**Section II: Summary of Findings** **and Comparison with FY 2006
Actuarial Review**

This section presents the economic value and capital ratios of the Fund
for FY 2007 and provides an explanation of how the results of this
year\'s Review compare with those of the FY 2006 Review.

**A. The FY 2007 Actuarial Review**

The FY 2007 Actuarial Review assessed the actuarial soundness of the MMI
Fund as of the end of FY 2007 (September 30, 2007) in terms of whether
the Fund has maintained at least the two percent capital ratio required
by NAHA, and projected the status of the Fund through FY 2014. 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 those 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 historical data provided by FHA,
applying the appropriate policy parameters, and using 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 2006 Review with some enhancements for this FY 2007
Review. The analysis utilizes loan-level data on the Fund\'s experience
reported by HUD through May 2007. 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, whether a judicial process is used for
foreclosure by the state where the collateral property is located, and
whether downpayment assistance from non-profit organizations were
received. (For descriptions of the individual models and assumptions,
see Appendices A through D.) Our major findings are as follows:

-   as of the end of FY 2007, the MMI Fund was projected to have an
    estimated economic value of **\$21.277** **billion** and an
    unamortized insurance-in-force of **\$332.293 billion**;

-   the FY 2007 book of business was projected to bring an estimated
    negative **\$406 million** in present value to the economic value of
    the MMI Fund;

-   the capital ratio was estimated to be **6.40 percent** as of
    September 30, 2007, and projected that this ratio will be **7.25
    percent** as of September 30, 2014. Based on these estimates, we
    conclude that the Fund would continue to exceed the NAHA-mandated
    2.00 percent capital ratio in the foreseeable future.

Our current projections indicate that the Fund\'s economic value will
continue to increase in the future, rising by an average of 8.39 percent
per year through FY 2014. With the expected slower prepayment rate of
the existing books of business implied by the rising interest rate
environment and FHA's projection of a lower endorsement volume of future
books of business, the insurance in force (IIF) of the Fund would
increase by an average rate of 6.48 percent per year through FY 2014.
The economic value is expected to grow at a much faster rate than that
of the IIF, causing the Fund's projected capital ratio to increase to
7.25 percent at the end of FY 2014. Exhibit II-1 provides estimates of
the Fund\'s economic value, insurance in force and capital ratio through
the end of FY 2014.

**Exhibit II-1**

+---------+---------+---------+---------+---------+---------+---------+
| **Pr    |         |         |         |         |         |         |
| ojected |         |         |         |         |         |         |
| MMI     |         |         |         |         |         |         |
| Fund    |         |         |         |         |         |         |
| Perf    |         |         |         |         |         |         |
| ormance |         |         |         |         |         |         |
| for FYs |         |         |         |         |         |         |
| 2007 to |         |         |         |         |         |         |
| 2014**  |         |         |         |         |         |         |
|         |         |         |         |         |         |         |
| **(\$   |         |         |         |         |         |         |
| 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** |         |
+---------+---------+---------+---------+---------+---------+---------+
| 2007    | 21,277  | 6.40    | 52,193  | 332,293 | -406    | 　      |
+---------+---------+---------+---------+---------+---------+---------+
| 2008    | 22,748  | 6.67    | 50,149  | 341,012 | 390     | 1,082   |
+---------+---------+---------+---------+---------+---------+---------+
| 2009    | 24,706  | 6.83    | 58,381  | 361,566 | 849     | 1,108   |
+---------+---------+---------+---------+---------+---------+---------+
| 2010    | 26,796  | 6.86    | 65,658  | 390,544 | 892     | 1,199   |
+---------+---------+---------+---------+---------+---------+---------+
| 2011    | 29,053  | 6.87    | 72,556  | 422,986 | 936     | 1,321   |
+---------+---------+---------+---------+---------+---------+---------+
| 2012    | 31,492  | 6.91    | 77,773  | 455,984 | 985     | 1,454   |
+---------+---------+---------+---------+---------+---------+---------+
| 2013    | 34,251  | 7.01    | 86,237  | 488,420 | 1,167   | 1,592   |
+---------+---------+---------+---------+---------+---------+---------+
| 2014    | 37,405  | 7.25    | 92,439  | 515,698 | 1,410   | 1,744   |
+---------+---------+---------+---------+---------+---------+---------+

^a^ All values are as of the end of each fiscal year. The economic value
for future years (FYs 2008 through 2014) 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 balance, plus the economic value of
the new book of business.

