FEDERAL HOUSING 

ADMINISTRATION

Capital Requirements 

and Stress Testing 

Practices Need 

Strengthening

Report to Congressional Requesters

November 2017

GAO-18-92

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-18-92, a report to 

congressional requesters

November 2017

FEDERAL HOUSING ADMINISTRATION

Capital Requirements and Stress Testing Practices 

Need Strengthening

What GAO Found

The Federal Housing Administration’s (FHA) budgetary reviews of the Mutual 

Mortgage Insurance Fund (MMI Fund) assess whether it needs more budget 

authority to cover expected future costs, and independent actuarial reviews 

provide complementary information on the fund’s finances. FHA uses the

actuarial reviews to assess whether the MMI Fund’s capital ratio (economic 

value divided by insurance obligations) meets the 2 percent requirement and 

how fund components would perform under alternative economic scenarios.

While the actuarial assessment does not directly determine the need for

additional budget authority, it evaluates the fund’s ability to absorb unexpected 

losses and may prompt changes in FHA policies and insurance premiums.

Capital requirements and stress testing practices—tools for managing financial 

risks—for the MMI Fund are not consistent with all elements of a framework 

GAO developed to help assess these tools in the context of FHA’s single-family 

mortgage insurance programs. In accordance with the framework, FHA’s capital 

assessments and stress tests are transparent and incorporate a number of 

relevant risk factors. However, areas of inconsistency include the following:

• Scenario-based requirement. The statutory capital requirement is intended 

to help ensure the fund can absorb unexpected losses but is not based on a 

specified risk threshold, such as an adverse economic scenario the fund 

would be expected to withstand without requiring supplemental funds. 

• Accountability mechanisms. The capital requirement also does not include 

accountability mechanisms, such as a set of steps FHA would have to take if 

the capital ratio again fell below the 2 percent minimum.

• Fund-wide stress tests. FHA has conducted separate stress tests—

projections of financial condition under adverse scenarios—of its forward 

(traditional) and reverse mortgage (loans against home equity available to 

seniors) portfolios, but has not performed tests on a fund-wide basis. 

• Stress test objectives. FHA has not defined specific objectives for its stress 

tests such as determining the amount of additional capital, if any, that would 

be needed to withstand conditions similar to the last housing crisis.

Strengthening FHA’s capital requirement and stress testing practices could help 

ensure that the MMI Fund is able to withstand economic downturns and that 

stress test results are as relevant and useful as possible for risk management. 

Including reverse mortgages in the fund’s capital assessment has advantages 

and disadvantages. Unlike for stress tests, FHA jointly assesses forward and 

reverse mortgages to calculate a combined capital ratio. Subjecting the reverse 

mortgage portfolio to capital assessment has made its financial condition more 

transparent. But, the portfolio’s sensitivity to changes in economic assumptions 

makes the combined ratio more unpredictable. Alternative approaches also pose 

trade-offs. For example, a separate reverse mortgage capital requirement may

help ensure the financial transparency of both portfolios, but requiring FHA to 

hold more capital to account for the volatility of the reverse mortgage portfolio 

could compel FHA to raise insurance premiums or lower borrowing limits. 

View GAO-18-92. For more information, 

contact Daniel Garcia-Diaz at (202) 512-8678 

or garciadiazd@gao.gov.

Why GAO Did This Study

FHA insures private lenders against 

losses from defaults on single-family 

mortgages. According to independent 

actuarial reviews, in fiscal years 2009–

2014, FHA’s MMI Fund (which insures 

$1.2 trillion in single-family traditional 

and reverse mortgages) did not meet 

its statutory 2 percent capital 

requirement. Also, a budgetary review

determined that the fund required

$1.69 billion in supplemental funds in

fiscal year 2013. 

GAO was asked to examine issues 

concerning the MMI Fund’s capital 

requirement and actuarial reviews. 

This report examines the types of 

information provided by assessments

of the fund’s financial condition, FHA’s

capital requirement and stress testing 

practices, and trade-offs associated 

with including reverse mortgages in the 

fund’s capital assessment. 

GAO analyzed actuarial and budgetary 

assessments of the MMI Fund. GAO

reviewed financial institution and 

regulatory capital and stress testing 

principles to develop an evaluative 

framework and applied it to FHA. GAO 

also interviewed federal and mortgage 

industry officials. 

What GAO Recommends

Congress should consider specifying 

the economic conditions the MMI Fund 

would be expected to withstand without 

supplemental funds, and FHA should 

conduct stress tests on a fund-wide 

basis and specify the objectives of its

stress tests. GAO also continues to 

maintain that Congress should 

incorporate accountability mechanisms 

into FHA’s capital requirement (as 

stated in GAO-13-722). FHA agreed 

with GAO’s recommendations.
Page i GAO-18-92 FHA Capital Reserves

Letter 1

Background 4

Budgetary and Actuarial Assessments of the Fund Serve Different 

but Complementary Functions 9

The MMI Fund’s Capital Requirement Lacks Accountability 

Mechanisms, and Stress Tests Are Not Fund-Wide 15

Joint Capital Assessment Has Advantages and Disadvantages 25

Conclusions 31

Matter for Congressional Consideration 32

Recommendations for Executive Action 32

Agency Comments 33

Appendix I Objectives, Scope, and Methodology 35

Appendix II Mutual Mortgage Insurance Fund Budgetary and Actuarial Reviews 39

Appendix III Comparison of Economic Scenarios Used in Mutual Mortgage 

Insurance Fund and Federal Reserve Supervisory Stress Tests 41

Appendix IV Comments from the Department of Housing and Urban Development 48

Appendix V GAO Contact and Staff Acknowledgments 50

Tables

Table 1: Mutual Mortgage Insurance Fund (MMI Fund) Capital 

Ratio Calculation for Fiscal Year 2016 11

Table 2: Mutual Mortgage Insurance Fund (MMI Fund) Capital 

Ratio for Fiscal Year 2016 under Different Economic 

Scenarios 13

Table 3: Assessment of the Federal Housing Administration’s 

Capital Requirement Using GAO’s Framework 15

Table 4: Assessment of the Federal Housing Administration’s 

Stress Testing Practices Using GAO’s Framework 20

Contents
Page ii GAO-18-92 FHA Capital Reserves

Table 5: Overview of Budgetary and Actuarial Reviews 39

Figures

Figure 1: Fiscal Year 2016 Forward Mortgage and HECM Portfolio 

Capital Ratios under Different Economic Scenarios 26

Figure 2: Forward Mortgage, HECM, and Combined Capital 

Ratios, Fiscal Years 2009–2016 27

Figure 3: Hypothetical Illustration of Budgetary and Actuarial 

Review Components (dollars in billions) 40

Figure 4: Projected Percentage Change in House Price Index 

under Selected MMI Fund Actuarial and Federal Reserve 

Supervisory Stress Test Scenarios Starting in 2016 44

Figure 5: Projected 30-Year Fixed Mortgage Interest Rate under 

Selected MMI Fund Actuarial and Federal Reserve 

Supervisory Stress Test Scenarios Starting in 2016 46

Figure 6: Projected Unemployment Rate under Selected MMI 

Fund Actuarial and Federal Reserve Supervisory Stress 

Test Scenarios Starting in 2016 47
Page iii GAO-18-92 FHA Capital Reserves

Abbreviations

CCAR Comprehensive Capital Analysis and Review

DFAST Dodd-Frank Act Stress Tests

FCRA Federal Credit Reform Act of 1990

Federal Reserve Board of Governors of the Federal Reserve System

FHA Federal Housing Administration

FHFA Federal Housing Finance Agency

GAAP generally accepted accounting principles

HECM Home Equity Conversion Mortgage

HERA Housing and Economic Recovery Act of 2008

HUD Department of Housing and Urban Development

MMI Fund Mutual Mortgage Insurance Fund

PMIER Private Mortgage Insurer Eligibility Requirements

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Page 1 GAO-18-92 FHA Capital Reserves

441 G St. N.W.

Washington, DC 20548

November 9, 2017

The Honorable Sean P. Duffy

Chairman

Subcommittee on Housing and Insurance

Committee on Financial Services

House of Representatives

The Honorable Blaine Luetkemeyer

Chairman

Subcommittee on Financial Institutions and Consumer Credit

Committee on Financial Services

House of Representatives

The Department of Housing and Urban Development’s (HUD) Federal 

Housing Administration (FHA) administers single-family forward and 

reverse mortgage programs that insure private lenders against losses on 

mortgages that finance home purchases, refinance existing mortgages, 

and convert home equity into cash advances.1 These programs have 

helped millions of households achieve homeownership or benefit from 

home equity while living in their homes. FHA insures almost all of its 

single-family mortgages under its Mutual Mortgage Insurance Fund (MMI 

Fund). As of the end of fiscal year 2016, the fund’s insurance-in-force 

(total insured mortgage balances outstanding) was about $1.2 trillion. 

The MMI Fund is statutorily required to maintain at least a 2 percent 

capital ratio, defined as the economic net worth (economic value) of the 

fund divided by the amortized insurance-in-force.2 The fund’s economic 

value depends on actual and estimated cash inflows (for example 

insurance premiums collected from borrowers) and outflows (for example, 

claim payments to lenders on defaulted loans). Therefore, FHA must 

manage the fund such that, on average, the inflows exceed the outflows 

 1

Traditional mortgages, also known as forward mortgages, require borrowers to make 

monthly payments to the lender, increasing home equity and decreasing the loan balance 

over time. Reverse mortgages are a type of loan against home equity available to seniors. 

Reverse mortgage borrowers receive payments from the lender, decreasing home equity 

and increasing the loan balance over time.

2

12 U.S.C. § 1711(f)(4). The economic value of the MMI Fund is the sum of existing 

capital resources plus the net present value of projected future cash flows. The amortized 

insurance-in-force is the remaining principal balance on all insured loans in the MMI Fund.

