**Section IV: Characteristics of the Fiscal Year 2005 Book of Business**

This section takes a closer look at the characteristics of the FY 2005
book of business. The characteristic descriptions include: the analysis
of loan origination volume and composition, the breakdown of new
purchase versus refinancing, and the distribution of loans by relative
loan size and loan-to-value ratios. This section also examines and
compares the FY 2005 book with previous books in order to gain insights
into how the FY 2005 book is likely to influence future performance.

# A. Volume and Share of Mortgage Originations

In FY 2005, FHA insured about \$ 58.3 billion in single-family mortgages
through the MMI Fund, bringing the fund's total unamortized
insurance-in-force to about \$ 359 billion. Exhibit IV-1 shows the
annual FHA originations count as well as the streamline refinancing
count from FY 1976 to FY 2005.

**Exhibit IV-1**

![](media/image1.wmf)

Source: FHA data warehouse, March 31, 2005 extract.

From Exhibit IV-1, note that FHA's book of business started to decrease
after reaching its peak at FY 2003. Exhibit IV-2 shows FHA's recent
market share.

**Exhibit IV-2**

+----------+-------+--------+-----------+--------+--------+-----------+
| **FHA\'s |       |        |           |        |        |           |
| Market   |       |        |           |        |        |           |
| Shares   |       |        |           |        |        |           |
| of New   |       |        |           |        |        |           |
| I        |       |        |           |        |        |           |
| nsurance |       |        |           |        |        |           |
| Counts   |       |        |           |        |        |           |
| and      |       |        |           |        |        |           |
| V        |       |        |           |        |        |           |
| olumes** |       |        |           |        |        |           |
|          |       |        |           |        |        |           |
| **       |       |        |           |        |        |           |
| National |       |        |           |        |        |           |
| Home     |       |        |           |        |        |           |
| Purchase |       |        |           |        |        |           |
| Market** |       |        |           |        |        |           |
+----------+-------+--------+-----------+--------+--------+-----------+
| ** **    | **N   |        |           | **     |        |           |
|          | umber |        |           | Volume |        |           |
| **Fiscal | of    |        |           | of     |        |           |
| Year **  | Mort  |        |           | Mo     |        |           |
|          | gages |        |           | rtgage |        |           |
|          | Or    |        |           | Origin |        |           |
|          | igina |        |           | ated** |        |           |
|          | ted** |        |           |        |        |           |
|          |       |        |           | **(bil |        |           |
|          | **(0  |        |           | lions, |        |           |
|          | 00)** |        |           | c      |        |           |
|          |       |        |           | urrent |        |           |
|          |       |        |           | doll   |        |           |
|          |       |        |           | ars)** |        |           |
+----------+-------+--------+-----------+--------+--------+-----------+
|          | **FHA | *      | **FHA     | *      | **Ma   | **FHA     |
|          | ^a^** | *Marke | Share     | *FHA** | rket** | Share     |
|          |       | t^b^** | (%)**     |        |        | (%)**     |
+----------+-------+--------+-----------+--------+--------+-----------+
| 1989     | 678   | 4,243  | 15.99     | 43     | 510    | 8.39      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 1990     | 742   | 4,084  | 18.16     | 49     | 502    | 9.83      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 1991     | 656   | 3,784  | 17.34     | 45     | 480    | 9.44      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 1992     | 597   | 4,055  | 14.71     | 43     | 527    | 8.07      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 1993     | 639   | 4,497  | 14.21     | 48     | 593    | 8.17      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 1994     | 652   | 4,935  | 13.21     | 52     | 676    | 7.65      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 1995     | 556   | 4,758  | 11.69     | 45     | 666    | 6.69      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 1996     | 686   | 5,197  | 13.20     | 58     | 758    | 7.68      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 1997     | 751   | 5,379  | 13.96     | 66     | 827    | 7.97      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 1998     | 789   | 6,020  | 13.10     | 71     | 976    | 7.31      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 1999     | 909   | 6,449  | 14.09     | 89     | 1,099  | 8.14      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 2000     | 856   | 6,335  | 13.52     | 89     | 1,135  | 7.87      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 2001     | 869   | 6,405  | 13.57     | 96     | 1,196  | 8.03      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 2002     | 806   | 6,615  | 12.18     | 94     | 1,321  | 7.11      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 2003     | 655   | 7,148  | 9.16      | 80     | 1,527  | 5.25      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 2004     | 505   | 7,902  | 6.39      | 63     | 1,842  | 3.40      |
+----------+-------+--------+-----------+--------+--------+-----------+
| 2005^c^  | 193   | 5,119  | 3.77      | 24     | 1,274  | 1.85      |
+----------+-------+--------+-----------+--------+--------+-----------+

Source: 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^ FY2005 data is for the October 2004 - May 2005 period.

