**Section II: Summary of Findings** **and Comparison with FY 2007
Actuarial Review**

This section presents the economic value and capital ratios of the Fund
for FY 2008 and provides an explanation of how the results of this
year\'s Review compare with those of the FY 2007 Review.

**A. The FY 2008 Actuarial Review**

The FY 2008 Actuarial Review assessed the actuarial soundness of the MMI
Fund as of the end of FY 2008 (projected to September 30, 2008) in terms
of whether the Fund has maintained at least a two‑percent capital ratio
as required by NAHA, and projected the status of the Fund through FY
2015. The objectives of our analysis included:

-   evaluating the historical experience of the Fund, including loan
    termination experience due to claims and prepayments, and losses
    associated with these terminations;

-   estimating future loan termination rates and their corresponding
    losses and projecting future cash flows of the existing Fund
    portfolio and future books of business; and

-   determining the adequacy of current and future capital resources to
    meet estimated cash outflow requirements.

We conducted this review by estimating the economic relationships of
historical loan performance using data provided by FHA, applying the
appropriate policy parameters, and using independent forecasts of future
macroeconomic conditions published by Global Insight, Inc.

The econometric and cash flow models are similar in most respects to
those of the FY 2007 Review, with some enhancements implemented for this
FY 2008 Review. The analysis utilizes loan-level data on the Fund\'s
experience reported by HUD through March 2008. These models also
incorporate a set of economic assumptions and forecasts for future
years. To estimate future claim loss rates, the model applies the
historical average claim loss severity rates that were realized during
FY 2006 for each of the six FHA mortgage product types, and further
stratified according to whether a judicial foreclosure process is
required by the state where the collateral property is located and
whether the loan was supported by downpayment assistance from non-profit
organizations. Descriptions of the individual models and assumptions are
presented in Appendices A through D. Our main findings are as follows:

-   as of the end of FY 2008, the MMI Fund was projected to have an
    estimated economic value of **\$12.908** **billion** and an
    unamortized insurance-in-force of **\$429.634 billion**;

-   the FY 2008 book of business was projected to contribute an
    estimated **negative** **\$3.643 billion** in present value to the
    economic value of the MMI Fund;

-   the capital ratio was estimated to be **3.00 percent** as of
    September 30, 2008, and projected to be **2.90 percent** as of
    September 30, 2015. Based on these estimates, we conclude that the
    Fund will continue to exceed the NAHA-mandated 2 percent capital
    ratio in the foreseeable future. However the levels of these capital
    ratios dropped significantly from those projected in last year's
    Review and is estimated to barely exceed 2 percent in FY 2011.

Our current projections indicate that the Fund\'s economic value will
continue to increase in the future, rising by an average of 23.79
percent per year through FY 2015. With the expected slower prepayment
rates of the existing books of business implied by the rising interest
rate environment projected after FY 2009, and FHA's projection of record
high endorsement volume of future books of business, the insurance in
force (IIF) will increase by an average rate of 24.41 percent per year
through FY 2015. The economic value is expected to grow at a slower rate
than that of IIF, causing the Fund's projected capital ratio to decrease
to 2.90 percent by the end of FY 2015. Exhibit II-1 provides estimates
of the Fund\'s economic value, IIF, and capital ratio through the end of
FY 2015. The capital ratio is projected to decline over the next three
years to a low value of 2.28 percent and then increase over the
remainder of the period.