Letter
Page 2 GAO-18-92 FHA Capital Reserves

by enough to maintain the required capital reserve. However, in fiscal 

year 2009, in the midst of the 2007–2011 housing crisis, the MMI Fund’s

capital ratio fell below 2 percent and did not meet the statutory 

requirement again until fiscal year 2015, according to independent 

actuarial reviews.3 Additionally, at the end of fiscal year 2013, the MMI 

Fund required supplemental funds—about $1.7 billion—for the first time in 

its history to help ensure that it had sufficient resources to cover expected 

net future costs on outstanding insurance. These developments highlight 

a key challenge FHA and Congress face in balancing the fund’s financial 

self-sufficiency with FHA’s role in facilitating mortgage credit to 

underserved borrowers and stabilizing the housing market during 

economic downturns.

In light of the MMI Fund’s recent fiscal challenges, you asked us to 

examine issues pertaining to the MMI Fund’s actuarial reviews, capital 

requirement, and stress tests.4 This report examines (1) the types of 

information actuarial reviews and other assessments provide about the 

MMI Fund’s financial condition, including its ability to remain selfsufficient; (2) the extent to which the capital requirement and stress 

testing practices for the MMI Fund are consistent with principles and 

practices underlying those of other financial institutions; and (3) key 

advantages and disadvantages of including both forward and reverse 

mortgages in the MMI Fund’s capital assessment.

To examine the types of information actuarial reviews and other 

assessments provide about the MMI Fund’s financial condition, including 

its ability to remain self-sufficient, we reviewed actuarial reports of the 

fund prepared by an FHA contractor and related FHA reports to 

Congress. Additionally, we reviewed FHA budget documents and audited 

financial statements containing assessments of the fund, as well as FHA 

documents and our prior reports describing the mechanisms used to 

provide supplemental resources to the fund, if necessary.

To assess the extent to which capital requirements and stress testing 

practices for the MMI Fund are consistent with principles underlying 

 3

We use the 2007–2011 date range to identify the housing crisis based on trends in 

average home prices. According to the S&P/Case Shiller National Home Price Index, 

average home prices fell each calendar year from 2007 through 2011, for a total decline of 

almost 27 percent. This index is a composite of single-family home price indexes for the 

nine U.S. Census divisions and is calculated monthly.

4

Stress tests are projections of financial condition under adverse scenarios.
Page 3 GAO-18-92 FHA Capital Reserves

requirements for other institutions, we developed and applied two 

evaluative frameworks. We developed draft frameworks by reviewing 

documents on the requirements and practices of financial regulators and 

institutions, and by identifying key common elements that could apply to 

the MMI Fund, assuming the fund would continue to operate under 

federal accounting standards and budgeting requirements.5 In addition to 

FHA, we shared the draft frameworks with the Federal Housing Finance 

Agency (FHFA), the National Association of Insurance Commissioners, 

and the American Academy of Actuaries and interviewed officials from 

these organizations to obtain their input on the frameworks. We chose 

these organizations based on their expertise in financial assessments of 

housing finance and mortgage insurance institutions. To provide 

additional perspective on stress tests of the MMI Fund, we compared the 

two most stressful economic scenarios from the fiscal year 2016 actuarial 

review of FHA’s forward mortgage portfolio with the severely adverse 

scenario used by the Board of Governors of the Federal Reserve System 

(Federal Reserve) in its 2016 supervisory stress tests of large banking 

organizations.

To identify key advantages and disadvantages of jointly considering 

forward and reverse mortgages in the MMI Fund’s capital assessment, 

we reviewed actuarial results for both mortgage portfolios for fiscal years 

2009–2016 and recent FHA reports to Congress discussing this issue. 

Using information from the actuarial reviews, we analyzed the 

implications of including the reverse mortgage portfolio in the joint capital 

assessment and of holding the reverse mortgage portfolio to a separate 

capital requirement. We also interviewed FHA officials and five mortgage 

industry associations and stakeholders (selected based on their 

knowledge of FHA and reverse mortgages) to obtain their views on the 

joint capital assessment and possible alternative approaches. Appendix I 

describes our objectives, scope, and methodology in greater detail.

We conducted this performance audit from August 2016 to November 

2017 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

 5

In a September 2013 report, we identified key differences between the capital 

requirements and reserving practices of FHA and private mortgage insurers, including 

differences stemming from the federal accounting standards and budgeting requirements 

FHA must follow. See GAO, FHA Mortgage Insurance: Applicability of Industry 

Requirements Is Limited, but Certain Features Could Enhance Oversight, GAO-13-722 

(Washington, D.C.: Sept. 9, 2013).
Page 4 GAO-18-92 FHA Capital Reserves

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives.

FHA’s single-family mortgage insurance programs insure private lenders 

against losses from borrower defaults on mortgages that meet FHA 

criteria for properties with one to four housing units.6 FHA insures a 

variety of mortgage types, including loans for initial home purchases, 

construction and rehabilitation, and refinancing. In fiscal year 2016, FHA 

insured roughly 1.3 million single-family mortgages with total initial 

balances of approximately $260 billion. Partly because of its low 3.5 

percent minimum down-payment requirement, FHA has played a 

particularly large role among groups with lower average levels of 

accumulated wealth, including minority, lower-income, and first-time 

home buyers. For example, in fiscal year 2016, roughly 82 percent of 

FHA-insured home purchase loans went to first-time home buyers and 

more than 33 percent went to minority home buyers.

FHA also generally is thought to promote stability in the housing market 

by helping to ensure the availability of mortgage credit in areas that may 

be underserved by the private sector or that are experiencing economic 

downturns. Consistent with this view, the volume of FHA-insured forward 

mortgages peaked in fiscal year 2009, toward the end of the 2007–2009 

recession and in the midst of the 2007–2011 housing crisis.7 In terms of 

loan originations, the share of the single-family home purchase mortgage 

market insured by FHA reached nearly 30 percent in fiscal year 2009, 

while in more recent years it has been about 20 percent.

 6

Among other things, FHA has criteria for loan size, down payment, borrower credit score, 

and borrower debt burden. For more information, see GAO, Home Mortgage Guarantees: 

Issues to Consider in Evaluating Opportunities to Consolidate Two Overlapping SingleFamily Programs, GAO-16-801 (Washington, D.C.: Sept. 29, 2016). 

7

The recession of 2007–2009 started in December 2007 and ended in June 2009, 

according to the Business Cycle Dating Committee of the National Bureau of Economic

Research.

Background

FHA’s Role and Insured 

Portfolio
Page 5 GAO-18-92 FHA Capital Reserves

The MMI Fund includes almost all of FHA’s single-family mortgage 

insurance programs, the largest of which is the 203(b) program.8 The 

Housing and Economic Recovery Act of 2008 (HERA) moved a number 

of other programs that were previously under the General and Special 

Risk Insurance Fund to the MMI Fund.9 These included programs for 

insuring mortgages on condominium units, mortgages that simultaneously 

finance home purchase and rehabilitation costs, and reverse 

mortgages.10

A reverse mortgage is a type of loan against the borrower’s home equity. 

With a reverse mortgage, borrowers do not need to repay the loan as 

long as they meet certain conditions. These conditions, among others, 

require the borrower to live in the home, pay property taxes and 

homeowners’ insurance, maintain the property, and retain the title in his 

or her name. Unlike forward mortgages, where the borrower makes 

monthly payments to the lender, increasing equity and decreasing the 

loan balance over time, reverse mortgages typically are “rising debt, 

falling equity” loans. For reverse mortgages, the loan balance increases 

and the home equity decreases over time. As the borrower receives 

payments from the lender, the lender adds the principal and interest to 

the loan balance, reducing the homeowner’s equity. FHA insures reverse 

mortgages under its Home Equity Conversion Mortgage (HECM) 

program, which serves eligible borrowers aged 62 or older.11 Congress 

established the HECM program in 1988 as a way to alleviate economic 

hardship caused by the increasing costs of health care, housing, and 

subsistence needs at a time in life when income is reduced, while 

 8

The 203(b) program is FHA’s basic program for home purchases and refinancings. This 

program was authorized by Section 203 of the National Housing Act, Pub. L. No. 73-479, 

48 Stat. 1246 (1934) (codified, as amended, at 12 USC 1709).

9

When HERA moved the programs from the General and Special Risk Insurance Fund 

into the MMI Fund, only new loans became part of the MMI Fund. Loans originated prior to 

fiscal year 2009 were kept in the General and Special Risk Insurance Fund. 

10Pub. L. No. 110-289, §§ 2115, 2117, 2118, 122 Stat. 2654, 2832–2835 (2008). 

11For more information on HECMs, see GAO, Reverse Mortgages: Policy Changes Have 

Had Mostly Positive Effects on Lenders and Borrowers, but These Changes and Market 

Developments Have Increased HUD’s Risk, GAO-09-836 (Washington, D.C.: July 30, 

2009) and Product Complexity and Consumer Protection Issues Underscore Need for 

Improved Controls over Counseling for Borrowers, GAO-09-606 (Washington, D.C.: June 

29, 2009). 

FHA’s Mutual Mortgage 

Insurance Fund
Page 6 GAO-18-92 FHA Capital Reserves

protecting reverse mortgage lenders and borrowers from financial 

losses.12

The MMI Fund is supported by insurance premiums paid by borrowers. 

For forward mortgages, FHA has the authority to establish and collect a 

single up-front premium (in an amount not to exceed 3.0 percent of the 

amount of the original insured principal of the mortgage) and annual 

premiums of up to 1.5 percent of the remaining insured principal balance, 

or 1.55 percent for borrowers with down payments of less than 5.0 

percent. As of September 2017, FHA charged a 1.75 percent up-front 

premium and either a 0.80 percent or 0.85 percent annual premium, 

depending on the size of the down payment.13 As of the same date, FHA 

charged HECM borrowers an initial premium of either 0.50 percent or 2.5 

percent, depending on how they draw down available funds, and an 

annual premium equal to 1.25 percent of the outstanding HECM 

balance.14

Each year, the MMI Fund is subject to three different financial 

assessments:

Independent actuarial review. The National Housing Act requires an 

annual independent actuarial review of the MMI Fund’s financial 

position.15 FHA uses the results of the actuarial review to determine 

whether the MMI Fund is meeting the act’s requirement that it maintain a 

capital ratio of at least 2 percent. Each year, an independent actuarial 

contractor conducts two separate actuarial reviews—one for forward 

mortgages and one for HECMs—to estimate the economic value of the 

two portfolios. In a separate annual report to Congress, FHA combines 

 1212 U.S.C. § 1715z-20 (a). 

13These percentages apply to home purchase mortgages less than or equal to $625,000 

and with durations greater than 15 years. FHA charges different premiums for larger 

mortgages, mortgages with durations of 15 years or less, and certain refinance 

mortgages.