The steady decrease in mortgage interest rates during the last 5 years
has substantially improved housing affordability in the United States.
Although the rapid rising house price during the same period partially
offset the housing affordability, we observed highest number of homes
sold in the nation's history over the past four years. In specific, the
number of homes sold increased steadily from FY 2000 to FY 2004 by about
25 percent. On the other hand, the home-purchase loans endorsed by FHA
dropped by 41 percent. Combining this trend with the rapid house price
appreciation rates observed during the same period, the market volume of
home sales rose by 62 percent, while the FHA endorsement dollar volume
dropped by 29 percent.

The opposite trend between the number of houses sold and number of loans
FHA endorsed led to the substantial decrease in FHA's market share in
the recent years. FHA's share by loan count decreased from 12.18 percent
in 2002 to 6.39 percent in 2004 and could be as low as 3.77 percent for
the 2005 fiscal year. The same decreasing trend is observed when
measured by dollar volume. The estimated FHA market share in dollar
amount insured is about 1.85 percent, down from 8.03 percent in 2001.

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

The high rate of house price appreciation has contributed to this
decrease in FHA market share. On June 1, 2005, the Office of Federal
Housing Enterprise Oversight (OFHEO) announced that its national house
price index showed another strong one-year growth rate of 12.5 percent.
This growth rate is substantially higher than the 4.07 percent assumed
in last year's Review. The continued strong housing value expansion
during 2005 has strengthened the quality of the FY 2004 and previous
books of business by lowering their current loan-to-value ratios.
However, the rapid growth rate also implies that many houses have become
too expensive to be financed through FHA programs due to the loan size
limit.

Another hypothesis raised by the mortgage industry is that the
continuous expansion into the less than prime mortgage business by
private mortgage lenders and private mortgage insurers could marginalize
FHA's business volume and adversely affect the overall quality of loans
endorsed by FHA. Again, such a hypothesis has not been carefully
researched. 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 we
developed for the MMI Fund.

**B. Originations by Location**

Even though FHA insures loans in all parts of the U.S., 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 2001 through 2005. The table includes the top
9 States during FY 2005 plus California.

**Exhibit IV-3**

  -------------- ----------- ------------ ------------ ----------- ------------
  **Percentage                                                     
  of FHA Dollar                                                    
  volume                                                           
  Originated                                                       
  Between FY                                                       
  2001 and FY                                                      
  2005**                                                           

                                                                   

  **State**      **2001**    **2002**     **2003**     **2004**    **2005**

  Texas          7.00        8.35         9.55         11.52       13.46

  Georgia        4.59        4.60         4.37         5.37        5.88

  Colorado       4.71        4.98         5.70         5.04        4.87

  Illinois       4.89        4.80         5.15         4.82        4.47

  Florida        5.21        5.09         4.93         5.32        4.45

  New Jersey     3.53        3.53         3.76         4.09        4.28

  Ohio           3.34        3.53         3.50         3.85        4.01

  Maryland       5.03        4.98         5.64         3.80        3.11

  New York       3.68        3.73         3.09         3.59        3.07

  California\*   14.25       12.21        9.17         5.24        2.83

  **% of Total** 56.23       55.80        54.85        52.63       50.44
  -------------- ----------- ------------ ------------ ----------- ------------

Source: FHA data warehouse, March 31, 2005 extract.

\* California had been one of the top 10 States in FHA's business till
FY 2004. During the first two quarters of FY 2005, it is ranked 12^th^
in FHA's origination volume.