^b^ Based on HUD August 2007 projection.

^c^ Estimated based on the MMI Fund data extract as of May 31, 2007.

### B. Change in the Estimated Strength 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 2006
and the 2007 Reviews. The FY 2006 Review estimated that the Fund had
\$22.021 billion in economic value at the end of FY 2006 to cover future
claim losses.

Exhibit II-2

  ------------------------------------------- -------------- --------------
  **Estimates of MMI Fund Economic Value as                  
  End of FY 2007**                                           

  **(\$ Millions)**                                          

  **Item**                                    **End of FY    **End of FY
                                              2006^a^**      2007**

                                                              

  Cash                                        \$ 5,811       

  Investments                                 22,004         

  Properties and Mortgages                    1,628          

  Other Assets and Receivables                255            

  Total Assets                                \$ 29,698      

  Liabilities                                 5,476          

  Total Capital Resources                     \$ 24,222      

  Net Gain from Investments                                  1,214^b^

  Net Insurance Income in FY 2007                            \(71\)

  **Total Capital Resources**                                **25,365**

                                                             

  PV of Future Cash Flows on Outstanding                     (3,952)
  Business                                                   

  Special Loss Reserve for Damages from 2005                 (136)^c^
  Hurricanes                                                 

  **Economic Value**                          **\$           **21,277**
                                              22,021**^d^    

                                                             

  Unamortized Insurance-In-Force              323,028^d^     332,293

  **Current Capital Ratio**                   **6.82%**^d^   **6.40%**

                                                             

  Amortized Insurance-In-Force                               305,449

  **Current Capital Ratio with Amortized                     **6.97%**
  Insurance-In-Force**                                       
  ------------------------------------------- -------------- --------------

^a^ Source: Audited Financial Statements for FY 2006.

^b^ Estimated by assuming the total capital resources as of the end of
FY 2006 earns a total investment return equal to 1-year Treasury
Constant-Maturity Rate, which averaged 5.01 percent during FY 2007.
(Source: Board of Governors of the Federal Reserve System).

^c^ Estimated by HUD as of October 2007.

^d^ From the FY 2006 Actuarial Review.

We estimated that the Fund had total capital resources of \$25.365
billion at the end of FY 2007. The present value of future cash flows
was -\$3.952 billion. The special loss reserve for damages related to
2005 Hurricanes was -\$136 million. Thus, as of the end of FY 2007, the
Fund had \$21.277 billion in economic value, which can be used to cover
unanticipated future claim losses of the existing portfolio.

As seen in Exhibit II-2, the current economic value of the MMI Fund
decreased by 3.38 percent from that of last year's Review, and the
current Fund\'s capital ratio actually decreased by 6.16 percent from
that of last year's Review. That is, the capital ratio decreased from
6.82 percent to 6.40 percent. This decrease is due mainly to the
significant deterioration of the national housing market. The negative
2.14 percent national house price appreciation during FY 2007
significantly lowered the present value of future cash flows of all
existing books. Exhibit II-3 compares the FY 2006 and FY 2007 Reviews by
annual books of business to highlight how the value of each book has
changed. It shows that the present value of future cash flows of all
recent books of business declined from the FY 2006 projection. The
deterioration is mainly due to the much worse-than-expected house price
appreciation rate during FY 2007 and the adjusted future appreciation
rates. Last year, Global Insight projected the national house price
appreciation of 5.94 percent during the 2007 to 2008 two-year period.
However, in their August 2007 forecast, Global Insight revised the
projection of the appreciation rate during the same two-year period to
be negative 3.28 percent. The negative appreciation rate causes many
newly originated loans to fall into a negative equity position, leading
to high claim rates. The current Review shows that the total present
value of future cash flows on outstanding books of business has dropped
from negative \$1.44 billion to negative \$2.62 billion.