14On August 29, 2017, HUD announced that, effective October 2, 2017, new HECM 

borrowers will be required to pay an initial premium of 2.0 percent and an annual premium 

of 0.5 percent. HUD also announced new, lower limits on the amount of home equity new 

HECM borrowers can borrow, effective as of the same date. 

1512 U.S.C. § 1708(a)(4). The requirement for an annual independent actuarial review 

originated in the Omnibus Budget Reconciliation Act of 1990. Pub. L. No. 101-508 § 

2105, 104 Stat. 1388, 1388-19 (1990).

Reviews of the MMI Fund
Page 7 GAO-18-92 FHA Capital Reserves

the findings of the forward mortgage and HECM actuarial reviews to 

determine the capital ratio for the MMI Fund as a whole.16 As previously 

noted, the capital ratio is the fund’s economic value divided by the 

insurance-in-force.

Budgetary review. FHA estimates and reestimates the net lifetime 

costs—known as credit subsidy costs—of the mortgages it insures as part 

of the MMI Fund’s annual budgetary review. Under the Federal Credit 

Reform Act of 1990 (FCRA), FHA and other federal agencies must 

estimate the credit subsidy costs of their direct loan or loan guarantee 

programs in their annual budgets.17 Credit subsidy costs represent the 

present value of estimated cash flows to the government minus the 

present value of estimated cash flows from the government over the life 

of the loan, excluding administrative costs. For a mortgage insurance 

program, cash inflows consist primarily of insurance premiums charged to 

borrowers and proceeds from sales of foreclosed properties, and cash 

outflows consist mostly of insurance claim payments to lenders. Annually, 

agencies estimate credit subsidy costs for new loan cohorts—the loans 

agencies commit to guarantee in a given fiscal year. When estimated 

cash inflows exceed expected cash outflows, a cohort is said to have a 

negative credit subsidy cost, meaning that the cohort is estimated to 

generate income. When the opposite is true, the cohort is said to have a 

positive credit subsidy cost.

Generally, agencies also are required to produce annual updates of their 

subsidy estimates—known as reestimates—for each loan cohort on the 

basis of information on actual performance and estimated changes in 

future loan performance. Each additional year provides more historical 

data on loan performance that may influence estimates of the amount and 

timing of future claims. Additionally, economic assumptions (such as 

house prices and interest rates) also can change from year to year, which 

would affect estimates of future loan performance. In recognition of the 

difficulty in making credit subsidy estimates that mirror actual loan 

performance, FCRA provides permanent and indefinite budget authority 

for reestimates that reflect increased credit subsidy costs (upward 

 16The annual report to Congress is required by 12 U.S.C. § 1708(a)(4). 

17Pub. L. No. 101-508, § 13201(a), 104 Stat. 1388, 1388-609 (1990), codified, as 

amended, at 2 U.S.C. §§ 661-661f.
Page 8 GAO-18-92 FHA Capital Reserves

reestimates).18 While FHA has had a number of upward reestimates, the 

only year in which the MMI Fund has needed to draw on permanent and 

indefinite budget authority was fiscal year 2013, when it received $1.69 

billion. All other upward reestimates were covered by funds held in the 

MMI Fund’s capital reserve account.

Financial accounting review. The preparation of FHA’s financial 

statements also provides a review of the MMI Fund. FHA is required to 

prepare financial statements in accordance with generally accepted 

accounting principles for the federal government (federal GAAP). The 

financial statements provide information on the overall financial position of 

the MMI Fund, including its assets, liabilities, and actual cash flows during 

the year. In addition, federal GAAP requires FHA to calculate a liability for 

loan guarantees, which represents the estimated net present value of 

expected future cash flows for outstanding insurance.19

In general, capital exists to absorb unexpected losses and allow a 

financial institution to continue operations during economic downturns. 

The MMI Fund plays a key role during such periods by helping to 

maintain the flow of mortgage credit to areas that may be underserved by 

the private sector. As previously noted, the MMI Fund is statutorily 

required to maintain at least a 2 percent capital ratio. It also is the only 

federal credit program with a capital requirement.20 Because the MMI 

Fund can draw on permanent and indefinite budget authority, if 

necessary, it has greater ability to weather adverse economic conditions 

than a private entity. However, the capital requirement is intended to help 

ensure that the fund remains self-sufficient by creating a reserve for 

unexpected losses. The size of the MMI Fund’s capital reserve can be 

expected to fluctuate depending on economic conditions and other 

factors. For example, the reserve may tend to grow when the economy is 

strong (limiting borrower defaults and FHA insurance losses), and may 

tend to shrink when the economy is weak (increasing borrower defaults 

and FHA insurance losses).

 18Permanent and indefinite budget authority is available for obligation and expenditure 

without fiscal year limitation and is not limited to a specified amount or ceiling.

19The liability for loan guarantees applies to insurance commitments made on or after 

October 1, 1991.

20Congress has imposed reserve requirements on other federal funds such as the Federal 

Deposit Insurance Corporation’s Deposit Insurance Fund. 

Capital Requirements and 

Stress Testing
Page 9 GAO-18-92 FHA Capital Reserves

Stress tests are a risk management tool used by banks and other 

financial institutions. The International Actuarial Association defines 

stress testing as a projection of the financial condition of an institution 

under a specific set of adverse conditions. While there is no requirement 

that FHA stress test the MMI Fund, actuarial reviews of the MMI Fund 

have included analyses of the MMI Fund’s economic value and 

insurance-in-force under alternative scenarios, including adverse 

scenarios. As discussed later in this report, the alternative scenarios 

include selected economic paths used in estimating the economic value 

of the MMI Fund’s forward mortgage and HECM portfolios, as well as 

baseline and economic slump paths produced by Moody’s Analytics.21

FHA considers these analyses to be a form of stress testing.

FHA assessments performed as part of the MMI Fund’s annual budgetary 

review—specifically, the credit subsidy estimates and reestimates 

discussed previously—determine the fund’s financing account and capital 

reserve account balances. The financing account is designed to hold 

sufficient funds to cover anticipated net future costs on outstanding 

insurance.22 The capital reserve account holds additional funds that could 

be used to cover unexpected losses (for example, due to higher-thananticipated mortgage defaults).23 If the capital reserve account had 

insufficient funds to cover an upward credit subsidy reestimate (that is, an 

 21Moody’s Analytics provides economic data, research, analysis, and forecasting.

22The financing account appears in the President’s budget for informational and analytical 

purposes, but is not included in the budget totals for budget authority or outlays. It is 

required to record lifetime cash flows for loans insured in 1992 and thereafter. All federal 

credit programs have financing accounts. 

23FHA created the capital reserve account to retain the MMI Fund’s negative credit 

subsidy and any subsequent downward credit subsidy reestimates. 

Budgetary and 

Actuarial 

Assessments of the 

Fund Serve Different 

but Complementary 

Functions

Supplemental Funding Is 

Determined by Budgetary 

Assessments, and 

Actuarial Reviews Provide 

Complementary 

Information
Page 10 GAO-18-92 FHA Capital Reserves

increase in expected lifetime costs), FHA would draw on permanent and 

indefinite budget authority. As previously noted, this has occurred one 

time (fiscal year 2013) since the implementation of FCRA. Drawing on 

permanent and indefinite budget authority means that the MMI Fund is 

not self-sufficient under FCRA requirements. However, it does not 

indicate that the fund is unable to pay insurance claims in the near-term 

without supplemental funding, because the fund’s financing account holds

balances to cover the anticipated net future costs on claims expected in 

the near-term and over the long-term for the existing insurance portfolio.24

In contrast, the actuarial reviews do not directly determine the need for 

additional budget authority; rather, they are used to assess whether the 

MMI Fund is in compliance with the requirement to maintain at least a 2 

percent capital ratio. Additionally, the reviews are statutorily required to 

be conducted by an independent actuary rather than by FHA. As 

previously noted, the actuarial reviews estimate the economic value of the 

forward mortgage and HECM portfolios separately, and FHA combines 

these estimates to calculate the capital ratio (that is, the economic value 

divided by the insurance-in-force) for the MMI Fund as a whole. The 

economic value of each portfolio consists of existing net capital resources 

(assets less liabilities) plus the net present value of anticipated future 

cash inflows and outflows on outstanding insurance.25

To determine existing net capital resources, FHA’s actuarial contractor 

uses information on the assets and liabilities of the financing and capital 

reserve accounts previously discussed. Beginning with the fiscal year 

2012 actuarial review and continuing through the fiscal year 2016 review 

(the most recently completed one), FHA’s actuarial contractor has 

estimated the net present value of cash flows using Monte Carlo 

simulation—a methodology that involves running simulations of multiple 

economic paths.26 Specifically, for the forward mortgage and HECM 

portfolios separately, the contractor generated 100 economic paths, 

 24In the event of an increase in expected credit subsidy costs, the financing account would 

receive funds from the capital reserve account or, if the capital reserve account were 

depleted, through the provision of permanent and indefinite budget authority. 

25The present value of a stream of future cash inflows or outflows is its worth in terms of 

money paid immediately. In calculating present value under FCRA, interest rates on 

Treasury securities when the underlying loans were disbursed provide the basis for

converting future amounts into their “money now” equivalents. 

26Monte Carlo methods use random sampling to “draw” values for variables from 

prespecified distributions.
Page 11 GAO-18-92 FHA Capital Reserves

centered around Moody’s Analytics’ baseline economic scenario, and 

computed a net present value of future cash flows for each of these 

paths.27 The contractor added the average of these 100 numbers to the 

existing net capital resources to produce the economic value used to 

assess compliance with the MMI Fund’s 2 percent capital requirement. 