**Exhibit II-1**

+---------+---------+---------+---------+---------+---------+---------+
| **Pr    |         |         |         |         |         |         |
| ojected |         |         |         |         |         |         |
| MMI     |         |         |         |         |         |         |
| Fund    |         |         |         |         |         |         |
| Perf    |         |         |         |         |         |         |
| ormance |         |         |         |         |         |         |
| for FYs |         |         |         |         |         |         |
| 2008 to |         |         |         |         |         |         |
| 2015**  |         |         |         |         |         |         |
|         |         |         |         |         |         |         |
| **(\$   |         |         |         |         |         |         |
| Mill    |         |         |         |         |         |         |
| ions)** |         |         |         |         |         |         |
+---------+---------+---------+---------+---------+---------+---------+
| *       | **E     | **      | *       | **In    | **E     | **Inv   |
| *Fiscal | conomic | Capital | *Volume | surance | conomic | estment |
| Year**  | Value   | Ratio   | of New  | in      | Value   | E       |
|         | of the  | (%)**   | Endo    | For     | of Each | arnings |
|         | Fu      |         | rse-men | ce^c^** | New     | on Fund |
|         | nd^a^** |         | ts^b^** |         | Book of | Bal     |
|         |         |         |         |         | Bus     | ances** |
|         |         |         |         |         | iness** |         |
+---------+---------+---------+---------+---------+---------+---------+
| 2008    | 12,908  | 3.00    | 154,240 | 429,634 | -3,643  | 　      |
+---------+---------+---------+---------+---------+---------+---------+
| 2009    | 15,823  | 2.52    | 280,404 | 626,968 | 2,384   | 532     |
+---------+---------+---------+---------+---------+---------+---------+
| 2010    | 20,491  | 2.30    | 331,092 | 891,329 | 3,999   | 669     |
+---------+---------+---------+---------+---------+---------+---------+
| 2011    | 26,597  | 2.28    | 357,002 | 1,      | 5,192   | 914     |
|         |         |         |         | 165,450 |         |         |
+---------+---------+---------+---------+---------+---------+---------+
| 2012    | 33,807  | 2.39    | 364,405 | 1,      | 5,957   | 1,254   |
|         |         |         |         | 416,798 |         |         |
+---------+---------+---------+---------+---------+---------+---------+
| 2013    | 41,179  | 2.53    | 359,606 | 1,      | 5,710   | 1,662   |
|         |         |         |         | 626,564 |         |         |
+---------+---------+---------+---------+---------+---------+---------+
| 2014    | 49,030  | 2.71    | 364,344 | 1,      | 5,810   | 2,041   |
|         |         |         |         | 809,316 |         |         |
+---------+---------+---------+---------+---------+---------+---------+
| 2015    | 57,512  | 2.90    | 382,138 | 1,      | 6,055   | 2,427   |
|         |         |         |         | 981,451 |         |         |
+---------+---------+---------+---------+---------+---------+---------+

^a^ All values are as of the end of each fiscal year. The economic value
for future years (FY 2009 through FY 2015) is equal to the economic
value of the Fund at the end of the previous year, plus the current
year\'s interest earned on the previous fund economic value, plus the
economic value of the new book of business.

^b^ Based on HUD August 2008 projection.

^c^ Estimated based on the MMI Fund data extract as of June 30, 2008.

### 

### 

### B. Change in the Economic Value of the Fund 

Exhibit II-2 displays the components of the Fund\'s current economic
value and capital ratio, with comparisons between values in the FY 2007
and FY 2008 Reviews. The FY 2007 Review estimated that the Fund had
\$21.277 billion in economic value at the end of FY 2007 to cover future
claim losses.

We estimated that the Fund had total capital resources of \$27.281
billion at the end of FY 2008. The present value of future cash flows
was negative \$14.374 billion. Thus, as of the end of FY 2008, the Fund
had \$12.908 billion in economic value that can be used to cover
unanticipated future claim losses on the existing portfolio. To be more
specific, the \$12.908 billion is what remains and is available to pay
claims above their expected level in case future economic conditions
turn out to be worse than assumed in our base-case projections.