**Exhibit II-3**

+-----------------+----------------+-----------------+-----------------+
| **Present Value |                |                 |                 |
| of Future Cash  |                |                 |                 |
| Flows**         |                |                 |                 |
|                 |                |                 |                 |
| **by Book of    |                |                 |                 |
| Business, FY    |                |                 |                 |
| 2006 Review, FY |                |                 |                 |
| 2007 Review,    |                |                 |                 |
| and Difference  |                |                 |                 |
| (\$ Millions)** |                |                 |                 |
+=================+================+=================+=================+
| **Book of       | **FY 2006      | **FY 2007       | **              |
| Business**      | Review^a^**    | Review^b^**     | Difference^c^** |
+-----------------+----------------+-----------------+-----------------+
| 1978            | 0              | 0               | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1979            | 1              | 0               | -1              |
+-----------------+----------------+-----------------+-----------------+
| 1980            | 1              | 0               | -1              |
+-----------------+----------------+-----------------+-----------------+
| 1981            | 0              | 0               | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1982            | 0              | 0               | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1983            | 1              | 1               | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1984            | 0              | 0               | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1985            | -1             | -1              | 0               |
+-----------------+----------------+-----------------+-----------------+
| 1986            | -3             | -1              | 2               |
+-----------------+----------------+-----------------+-----------------+
| 1987            | -4             | -3              | 1               |
+-----------------+----------------+-----------------+-----------------+
| 1988            | -3             | -2              | 1               |
+-----------------+----------------+-----------------+-----------------+
| 1989            | -4             | -2              | 2               |
+-----------------+----------------+-----------------+-----------------+
| 1990            | -5             | -3              | 2               |
+-----------------+----------------+-----------------+-----------------+
| 1991            | -6             | -4              | 2               |
+-----------------+----------------+-----------------+-----------------+
| 1992            | -6             | -4              | 2               |
+-----------------+----------------+-----------------+-----------------+
| 1993            | -10            | -8              | 2               |
+-----------------+----------------+-----------------+-----------------+
| 1994            | -15            | -12             | 3               |
+-----------------+----------------+-----------------+-----------------+
| 1995            | -11            | -12             | -1              |
+-----------------+----------------+-----------------+-----------------+
| 1996            | -27            | -24             | 3               |
+-----------------+----------------+-----------------+-----------------+
| 1997            | -29            | -27             | 2               |
+-----------------+----------------+-----------------+-----------------+
| 1998            | -54            | -50             | 4               |
+-----------------+----------------+-----------------+-----------------+
| 1999            | -107           | -96             | 11              |
+-----------------+----------------+-----------------+-----------------+
| 2000            | -118           | -92             | 26              |
+-----------------+----------------+-----------------+-----------------+
| 2001            | -45            | -57             | -12             |
+-----------------+----------------+-----------------+-----------------+
| 2002            | -26            | -86             | -60             |
+-----------------+----------------+-----------------+-----------------+
| 2003            | 256            | 25              | -231            |
+-----------------+----------------+-----------------+-----------------+
| 2004            | -144           | -262            | -118            |
+-----------------+----------------+-----------------+-----------------+
| 2005            | -230           | -547            | -317            |
+-----------------+----------------+-----------------+-----------------+
| 2006            | -853           | -1,355          | -502            |
+-----------------+----------------+-----------------+-----------------+
| **Total**       | -1,442         | -2,622          | -1,180          |
+-----------------+----------------+-----------------+-----------------+

^a^Values as of the end of FY 2006

^b^Values as of the end of FY 2007

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

### C. Changes from the FY 2006 Review to the FY 2007 Review 

This section describes the sources of change in estimates between the FY
2006 Review and the FY 2007 Review for the FY 2007 economic value and
the FY 2013 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 2006
Review estimates, by source of change. The purpose of the decomposition
is twofold. First, it describes the change in the economic value from FY
2006 to FY 2007. Second, it explains changes between the current
estimate of the capital ratio in FY 2007 and the estimate for FY 2007
that was previously presented in the FY 2006 Review.