Table 1 shows the fiscal year 2016 economic value, insurance-in-force, 

and capital ratio for the forward mortgage and HECM portfolios, as well 

as for the MMI Fund as a whole.

Table 1: Mutual Mortgage Insurance Fund (MMI Fund) Capital Ratio Calculation for Fiscal Year 2016

Portfolio component

Economic value

(dollars in billions)

Insurance-in-force

(dollars in billions)

Capital ratio

(percent)

Forward mortgages 35.27 1,076.65 3.28 

Home Equity Conversion Mortgages -7.72 111.92 -6.90 

Overall MMI Fund 27.55 1,188.57 2.32 

Source: Federal Housing Administration. | GAO-18-92

Under the independent actuarial reviews, an economic value of zero—

and therefore a capital ratio of zero—for the MMI Fund as a whole 

indicates that estimated resources are enough to cover anticipated net 

future costs and no more. Specifically, if the capital ratio is zero, the MMI 

Fund’s existing net capital resources (for example, cash and Treasury 

investments) and the net present value of future cash inflows (for 

example, premium revenue and proceeds from sales of foreclosed 

homes) are estimated to be equal to the net present value of future cash 

outflows (for example, insurance claim payments and costs to maintain 

foreclosed properties). Therefore, in concept, a positive economic value is 

similar to a positive balance in the capital reserve account under the 

budget process—that is, it projects the availability of funds above what is 

needed to cover expected net future costs on outstanding insurance.

However, the independent actuarial reviews have used different 

estimation models and economic assumptions from those used in FHA’s 

budgetary assessment to estimate the present value of future cash flows; 

therefore, the actuarial and budgetary reviews have not produced 

identical capital estimates. (See app. II for more information on the 

related components of the budgetary and actuarial reviews.) A capital 

 27According to Moody’s Analytics, the baseline economic scenario represents the most 

likely outcome based on current conditions. 
Page 12 GAO-18-92 FHA Capital Reserves

ratio below 2 percent, or even below zero, does not directly determine the 

need for permanent and indefinite budget authority. However, it indicates 

that according to the models and assumptions of the actuarial reviews, 

the MMI Fund’s ability to absorb unexpected losses may be limited and 

that premium and policy changes designed to bolster the fund’s capital 

position may be needed.

In addition to the capital assessment, the actuarial reviews also have 

projected the MMI Fund’s performance under alternative economic 

scenarios, including stress scenarios. For example, the fiscal year 2016 

actuarial reviews estimated the economic value and insurance-in-force of 

the MMI Fund under eight alternative scenarios, including both strong 

economic conditions and economic downturns. Specifically, the fiscal 

year 2016 reviews estimated the 10th best and worst, 25th best and 

worst, and worst economic values produced by the Monte Carlo 

simulation, along with the economic values resulting from Moody’s 

Analytics’ baseline and protracted slump scenarios.28 In addition, the 

fiscal year 2016 reviews included a low-interest-rate scenario, which 

assumes that low interest rates persist for 2 years, before resuming on 

the path of the Moody’s Analytics’ baseline scenario.29 The reviews also 

include information on the house price index values, interest rates, and 

unemployment rates from the economic paths that produced these 

alternative economic values.

The actuarial reviews have analyzed the economic value under 

alternative scenarios separately for the forward mortgage and HECM 

portfolios. The estimated economic values for the forward mortgage and 

HECM portfolios can be combined to arrive at fund-wide capital ratios for 

the average of the 100 economic values produced by the simulation—

Monte Carlo average—and all of the Moody’s Analytics’ scenarios (see 

table 2). However, the 10th best and worst, 25th best and worst, and 

 28Under Moody’s Analytics’ protracted slump scenario, the level of the house price index 

falls significantly for 2 years and then converges to the long-term index level of its baseline 

forecast. As a result, this scenario shows low house-price growth rates in the short term, 

followed by higher growth rates. FHA’s actuarial contractor modified this scenario to show 

less optimistic house-price growth rates after the initial stress period. 

29Lower interest rates reduce the MMI Fund’s economic value because they provide 

incentives for borrowers to refinance their loans (including refinancings into non-FHA 

loans), resulting in higher prepayments and reduced premium income for FHA from 

existing loans. 

Actuarial Reviews Also 

Include Stress Tests of the 

MMI Fund and Other 

Insights
Page 13 GAO-18-92 FHA Capital Reserves

worst economic values produced by the Monte Carlo simulations cannot 

be combined. This limitation is due to the fact that the economic scenario 

that led to the 10th best forward mortgage economic value, for example, 

may be different from the scenario that led to the 10th best HECM 

economic value.30

Table 2: Mutual Mortgage Insurance Fund (MMI Fund) Capital Ratio for Fiscal Year 2016 under Different Economic Scenarios

Monte Carlo

simulation scenarios Moody’s Analytics scenarios

Average

(percent)

Baseline

(percent)

Baseline with low 

interest ratea

(percent)

Protracted slumpb

(percent)

Combined capital ratio 2.32 2.74 2.13 -4.66 

Source: GAO analysis of Federal Housing Administration data. | GAO-18-92

a

This scenario holds interest rates low for the first 2 years of the projection, then follows the Moody’s 

Analytics baseline scenario beginning in year 3.

b

This scenario modified the Moody’s Analytics protracted slump scenario by assuming less optimistic 

house-price growth rates after the initial stress period.

In contrast, the budgetary reviews do not include analysis of future loan 

performance under alternative economic scenarios. The budgetary 

reviews are required to use the President’s economic assumptions, which 

the Office of Management and Budget provides to agencies for budget 

formulation.

In addition to the actuarial reviews prepared by FHA’s contractor, FHA 

compiles statutorily required annual reports for Congress based on the 

results of the actuarial analysis. These reports include the calculation of 

the MMI Fund’s overall capital ratio and some additional analyses of the 

MMI Fund’s financial condition. Statutory requirements for the content of 

the reports to Congress are broad, and each year, FHA determines the 

types of information it believes will be most useful to Congress.31 FHA 

officials said they consider what they reported in the previous year,

events from the past year, and feedback from readers to determine what 

 30The combination of house price, interest rate, and unemployment assumptions that 

comprise an economic scenario may not affect forward mortgages and HECMs similarly 

because of differences between the two portfolios in their sensitivity to economic 

conditions and the timing of their cash flows.

3112 U.S.C. § 1708(a)(4). The statute states that the Secretary of HUD shall submit a 

report annually to the Congress describing the results of the actuarial reviews and 

assessing the financial status of the MMI Fund. 
Page 14 GAO-18-92 FHA Capital Reserves

would be most useful to include. For example, in its fiscal year 2015 

report to Congress, FHA discussed the amount of additional capital that 

would have been needed for the forward mortgage portfolio to achieve a 

2 percent capital ratio and withstand losses in the event of an economic 

downturn similar to the last economic crisis.

FHA’s financial statements present the MMI Fund from a financial 

accounting perspective and are prepared according to federal GAAP. The 

financial statements are composed of year-end balance sheets, the 

related statements of net cost and changes in net position, and the 

combined statements of budgetary resources. As with the budgetary and 

actuarial reviews, FHA’s annual management reports, which include the 

financial statements, also include information on the MMI Fund’s capital 

resources and a net present value calculation of cash flows from 

outstanding insurance. Information used in preparing the financial 

statements—specifically, the MMI Fund’s assets and liabilities (excluding 

the liability for loan guarantees)—is used in the budgetary review to 

inform the amount needed in the financing account and is used by the 

actuarial review to determine the existing capital resources component of 

the economic value calculation. Like the budgetary reviews, the financial 

statement reviews do not include analysis of future loan performance 

under alternative economic scenarios.

Another source of information on the MMI Fund’s financial status is 

quarterly reports FHA issues to Congress, as required by HERA.32 The 

quarterly reports can help provide early insight into whether there are 

potential deviations from the prior year’s projections before the next 

annual budgetary and actuarial reviews are completed. Among other 

topics, the reports must include information on any significant changes 

between actual and projected claim and prepayment activity, and 

projected versus actual loss rates. However, while the quarterly reports 

update certain measures of the MMI Fund’s performance and financial 

condition, they are not intended to provide a full actuarial or budgetary 

analysis.

 32Pub. L. No. 110-289, 122 Stat. 2654, 2834 (2008) (codified at 12 U.S.C. § 1708(a)(5)).

Financial Statements and 

Quarterly Reports Provide 

Additional Perspectives on 

the MMI Fund’s Financial 

Condition
Page 15 GAO-18-92 FHA Capital Reserves

The MMI Fund’s capital requirement and stress tests are consistent with 

some principles and practices promulgated or used by financial 

institutions and regulators, but are not consistent with others. To assess 

the MMI Fund’s consistency with these principles and practices, we 

developed a framework of important considerations in designing capital 

requirements and another for designing stress tests. Our frameworks 

include underlying principles or key features of the requirements and 

practices of institutions we reviewed—such as transparency and 

accountability—that could also be applied to the MMI Fund. See appendix 

I for further details on our methodology.

The MMI Fund’s capital requirement is consistent with our framework 

element on transparency and partially consistent with two other 

elements—that the requirement include both risk-based and fixed 

components and that the requirement be designed to cover unexpected 

losses and be based on specified risk thresholds. However, the MMI 

Fund’s capital requirement is not consistent with the element on including 

accountability mechanisms. We were unable to determine whether the 

requirement is consistent with the element on balancing financial 

soundness with the entity’s role and mission because such an 

assessment would require more information about the severity of the 

economic conditions the capital requirement was designed to withstand 

without supplemental funding. Table 3 summarizes our assessments.

