Number range CHAPTER**Section V: MMI Fund Sensitivities - Performance
under Alternative Scenarios**

This section reports the results of the sensitivity analyses we
performed as part of the FY 2007 Actuarial Review of the MMI Fund. To
understand the possible deviations of the economic values and capital
ratios of the MMI Fund with respect to the economic forecasts and some
key assumptions in the base-case scenario, several sensitivity analyses
were conducted and are presented in this section. Although these
scenario analyses do not describe all possible outcomes, they provide
insights into the relative importance and magnitude of the impact of
each selected factor on the performance of the MMI Fund. Among those
parameters and economic factors, one of the most critical factors is the
future economic conditions that may prevail during the remaining life of
FHA's currently existing portfolio. Essentially, the purpose of this
analysis is to test the sensitivity of the economic value of the MMI
Fund in response to possible negative economic developments. The
selected scenarios are those we believe may have the most significant
impacts on the MMI Fund's economic value. These sensitivity analyses
consist of:

-   Extended housing recession

-   High interest rate with extended housing recession

-   High claim loss-severity rates

-   Continued high concentration of loans with gift letters from
    non-profit organizations

We used the August 2007 quarterly economic forecasts from Global
Insight, Inc. to serve as the base-case scenario of our actuarial
analysis. The forecasted series include the OFHEO national house price
index, FHLMC 30-year fixed-rate mortgage commitment rates, and 10-year
and 1‑year Treasury rates. In addition, we assumed that future loss
severity rates would be similar to the rates observed for FY 2006 claim
terminations, by loan type, judicial foreclosure requirements, and
whether downpayment gifts from non-profit organizations were received.
Details of the methodology and support for the selection of the assumed
values of these economic variables are provided in Appendix D.

Exhibit V-1 displays the projected MMI Fund performance under the
base-case scenario. The current forecasted economic value of the MMI
Fund is \$21.277 billion and the estimated current capital ratio is 6.40
percent, which exceeds the NAHA-mandated capital ratio of 2 percent.
Exhibit V-1 also shows the predicted economic values and capital ratios
for the MMI Fund from FYs 2008 through 2014. The economic values and
capital ratios of the MMI Fund over FYs 2007 through 2014 under
alternative scenarios are presented in Exhibits V-2 to V-4.

Exhibit V-1

  ------------- ------------ ----------- ----------------- ------------- ------------ --------------
  **Projected                                                                         
  MMI Fund                                                                            
  Performance                                                                         
  for the                                                                             
  Base-Case                                                                           
  Scenario (\$                                                                        
  Millions)**                                                                         

  **Fiscal      **Economic   **Capital   **Volume of New   **Insurance   **Economic   **Investment
  Year**        Value of the Ratio (%)** Endorse-ments**   in Force**    Value of     Earnings on
                Fund**                                                   Each New     Fund
                                                                         Book of      Balances**
                                                                         Business**   

  2007          21,277       6.40        52,193            332,293       -406         　

  2008          22,748       6.67        50,149            341,012       390          1,082

  2009          24,706       6.83        58,381            361,566       849          1,108

  2010          26,796       6.86        65,658            390,544       892          1,199

  2011          29,053       6.87        72,556            422,986       936          1,321

  2012          31,492       6.91        77,773            455,984       985          1,454

  2013          34,251       7.01        86,237            488,420       1,167        1,592

  2014          37,405       7.25        92,439            515,698       1,410        1,744
  ------------- ------------ ----------- ----------------- ------------- ------------ --------------

A. Extended Housing Recession

The house price appreciation rate is the most important economic factor
that influences mortgage insurance claim rates. Under the extended
housing recession scenario, we investigated the impact on the MMI Fund
performance by assuming that the FY 2007 housing recession forecasted by
Global Insight, Inc. will last for 3 more years -- FYs 2008 through 2010
-- and then return to the baseline level starting in FY 2011. Exhibit
V-2 indicates that, compared to the baseline scenario, the economic
value of the FY 2007 MMI Fund would decrease by \$2.18 billion from its
base case value, and the capital ratio of FY 2007 would be reduced to
5.75 percent. The impact lasts through FY 2014 and would reduce the FY
2014 capital ratio by as much as 1.36 percentage points. This can be
explained by the change in the level of claims due to higher
probabilities of negative equity as mortgage borrowers are faced with a
more stressed housing economy.