Exhibit II-2

+-----------------------------------------+-------------+--------------+
| **Estimates of MMI Fund Economic Value  |             |              |
| as End of FY 2008**                     |             |              |
+-----------------------------------------+-------------+--------------+
| **(\$ Millions)**                       |             |              |
+-----------------------------------------+-------------+--------------+
| **Item**                                | **End of FY | **End of FY  |
|                                         | 2007^a^**   | 2008**       |
+-----------------------------------------+-------------+--------------+
|                                         |             |              |
+-----------------------------------------+-------------+--------------+
| Cash                                    | \$ 4,413    |              |
+-----------------------------------------+-------------+--------------+
| Investments                             | 22,473      |              |
+-----------------------------------------+-------------+--------------+
| Properties and Mortgages                | 1,394       |              |
+-----------------------------------------+-------------+--------------+
| Other Assets and Receivables            | 183         |              |
+-----------------------------------------+-------------+--------------+
| Total Assets                            | \$ 28,463   |              |
+-----------------------------------------+-------------+--------------+
| Liabilities                             | 3,560       |              |
+-----------------------------------------+-------------+--------------+
| Total Capital Resources                 | \$ 24,903   |              |
+-----------------------------------------+-------------+--------------+
| Net Gain from Investments               |             | 1,026^b^     |
+-----------------------------------------+-------------+--------------+
| Net Insurance Income in FY 2008         |             | 1,352        |
+-----------------------------------------+-------------+--------------+
| **Total Capital Resources**             |             | **27,281**   |
+-----------------------------------------+-------------+--------------+
|                                         |             |              |
+-----------------------------------------+-------------+--------------+
| PV of Future Cash Flows on Outstanding  |             | (14,374)     |
| Business                                |             |              |
+-----------------------------------------+-------------+--------------+
| **Economic Value**                      | **\$        | **12,908**   |
|                                         | 21,277**^c^ |              |
+-----------------------------------------+-------------+--------------+
|                                         |             |              |
+-----------------------------------------+-------------+--------------+
| Unamortized Insurance-In-Force          | 332,293^c^  | 429,634      |
+-----------------------------------------+-------------+--------------+
| **Current Capital Ratio**               | *           | **3.00%**    |
|                                         | *6.40%**^c^ |              |
+-----------------------------------------+-------------+--------------+
| ** **                                   |             |              |
+-----------------------------------------+-------------+--------------+
| Amortized Insurance-In-Force            |             | 401,461      |
+-----------------------------------------+-------------+--------------+
| **Current Capital Ratio with            |             | **3.22%**    |
| Amortized**                             |             |              |
|                                         |             |              |
| **Insurance-In-Force**                  |             |              |
+-----------------------------------------+-------------+--------------+

^a^ Source: Audited Financial Statements for FY 2007.

^b^ Estimated by assuming the total capital resources as of the end of
FY 2007 earns a total investment return equal to 1-year Treasury
Constant-Maturity Rate, which averaged 4.12 percent during FY 2008.
(Source: Board of Governors of the Federal Reserve System).

^c^ From the FY 2007 Actuarial Review.

As seen in Exhibit II-2, the economic value of the MMI Fund decreased by
39.34 percent from that of last year's Review, and the current Fund\'s
capital ratio decreased by over half of its level in last year's Review
-- from 6.40 percent to 3.00 percent. This decrease is driven mainly by
the significant deterioration of the national housing market. The
negative 9.14 percent national house price change during FY 2008
significantly lowered the present value of future cash flows of all
existing books. Exhibit II-3 compares the FY 2007 and FY 2008 Reviews by
annual books of business to highlight how the value of each book has
changed.

**Exhibit II-3**

+-----------------+----------------+-----------------+-----------------+
| **Present Value |                |                 |                 |
| of Future Cash  |                |                 |                 |
| Flows**         |                |                 |                 |
|                 |                |                 |                 |
| **By Book of    |                |                 |                 |
| Business, FY    |                |                 |                 |
| 2007 Review, FY |                |                 |                 |
| 2008 Review,    |                |                 |                 |
| and Difference  |                |                 |                 |
| (\$ Millions)** |                |                 |                 |
+=================+================+=================+=================+
| **Book of       | **FY 2007      | **FY 2008       | **              |
| Business**      | Review^a^**    | Review^b^**     | Difference^c^** |
+-----------------+----------------+-----------------+-----------------+
| 1979            | 0              | 0               | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1980            | 0              | 0               | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1981            | 0              | 1               | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1982            | 0              | 1               | 1               |
+-----------------+----------------+-----------------+-----------------+
| 1983            | 1              | 3               | 2               |
+-----------------+----------------+-----------------+-----------------+
| 1984            | 0              | 0               | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1985            | -1             | -1              | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1986            | -1             | -2              | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1987            | -3             | -3              | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1988            | -2             | -2              | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1989            | -2             | -2              | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1990            | -3             | -3              | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1991            | -4             | -3              | 1               |
+-----------------+----------------+-----------------+-----------------+
| 1992            | -4             | -3              | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1993            | -8             | 10              | 18              |
+-----------------+----------------+-----------------+-----------------+
| 1994            | -12            | 15              | 27              |
+-----------------+----------------+-----------------+-----------------+
| 1995            | -12            | 9               | 21              |
+-----------------+----------------+-----------------+-----------------+
| 1996            | -24            | 4               | 28              |
+-----------------+----------------+-----------------+-----------------+
| 1997            | -27            | 2               | 30              |
+-----------------+----------------+-----------------+-----------------+
| 1998            | -50            | 9               | 59              |
+-----------------+----------------+-----------------+-----------------+
| 1999            | -96            | 23              | 119             |
+-----------------+----------------+-----------------+-----------------+
| 2000            | -92            | -35             | 57              |
+-----------------+----------------+-----------------+-----------------+
| 2001            | -57            | -76             | -20             |
+-----------------+----------------+-----------------+-----------------+
| 2002            | -86            | -167            | -82             |
+-----------------+----------------+-----------------+-----------------+
| 2003            | 25             | -433            | -458            |
+-----------------+----------------+-----------------+-----------------+
| 2004            | -262           | -850            | -588            |
+-----------------+----------------+-----------------+-----------------+
| 2005            | -547           | -1,259          | -711            |
+-----------------+----------------+-----------------+-----------------+
| 2006            | -1,355         | -1,998          | -643            |
+-----------------+----------------+-----------------+-----------------+
| 2007            | -1,331         | -3,297          | -1,966          |
+-----------------+----------------+-----------------+-----------------+
| **Total**       | -3,952         | -8,056          | -4,104          |
+-----------------+----------------+-----------------+-----------------+