Using this year's ranking, Maryland, Ohio and New Jersey appear for the
first time in the top ten list. We also see that California has
experienced a gradual decrease in the percentage while Texas has been
increasing its percentage share. The rapid growth in California house
prices during the past few years has pushed more home mortgages over the
FHA loan size limit. According to OFHEO, California ranks second while
Texas ranks last in house price appreciation among all states. FHA's
large concentration in Texas for FY 2004 and 2005 is likely a reflection
of the relatively low rate of house price appreciation there.

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

**C. Originations by Mortgage Type**

Exhibit IV-4 shows historically that the 30-year FRM made up almost all
of FHA's business. This trend began to change in the early 1990s when
FHA introduced the adjustable rate mortgage (ARM) and the
streamline-refinancing mortgage (SR). Gradually, adjustable rate and
streamline refinancing mortgages took on a bigger share of the annual
originations. For the past few years, it is clear from Exhibit IV-4 that
the 30-year FRM share has decreased relative to SRs, with 2003 being the
extreme condition. As indicated by Exhibit IV-4, as market interest
rates have raised recently, this trend was reversed.

The 15-year FRMs and 15-year SRs continue to be minor product types of
the MMI Fund. With relatively low interest rates, some borrowers were
able to convert a previously borrowed 30-year mortgage into 15 years
without much increase in the payment burden. However, for the vast
majority of cash-out refinancers, the 30-year FRM remains the popular
choice.

FHA's ARM share has decreased from its mid-1990s high to an
insignificant level during the beginning of the 2000s, then it started
to increase over the past two years. With the expectation that interest
rates will continue to rise in the future, borrowers see an opportunity
to lock in their mortgage rates for the long term by choosing 30-year
FRMs. This tends to keep the portion of borrowers choose to take
adjustable rate loans small. The increase in ARM share could be
attributed to borrowers with shorter expected tenure in the houses and
those believing the rates will remain low in the near future to take the
advantage of the interest rate spread between FRMs and ARMs. However,
there could still be some income-constrained borrowers who need the
lower initial payments of ARMs in order to qualify for or afford the
mortgage.

The dynamics of MMI Fund's concentration among product types is captured
by our econometric models with six different models separately 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)**                                                                         

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

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

                                                                                    

  1976            99.78         0.22        n/a        n/a              n/a         n/a

  1977            99.84         0.16        n/a        n/a              n/a         n/a

  1978            99.89         0.10        n/a        n/a              n/a         n/a

  1979            99.90         0.10        n/a        n/a              n/a         n/a

  1980            99.84         0.16        n/a        n/a              n/a         n/a

  1981            99.77         0.22        n/a        n/a              n/a         n/a

  1982            99.50         0.49        n/a        n/a              n/a         n/a

  1983            92.58         7.41        n/a        n/a              n/a         n/a

  1984            93.45         6.54        n/a        n/a              n/a         n/a

  1985            92.02         7.81        0.15       0.02             n/a         n/a

  1986            88.96         8.12        0.75       1.84             0.33        0.00

  1987            80.53         4.88        1.49       11.20            1.84        0.06

  1988            86.54         3.31        5.04       4.63             0.45        0.04

  1989            93.26         2.37        1.54       2.64             0.19        0.00

  1990            93.35         2.46        0.81       3.13             0.25        0.00

  1991            88.42         2.77        4.47       3.71             0.59        0.04

  1992            66.55         2.38        16.35      11.07            2.23        1.41

  1993            45.20         1.95        12.05      30.53            8.05        2.22

  1994            41.93         1.59        16.88      28.49            8.30        2.81

  1995            64.81         1.22        29.24      3.01             1.01        0.72

  1996            60.15         1.05        25.19      9.59             1.97        2.06

  1997            56.51         0.94        34.73      4.28             0.86        2.68

  1998            63.75         0.89        11.70      19.60            1.66        2.40

  1999            72.01         0.90        4.17       19.91            1.96        1.05

  2000            84.83         0.65        10.92      2.58             0.32        0.69

  2001            74.18         0.76        2.00       21.43            0.81        0.81

  2002            65.10         0.93        5.79       22.97            1.86        3.36

  2003            49.10         0.93        3.51       39.38            3.58        3.50

  2004            61.43         1.04        8.17       21.76            2.76        4.84

  2005            62.37         0.95        10.02      19.88            1.85        4.93
  --------------- ------------- ----------- ---------- ---------------- ----------- ----------

Source: FHA data warehouse, March 31, 2005 extract.