Exhibit V-2

+--------+----------+--------+---------+---------+---------+---------+
| **Pro  |          |        |         |         |         |         |
| jected |          |        |         |         |         |         |
| MMI    |          |        |         |         |         |         |
| Fund   |          |        |         |         |         |         |
| Perfo  |          |        |         |         |         |         |
| rmance |          |        |         |         |         |         |
| with   |          |        |         |         |         |         |
| Ex     |          |        |         |         |         |         |
| tended |          |        |         |         |         |         |
| H      |          |        |         |         |         |         |
| ousing |          |        |         |         |         |         |
| Rec    |          |        |         |         |         |         |
| ession |          |        |         |         |         |         |
| Scen   |          |        |         |         |         |         |
| ario** |          |        |         |         |         |         |
|        |          |        |         |         |         |         |
| **(\$  |          |        |         |         |         |         |
| Milli  |          |        |         |         |         |         |
| ons)** |          |        |         |         |         |         |
+--------+----------+--------+---------+---------+---------+---------+
| **     | **       | **C    | *       | **In    | **E     | **Inv   |
| Fiscal | Economic | apital | *Volume | surance | conomic | estment |
| Year** | Value of | Ratio  | of New  | in      | Value   | E       |
|        | the      | (%)**  | E       | Force** | of Each | arnings |
|        | Fund**   |        | ndorse- |         | New     | on Fund |
|        |          |        | ments** |         | Book of | Bal     |
|        |          |        |         |         | Bus     | ances** |
|        |          |        |         |         | iness** |         |
+--------+----------+--------+---------+---------+---------+---------+
| 2007   | 19,100   | 5.75   | 52,193  | 332,295 | -1,300  | 　      |
+--------+----------+--------+---------+---------+---------+---------+
| 2008   | 19,246   | 5.65   | 50,149  | 340,924 | -825    | 971     |
+--------+----------+--------+---------+---------+---------+---------+
| 2009   | 20,024   | 5.53   | 58,381  | 361,866 | -160    | 938     |
+--------+----------+--------+---------+---------+---------+---------+
| 2010   | 21,471   | 5.48   | 65,658  | 391,891 | 476     | 971     |
+--------+----------+--------+---------+---------+---------+---------+
| 2011   | 23,465   | 5.50   | 72,556  | 426,319 | 935     | 1,059   |
+--------+----------+--------+---------+---------+---------+---------+
| 2012   | 25,623   | 5.55   | 77,773  | 461,625 | 984     | 1,174   |
+--------+----------+--------+---------+---------+---------+---------+
| 2013   | 28,086   | 5.66   | 86,237  | 496,232 | 1,168   | 1,295   |
+--------+----------+--------+---------+---------+---------+---------+
| 2014   | 30,925   | 5.89   | 92,439  | 524,795 | 1,409   | 1,430   |
+--------+----------+--------+---------+---------+---------+---------+

B. High Interest Rates with Extended Housing Recession Scenario

In this scenario, the housing recession experienced in FY 2007 under
Global Insight's forecast will continue for FYs 2008 through 2010, just
as in the previous scenario. In addition, we assumed an interest rate
shock of 300 basis points higher than the Global Insight's forecast for
FYs 2008 through 2010, and then rates return to the baseline levels in
FY 2011. This compound effect of more adverse interest rates and housing
recession was the most severe scenario considered for this Review.

From the previous scenario, it is clear that the assumed extended
housing recession leads to a higher claim rate. The high interest rate
scenario interacts with the extended housing recession in the following
way. As interest rates go up, prepayment rates go down. As fewer loans
are prepaid, more loans remain in the Fund and are therefore subject to
the risk of claim. Even where the conditional claim rate does not
increase, the cumulative claim rate increases, causing the lifetime
claim loss to increase.

Exhibit V-3 displays the results from this scenario. Holding the
extended housing recession constant (by referring to the results above),
the impact of higher interest rates is mainly on the higher IIF in
future years due to slower prepayment rates. The next three books of
business from FY 2008 to FY 2010 will be originated with higher initial
interest rates. When the rate drops suddenly in FY 2011, most
good-quality loans would be refinanced, while remaining borrowers are
unable to refinance, presumably due to lower credit quality or the lack
of borrower equity. This adverse-selection effect shows strongly in the
negative economic values of the FY 2008 to 2010 books of business.

As a result, the capital ratio for FY 2007 would be reduced to 5.97
percent and the FY 2014 capital ratio of the MMI Fund falls to 5.31
percent. Nevertheless, the capital ratio still remains above the
NAHA-mandated 2.00 percent level through FY 2014.