^a^Values as of the end of FY 2007

^b^Values as of the end of FY 2008

^c^Numbers do not add due to rounding for this and some subsequent
Exhibits.

Exhibit II-3 shows that the present value of future cash flows of all
recent books of business declined materially from the FY 2007
projection. The deterioration in Fund performance is mainly due to the
much worse-than-expected house price appreciation rate during FY 2008
and the adjusted forecast of future appreciation rates. In July 2007
Global Insight, Inc. projected national average house price appreciation
of 2.47 percent during the 2008 to 2009 two-year period. However, in
their July 2008 forecast, Global Insight, Inc. revised the projection of
the appreciation rate during the same two-year period to negative 10.02
percent. The severe negative house price appreciation rate quickly
places many newly originated loans in a negative equity position,
leading to higher projected claim rates. As a result, the total present
value of future cash flows on outstanding books of business has dropped
from negative \$3.952 billion to negative \$8.056 billion.

### C. Changes from the FY 2007 Review to the FY 2008 Review 

This section describes the sources of change in estimates between the FY
2007 Review and the FY 2008 Review for the FY 2008 economic value and
the FY 2014 capital ratio. Separating out the effects of interrelated
approaches and assumptions can be done only up to a certain degree of
accuracy. The interrelationships among the approaches and assumptions
prevent us from identifying and analyzing these as purely independent
effects, since these are sometimes jointly determined. However, this
section presents a reasonable allocation of all the changes from FY 2007
Review estimates, by source of change. The purpose of this decomposition
is twofold. First, it traces the change in the economic value from FY
2007 to FY 2008 to their sources. Second, it explains changes between
the current estimate of the capital ratio in FY 2014 and the estimate
for FY 2014 that was presented in the FY 2007 Review.

**1. Change in Economic Value from FY 2007 to FY 2008**

The FY 2007 Review estimated the economic value of the Fund as of the
end of FY 2007 to be \$21.277 billion, and the projected FY 2007 and FY
2014 capital ratios to be 6.40 and 7.25 percent, respectively. In this
Review, we estimate the end-of-FY 2008 economic value for the MMI Fund
to be \$12.908 billion, which represents a decrease of \$8.369 billion
from the FY 2007 economic value reported in the FY 2007 Review. This
39.34 percent decrease in the estimated economic value of the MMI Fund
is accompanied by an increase in the unamortized IIF of 29.29 percent.
The lower estimated economic value combined with the higher unamortized
IIF caused the estimated capital ratio to decrease considerably by 3.40
percentage points, from 6.40 percent as of the end of FY 2007 to 3.00
percent as of the end of FY 2008.

**2. Current Estimate of FY 2008 Economic Value Compared with the
Estimate Presented in the FY 2007 Actuarial Review**

The FY 2007 Review projected that the FY 2008 book of business and
investment earnings on Fund balances would add \$0.390 billion and
\$1.082 billion, respectively, to the economic value of the Fund,
resulting in a projected FY 2008 economic value of \$22.748 billion.
With the updated MMI Fund data extract, we now estimate the value of the
FY 2008 book to be a *negative* \$3.643 billion and the investment
earnings in FY 2008 to be \$1.026 billion. This year's estimate of FY
2008 economic value is \$9.840 billion lower than the economic value
projected for FY 2008 in last year's Review, as shown in Exhibit II-4.