Table 3: Assessment of the Federal Housing Administration’s Capital Requirement Using GAO’s Framework

Framework element Assessment

1. Capital requirement and results of capital assessments are transparent ●

2. Includes risk-based and fixed components ◑

3. Is designed to cover unexpected losses and is based on specified risk thresholds ◑

4. Includes accountability mechanisms ○

5. Balances financial soundness with the entity’s role and missiona

─

○ Not consistent ◑ Partially consistent ● Consistent ─ Unable to determine

Source: GAO. | GAO-18-92

a

We were unable to determine whether the requirement is consistent with the element on balancing 

financial soundness with the entity’s role and mission because such an assessment would require 

more information about the severity of the economic conditions the capital requirement was designed 

to withstand without supplemental funding.

The MMI Fund’s 

Capital Requirement 

Lacks Accountability 

Mechanisms, and 

Stress Tests Are Not 

Fund-Wide

The Capital Requirement 

Is Not Based on a 

Specified Risk Threshold 

and Lacks Accountability 

Mechanisms
Page 16 GAO-18-92 FHA Capital Reserves

The MMI Fund’s capital requirement is consistent with the framework 

element of being transparent so that external parties can understand the 

financial risks facing the entity.33 FHA’s actuarial reports and 

accompanying report to Congress provide specific information about the 

MMI Fund’s capital requirement and capital assessment results. For 

example, the actuarial reports describe how the capital ratio is calculated, 

the models and data sources used to calculate the net present value of 

future cash flows, key economic assumptions used in calculating the MMI 

Fund’s economic value, and estimated economic values of the forward 

mortgage and HECM portfolios. Additionally, FHA’s reports to Congress 

include calculations of the Fund-wide capital ratio based on these values, 

as well as analyses of factors affecting the past performance of the 

forward mortgage and HECM portfolios and factors that could affect their 

future performance. The actuarial reviews and reports to Congress are 

publicly available on HUD’s website.34

The MMI Fund’s capital requirement is partially consistent with the 

framework element of having both a risk-based and a fixed component. 

For capital requirements with this feature, whichever component requires 

the greater level of capital is the binding minimum requirement. Among 

other things, a risk-based component helps to ensure that the entity holds 

more capital as the asset quality of its portfolio (credit quality, specifically, 

in the case of a mortgage portfolio) decreases.35 A fixed component is 

insensitive to asset quality; it therefore is not subject to the potential for 

estimation errors of risk-based assessments and serves as a backstop to 

the risk-based component.

While the MMI Fund’s capital requirement is statutorily set at 2 percent, it 

is risk-based because the calculation of the capital ratio’s numerator 

(economic value) accounts for loan and borrower quality. As loan and 

borrower characteristics, such as loan-to-value ratios and borrower credit 

scores, get riskier, the models used to estimate the MMI Fund’s economic 

 33Private sector entities may be more limited in what they can disclose compared with 

FHA because of their need to protect proprietary business information.

34The actuarial reports, accessed on August 15, 2017, can be found at 

https://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/rmra/oe/rpts/actr/actr

menu and the annual reports to Congress, accessed on August 22, 2017, can be found at 

https://portal.hud.gov/hudportal/HUD?src=/fhammifrpt.

35In this framework element, we focus on risks related to the characteristics of loans and 

borrowers that may affect the likelihood of repayment. We discuss risks related to 

changes in economic conditions in the next framework element. 

Transparency

Risk-Based and Fixed 

Components
Page 17 GAO-18-92 FHA Capital Reserves

value predict higher insurance claims and higher net losses on claims 

(due to increased foreclosures and decreased returns on sales of 

foreclosed properties).36 This, in turn, reduces the MMI Fund’s estimated 

economic value and makes it more difficult for the fund to meet the 2 

percent capital requirement. The MMI Fund’s capital requirement also has 

attributes similar to a fixed component in that the fund’s economic value 

must be at least 2 percent of the insurance-in-force, regardless of the 

credit quality of the insurance portfolio. However, the requirement does 

not have a separate fixed component that backstops the risk-based 

component (that is, becomes binding when it is the more stringent of the 

two).

Developing and implementing a separate fixed component to the MMI 

Fund’s capital requirement would pose challenges. For example, a 

requirement that was insensitive to portfolio credit quality would not align 

with the FCRA requirements and accounting principles that FHA must 

follow. These requirements and principles emphasize the consideration of 

risk factors in estimating potential financial losses. Additionally, 

substantial additional analysis would be required to determine the 

structure of a separate fixed component, the level at which it should be 

set, under what conditions it might become binding, and how it might 

affect FHA’s ability to fulfill its mission. As a result, it is unclear whether 

developing a separate fixed component to the MMI Fund’s capital 

requirement would be beneficial.

The MMI Fund’s capital requirement is partially consistent with the 

framework element of being able to cover unexpected losses and being 

based on a specified risk threshold, such as an adverse economic 

scenario that the entity would be expected to withstand. The MMI Fund’s 

capital requirement is designed to cover some unexpected losses. As 

previously noted, the MMI Fund’s capital ratio is calculated by dividing the 

economic value of the fund by the amortized insurance-in-force. The 

economic value is determined by adding existing capital resources to the 

net present value of future cash flows on outstanding insurance. An 

economic value of zero (and therefore a capital ratio of zero) indicates 

that based on the actuarial calculations, the sum of the MMI Fund’s 

existing capital resources and the present value of expected cash inflows 

 36The loan-to-value ratio is the amount of the loan divided by the value of the home at 

origination. Borrower credit scores are numeric values generally ranging from 300 to 850 

calculated based on credit reports from the national credit bureaus. Credit scores are an 

indicator of a borrower’s ability to repay future obligations.

Unexpected Losses and 

Specified Risk Thresholds
Page 18 GAO-18-92 FHA Capital Reserves

(for example, premium income) is exactly the amount needed to cover the 

present value of expected cash outflows (for example, claim payments). 

Therefore, a 2 percent capital requirement serves the purpose of covering 

some losses above expected amounts. However, the requirement was 

not designed to absorb losses associated with a specified economic 

scenario, so the extent of loss protection it provides is unclear.37

In a February 2001 report, we concluded that neither the statute that 

created the 2 percent capital requirement nor FHA had established 

criteria to determine how severe of a stress the MMI Fund should be able 

to withstand.38 Accordingly, we recommended that Congress or FHA 

specify the economic conditions that the MMI Fund would be expected to 

withstand.39 In March 2002, a legislative proposal was introduced in the 

House of Representatives that would have required a capital ratio 

sufficient to withstand a broad range of adverse economic circumstances, 

but it was not enacted.40 Neither Congress nor FHA has subsequently 

specified the economic conditions the MMI Fund should be able to 

withstand or corresponding minimum capital ratios. FHA officials said they 

did not consider it their role to define those economic conditions and 

would comply with any requirement Congress established. Because the 

MMI Fund’s capital requirement is not based on a specified risk threshold, 

it may not provide an adequate financial cushion under economic 

scenarios in which Congress may anticipate that the fund would be selfsufficient.

The MMI Fund’s capital requirement is not consistent with the framework 

element of having accountability mechanisms such as additional reporting 

requirements, remediation plans, and operational restrictions that are 

triggered if capital requirements are not met. Failure to comply with the 

MMI Fund’s capital requirement does not trigger a defined process or set 

 37Research done at the time the requirement was enacted suggested that a 1.25 percent 

capital ratio could allow the MMI Fund to weather a mild recession. See Price 

Waterhouse, Office of Government Services, (Washington, D.C.: 1990). In a February 

2001 report, we concluded that a 2 percent capital buffer appeared sufficient to withstand 

moderately severe economic scenarios but cautioned that our results were valid only for 

the MMI Fund at that time. See GAO, Mortgage Financing: FHA’s Fund Has Grown, but 

Options for Drawing on the Fund Have Uncertain Outcomes, GAO-01-460 (Washington, 

D.C.: Feb. 28, 2001). 

38GAO-01-460. 

39In comments on the report, FHA neither agreed nor disagreed with our recommendation. 

40H.R. 3995, 107th Cong. (2002).

Accountability Mechanisms
Page 19 GAO-18-92 FHA Capital Reserves

of steps to be taken by FHA. In a September 2010 report, we stated that 

Congress should consider establishing a minimum time frame for 

restoring the capital ratio to 2 percent should the ratio fall below that 

level.41 A legislative proposal was introduced in Congress in December 

2011 that, among other things, would have required FHA to return the 

MMI Fund’s capital ratio to the statutorily required level within 2 years, but 

it was not enacted.42 In addition, in a September 2013 report, we stated 

that Congress should consider requiring FHA to submit a capital 

restoration plan and regular updates on plan implementation whenever 

the capital ratio falls below 2 percent.43 Congress has not yet acted on 

this suggestion, but doing so could help ensure prompt action by FHA 

and focus Congress’s monitoring efforts should this situation arise in the 

future.

We could not assess the consistency of the MMI Fund’s capital 

requirement with the framework element of balancing financial soundness 

with the entity’s role and mission. Such an assessment would require 

more information about the severity of the economic conditions the capital 

requirement was designed to withstand without supplemental funding. As 

previously discussed, the statute that created the requirement did not 

specify those conditions. As a result, it is unclear whether FHA’s 

difficulties in maintaining the financial soundness of the MMI Fund while 

carrying out its public mission during and after the 2007–2011 housing 

crisis indicate that the 2 percent capital requirement is insufficient.

Any reconsideration of the capital requirement would involve policy 

decisions that would need to be made through congressional 

deliberations. These decisions center on the relative weight FHA should 

place on its financial and mission goals and requirements. On the one 

hand, FHA has a statutory operational goal to minimize mortgage default 

risk to the MMI Fund and a statutory requirement to maintain a capital 

ratio of at least 2 percent. A minimum capital requirement that is too low 

may result in FHA taking on too much risk and having an insufficient 

capital buffer to withstand an economic downturn without requiring 

 41GAO, Mortgage Financing: Opportunities to Enhance Management and Oversight of 

FHA’s Financial Condition, GAO-10-827R (Washington, D.C.: Sept. 14, 2010).

42S. 1997, the FHA Bailout Protection Act of 2011, was introduced in the Senate on 

December 15, 2011. It was referred to the Senate Committee on Banking, Housing, and 

Urban Affairs but was not reported out of committee.

43GAO-13-722. 