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

Based on the 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 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                                                                                                           
  FHA-Insured                                                                                                             
  Mortgages by                                                                                                            
  Dollar Volume)**                                                                                                        

  **Book of        **Unknown   **0-75%**   **75-80%**   **80-90%**   **90-95%**   **95-97%**   **97-98%**   **98-100%**   **100-105%**
  Business**       LTV**                                                                                                  

                                                                                                                          

  1976             18.26       2.04        2.04         12.50        32.24        27.01        1.85         4.07          0.74

  1977             11.54       2.59        2.58         14.38        37.35        26.21        1.89         3.46          0.00

  1978             17.42       2.75        2.13         12.03        27.99        32.05        2.61         3.01          0.00

  1979             22.15       4.03        2.48         12.38        23.60        31.92        1.95         1.50          0.00

  1980             12.03       8.02        4.77         19.65        25.73        27.59        1.36         0.85          0.00

  1981             28.27       6.76        4.66         18.44        21.07        19.68        0.68         0.44          0.00

  1982             16.61       12.42       7.20         22.72        23.72        16.56        0.45         0.31          0.00

  1983             20.55       13.06       6.94         22.38        21.74        14.38        0.59         0.35          0.00

  1984             2.74        10.55       6.28         24.25        26.03        23.36        2.03         4.64          0.13

  1985             1.09        10.47       6.06         30.52        27.00        22.95        1.03         0.87          0.02

  1986             0.54        11.47       7.01         30.24        27.15        21.95        0.87         0.74          0.02

  1987             0.17        9.82        5.95         27.19        29.64        25.30        0.76         1.10          0.07

  1988             0.05        4.95        3.02         19.56        35.54        33.55        1.21         2.09          0.00

  1989             0.08        4.89        2.55         18.26        36.33        34.39        1.25         2.24          0.01

  1990             0.01        4.71        2.44         18.24        36.38        34.51        1.46         2.23          0.01

  1991             1.36        3.72        2.07         15.59        29.58        31.38        11.44        4.60          0.26

  1992             1.07        2.93        1.71         13.90        28.13        38.87        8.40         4.59          0.41

  1993             0.08        2.06        1.51         12.40        25.76        33.51        20.56        3.82          0.29

  1994             0.06        1.95        1.38         11.26        24.48        33.48        24.02        3.20          0.18

  1995             0.02        1.54        1.16         10.18        24.49        34.69        24.21        3.49          0.23

  1996             0.00        1.42        1.20         10.42        25.62        35.41        23.11        2.61          0.19

  1997             0.00        1.64        1.46         10.86        26.30        35.29        22.03        2.15          0.26

  1998             0.00        1.73        1.55         11.18        26.46        35.85        21.08        1.81          0.33

  1999             0.00        1.52        1.39         8.10         13.06        31.65        42.23        1.79          0.26

  2000             0.00        1.12        1.13         5.86         6.75         34.41        49.24        1.35          0.15

  2001             0.00        1.50        1.44         6.45         6.57         37.92        45.01        0.92          0.19

  2002             0.00        1.81        1.52         6.61         6.49         40.56        42.16        0.69          0.16

  2003             0.00        2.51        1.86         7.17         6.63         41.74        39.48        0.48          0.14

  2004             0.00        2.57        1.89         7.31         7.11         43.22        37.37        0.40          0.12

  2005             0.32        2.73        2.00         7.69         6.90         42.94        36.91        0.42          0.42
  ---------------- ----------- ----------- ------------ ------------ ------------ ------------ ------------ ------------- --------------

Source: FHA data warehouse, March 31, 2005 extract, and the December
2003 extract prepared for FHA's external auditor

As Exhibit IV-5 indicates, the LTV distribution of FY 2005 originations
is very similar to that of FY 2004 originations. Nearly 80 percent of
the mortgages originated in FY 2005 have LTV ratios of 95 percent or
more, and over 85 percent have LTV ratios above 90 percent. LTV ratios
between 95 percent and 98 percent comprise the most popular category,
with 80 percent of loans falling in this range.