Exhibit II-4 also provides a summary of the decomposition of changes in
the current economic value of the Fund and the capital ratios as of
end‑of‑FY 2014 from the FY 2007 and the FY 2008 Reviews. The net change
is mainly driven by five factors: the change in the economic forecast
from last year, the change in the forecasted volume of new books of
business, the change in capital resources, the update and enhancement of
the econometric model, and the revision of loss severity rates to
capture rising FHA loss rates in recent years. The worse-than-expected
housing market recession in FY 2008 and FY 2009 makes the FY 2007 to FY
2009 books the worst performing in the past 20 years. The record high
endorsement volume of new books of business causes the rapid increase in
the Fund's IIF. Because the IIF is the denominator of the capital ratio,
this increase in the denominator reduces the capital ratio. The actual
capital resources of the MMI Fund as of end of FY 2007 turned out to be
lower than estimated in the FY 2007 Review. Updating and enhancing the
econometric model had a negative impact on the economic value. Finally,
the revised higher loss rates lead to a decrease in the economic value.
We now provide a more detailed discussion of these individual sources of
change.

# Exhibit II-4

+---------------------------------+--------+--------+--------+---------+
| **Summary of Changes in MMI     |        |        |        |         |
| Fund Estimated Economic Value   |        |        |        |         |
| Between FY 2007 and FY 2008**   |        |        |        |         |
|                                 |        |        |        |         |
| **(\$ Millions)**               |        |        |        |         |
+---------------------------------+--------+--------+--------+---------+
|                                 | Change | FY     | Change | Corres  |
|                                 | in FY  | 2008   | in     | ponding |
|                                 | 2008   | Ec     |        |         |
|                                 | Ec     | onomic | FY     | FY 2014 |
|                                 | onomic | Value  | 2014   | Capital |
|                                 | Value  |        | C      | R       |
|                                 |        |        | apital | atio^b^ |
|                                 |        |        | Ratio  | (%)     |
|                                 |        |        | (perc  |         |
|                                 |        |        | entage |         |
|                                 |        |        | p      |         |
|                                 |        |        | oints) |         |
+---------------------------------+--------+--------+--------+---------+
| FY 2007 Economic Value          |        | \$21,  |        |         |
| Presented in the FY 2007 Review |        | 277^a^ |        |         |
+---------------------------------+--------+--------+--------+---------+
| FY 2008 Economic Value          | \      | \$     |        |         |
| Presented in the FY 2007        | $1,082 | 22,359 |        |         |
| Review, Excluding the FY 2008   |        |        |        |         |
| Book of Business:               |        |        |        |         |
+---------------------------------+--------+--------+--------+---------+
| Plus: Forecasted Value of FY    | \$390  |        |        |         |
| 2008 Book of Business Presented |        |        |        |         |
| in the FY 2007 Review           |        |        |        |         |
+---------------------------------+--------+--------+--------+---------+
| Equals: FY 2008 Economic Value  |        | **\$22 |        | **      |
| Presented in the FY 2007        |        | ,748** |        | 7.25%** |
| Actuarial Review                |        |        |        |         |
+---------------------------------+--------+--------+--------+---------+
| Plus: a. Update Origination     | -\$44  | \$     | -0.01% | 7.24%   |
| Volume in the FY 2007           |        | 22,704 |        |         |
+---------------------------------+--------+--------+--------+---------+
| Plus: b. Update Actual Capital  | -\$484 | \$     | -0.12% | 7.12%   |
| Resources as of the End of FY   |        | 22,220 |        |         |
| 2007                            |        |        |        |         |
+---------------------------------+--------+--------+--------+---------+
| Plus: c. Update to Global       | -\     | \$     | -0.99% | 6.13%   |
| Insights July 2008 Economic     | $4,608 | 17,162 |        |         |
| Forecasts                       |        |        |        |         |
+---------------------------------+--------+--------+--------+---------+
| Plus: d. Switch to the FY 2008  | -\$582 | \$     | -0.90% | 5.23%   |
| Econometric Model               |        | 16,580 |        |         |
+---------------------------------+--------+--------+--------+---------+
| Plus: e. Update Forecast of     | \$659  | \$     | 0.70%  | 5.93%   |
| Future Book Compositions        |        | 17,239 |        |         |
+---------------------------------+--------+--------+--------+---------+
| Plus: f. Update Demand Volume   | -\     | \$     | -2.87% | 3.06%   |
| Forecasts                       | $2,130 | 15,109 |        |         |
+---------------------------------+--------+--------+--------+---------+
| Plus: g. Incorporate FHA's      | \$0    | \$     | 0.12%  | 3.18%   |
| Risk-Base Pricing Schedule      |        | 15,109 |        |         |
+---------------------------------+--------+--------+--------+---------+
| Plus: h. Change in Loss         | -\     | \$     | -0.28% | 2.90%   |
| Severity Assumptions            | $2,201 | 12,908 |        |         |
+---------------------------------+--------+--------+--------+---------+
| Equals: Estimate of FY 2008     | -\     | \$     | -4.35% | 2.90%   |
| Economic Value                  | $9,840 | 12,908 |        |         |
+---------------------------------+--------+--------+--------+---------+