Balancing Financial 

Soundness and Mission
Page 20 GAO-18-92 FHA Capital Reserves

supplemental funding. On the other hand, FHA also has a statutory 

operational goal to provide mortgage insurance to traditionally 

underserved borrowers—such as low-income, minority, and first-time 

home buyers—and historically has played a role in stabilizing housing 

markets during economic downturns. Setting a minimum capital 

requirement that is too high may limit FHA’s ability to serve the borrowers 

for which it was intended or play its market-stabilizing role, because it 

might require FHA to charge insurance premiums that many borrowers 

cannot afford or impose underwriting standards they cannot meet. The 

tension between the financial and mission aspects of FHA’s goals and 

requirements poses trade-offs that must be weighed by policymakers in 

setting the MMI Fund’s capital requirement.

Stress testing practices for the MMI Fund are consistent with two of the 

five elements in our stress testing framework—that stress testing 

methods and results be transparent and stress testing scenarios capture 

relevant risks. The stress testing practices are inconsistent with two other 

elements—that the scope of testing includes entity-wide assessments 

and that the specific objectives of the tests be defined. We were unable to 

determine the consistency of MMI Fund stress testing practices with the 

framework element that methods and scenarios be consistent with the 

objectives of the tests because FHA has not defined specific objectives. 

Table 4 summarizes our assessments.

Table 4: Assessment of the Federal Housing Administration’s Stress Testing Practices Using GAO’s Framework

Framework element Assessment

1. The stress testing methods and results are transparent ●

2. The stress scenarios capture risks relevant to the entity ●

3. The scope of the stress testing includes entity-wide assessments ○

4. The specific objectives of the stress testing are defined ○

5. The stress testing methods and scenarios are consistent with the objectives of the tests ─

○ Not consistent ● Consistent ─ Unable to determine

Source: GAO. | GAO-18-92

Stress tests of the MMI Fund are consistent with the framework element 

of transparency. Specifically, stress testing methods, scenarios, and 

FHA Has Not Conducted 

Fund-Wide Stress Tests or 

Specified the Objectives of 

Its Tests

Transparency
Page 21 GAO-18-92 FHA Capital Reserves

results should be specific and available for review.44 Actuarial reports on 

the MMI Fund provide detailed information on the methodology and 

results of fund stress tests. For example, the actuarial reports describe 

the stress testing method of estimating economic values for the forward 

mortgage and HECM portfolios using hypothetical scenarios based on 

projected unemployment, house price appreciation, and interest rates. 

The reports also describe sources for these projections, including 

scenarios developed by Moody’s Analytics and generated by the actuarial 

contractor through Monte Carlo simulation. In addition, for each variable, 

the reports present graphics showing their projected paths under each 

scenario over the stress period. Furthermore, for each scenario, the 

reports provide quantitative results and an accompanying narrative 

discussion highlighting key drivers of the results. The reports are publicly 

available on HUD’s website.45

Stress tests of the MMI Fund are consistent with the framework element 

of capturing risks that are relevant to the entity. The stress scenarios 

used in the actuarial reviews have incorporated risks the MMI Fund faces 

by considering changes in economic conditions that would negatively 

affect the fund’s cash flows and, by extension, the fund’s economic value. 

More specifically, they include declines in house prices and rises in 

unemployment, which can be expected to increase borrower defaults on 

FHA-insured mortgages and increase the number and severity of 

insurance claims FHA pays to lenders.46 In addition, the scenarios include 

declines in interest rates, which can be expected to increase the number 

of FHA-insured mortgages that are paid off before maturity—for example, 

as borrowers refinance out of their FHA-insured mortgages into 

conventional mortgages (those without government insurance or 

guarantees)—thus reducing the amount of insurance premiums FHA 

collects. To examine these risks, the stress scenarios in recent FHA 

actuarial reviews have included substantial declines in a Federal Housing 

 44Private sector entities may be more limited in what they can disclose compared with 

FHA because of their need to protect proprietary business information.

45The actuarial reports, accessed on August 15, 2017, can be found at 

https://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/rmra/oe/rpts/actr/actr

menu.

46Severity refers to the size of the loss relative to the insurance claim. In an environment 

where house prices are declining, claim severity can be expected to increase because 

lower housing values reduce FHA’s ability to offset claim payments with proceeds from the 

sale of foreclosed properties.

Risks Relevant to Entity
Page 22 GAO-18-92 FHA Capital Reserves

Finance Agency national house price index, increases in unemployment 

rates, and decreases in interest rates for 30-year home mortgages.

To provide additional perspective on the severity, duration, and timing of 

scenarios used to stress test the MMI Fund, appendix III compares 

selected MMI Fund stress scenarios to the severely adverse scenario 

used by the Federal Reserve in conducting annual supervisory stress 

tests of large banking organizations.

47

Stress tests of the MMI Fund are not consistent with the framework 

element of including entity-wide assessments to provide a complete 

picture of risk.48 Since fiscal year 2009, when the HECM portfolio was first 

included in the MMI Fund, stress tests of the MMI Fund have analyzed 

the forward mortgage and HECM portfolios separately, but not on a fundwide basis. This practice partly reflects the way in which capital 

assessments of the MMI Fund are performed—through separate 

assessments of the forward mortgage and HECM portfolios. Additionally, 

an FHA official said the agency has been reluctant to report combined 

ratios for stress scenarios because the results could be misinterpreted 

(for example, result in too much or too little confidence in the fund’s ability 

to withstand stress) if the scenarios are not viewed in the proper historical 

context.49 However, without the combined analysis, it is unclear what the 

capital position of the MMI Fund as a whole would be under stressful 

conditions. As a result, FHA and Congress may lack information that 

could be useful in assessing risks to the MMI Fund, including 

circumstances that could cause the fund’s capital ratio to fall below the 

statutory minimum.

 47The Dodd-Frank Wall Street Reform and Consumer Protection Act requires that all 

financial companies with more than $10 billion in total consolidated assets that are 

supervised by a primary federal financial regulatory agency are required to conduct an 

annual company-run stress test. Only bank holding companies with total consolidated 

assets of $50 billion or more and each nonbank financial company that the Financial 

Stability Oversight Council has designated for supervision by the Federal Reserve are 

subject to the annual supervisory stress test conducted by the Federal Reserve. The 

supervisory stress tests must provide for at least three different sets of conditions—

baseline, adverse, and severely adverse—under which the Federal Reserve would 

conduct its evaluation. 12 U.S.C. § 5365(i)(2); 12 C.F.R. § 252.52(g).

48For purposes of this framework element, we considered the MMI Fund to be the entity 

because the capital requirement applies to the fund as a whole. 

49As previously noted in this report, combined capital ratios can be calculated for the 

stress scenarios not generated from Monte Carlo simulations.

Entity-Wide Scope
Page 23 GAO-18-92 FHA Capital Reserves

Stress testing of the MMI Fund is not consistent with the framework 

element of defining the specific objectives of the tests. According to 

guidance from federal banking regulators, large banking organizations 

should indicate the specific purpose and focus of stress tests within a 

framework that allows for consistent, repeatable exercises.50 Additionally, 

this guidance and stress testing principles and practices from two 

international financial organizations provide examples of stress testing 

objectives such as informing assessment of vulnerabilities, contingency 

planning, identifying and monitoring risk concentrations, and determining 

the level of risk the entity is willing to accept (risk appetite).51

The MMI Fund actuarial reviews have included the broad statement that 

the stress tests performed as part of the reviews provide insights into the 

sensitivity of the MMI Fund’s economic value under different economic 

conditions. In addition, FHA has included some information from the 

stress tests in recent annual reports to Congress to highlight different 

points. However, FHA has not articulated specific objectives for the stress 

tests, in part because a key use of the actuarial reviews is to help 

determine the MMI Fund’s compliance with the capital requirement under 

a baseline economic scenario (which, in recent actuarial reviews, has 

been the Monte Carlo average). Accordingly, the types of information 

FHA has reported to Congress have varied from year to year. For 

example, in recent years, FHA’s reporting on stress test results has 

ranged from no information (fiscal year 2016), to how much additional 

capital the forward mortgage portfolio would need to withstand losses 

comparable to the last economic crisis (fiscal year 2015), to the 

probability that the economic value of the HECM portfolio would fall below 

zero under deteriorating economic conditions (fiscal year 2013). Without 

specific objectives for its stress testing, FHA has limited assurance that its 

stress tests are targeted to risk-management needs and that its reporting 

to Congress provides consistent information on the MMI Fund’s ability to 

withstand adverse conditions.

 50Board of Governors of the Federal Reserve System, Federal Deposit Insurance 

Corporation, Office of the Comptroller of the Currency, Guidance on Stress Testing for 

Banking Organizations with Total Consolidated Assets of More Than $10 Billion, SR 

Letter 12-7 (May 14, 2012). While FHA is not bound by this guidance, it faces challenges 

similar to those faced by large banking organizations in understanding potential risk 

exposures and preparing for stressful economic events.

51Basel Committee on Banking Supervision, Bank for International Settlements, Principles 

for Sound Stress Testing Practices and Supervision (Basel, Switzerland: May 2009); and 

International Actuarial Association, Stress Testing and Scenario Analysis (Ottawa, 

Canada: July 2013).

Defined Objectives
Page 24 GAO-18-92 FHA Capital Reserves

Because FHA has not defined specific objectives for MMI Fund stress 

tests, we could not assess whether existing tests were consistent with the 

framework element of using stress testing methods and scenarios that 

are consistent with stated objectives. Entities should use stress testing 

methods—such as conventional stress testing (which looks at the effect 

of specified hypothetical or historical stress scenarios) or reverse stress 

testing (which assumes a negative outcome and identifies scenarios that 

would lead to that outcome)—that yield information responsive to the 

objectives of the stress tests.