**1. Change in Economic Value from FY 2006 to FY 2007**

The FY 2006 Review estimated the economic value of the Fund as of the
end of FY 2007 to be \$23.127 billion, and the projected FY 2007 and FY
2013 capital ratios to be 6.90 and 6.73 percent, respectively. In this
Review, we estimated the end-of-FY 2007 economic value for the MMI Fund
of \$21.277 billion, which represents a decrease of \$744 million from
the FY 2006 economic value reported in the FY 2006 Review. This 3.38
percent decrease in the estimated economic value of the MMI Fund is
accompanied by an increase in the unamortized IIF of 2.87 percent and
caused the estimated capital ratio to decrease by 0.42 percentage
points, from 6.82 percent as of the end of FY 2006 to 6.40 percent as of
the end of FY 2007.

**2. Current Estimate of FY 2007 Economic Value Compared with the
Estimate Presented in the FY 2006 Actuarial Review**

The FY 2006 Review projected that the FY 2007 book of business and
investment earnings on Fund balances would add \$81 million and \$1,025
million, respectively, to the economic value of the Fund, resulting in a
projected FY 2007 economic value of \$23.127 billion. With the updated
MMI Fund data extract, we now estimate the value of the FY 2007 book to
be a *negative* \$406 million and the investment earnings in FY 2007 to
be \$1,214 million. This year's estimate of the FY 2007 economic value
is \$1,850 million lower than the economic value projected for FY 2007
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 ratio in FY 2013
from the FY 2006 and the FY 2007 Reviews. The net change is mainly
driven by three factors: the change in the economic forecast from last
year, the change in capital resources, and the enhancement of the
econometric model to better model the impact of borrower credit scores.
The worse-than-expected housing market slowdown in FY 2007 and FY 2008
makes the FY 2006 to FY 2008 the worst performing books in the past 20
years. The actual capital resource of the MMI Fund as of end of FY 2006
turned out to be higher than estimated in the FY 2006 Review. The
updated estimate of the one-time special loss reserve for damages by
2005 hurricanes is less severe than the previous estimate. Enhancing the
econometric model to incorporate loan-level borrower credit scores had a
positive impact on the economic value. The following pages provide more
detailed discussions of individual sources of change.