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
the behavioral difference among borrowers self-selected into different
initial LTV categories.

**E. Initial Loan Size Distributions**

One of our model's explanatory variables is the loan size category. 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 location. Existing literature indicated
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 categories one through six
are based on breakpoints determined by a percentage of the average loan
amount in each of the metropolitan statistical areas (MSAs) or the
Census regions depending on the specific location of the mortgaged
house.

Exhibit IV-6 shows the percentage of new originations within each
relative loan size category. Overall, the FY 2005 book of business is
similar to the FY 2004 book of business. One noticeable difference is
that FY 2005 book has a higher percentage share in the largest loan size
category. Over the years, the largest loan size category (\>140% of the
average loan size) has been gradually increasing. Most of the increase
results in a decrease in the percentage of 80-100%, 100-120% and
120-140% 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, the loss severity tends to be lower.
The loss severity is defined as the percentage of a claim amount not
recovered through the sale of the conveyed property or mortgage note.
Those houses associated with larger FHA loans tend to be in the average
house price range for their surrounding areas. Since this market is
relatively liquid and there are a relatively large number of these
similar-quality homes in the area, the house price volatility of these
houses tends to be relatively small in comparison to the house price
volatility of the extremely low- and high-priced houses. With similar
initial LTVs, the higher priced houses tend to 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-6**

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

  **(Percentage                                                                
  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**

                                                                               

                                                                               

  1976             3.59       12.55      23.68       28.27        20.17        11.73

  1977             3.14       11.83      24.42       31.06        21.04        8.51

  1978             3.52       12.23      25.49       27.27        18.18        13.31

  1979             3.81       11.78      23.90       28.19        21.03        11.29

  1980             4.14       11.69      22.47       30.04        19.47        12.18

  1981             4.58       11.84      22.27       26.77        19.57        14.96

  1982             5.46       11.72      20.42       25.56        19.68        17.16

  1983             4.45       11.80      21.73       27.22        21.87        12.93

  1984             4.59       12.05      21.81       26.94        21.11        13.50

  1985             4.40       11.75      21.66       27.66        23.92        10.61

  1986             3.62       11.52      23.00       29.94        24.05        7.86

  1987             3.53       11.82      23.13       29.38        23.91        8.24

  1988             4.25       12.23      21.71       28.28        21.49        12.04

  1989             4.53       12.43      21.38       25.99        21.33        14.34

  1990             4.82       12.69      21.26       25.55        18.91        16.77

  1991             4.83       12.59      21.38       24.08        21.41        15.70

  1992             4.44       12.35      21.98       25.55        21.60        14.08

  1993             3.92       12.31      23.15       26.86        20.92        12.83

  1994             4.34       12.82      22.32       24.95        20.29        15.28

  1995             4.74       12.98      20.92       24.61        20.85        15.89

  1996             4.56       12.87      21.02       25.27        21.54        14.74

  1997             4.63       12.92      20.49       25.78        21.68        14.49

  1998             4.29       12.53      21.14       27.72        21.53        12.80

  1999             4.63       12.94      21.45       25.83        19.07        16.07

  2000             5.27       12.82      20.80       23.99        18.92        18.19

  2001             4.93       12.31      22.02       24.85        19.11        16.78

  2002             5.14       12.29      21.71       24.52        18.88        17.46

  2003             5.08       12.22      21.78       25.08        18.88        16.95

  2004             5.89       12.47      20.10       22.97        18.79        19.79

  2005             6.07       12.51      19.36       22.75        18.84        20.46
  ---------------- ---------- ---------- ----------- ------------ ------------ ----------

Source: FHA data warehouse, March 31, 2005 extract

Exhibit IV-7 provides a detailed breakdown of average loan sizes by
relative loan size category.