Actuarial reviews of the MMI Fund have used conventional stress testing 

and a range of stress scenarios developed by Moody’s Analytics and 

generated by Monte Carlo simulation. But, depending on how FHA 

defines the specific objectives of the MMI Fund’s stress tests, other stress 

testing methods or scenarios might provide useful information for risk 

management. For example, if the objective of the stress testing was to 

identify the conditions that might cause the MMI Fund’s capital ratio to fall 

below 2 percent or require supplemental funding, reverse stress testing 

would be an appropriate method. If the objective was to assess the MMI 

Fund’s ability to withstand conditions similar to those of the Great 

Depression or the 2007–2011 housing crisis, developing historical stress 

scenarios would be appropriate. Additionally, if the objective was to 

assess the effect of changes to a particular variable or input (as opposed 

to a broader economic scenario), sensitivity stress tests would be 

appropriate.52

 52In contrast to scenario stress tests, sensitivity stress tests may explore the impact of 

changes—including extreme values or shocks—to particular variables or inputs without 

defining the events or underlying reasons for those changes. Instead, the changes may be 

computed using statistical measures or be based on judgment.

Methods and Scenarios 

Consistent with Objectives
Page 25 GAO-18-92 FHA Capital Reserves

Beginning with the 2009 loan cohort, HERA placed new HECMs (FHAinsured reverse mortgages) in the MMI Fund, while previous HECMs 

remained in the General and Special Risk Insurance Fund. When the 

post-2008 HECM portfolio became part of the MMI Fund, it also was 

included in the MMI Fund’s capital ratio assessment and became subject 

to annual actuarial review requirements. These changes have had some 

advantages. First, subjecting HECMs to the annual actuarial review 

requirements has improved the transparency of the program’s financial 

condition. For example, the actuarial reviews have included estimates of 

the HECM portfolio’s economic value and performance under alternative 

economic conditions, which were not available prior to 2009.

Second, jointly considering the forward mortgage and HECM portfolios in 

the MMI Fund’s capital assessment mitigates the potential difficulty of 

independently holding the HECM portfolio to a specified capital ratio. The 

economic value of the HECM portfolio is more sensitive to changes in

economic conditions and inputs to the models than the forward mortgage 

portfolio.53 As a result, the capital ratio for the HECM portfolio is more 

volatile, and requiring HECMs to independently meet a capital ratio would 

be difficult. Specifically, it could be difficult to manage HECM insurance 

premiums, loan limits, and other program requirements to ensure that a 

capital requirement is consistently met. Estimates of HECM capital ratios 

under alternative economic scenarios from the fiscal year 2016 actuarial

review illustrate the sensitivity of this portfolio’s economic value—and 

 53One reason the HECM portfolio is more sensitive to economic assumptions is that 

HECMs are, on average, longer in duration than forward mortgages. Because their cash 

flows extend over a lengthier time frame, the economic value of HECMs is more sensitive 

to assumptions, such as interest rates, that have greater effects the longer they are 

applied. In addition, HECMs are negative amortization loans, meaning the loan balances 

grow over time. Therefore, an increase in interest rates would have a larger effect on the 

growing balances of HECMs than it would on the decreasing balances of forward 

mortgages, and the present value of cash flows from HECMs will be more affected by 

even a small change in interest rates. Similarly, because a HECM loan balance grows 

over time and proceeds from the sale of the house are typically used to pay off the 

balance when it becomes due, a decline in house values increases the likelihood that the 

proceeds will not cover the loan balance, resulting in an insurance claim and loss to FHA. 

Joint Capital 

Assessment Has 

Advantages and 

Disadvantages

Advantages of Including 

Reverse Mortgages in the 

Fund’s Capital 

Requirement Include 

Greater Transparency
Page 26 GAO-18-92 FHA Capital Reserves

therefore its capital ratio—to changes in economic conditions (see fig.1). 

While the capital ratio for forward mortgages ranged from negative 3.3 

percent to positive 4.17 percent under all of the economic scenarios, the 

corresponding range for HECMs was negative 38.74 percent to positive 

3.07 percent.

Figure 1: Fiscal Year 2016 Forward Mortgage and HECM Portfolio Capital Ratios under Different Economic Scenarios

a

The Monte Carlo average capital ratios are calculated using the average of the Monte Carlo 

simulation’s 100 economic values.

b

The 10th best, 25th best, 25th worst, 10th worst, and worst Monte Carlo simulation paths are the 

economic scenarios that produced the corresponding economic value for each portfolio. Because the 

combination of house price, interest rate, and unemployment assumptions that comprise an economic 

scenario may not affect forward mortgages and HECMs similarly, the economic scenarios 

represented by each of these paths may be different for forward mortgages and HECMs.

c

This scenario holds interest rates low for the first 2 years of the projection, then follows the Moody’s 

Analytics baseline scenario beginning in year 3.

d

This scenario modified the Moody’s Analytics protracted slump scenario by assuming less optimistic 

house-price growth rates after the initial stress period.
Page 27 GAO-18-92 FHA Capital Reserves

Under the current approach of jointly considering the HECM and forward 

mortgage portfolios in the capital assessment, both portfolios in

combination are subject to the capital requirement, but the volatility of the 

HECM portfolio’s economic value is mitigated by the relative stability of 

the forward mortgage portfolio. More specifically, because the forward 

mortgage portfolio is substantially larger than the HECM portfolio (with the 

HECM portfolio accounting for roughly 10 percent of the MMI Fund’s 

insurance-in-force in fiscal year 2016), the combined capital ratio more 

closely follows the generally less volatile capital ratio for forward 

mortgages (see fig. 2). As a result, the combined capital ratio is less 

uncertain than the HECM capital ratio, and managing the HECM portfolio 

within that combined framework is more feasible than managing it to a 

separate capital requirement.

Figure 2: Forward Mortgage, HECM, and Combined Capital Ratios, Fiscal Years 

2009–2016

Finally, another possible advantage of the joint assessment is some 

degree of risk diversification. The cash inflows and outflows of the forward 

mortgage and HECM portfolios do not necessarily rise and fall in tandem 
Page 28 GAO-18-92 FHA Capital Reserves

in response to changes in macroeconomic conditions. For example, all 

other things being equal, rising mortgage interest rates tend to increase 

the economic value of the forward mortgage portfolio but tend to 

decrease the economic value of the HECM portfolio.54 Because the cash 

flows of the two portfolios are not fully correlated, the amount of capital 

needed for the two portfolios in combination may be less than the sum of 

the amount of capital needed for each portfolio separately.

Joint assessment of the forward mortgage and HECM portfolios in 

determining compliance with the capital requirement also has some 

disadvantages. First, including HECMs in the MMI Fund can result in 

more uncertainty about the Fund’s expected performance. As previously 

discussed, the economic value of HECMs is more volatile and sensitive to 

economic conditions than the economic value of forward mortgages. As a 

result, estimates of the MMI Fund’s economic value and capital ratio and 

its potential performance under alternative economic scenarios are less 

predictable and more difficult to interpret with the inclusion of HECMs.

Although the combined capital ratio generally tracks with the forward 

mortgage capital ratio, the inclusion of HECMs in the assessment can 

affect the combined capital ratio. For example, in fiscal year 2015, a high 

HECM capital ratio (6.44 percent) pulled the combined capital ratio above 

2 percent (2.07 percent), even though the forward mortgage capital ratio 

was below 2 percent (1.63 percent). In this case, the inclusion of the 

HECM portfolio in the capital ratio resulted in the MMI Fund meeting the 2 

percent capital requirement for the first time in 6 years. In its fiscal year 

2014 report to Congress, FHA concluded that the HECM portfolio was 

over 10 times more volatile than the forward mortgage portfolio, noting 

that small changes to the HECM program can affect the overall value of 

the MMI Fund. Further, in its fiscal year 2015 report to Congress, FHA 

noted that because the HECM portfolio is projected to continue growing at 

a faster rate than the forward portfolio, year-to-year HECM volatility is 

likely to contribute more uncertainty to future actuarial valuations of the 

MMI Fund. In recent years, HECMs have accounted for an increasing 

 54When interest rates rise, borrowers with forward mortgages are less likely to prepay 

their mortgages (for example, through refinancing). As a result, FHA benefits from the 

insurance premiums it continues to collect from those borrowers. In contrast, for HECM 

borrowers (many of whom have adjustable-rate loans) rising interest rates tend to make 

their loan balances grow more quickly. This increases the likelihood and size of insurance 

claims because the amount borrowed is more likely to exceed the net proceeds from the 

sale of the home when the loan terminates.

Disadvantages of 

Including HECMs in the 

MMI Fund Include More 

Uncertainty about the MMI 

Fund’s Financial Condition
Page 29 GAO-18-92 FHA Capital Reserves

percentage of the MMI Fund’s insurance-in-force, rising from 4.01 percent 

in fiscal year 2009 to 9.42 percent in fiscal year 2016.

Second, relying on a combined capital ratio to assess the MMI Fund’s 

compliance with the capital requirement could mask the financial 

condition of the individual portfolios. Information on the performance of 

each portfolio is available in separate actuarial reports, but differences 

between the financial health of the two portfolios may be overlooked 

because compliance with the 2 percent capital requirement is determined 

by the combined capital ratio. For example, in fiscal year 2013, the 

combined capital ratio was below 2 percent (negative 0.11 percent), while 

the HECM capital ratio was 7.50 percent. In contrast, in fiscal year 2016, 

the combined ratio was above 2 percent (2.32 percent), while the HECM 

capital ratio was below 2 percent (negative 6.90 percent). In those years, 

the substantial difference between the financial condition of the HECM 

portfolio and the overall MMI Fund would not have been evident from the 

combined capital ratio.

Even in years when the capital ratios of both the forward mortgage and 

HECM portfolios are above or below the 2 percent level, the combined 

capital ratio may still hide important differences between the two. For 

example, in fiscal year 2014, the capital ratios for both the forward 

mortgage and HECM portfolios were below 2 percent. However, the 

forward mortgage capital ratio was positive (0.56 percent), while the 

HECM capital ratio was negative (-1.20 percent). This difference may be 

important to policymakers because a positive capital ratio indicates that 

the portfolio has some capital cushion to absorb unexpected losses, even 

if it is small. In contrast, a negative ratio suggests the portfolio may not 

have sufficient capital to independently cover all expected net losses on 

outstanding insurance, and may essentially be financially supported by 

the other portfolio in the MMI Fund.