# Exhibit II-4

+--------------------------------+--------+--------+--------+--------+
| **Summary of Changes in MMI    |        |        |        |        |
| Fund Estimated Economic Value  |        |        |        |        |
| Between FY 2006 and FY 2007**  |        |        |        |        |
|                                |        |        |        |        |
| **(\$ Millions)**              |        |        |        |        |
+--------------------------------+--------+--------+--------+--------+
|                                | Change | FY     | Change | C      |
|                                | in FY  | 2007   | in     | orresp |
|                                | 2007   | Ec     |        | onding |
|                                | Ec     | onomic | FY     |        |
|                                | onomic | Value  | 2013   | FY     |
|                                | Value  |        | C      | 2013   |
|                                |        |        | apital | C      |
|                                |        |        | Ratio  | apital |
|                                |        |        | (%)    | Ra     |
|                                |        |        |        | tio^b^ |
|                                |        |        |        | (%)    |
+--------------------------------+--------+--------+--------+--------+
| FY 2006 Economic Value         |        | 22,    |        |        |
| Presented in the FY 2006       |        | 021^a^ |        |        |
| Review                         |        |        |        |        |
+--------------------------------+--------+--------+--------+--------+
| FY 2007 Economic Value         | \      | 23,046 |        |        |
| Presented in the FY 2006       | $1,025 |        |        |        |
| Review, Excluding the FY 2007  |        |        |        |        |
| Book of Business:              |        |        |        |        |
+--------------------------------+--------+--------+--------+--------+
| Plus: Forecasted Value of FY   | \$81   |        |        |        |
| 2007 Book of Business          |        |        |        |        |
| Presented in the FY 2006       |        |        |        |        |
| Review                         |        |        |        |        |
+--------------------------------+--------+--------+--------+--------+
| Equals: FY 2007 Economic Value |        | **\$23 |        | **6    |
| Presented in the FY 2006       |        | ,127** |        | .73%** |
| Actuarial Review               |        |        |        |        |
+--------------------------------+--------+--------+--------+--------+
| Plus: a. Update Actual         | \- \$1 | \$     | \-     | 6.72%  |
| Origination Volume in the FY   |        | 23,126 | 0.01%  |        |
| 2006                           |        |        |        |        |
+--------------------------------+--------+--------+--------+--------+
| Plus: b. Updated Special Loss  | \$505  | \$     | 0.15%  | 6.87%  |
| Reserve for Damages from 2005  |        | 23,631 |        |        |
| Hurricanes in the FY 2006      |        |        |        |        |
+--------------------------------+--------+--------+--------+--------+
| Plus: c. Update Actual         | \$156  | \$     | 0.04%  | 6.91%  |
| Termination Rates and Net      |        | 23,787 |        |        |
| Income during FY 2006          |        |        |        |        |
+--------------------------------+--------+--------+--------+--------+
| Plus: d. Switch to the FY 2007 | \$472  | \$     | 0.35%  | 7.26%  |
| Econometric Model              |        | 24,259 |        |        |
+--------------------------------+--------+--------+--------+--------+
| Plus: e. Update to Global      | \-     | \$     | \-     | 6.41%  |
| Insights August 2007 Economic  | \      | 21,087 | 0.85%  |        |
| Forecasts                      | $3,172 |        |        |        |
+--------------------------------+--------+--------+--------+--------+
| Plus: f. Update Demand         | \$145  | \$     | 0.63%  | 7.04%  |
| Forecasts and Composition of   |        | 21,232 |        |        |
| Future Books                   |        |        |        |        |
+--------------------------------+--------+--------+--------+--------+
| Plus: g. Change in Loss        | \$45   | \$     | -0.03% | 7.01%  |
| Severity Assumptions           |        | 21,277 |        |        |
+--------------------------------+--------+--------+--------+--------+
| Equals: Estimate of FY 2007    | \$     | \$     | 0.28%  | 7.01%  |
| Economic Value                 | -1,850 | 21,277 |        |        |
+--------------------------------+--------+--------+--------+--------+

^a^ Economic value as the end of FY 2006.

^b^ The 2013 capital ratios are presented so they can be directly
compared with those projected in the FY 2006 Review

**3. Decomposition of the Differences in Economic Value and Capital
Ratio of the Current Review versus the FY 2006 Review**

We first identified the change in the estimated status of the Fund by
adjusting for the actual FY 2006 origination volume and for the FY 2006
actual conditional prepayment and claim rates and other net cash flows.
Then we decomposed the change in the estimated status of the fund that
resulted from econometric model enhancements made in the current FY 2007
Review and from the new economic and origination volume forecasts.
Finally, the loss severity rates are further differentiated by the state
judicial foreclosure regulation of the collateral housing. Exhibit II-4
summarizes the effects of the individual sources of changes on the
Fund's economic value at the end of FY 2007 and the capital ratio at the
end of FY 2013.

**a. Updated Origination Volume of FY 2006**

The first component of change depicted in Exhibit II-4 is with respect
to the updated origination volume for FY 2006. The actual realized
origination volume of the FY 2006 book is 3.1 percent less than the
forecasted volume reported in the FY 2006 Review. With the smaller size
of the estimated initial economic value of the FY 2007 book, this change
caused a trivial reduction of \$1 million in the FY 2007 economic value.

**b. Updated Special Loss Reserve for Damages from 2005 Hurricanes**

The second element of change described in Exhibit II-4 is the adjustment
of updated estimate of the special loss reserve for damages related to
2005 hurricanes. As of the end of FY 2006, HUD estimated that the
one-time 2005 hurricane loss reserve was about \$613 million. This
estimate was updated to be about \$136 million when using the data in
October 2007. This updated estimation leads to less expected loss and
cause the FY 2007 economic value to increase by \$505 million. This
additional amount causes the projected capital ratio for FY 2013 to
increase by 0.15 percentage points.