Exhibit V--3

  ------------- ------------ ----------- ----------------- ------------- ------------ --------------
  Projected MMI                                                                       
  Fund                                                                                
  Performance                                                                         
  under High                                                                          
  Interest                                                                            
  Rates with                                                                          
  Extended                                                                            
  Housing                                                                             
  Recession                                                                           
  Scenario (\$                                                                        
  Millions)                                                                           

  **Fiscal      **Economic   **Capital   **Volume of New   **Insurance   **Economic   **Investment
  Year**        Value of the Ratio (%)** Endorse-ments**   in Force**    Value of     Earnings on
                Fund**                                                   Each New     Fund
                                                                         Book of      Balances**
                                                                         Business**   

  2007          19,829       5.97        52,193            332,295       -1,033       　

  2008          18,443       5.25        50,149            350,985       -2,394       1,008

  2009          17,452       4.58        58,381            380,745       -1,889       899

  2010          17,074       4.09        65,658            417,270       -1,225       847

  2011          18,852       4.39        72,556            429,495       937          842

  2012          20,780       4.76        77,773            436,251       984          944

  2013          22,998       5.03        86,237            457,018       1,168        1,050

  2014          25,579       5.31        92,439            481,539       1,409        1,171
  ------------- ------------ ----------- ----------------- ------------- ------------ --------------

C. High Claim Loss-Severity Rates Scenario

The loss-severity rate is defined as the portion of the unpaid principal
of a claimed loan that is not recovered through the disposition of the
foreclosed property. Under the high loss-severity scenario,
loss-severity rates are assumed to be 5 percentage points higher than
under the baseline for each of the product types for all future years.
Such a development would be of critical importance because losses on
claims comprise the largest expense to the MMI Fund. Although the loss
rate on FHA claim cases has shown a general trend of decreasing over FY
2000 to FY 2003, loans terminating during the period from FY 2004
through FY 2006 experienced loss-severity rates higher than those of the
previous three years. In the base-case scenario, we assumed that the
loss-severity rate will be similar to the level of the FY 2006 period.
However, due to the forecasted weakening of the housing market, there
exists the possibility that the loss-severity rate could exceed the FY
2006 experience. This potentially high loss-severity scenario is
designed to investigate the impact if loss rates rise further.

The higher level of loss-severity rates produces lower economic values
and capital ratios for FY 2007 through FY 2014 as shown in Exhibit V-4.
An increase in the loss-severity rate by 5 percentage points would
decrease the capital ratio for FY 2007 to 5.98 percent and the FY 2014
capital ratio to 6.53 percent. For the seven-year period, the projected
capital ratio is still above the 2.00 percent level required by NAHA.

**Exhibit V-**4

+--------+----------+--------+---------+---------+---------+--------+
| **Pro  |          |        |         |         |         |        |
| jected |          |        |         |         |         |        |
| MMI    |          |        |         |         |         |        |
| Fund   |          |        |         |         |         |        |
| Perfo  |          |        |         |         |         |        |
| rmance |          |        |         |         |         |        |
| with   |          |        |         |         |         |        |
| High   |          |        |         |         |         |        |
| Claim  |          |        |         |         |         |        |
| L      |          |        |         |         |         |        |
| oss-Se |          |        |         |         |         |        |
| verity |          |        |         |         |         |        |
| R      |          |        |         |         |         |        |
| ates** |          |        |         |         |         |        |
|        |          |        |         |         |         |        |
| **(\$  |          |        |         |         |         |        |
| Milli  |          |        |         |         |         |        |
| ons)** |          |        |         |         |         |        |
+--------+----------+--------+---------+---------+---------+--------+
| **     | **       | **C    | *       | **In    | **E     | **Inve |
| Fiscal | Economic | apital | *Volume | surance | conomic | stment |
| Year** | Value of | Ratio  | of New  | in      | Value   | Ea     |
|        | the      | (%)**  | E       | Force** | of Each | rnings |
|        | Fund**   |        | ndorse- |         | New     | on     |
|        |          |        | ments** |         | Book of | Fund   |
|        |          |        |         |         | Bus     | Bala   |
|        |          |        |         |         | iness** | nces** |
+--------+----------+--------+---------+---------+---------+--------+
| 2007   | 19,860   | 5.98   | 52,193  | 332,293 | -726    | 　     |
+--------+----------+--------+---------+---------+---------+--------+
| 2008   | 21,057   | 6.17   | 50,149  | 341,012 | 188     | 1,010  |
+--------+----------+--------+---------+---------+---------+--------+
| 2009   | 22,759   | 6.29   | 58,381  | 361,566 | 676     | 1,026  |
+--------+----------+--------+---------+---------+---------+--------+
| 2010   | 24,560   | 6.29   | 65,658  | 390,544 | 697     | 1,104  |
+--------+----------+--------+---------+---------+---------+--------+
| 2011   | 26,493   | 6.26   | 72,556  | 422,986 | 721     | 1,211  |
+--------+----------+--------+---------+---------+---------+--------+
| 2012   | 28,576   | 6.27   | 77,773  | 455,984 | 758     | 1,326  |
+--------+----------+--------+---------+---------+---------+--------+
| 2013   | 30,940   | 6.33   | 86,237  | 488,420 | 920     | 1,444  |
+--------+----------+--------+---------+---------+---------+--------+
| 2014   | 33,665   | 6.53   | 92,439  | 515,698 | 1,149   | 1,575  |
+--------+----------+--------+---------+---------+---------+--------+