Exhibit IV-7

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

  **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**

                                                                           

                                                                           

  1976         12,698     17,905     23,647      28,979       33,637       37,158

  1977         13,660     19,543     25,778      31,221       36,454       39,139

  1978         15,900     23,215     30,021      36,236       42,453       49,687

  1979         17,781     26,165     33,960      41,814       49,193       53,185

  1980         19,548     29,037     37,984      47,805       53,828       59,862

  1981         20,920     31,405     41,602      51,221       58,781       67,016

  1982         21,965     32,853     43,402      53,542       62,880       70,693

  1983         24,876     36,515     47,482      58,344       67,974       75,885

  1984         25,576     37,835     49,992      61,892       71,577       78,618

  1985         27,927     41,399     54,746      67,516       79,181       83,456

  1986         29,813     43,454     56,443      69,697       80,755       85,936

  1987         30,469     43,571     56,435      69,807       81,093       86,530

  1988         29,366     42,188     54,928      69,110       79,510       85,943

  1989         30,049     43,579     56,482      70,626       82,158       90,752

  1990         31,801     45,854     59,525      74,086       84,561       98,393

  1991         32,900     47,664     61,837      76,061       90,533       100,455

  1992         34,462     49,476     64,047      78,492       92,902       104,399

  1993         36,886     52,556     67,519      81,894       96,219       112,181

  1994         37,256     53,205     67,775      82,164       97,598       115,729

  1995         39,378     56,169     71,444      87,812       104,537      121,516

  1996         41,862     59,828     75,916      93,406       111,350      128,081

  1997         43,636     62,585     78,878      97,707       116,312      134,242

  1998         45,847     65,640     82,834      102,635      121,185      140,384

  1999         48,827     69,386     87,721      108,061      127,121      154,356

  2000         51,655     72,815     93,315      114,999      134,903      165,772

  2001         55,883     79,060     101,783     125,044      144,346      179,771

  2002         57,897     81,963     105,284     128,930      148,709      188,709

  2003         59,622     84,900     108,937     132,900      153,266      195,408

  2004         59,091     83,908     108,024     132,322      153,631      196,975

  2005         57,675     83,708     108,257     132,809      154,468      196,074
  ------------ ---------- ---------- ----------- ------------ ------------ ----------

Source: FHA data warehouse, March 31, 2005 extract

Despite the record high national house price growth rate revealed by the
OFHEO house price index during the past three years, the average loan
size of FHA business remained virtually unchanged.

**F. Initial Contract Interest Rate**

Exhibit IV-8 shows the average contract rate by mortgage type since FY
1989. Over the years, the average contract rate has been gradually
decreasing. On average, the FY 2005 book of business has the lowest
average contract rate since FY 1989. Even though the FY 2005 book of
business has a lower overall average contract rate than the FY 2004 book
of business, the rates of most mortgage types are actually increasing.
However, the 30-year fixed rate and the 30-year streamline refinance
experienced a slight decrease in interest rates.

Research has found that, in general, an FRM with a lower contract rate
tends to experience fewer claims, but they also have prepaid more
slowly. Slower prepayment rates imply that mortgages are exposed to
default risk for longer periods of time. Recent research has confirmed
the competing risk theory of prepayments and claims. That is, a borrower
can only exercise either the prepayment or the default option. Under an
environment in favor of prepayment, the conditional claims rate would be
lower than otherwise similar situations. Likewise, during a housing
recession where default is more likely, the conditional prepayment rate
also tends to be low. This competing risk nature of prepayments and
claims drives the performance of FRMs in particular. As the interest
rate is expected to rise, the prepayment rate of the FY 2005 book would
be low, which would leave more loans subject to claim risk for a longer
period. Meanwhile, the low house price growth rate forecasted by Global
Insight, Inc. also suggests the claim probability could rise from the
past few books of business. As a result, the FY 2005 book of business is
expected to experience higher cumulative claim rates than other books
originated in the early 2000s.