^a^ Economic value as the end of FY 2007.

^b^ The 2014 capital ratios are presented so they can be directly
compared with those projected in the FY 2007 Review

**3. Decomposition of the Differences in Economic Value and Capital
Ratio of the Current Review versus the FY 2007 Review**

We now present a step-by-step analysis of the differences in the FY 2007
and FY 2008 Reviews.

**a. Updated Origination Volume of FY 2007**

The first component of change depicted in Exhibit II-4 relates to the
updated origination volume for FY 2007. The actual realized origination
volume of the FY 2007 book is 10.4 percent greater than the forecasted
volume reported in the FY 2007 Review. Given the larger size of the
estimated initial economic value of the FY 2007 book, this change caused
a reduction of \$44 million in the FY 2008 economic value.

**b. Updated Actual Capital Resources as of the End of FY 2007**

The second element of change delineated in Exhibit II-4 is the impact of
actual capital resources realized as of the end of the FY 2007 exposure
year. Since the FY 2007 Actuarial Review was prepared before the
availability of the FY 2007 year‑end financial statement, the capital
resources of the MMI Fund as of end of FY 2007 were estimated from the
capital resources as of the end of FY 2006. The actual capital resources
reported in the audited financial statements indicate the capital
resources of the MMI Fund to be \$24,903 million, which is \$462 million
less than that estimated in the FY 2007 Actuarial Review. This deviation
is caused by the differences in the investment income, the insurance
related cash flows, and the realization of the additional losses related
to the damages from the 2005 hurricanes. The \$462 million difference is
compounded one year forward and contributed to a decrease in FY 2008
economic value of \$484 million.

**c. Changes in the Economic Projections**

The Global Insight, Inc. July 2008 forecast projects the three key
interest rates that were used in this Review. The three series decline
in the short and intermediate terms in contrast to the increasing rate
scenarios that were forecasted a year ago. All three rates rise to a
high long-term stable level after 2010. Higher near-term mortgage
interest rates imply that the FY 2008 and FY 2009 books will experience
lower prepayment rates than were previously estimated for the FY 2007
Review. The lower prepayment rates imply that these loans are exposed to
claim risk for longer periods of time, causing a decrease in economic
value, an increase in IIF, and leading to a lower capital ratio.

The housing recession experienced during the past several quarters
increased the risk of the existing books of business, particularly in
terms of increasing the probability of negative equity. According to the
Global Insight, Inc. forecast, the annualized national average house
price growth rate is projected to be negative 9.14 percent in FY 2008.
The annualized house appreciation rates are projected to be negative
10.56 percent and negative 8.51 percent, respectively, in the first and
second quarters of FY 2009. In FY 2007, Global Insight, Inc. forecasted
that the annualized house appreciation rates would be negative 1.17
percent in FY 2008, with positive 0.09 percent and positive 0.78 percent
rates forecast for the first and second quarters of FY 2009,
respectively. Therefore, the corresponding rates applied in this year's
Review were much worse than the rates originally forecasted by Global
Insight, Inc. in August 2007. The decline in house prices is now
forecast to continue during FY 2008, FY 2009, and all of FY 2010. Due to
this severe housing market correction, the performance of newer books of
business, especially those of FY 2006 to FY 2009, are expected to be
much worse than those projected in the FY 2007 Review. The very weak
housing market implies that many newly originated loans will quickly
fall into a negative equity position, thereby resulting in higher
projected claim rates relative to what were estimated in the FY 2007
Review. Exhibit II-4 shows that the economic value for the FY 2008 book
has decreased by \$4.608 billion due to the change in economic
forecasts.