**c. Updated Actual Mortgage Termination Experience**

The third element of change delineated in Exhibit II-4 is the impact of
updated conditional prepayment and claim experience actually realized
during the FY 2006 exposure year. The unexpected dip in interest rates
during late 2006 and the early months of 2007 increased the prepayment
rate relative to last year's projection. More significantly, the actual
house price appreciation rate during the late FY 2006 and early FY 2007
was much worse than was forecast in June 2006, leading to higher claim
rates for all newer books of business. Both factors lead to a rapid
decline in the IIF of the most recently originated loans. Therefore, the
smaller size of the insurance in force implies lower annual insurance
premium income, but it also reduces the risk for these books from
possible future claims. The adjustment for actual mortgage termination
experience and investment income causes the FY 2007 economic value to
increase by 156 million and the capital ratio in the FY 2013 to increase
by 0.04 percentage points.

**d. Change in Econometric Models**

To conduct this year's Review, we followed last year's econometric and
discounted cash flow models, with some changes in model specification.
(For descriptions of the changes in model specification assumptions, see
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. By using borrower information at the individual loan
level, the model is more sensitive and can better differentiate loans
that have the same product type, origination year, loan size and initial
LTV, but have different borrower scores. Modeling at the loan level also
provided better control for potential bias due to choice-based sampling
of historical credit scores. The estimation results confirm 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. These improvements
will also enhance the utility of the econometric models in supporting
FHA's risk-based pricing initiatives. Risk-based pricing is a key
component of FHA reforms included in the President's proposed FY 2007
Budget. Due to the improved measurement of the correlation between
borrower credit scores and other risk characteristics, econometric model
changes caused the economic value of FY 2006 to increase by \$472
million and the capital ratio of FY 2013 to rise by 0.35 percentage
points.

**e. Changes in Economic Environment**

Despite the flat yield curve observed in July 2007, the Global Insight
August 2007 forecast projects the three key interest rates used in this
Review to rise much faster in the short and intermediate terms than was
forecasted a year ago. All rates decline thereafter to a lower long-term
stable level after 2013. With lower long-term future interest rates, the
prepayment rates of FY 2010 and future books of business are expected to
be much higher than were estimated in the FY 2006 Review. The higher
prepayment rate, together with lower expected origination volume of
these future books, causes the insurance in force to be lower, and leads
to a higher 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 experiencing negative equity.
According to the Global Insight forecast, the annual house price growth
rates are projected to be negative 2.14 in FY 2007, and negative 1.17
percent in FY 2008. Due to this severe housing market slowdown, the
performances of the newer books of business, especially those of FYs
2006, 2007 and 2008, are expected to be much weaker than that of the
older books. The weaker housing market forecasts indicate that many
newly originated loans rapidly fall into a negative equity position,
thereby resulting in higher projected claim rates relative to what were
estimated in the FY 2006 Review. Exhibit II-4 shows that the economic
value for FY 2007 decreased by \$3,172 million due to the change in
economic forecasts.

**f. Changes Due to Forecast of Demand Volume and Composition of Future
Books**

This part depicts the changes in economic value for FY 2007 due to
changes in the assumptions of the FHA forecasted volumes of future books
of business, the composition among products, and loans with gift letters
from non-profit organizations.

First, relative to the FY 2006 Review, the volumes of future books of
business forecasted by FHA are lower this year. Based on FHA's August
2007 forecast, annual origination volumes will grow at a much slower
rate during the next seven years. The decrease in the size of new books
of business will lead to a smaller economic value and a lower IIF for FY
2013.

Second, during the last few years, there was a rapid reduction in FHA's
endorsement of high-LTV loans and ARMs. As will be shown in Section IV,
loans with less than 3 percent downpayment had declined from about 55
percent in FY 2005 to about 42 percent in FY 2007. Partially due to the
higher volume in fully underwritten cash-out refinance mortgages, larger
portions of the two newest books of business are shifted to having more
than 5 percent downpayments. The reduced concentration in high-LTV loans
helped improve the quality of the FY 2006, FY 2007, and future books of
business. Traditionally, ARM loans appear to be safer, realizing lower
claim rates during a normal economy. The stressed house price forecast
in this year's Review revealed that ARMs are vulnerable to economic
downturns. The claim rates of the FY 2006 to FY 2008 ARMs and streamline
refinance ARMs rise sharply in response to the projected negative house
price appreciation rates in FYs 2007 and 2008. In FY 2005, FHA's ARM
share was about 11.52 percent. The ARM share dropped to 2.86 percent in
FY 2006 and below 2 percent during the first three quarters in FY 2007.
The ARM share assumption for the future books of business in this Review
is also adjusted downward, reflecting this trend. The lower
concentration in ARM products for this Review considerably reduced the
impact of the poorer performance of the ARMs on the portfolio due to the
housing downturn.