Exhibit IV-8

  -------------------------------------------------------------------------------------------------
  **Average                                                                           
  Contract                                                                            
  Interest Rate                                                                       
  by Loan Type                                                                        
  and in the                                                                          
  Aggregate**                                                                         
  --------------- ---------- ---------- ---------- ---------- ---------- ------------ -------------
  **(Percent)**                                                                       

  **Year**        **F30s**   **F15s**   **ARMs**   **S30s**   **S15s**   **SRARMs**   **Average**

  1989            10.06      9.98       9.08       11.16      10.22      9.18         10.07

  1990            9.69       9.56       8.54       10.70      9.95       8.86         9.71

  1991            9.46       9.20       7.56       10.09      9.31       7.74         9.40

  1992            8.54       8.36       6.47       8.91       8.37       6.51         8.26

  1993            7.76       7.42       5.87       8.16       7.58       6.27         7.64

  1994            7.57       7.14       6.06       7.75       7.42       6.08         7.36

  1995            8.39       8.24       7.18       8.67       8.69       7.32         8.10

  1996            7.84       7.57       6.49       7.98       7.65       6.75         7.53

  1997            7.97       7.77       6.53       8.23       7.97       6.77         7.51

  1998            7.37       7.22       6.12       7.55       7.16       6.45         7.25

  1999            7.24       7.00       6.00       7.16       6.88       6.05         7.16

  2000            8.29       8.08       6.95       8.32       8.04       6.30         8.16

  2001            7.56       7.16       6.19       7.41       6.85       6.12         7.49

  2002            7.00       6.57       5.28       6.95       6.41       5.31         6.84

  2003            6.08       5.54       4.39       6.01       5.48       4.45         5.92

  2004            6.12       5.59       4.46       5.99       5.52       4.39         5.87

  2005            5.96       5.59       4.71       5.88       5.61       4.67         5.78
  -------------------------------------------------------------------------------------------------

Source: FHA data warehouse, March 31, 2005 extract.

**G. Downpayment Assistance through Gifts**

One newly observed trend in this year's data extract is the rapidly
rising concentration of loans with gift letters in the newer books of
business. FHA's database started tracking the sources of loans with
downpayment gift supports back in 1998. Exhibit IV-9 shows the
distribution of MMI loans by gift source.

Exhibit IV-9 shows that virtually all downpayment gifts prior to FY 2000
were funded by the borrower's relatives. However, starting FY 2000,
there was a rapid increase of share of loans with gift letter from
nonprofit, religious, or community entities. This concentration reached
about 10 percent by FY 2003 and almost doubled to 18 percent of the
entire FY 2004 book of business.[^1]

#### Exhibit IV-9

+----------+-----------+-----------+-----------+-----------+-----------+
| ##### Co |           |           |           |           |           |
| ncentrat |           |           |           |           |           |
| ion of L |           |           |           |           |           |
| oans wit |           |           |           |           |           |
| h Gift L |           |           |           |           |           |
| etter by |           |           |           |           |           |
|  Sources |           |           |           |           |           |
|          |           |           |           |           |           |
| **(Perc  |           |           |           |           |           |
| ent)\*** |           |           |           |           |           |
+----------+-----------+-----------+-----------+-----------+-----------+
| **Ori    | **No      | **R       | **N       | **G       | **E       |
| gination | Gift**    | elative** | onprofit, | overnment | mployer** |
| Year**   |           |           | R         | Ass       |           |
|          |           |           | eligious, | istance** |           |
|          |           |           | or        |           |           |
|          |           |           | Co        |           |           |
|          |           |           | mmunity** |           |           |
+----------+-----------+-----------+-----------+-----------+-----------+
| 1998     | 77.60     | 21.87     | 0.19      | 0.31      | 0.03      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 1999     | 82.20     | 16.32     | 0.55      | 0.86      | 0.06      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2000     | 77.17     | 18.81     | 1.83      | 2.10      | 0.09      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2001     | 83.23     | 11.08     | 4.25      | 1.36      | 0.07      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2002     | 82.26     | 9.15      | 7.05      | 1.48      | 0.06      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2003     | 81.44     | 7.39      | 9.67      | 1.44      | 0.06      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2004     | 70.26     | 9.57      | 18.04     | 2.06      | 0.08      |
+----------+-----------+-----------+-----------+-----------+-----------+

Source: FHA data warehouse, March 31, 2005 extract.

\* In 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.

With the significant number of loans receiving gifts for downpayments
and the aging of these loans, this year is the first time we have enough
historical data to conduct a closer investigation of the performance of
these gift loans. Exhibit IV-10 shows the conditional claim rates
realized on loans by gift source and origination year.