**d. Change in Econometric Models**

In this year's Review, we applied similar econometric and discounted
cash flow models as in previous years, with some changes in model
specification. Descriptions of the changes in model specification can be
found in Appendices A and B. The main enhancement of the econometric
model was to improve the incorporation of borrower credit history
information at the loan-level using mixed data sources. FHA started
collecting borrower credit history information in 2004. Loans with
credit history data from this direct source are entering their peak
claim seasons, which allowed the model to more accurately differentiate
the impact of these loans from the choice-based sample data collected in
previous years. The estimation results confirmed that credit history is
among the most influential factors explaining the claim probability
among individual FHA-insured mortgages and is also a significant factor
in explaining prepayment behavior.

Another model enhancement was the addition of a measure of relative
house price as an independent predictive variable, to better reflect
policy changes that allowed the movement of FHA into the jumbo loan
market during FY 2008. The model also further separated the performance
of fully underwritten refinance mortgages from purchase-money mortgages.

The combined model enhancements caused the economic value of FY 2008 to
decrease by \$582 million and the FY 2014 capital ratio to drop by 0.90
percentage points.

This component depicts the changes in the economic value for FY 2008 due
to changes in HUD forecasts of the composition of future books of
business across product types, credit scores, loan-to-value ratios, and
loans with downpayment assistance from non-profit organizations.

First, changes in the eligibility of loan with seller-funded downpayment
assistance alter the projected composition of future FHA endorsements.
As summarized in Section I of this Review, it is assumed that there will
be no seller-related non-profit organization funded downpayment-assisted
loans endorsed by the MMI Fund starting FY 2009. As these loans had very
high claim rates, it is important to keep close scrutiny of the new
endorsement data for the validity of this assumption.

Second, to provide relief to mortgage borrowers subject to increased
monthly payments due to the resetting of interest rates on ARMs from
private lenders, the *FHASecure* program allowed FHA to insure many
conventional-to-FHA refinance loans.

Third, FHA Modernization Act of 2008 requires a downpayment of at least
3.5 percent for any FHA loan effective January 1, 2009.

Fourth, FHA set a minimum FICO score of 500 unless borrowers had a ten
percent or more downpayment, effective July 14, 2008. According to FHA,
this policy has been and will be continued despite of the moratorium on
risk-based pricing.

With these new programs and underwriting standards, FHA projected that
the FICO-LTV combination for future fully underwritten mortgages will
follow the distribution shown in Exhibit II-5.

**Exhibit II-5**

  ----------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- -------------
  **Portfolio                                                                                                         
  Composition of FY                                                                                                   
  2009 (in                                                                                                            
  Percent)**                                                                                                          

  **Loan-to-Value   **FICO Score                                                                                      
  Ratio Range**     Range**                                                                                           

                    **850-680**   **679-640**   **639-620**   **619-600**   **599-560**   **559-500**   **499-300**   **Missing**

  X \<= 90          3.46          3.39          2.41          2.41          3.62          2.41          0.36          0.59

  90\<X\<=95        5.85          5.39          2.95          2.95          4.19          2.51          0.00          0.42

  95\<X\<=96.5      17.75         10.93         5.21          5.21          7.02          9.35          0.00          1.62
  ----------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- -------------

The *FHASecure* program is scheduled to terminate on December 31, 2008.
After excluding previously delinquent refinance loans from that program,
FHA forecasts that the FICO-LTV composition of FY 2010 and later books
of business will follow the composition in Exhibit II-6.

**Exhibit II**-6

  ------------------ ------------- ------------- ------------- ------------- ------------- ------------- ------------- -------------
  **Portfolio                                                                                                          
  Composition of FY                                                                                                    
  2010 to FY 2015                                                                                                      
  (in Percent)**                                                                                                       

  **Loan-to-Value    **FICO Score                                                                                      
  Ratio Range**      Range**                                                                                           

                     **850-680**   **679-640**   **639-620**   **619-600**   **599-560**   **559-500**   **499-300**   **Missing**

  **X \<= 90**       3.83          3.76          2.66          2.66          4.00          2.67          0.40          0.65

  **90\<X\<=95**     6.47          5.96          3.26          3.26          3.57          1.72          0.00          0.47

  **95\<X\<=96.5**   19.63         12.09         5.76          5.76          6.71          2.91          0.00          1.80
  ------------------ ------------- ------------- ------------- ------------- ------------- ------------- ------------- -------------

The changes in the expected composition of future books had a positive
impact on the MMI Fund by increasing the FY 2008 economic value by \$659
million and increasing the FY 2014 capital ratio by 0.70 percentage
points.