Finally, in May 2006, the IRS published a ruling disallowing tax-exempt
non-profit organizations from receiving contributions from home sellers
and passing them along to homebuyers as downpayment gifts. Under this
ruling, all institutions involved in this activity will lose their
tax-exempt status. Without the tax-exempt status, these organizations
will no longer be eligible as a source of downpayment gift funds for
FHA-insured loans. On October 1, 2007, HUD issued a ruling on GAO's
Federal Register that prohibits the endorsement of loans that receive
contributions from any party that is financially related to the seller
of the collateral housing. The rule will become effective after October
31, 2007. In view of these two rulings intended to eliminate these
high-claim-rate loans, we assume that complete elimination of these
non-profit gift loans will occur over the next year. By FY 2009, there
will be zero seller-related non-profit organization downpayment-assisted
loans endorsed by the MMI Fund. This assumption of the accelerated
elimination of these high loss loans tends to improve the performance of
new books of business. The validity of this particular assumption
depends on how effective these two rulings are enforced. It is important
to review it when the new endorsement information becomes available.

Combing the above three effects, the joint net change of the economic
value of the FY 2007 is increased by \$145 million and the capital ratio
in the FY 2013 is also increased by 0.63 percentage points.

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

In the FY 2006 Review, we applied the average loss rates of loans
claimed between FY 2005 and FY 2006 by product types and the source of
downpayment assistance. The updated data showed that the loss rate
during FY 2006 was higher than the previous two years. With an extended
housing recession projected by Global Insight for the next two years, we
believe the loss severity rates will at least remain high for the
foreseeable future. As a result, the loss severity rates used in the FY
2007 Review are based on the level of the FY 2006 experience, the
highest single-year loss severity rates during recent history. In
addition to disaggregating the loss rate by product type and non-profit
gift letter, the loss rate is disaggregated further to differentiate
among loans subject to different state foreclosure laws. Traditionally,
judicial foreclosure states tend to experience higher loss severity
rates than in other states, even for otherwise comparable loans. The
loss severity rates assumed in this year's Review are differentiated by
product type, the source of downpayment assistance, and whether the
state imposes a judicial foreclosure. Exhibit II-5 summarizes the loss
rates applied in this Review.

Exhibit II-5

  ------------- ---------------- ------------ -------- -------- -------- -------- -------- ------------
  **Average                                                                                
  Loss Severity                                                                            
  Rates of                                                                                 
  Claimed Loans                                                                            
  by Claim                                                                                 
  Year**                                                                                   

  **High-Risk   **Judicial       **Mortgage                                                
  Gift Loans**  Fore-closure**   Product                                                   
                                 Type**                                                    

                                 **1**        **2**    **3**    **4**    **5**    **6**    **Weighted
                                                                                           Average**

  no            No               36.00%       39.11%   31.48%   31.27%   31.39%   32.42%   39.05%

                Yes              47.40%       61.42%   42.01%   42.79%   51.10%   42.75%   

  yes           No               37.49%       39.15%   33.84%                              

                Yes              47.97%       43.05%   45.97%                              
  ------------- ---------------- ------------ -------- -------- -------- -------- -------- ------------

The refined loss rates have a positive impact on FY 2007 economic value
of \$45 million. On the other hand, the corresponding capital ratio for
FY 2013 was reduced by 0.03 percentage points. Although the assumed loss
rates yield a weighted average of 39.05 percent in FY 2006, higher than
the loss rates assumed in previous reviews, the more precise
differentiation among states with different foreclosure processes
actually lead to smaller future claim losses of the MMI Fund portfolio.