#### Exhibit IV-10

+----------+-----------+-----------+-----------+-----------+-----------+
| **Con    |           |           |           |           |           |
| ditional |           |           |           |           |           |
| Claim    |           |           |           |           |           |
| Rates of |           |           |           |           |           |
| Loans    |           |           |           |           |           |
| with     |           |           |           |           |           |
| D        |           |           |           |           |           |
| ifferent |           |           |           |           |           |
| Gift     |           |           |           |           |           |
| S        |           |           |           |           |           |
| ources** |           |           |           |           |           |
|          |           |           |           |           |           |
| **(Pe    |           |           |           |           |           |
| rcent)** |           |           |           |           |           |
+----------+-----------+-----------+-----------+-----------+-----------+
| **       | **No      | **R       | **N       | **G       | **E       |
| Exposure | Gift**    | elative** | onprofit, | overnment | mployer** |
| Year**   |           |           | R         | Ass       |           |
|          |           |           | eligious, | istance** |           |
|          |           |           | or        |           |           |
|          |           |           | Co        |           |           |
|          |           |           | mmunity** |           |           |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2000     |           |           |           |           |           |
| Book     |           |           |           |           |           |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2000     | 0.01      | 0.02      | 0.04      | 0.01      | 0.00      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2001     | 0.42      | 0.81      | 1.18      | 0.82      | 0.67      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2002     | 1.70      | 2.88      | 5.68      | 3.73      | 2.39      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2003     | 3.62      | 4.95      | 9.97      | 5.76      | 7.12      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2004     | 4.39      | 5.18      | 10.45     | 6.26      | 5.48      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2005\*   | 1.99      | 2.31      | 4.68      | 2.81      | 4.14      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2001     |           |           |           |           |           |
| Book     |           |           |           |           |           |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2001     | 0.01      | 0.02      | 0.02      | 0.03      | 0.00      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2002     | 0.38      | 0.75      | 1.34      | 1.08      | 1.26      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2003     | 1.68      | 2.33      | 5.73      | 4.10      | 1.75      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2004     | 3.23      | 3.91      | 9.38      | 5.51      | 5.39      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2005\*   | 1.73      | 2.10      | 4.61      | 2.71      | 5.50      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2002     |           |           |           |           |           |
| Book     |           |           |           |           |           |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2002     | 0.01      | 0.01      | 0.03      | 0.01      | 0.15      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2003     | 0.42      | 0.51      | 1.34      | 0.97      | 1.23      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2004     | 1.75      | 2.02      | 5.57      | 3.71      | 1.96      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2005\*   | 1.13      | 1.27      | 3.73      | 2.36      | 1.32      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2003     |           |           |           |           |           |
| Book     |           |           |           |           |           |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2003     | 0.01      | 0.01      | 0.02      | 0.03      | 0.00      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2004     | 0.42      | 0.49      | 1.57      | 1.10      | 0.55      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2005\*   | 0.50      | 0.64      | 1.91      | 1.54      | 1.15      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2004     |           |           |           |           |           |
| Book     |           |           |           |           |           |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2004     | 0.04      | 0.06      | 0.12      | 0.03      | 0.00      |
+----------+-----------+-----------+-----------+-----------+-----------+
| 2005\*   | 0.21      | 0.25      | 0.61      | 0.31      | 0.18      |
+----------+-----------+-----------+-----------+-----------+-----------+

Source: FHA data warehouse, March 31, 2005 extract.

\* Partial year data.

Holding everything else the same, we find those non-relative gift loans
performed worse than the loans without gifts across all origination
years and all exposure years. Although not reported in this Review, we
also found the loans with gift letters generally have slower prepayment
rates. In order to capture this significant difference in the
conditional claim rate, we further refined the econometric models to
capture this performance difference by gift source. Without further
research and investigation, it is unclear why these loans performed
significantly worse than the non-gift loans.

In order to reflect this growing business concentration and the
different performance of loans with different sources, we refined our
econometrics model by incorporating a series of categorical variables.
As shown in Appendix A, the estimated coefficients of these gift-source
variables are both economically and statistically significant.

[^1]: The downpayment assist loans only exist in purchase mortgages. The
    concentration rate would be even higher if refinance loans were
    excluded from the denominator.