**f. Change Due to Demand Volume Forecast**

Relative to the FY 2007 Review, the volumes of future books of business
forecasted by FHA are substantially higher this year. Based on FHA's
August 2008 demand forecast, the future annual origination volumes for
FYs 2008-2014 increased by multiples of 3.08, 4.80, 5.04, 4.92, 4.69,
4.17 and 3.94, respectively, from the corresponding volumes forecast in
August 2007. The total origination volume between FY 2008 and FY 2014 is
4.39 times greater than projected in last year. Due to the significantly
negative initial economic value of the FY 2008 book, higher volume
indicates a larger negative contribution to the economic value of the
Fund, causing the FY 2008 economic value to decrease by \$2.130 billion.
Also, the increase in the size of FY 2009 and later books of business
will lead to larger economic values and higher IIF for all future years.
However, the magnitude of the increase in the size of the economic value
is less than that of the increase in IIF, causing the capital ratio to
decrease in future FYs. By the end of FY 2014, the Fund's capital ratio
is estimated to decrease by 2.87 percentage points because of the change
in the demand volume forecast.

**g. Change Due to Risk-Based Premium Policy**

In its proposal for risk-based pricing effective July 14, 2008, FHA
established a minimum FICO score of 500 unless borrowers had a ten
percent or more downpayment. The policy also explained FHA's plan to
charge different upfront and annual premiums according to the credit
risks of individual loans. The premium schedule proposed by FHA differs
according to the FICO-LTV combinations. The detailed premium schedule is
presented in Appendix B. The passage of HERA placed a 12-month
moratorium on HUD's implementation of the risk-based premiums effective
October 1, 2008. In this Review, we assumed that the risk-based premium
will be implemented starting October 1, 2009. Since this policy does not
affect existing books of business, it has no impact on the FY 2008
economic value. It increases the FY 2014 capital ratio by 0.12
percentage points.

**h. Change Due to Loss Severity Assumption**

The loss rates applied in this Review follow the same methodology as
those of the FY 2007 Review. They are based on the level of the FY 2006
claim experience, the highest single-year loss severity rates during
recent history. As in last year's Review, the loss rates are
disaggregated by product type, non-profit downpayment source, and state
foreclosure practice. Traditionally, judicial foreclosure states tend to
experience higher loss severity rates than in other states, even for
otherwise comparable loans. Using updated claim loss data from FHA's
database, we revised the loss-rate assumptions for loans with different
characteristics. The updated loss rates are higher than those estimated
with data available for FY 2007 Review. Generally, loans with longer
times from claim to disposition tend to have higher ultimate loss rates.
This is due to the higher cost of carrying the real estate owned (REO)
and greater likelihood of physical deterioration. During the past year,
with the weakest housing market in recent history, REO properties
suffered from further decreases in market value. As a result, loans
associated with FHA insurance claims filed during FY 2006, but the REO
not disposed until FY 2008, may realize particularly severe loss rates.
The average loss rate for the FY 2006 terminated loans increased when
these high-loss-rate incidences were added to the database. Exhibit II-7
summarizes the loss rates applied in this Review.

**Exhibit II-7**

  ------------ ---------------- ------------ -------- --------- -------- -------- --------
  **Average                                                                       
  Loss                                                                            
  Severity                                                                        
  Rates of                                                                        
  Claimed                                                                         
  Loans by                                                                        
  Claim Year                                                                      
  (in                                                                             
  Percent)**                                                                      

  **Down       **Judicial       **Mortgage                                        
  Payment      Fore-closure**   Product                                           
  Assistance                    Type**                                            
  Loan**                                                                          

                                **1**        **2**    **3**     **4**    **5**    **6**

  No           No               39.82        41.74    34.87     34.27    34.09    35.17

               Yes              51.94        72.58    46.79     46.58    57.27    45.44

  Yes          No               41.37        43.16    37.47                       

               Yes              51.18        63.09    49.41                       
  ------------ ---------------- ------------ -------- --------- -------- -------- --------

Updating the loss severity rates has a substantially negative impact on
FY 2008 economic value of \$2.201 billion and the corresponding capital
ratio for FY 2014 was reduced by 0.28 percentage points.

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