,463     49,531     64,098      78,688       92,962       104,378

  1993         36,886     52,567     67,546      81,947       96,233       112,185

  1994         37,262     53,212     67,803      82,169       97,642       115,735

  1995         39,377     56,164     71,450      87,826       104,508      121,520

  1996         41,859     59,830     75,913      93,397       111,343      128,075

  1997         43,632     62,578     78,872      97,698       116,303      134,245

  1998         45,845     65,643     82,831      102,641      121,193      140,382

  1999         48,820     69,380     87,720      108,052      127,109      154,366

  2000         51,649     72,812     93,311      114,990      134,903      165,774

  2001         55,874     79,059     101,780     125,039      144,337      179,761

  2002         57,895     81,952     105,281     128,922      148,706      188,689

  2003         59,778     85,102     109,212     133,222      153,623      195,796

  2004         59,136     83,970     108,100     132,414      153,735      197,120

  2005         58,332     84,682     109,231     133,725      156,138      197,181

  2006         61,965     90,457     117,678     142,552      167,542      210,455

  2007^a^      66,281     97,564     127,108     153,736      180,601      224,555
  ------------ ---------- ---------- ----------- ------------ ------------ ----------

Source: FHA data warehouse, July 31, 2007 extract

^a^: Based on partial year data.

**G. Initial Contract Interest Rate**

Exhibit IV-9 shows the average contract rate by mortgage type since FY
1990. In general, average contract rates reached their lowest level
during the FY 2003 to FY 2005 period and have risen slightly during the
past two years for all loan types.

Research has found that, in general, an FRM with a lower initial
contract rate tends to prepay at a slower speed. Slower prepayment rates
imply that mortgages are exposed to default risk for longer periods of
time, which means that, under an environment in favor of prepayments,
the conditional claims rate would be lower than in otherwise similar
situations. Likewise, during a housing recession where default is more
likely, the conditional prepayment rate also tends to be low. This
drives the performance of FRMs in particular. As the interest rate is
expected to rise, the prepayment rate of the FY 2006 and FY 2007 books
would be low, which would leave more loans subject to claim risk for a
longer period of time. Meanwhile, the low house price growth rate
forecasted by Global Insight, Inc. also implies that the claim
probability could rise during the next few years. As a result of these
two reinforcing forces, the FY 2006 and FY 2007 books of business are
expected to experience higher cumulative claim rates than all other
books originated since 1990.

**Exhibit IV-**9

  --------------- ----------- ----------- ---------- ----------- ----------- --------- -----------
  **Average                                                                            
  Contract                                                                             
  Interest Rate                                                                        
  by Loan Type**                                                                       

  **(Percent)**                                                                        

  **Fiscal**      **30-Year   **15-Year   **ARMs**   **30-Year   **15-Year   **ARM**   **SRs
                  FRMs**      FRMs**                 SRs**       SRs**                 Average**

  **Year**                                                                   **SRs**   

  1990            9.69        9.48        8.54       10.70       9.95        8.94      9.71

  1991            9.46        9.15        7.56       10.10       9.32        7.78      9.40

  1992            8.54        8.35        6.47       8.92        8.38        6.52      8.26

  1993            7.76        7.40        5.87       8.16        7.59        6.28      7.64

  1994            7.56        7.12        6.06       7.76        7.43        6.09      7.36

  1995            8.39        8.23        7.18       8.70        8.74        7.34      8.10

  1996            7.84        7.53        6.49       8.01        7.69        6.79      7.53

  1997            7.97        7.75        6.53       8.29        8.04        6.81      7.51

  1998            7.37        7.18        6.12       7.58        7.18        6.48      7.25

  1999            7.24        6.95        6.00       7.17        6.89        6.05      7.16

  2000            8.30        8.07        6.95       8.31        8.05        6.19      8.16

  2001            7.56        7.12        6.19       7.42        6.85        6.12      7.49

  2002            7.00        6.53        5.28       6.95        6.42        5.31      6.84

  2003            6.07        5.50        4.38       6.01        5.49        4.44      5.91

  2004            6.12        5.57        4.46       5.98        5.52        4.39      5.88

  2005            5.92        5.63        4.79       5.85        5.65        4.67      5.79

  2006            6.33        6.18        5.42       6.14        6.04        5.13      6.28

  2007^a^         6.44        6.35        5.58       6.34        6.21        5.57      6.43
  --------------- ----------- ----------- ---------- ----------- ----------- --------- -----------

Source: FHA data warehouse, July 31, 2007 extract.

^a^: Based on partial year data.

**H. Downpayment Assistance through Gifts**

[]{.mark}

FHA's database started tracking the sources of loans with downpayment
gift support in FY 1998. Exhibit IV-10 shows the distribution of MMI
loans by gift source starting FY 1999.