D. Continued High Concentration of Loans with Downpayment Assistance

Loans with downpayment assistance from non-profit organizations produced
claim rates significantly higher than traditional FHA business. The IRS
issued a ruling in May 2006 prohibiting non-profit organizations from
receiving financial contributions by home sellers and subsequently
providing downpayment assistance to homebuyers. [^1] HUD also issued a
ruling in October 2007 that prohibits the endorsement of loans that
receive contributions from any party that is financially related to the
seller of the collateral housing. In the base-case scenario, we assume
that these rulings will be effectively enforced; making loans that
receive gift letters from seller-funded non-profit organizations phase
out quickly. Our alternative scenario shows the situation of the Fund
if, for any reason, the recent high concentration in these loans
continues into the future. Under this alternative scenario, there is no
impact on the FY 2007 economic value and capital ratio. However, due to
the higher projected claim rates of future books of business, the FY
2014 economic value will decrease by \$5.198 billion and the FY 2014
capital ratio will decrease by 0.97 percentage points from their base
case scenario levels.

**Exhibit V-**5

  --------------- ------------ ----------- ----------------- ------------- ------------ --------------
  **Projected MMI                                                                       
  Fund                                                                                  
  Performance                                                                           
  with High                                                                             
  Concentration                                                                         
  in Loans with                                                                         
  Downpayment                                                                           
  Gift Letters                                                                          
  (\$ Millions)**                                                                       

  **Fiscal Year** **Economic   **Capital   **Volume of New   **Insurance   **Economic   **Investment
                  Value of the Ratio (%)** Endorse-ments**   in Force**    Value of     Earnings on
                  Fund**                                                   Each New     Fund
                                                                           Book of      Balances**
                                                                           Business**   

  2007            21,277       6.40        52,193            332,293       -406         　

  2008            22,484       6.59        50,149            341,063       126          1,082

  2009            23,857       6.60        58,381            361,726       277          1,096

  2010            25,268       6.47        65,658            390,645       254          1,157

  2011            26,757       6.33        72,556            422,686       243          1,246

  2012            28,333       6.23        77,773            454,977       237          1,339

  2013            30,129       6.19        86,237            486,457       364          1,432

  2014            32,207       6.28        92,439            512,583       544          1,534
  --------------- ------------ ----------- ----------------- ------------- ------------ --------------

E. Summary

Exhibit V-6 reports the projected MMI Fund's capital ratio corresponding
to the selected alterative scenarios: (1) base-case, (2) extended
housing recession, (3) high interest rates with extended housing
recession, (4) high loss severity, and (5) continued concentration in
gift loans. In all five scenarios, the estimated capital ratios exceed
the NAHA mandated capital ratio of 2.0 percent during FY 2007 to FY
2014.

**Exhibit V-6**

  ------------- --------------- ------------- ----------------- ----------- ----------------
  **Projected                                                               
  MMI Fund\'s                                                               
  Capital Ratio                                                             
  by Scenario                                                               
  (%)**                                                                     

  **Fiscal      **Base-Case**   **Extended    **High Interest   **High      **High
  Year**                        Housing       Rates with        Claim Loss  Concentra-tion
                                Recession**   Extended Housing  Severity    in Gift Loans**
                                              Recession**       Rate**      

  2007          6.40            5.75          5.97              5.98        6.40

  2008          6.67            5.65          5.25              6.17        6.59

  2009          6.83            5.53          4.58              6.29        6.60

  2010          6.86            5.48          4.09              6.29        6.47

  2011          6.87            5.50          4.39              6.26        6.33

  2012          6.91            5.55          4.76              6.27        6.23

  2013          7.01            5.66          5.03              6.33        6.19

  2014          7.25            5.89          5.31              6.53        6.28
  ------------- --------------- ------------- ----------------- ----------- ----------------

[^1]: [Revenue Ruling 2006-27, 2006-21 I.R.B. 915 (May 22,
    2006)](http://www.irs.gov/pub/irs-tege/rr2006-27.pdf).