Exhibit IV-10 shows that virtually all downpayment gifts prior to FY
2000 were funded by the borrower's relatives. However, starting in FY
2000, there was a rapid increase in the share of loans with gift letters
from non-profit, religious, or community entities. This concentration
reached about 10 percent by FY 2003 and increased dramatically to over
20 percent in FY 2005 and remains at that high level at the present
time.

#### [Exhibit IV-10]{.mark}

  ------------------ -------- -------------- --------------- -------------- --------------
  **Concentration of                                                        
  Loans with Gift                                                           
  Letter by                                                                 
  Sources**                                                                 

  **(Percent)^a^**                                                          

  **Origination      **No     **Relative**   **Non-profit,   **Government   **Employer**
  Year**             Gift**                  Religious, or   Assistance**   
                                             Community**                    

  1999               82.20    16.32          0.55            0.86           0.06

  2000               77.17    18.81          1.83            2.10           0.09

  2001               83.24    11.08          4.25            1.36           0.07

  2002               82.26    9.15           7.05            1.48           0.06

  2003               81.35    7.41           9.76            1.42           0.06

  2004               70.24    9.59           18.05           2.04           0.08

  2005               63.87    9.50           23.52           3.03           0.08

  2006               62.02    9.39           24.30           4.18           0.10

  2007^b^            65.97    7.70           22.82           3.43           0.08
  ------------------ -------- -------------- --------------- -------------- --------------

Source: FHA data warehouse, July 31, 2007 extract.

^a^ As a percentage of all MMI Fund endorsed loans, including purchase
and refinance loans. The concentration rate of gift loans would be much
higher if refinance loans were excluded from this calculation.

^b^ Based on partial year data.

In view of the significant number of loans receiving gifts for
downpayments, and the relatively recent vintages of these loans that
puts them at greatest risk of default, we conducted a closer
investigation of these loans. Exhibit IV-11 shows the cumulative claim
rates realized on loans by gift source and origination year based on the
FHA data.

#### Exhibit IV-11

  --------------- -------- -------------- --------------- -------------- --------------
  **Cumulative                                                           
  Claim Rates of                                                         
  Loans with                                                             
  Different Gift                                                         
  Sources**                                                              

  **(Percent)**                                                          

  **Origination   **No     **Relative**   **Non-profit,   **Government   **Employer**
  Year**          Gift**                  Religious, or   Assistance**   
                                          Community**                    

  1999            4.87     8.01           12.73           12.35          8.60

  2000            6.17     8.51           15.99           13.47          8.93

  2001            4.77     6.38           15.32           12.91          7.44

  2002            3.53     4.23           12.17           9.57           5.37

  2003            2.26     3.04           9.37            7.46           4.06

  2004            1.82     2.14           6.65            3.96           3.09

  2005            1.03     0.98           3.46            2.00           1.50

  2006            0.27     0.21           1.04            0.48           0.53
  --------------- -------- -------------- --------------- -------------- --------------

Source: FHA data warehouse, July 31, 2007 extract.

Holding everything else the same, we find that the non-relative gift
loans performed worse than the loans without gifts across all
origination years. In order to reflect this growing business
concentration and the different performance of loans with different
sources, we refined our econometric model by incorporating a series of
categorical variables to reflect this important development. As shown in
Appendix A, the estimated coefficients of these gift-source variables
are both economically and statistically significant.

Among the different gift letter sources, non-profit organization sources
appear to have the highest cumulative claim rates for all origination
years. A GAO report pointed out that the gift letter program might have
been misused by many non-profit organizations that are funded by home
sellers. The high concentration of these high-claim-rate loans that
receives downpayment assistance from non-profit organizations makes the
credit risk of these recent books of business particularly high.

In 2006, the IRS issued a ruling stating that an organization that
receives funding from home sellers and then provide downpayment gifts to
home buyers will no longer qualify for tax-exempt status and may lose
its non-profit organization status. Subsequently, in late 2007, HUD
issued a separate ruling that prohibits the endorsement of loans that
receive downpayment assistance from any entity (including non-profit
organization) that are funded or receive contributions from the home
sellers. These two rulings indicated government's strong resolve to
eliminate this particular type of downpayment assistance loan from the
FHA program. As a result, we expect significantly fewer loans receiving
downpayment assistance from non-profit organizations to be endorsed by
FHA in the future years. If these rulings are effectively enforced, it
is likely the future books of business will improve in terms of their
credit quality, other things remaining the same. In the base case
analysis of this Review, we assumed that these loans will wind down over
FY 2008 and be zero in 2009.

[]{.mark}

[]{.mark}

[^1]: According to the August 2007 estimation by HUD.