Finally, in certain circumstances, the joint capital assessment could 

create pressure to raise insurance premiums or tighten underwriting 

standards in one program to compensate for the weaker financial 

performance of another program. For example, if the forward mortgage 

capital ratio were above 2 percent, but the HECM capital ratio pulled the 

combined ratio below 2 percent, raising insurance premium rates for 

forward mortgages could be the quickest way to regain a 2 percent capital 
Page 30 GAO-18-92 FHA Capital Reserves

ratio.55 In this example, a portion of the premiums paid by the forward 

mortgage borrower would essentially support the HECM program. While 

this situation would benefit HECM borrowers (because their insurance 

premiums would not increase), it would potentially create a burden for 

forward mortgage borrowers and could reduce the number of prospective 

borrowers who are able to afford FHA mortgage insurance. However, as 

of September 2017, FHA officials said that the agency had not increased 

forward mortgage premiums to support the HECM program or vice versa.

Alternatives to the MMI Fund’s joint capital assessment could address 

some of the disadvantages of this approach but would also involve 

potential trade-offs between mission, financial soundness, and 

transparency goals. Policy decisions about these trade-offs could have 

significant implications for the management of FHA’s programs and for 

potential FHA borrowers.

If Congress wishes to place additional emphasis on the financial selfsufficiency of the HECM program, it may be appropriate to hold the 

HECM portfolio to a capital requirement separate from that of forward 

mortgages. Under this option, future HECMs could either remain in the 

MMI Fund or be placed under a different insurance fund.56 The capital 

requirement could be set at the same congressionally defined level as the 

one for forward mortgages, or it could be tailored to the risks and volatility 

of the HECM portfolio. A separate HECM capital requirement would help 

ensure that the forward mortgage portfolio is not supporting the HECM 

portfolio, or vice versa. Decisions about premiums and other program 

requirements could be based solely on each portfolio’s financial condition 

and would not be influenced by a need to keep a combined capital ratio 

sufficiently high.

In addition, a separate HECM capital requirement would help ensure that 

for future loan cohorts, the financial conditions of the individual portfolios 

 55Raising HECM insurance premium rates by an equal amount would have a smaller 

effect because the program insures far fewer loans.

56When HERA moved HECMs from the General and Special Risk Insurance Fund into the 

MMI Fund, only new HECM cohorts became part of the MMI Fund. HECMs originated 

prior to fiscal year 2009 were kept in the General and Special Risk Insurance Fund. If 

Congress were to move the HECM portfolio again, and take the same approach of moving 

only new cohorts, the HECM portfolio could potentially be split among three different 

subportfolios. 

Alternative Approaches to 

Managing the HECM 

Program and Assessing 

the Capital Requirement 

Pose Trade-offs
Page 31 GAO-18-92 FHA Capital Reserves

are not masked by a combined capital ratio. However, if the HECM 

portfolio was required to independently meet a minimum capital ratio, the 

volatility of the portfolio’s economic value could make it difficult for FHA to 

consistently meet the requirement without targeting a capital level 

substantially above the minimum requirement. Doing so may require FHA 

to raise insurance premiums or place greater restrictions on the amount 

seniors can borrow, which would limit the program’s ability to serve its 

goal of alleviating economic hardship.

In comparison, if Congress wishes to place greater emphasis on 

maximizing the benefits of the HECM program for seniors, another option 

may be to exempt the HECM portfolio from a capital requirement. Under 

this option, future HECMs would not be part of the MMI Fund and would 

not be subject to the MMI Fund’s capital requirement. As with a separate 

HECM capital requirement, this option would help ensure that the 

financial condition of future loan cohorts in the forward mortgage portfolio 

is not masked by a combined capital ratio. But, the financial condition of 

the HECM portfolio would not be as transparent, unless FHA continued to 

conduct HECM actuarial assessments. In addition, FHA could set 

premiums and program limits without consideration for building a capital 

buffer, which might decrease the likelihood that the HECM program would 

operate on at least a break-even basis over the long run. Some industry 

participants we spoke with did not think that HECMs should be exempted 

from a capital requirement, noting that the increased transparency and 

accountability of HECMs were important. However, even without a capital 

requirement, FHA could choose to continue conducting actuarial 

assessments of the HECM program for continued transparency.

The programs FHA administers under its MMI Fund play an important role 

in the mortgage market by expanding homeownership opportunities and 

helping stabilize housing markets during economic downturns. However, 

the MMI Fund’s financial challenges in the wake of the 2007–2011 

housing crisis illustrate the fund’s vulnerability to severely adverse 

economic conditions and underscore the importance of capital 

requirements and stress testing practices for this $1.2 trillion mortgage 

insurance portfolio. Opportunities exist to strengthen these requirements 

and practices by making them more consistent with those used by 

financial institutions and regulators, as reflected in our two evaluative 

frameworks.

As we concluded in our September 2013 report, and consistent with the 

capital requirements framework in this report, including accountability 

Conclusions
Page 32 GAO-18-92 FHA Capital Reserves

mechanisms in FHA’s capital requirement could enhance management 

and oversight of the MMI Fund. Therefore, as we suggested in our 2013 

report, we maintain that Congress should consider requiring FHA to 

submit a capital restoration plan and regular updates on plan 

implementation whenever the fund’s capital ratio falls below the required 

level.57 In our current review, we identified three additional areas where 

the capital requirement and stress testing practices for the MMI Fund 

could be strengthened in accordance with our frameworks. Specifically, 

the statutory 2 percent capital requirement does not specify the economic 

conditions the fund would be expected to withstand. As a result, it may 

not provide an adequate financial cushion under scenarios in which 

Congress may anticipate that the fund would be self-sufficient. In addition, 

FHA has not analyzed or reported stress test results on a fund-wide 

basis, making it unclear what the capital position of the fund as a whole 

would be under stressful conditions. Finally, FHA has not defined the 

specific objectives of the fund’s stress tests and therefore has limited 

assurance that its stress testing methods and scenarios are targeted to 

risk-management needs.

Congress should consider amending the National Housing Act to specify 

the economic conditions the MMI Fund would be expected to withstand 

without substantial risk of drawing on permanent and indefinite budget 

authority, and require FHA to specify and comply with a capital ratio 

consistent with these conditions. In specifying the economic conditions, 

Congress should take into account FHA’s statutory operational goals and 

role in supporting the mortgage market during periods of economic stress. 

(Matter for Consideration 1)

We are making the following two recommendations to FHA:

The Commissioner of FHA should combine stress test results for the 

forward mortgage and HECM portfolios, where possible, and report 

estimated MMI Fund-wide capital ratios for the stress scenarios 

examined. (Recommendation 1)

 57GAO-13-722.

Matter for 

Congressional 

Consideration

Recommendations for 

Executive Action
Page 33 GAO-18-92 FHA Capital Reserves

The Commissioner of FHA should develop specific objectives for stress 

tests of the MMI Fund and apply stress testing methods and scenarios 

consistent with those objectives. (Recommendation 2)

We provided a draft of this report to HUD, the Federal Reserve, and 

FHFA for their review and comment. The Federal Reserve and FHFA had 

no comments. In its comments, reproduced in appendix IV, HUD agreed 

with our recommendations. HUD said that FHA’s forthcoming annual 

actuarial reports and report to Congress on the MMI Fund would include 

stress test results for forward mortgages and HECMs, but HUD did not 

state whether the reports would address our recommendations. By 

analyzing and reporting stress test results on a fund-wide basis and 

defining the specific objectives of its stress tests, FHA would better 

understand the capital position of the MMI Fund as a whole under 

stressful conditions and have greater assurance that its stress testing 

methods and scenarios are targeted to risk-management needs. 

HUD also said it was important to recognize the trade-offs between FHA’s 

mission and insurance policy holders when considering financial 

soundness. HUD said it appreciated our report’s statement that minimum 

capital requirements that are too high may limit FHA’s ability to serve its 

mission and market role and recommended that we make this statement 

more prominent. While our report does contain that statement, it also 

states that a minimum capital requirement that is too low may result in 

FHA taking on too much risk and having an insufficient capital buffer to 

withstand an economic downturn without requiring supplemental funding. 

Accordingly, we added language to the introduction of the report noting 

the challenge FHA and Congress face in balancing the fund’s financial 

self-sufficiency with FHA’s role in facilitating mortgage credit to 

underserved borrowers and stabilizing the housing market during 

economic downturns.

As agreed with your offices, unless you publicly announce the contents of 

this report earlier, we plan no further distribution until 30 days from the 

report date. At that time, we will send copies to the appropriate 

congressional committees, the Secretary of Housing and Urban 

Development, the Chair of the Board of Governors of the Federal 

Reserve System, the Director of the Federal Housing Finance Agency, 

and other interested parties. In addition, the report will be available at no 

charge on the GAO website at http://www.gao.gov.

Agency Comments
Page 34 GAO-18-92 FHA Capital Reserves

If you or your staff have any questions about this report, please contact 

me at (202) 512-8678 or garciadiazd@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs may be found on 

the last page of this report. GAO staff who made key contributions to this

report are listed in appendix V.

Daniel Garcia-Diaz

Director, Financial Markets and Community Investment
Appendix I: Objectives, Scope, and 

Methodology

Page 35 GAO-18-92 FHA Capital Reserves

Our objectives were to examine (1) the types of information actuarial 

reviews and other assessments provide about the Mutual Mortgage 

Insurance Fund’s (MMI Fund) financial condition, including its ability to 

remain self-sufficient; (2) the extent to which the capital requirement and 

stress testing practices for the MMI Fund are consistent with principles 

and practices underlying those of other financial institutions; and (3) key 

advantages and disadvantages of including both forward and Home 

Equity Conversion Mortgages (HECM) in the MMI Fund’s capital 

assessment.

To examine the types of information actuarial reviews and other 

assessments provide about the MMI Fund’s financial condition, including 

its ability to remain self-sufficient, we reviewed actuarial reports of the 

fund prepared by a Federal Housing Administration (FHA) contractor and 

related FHA reports to Congress. We focused on reports for fiscal year 

2009 (the first year HECMs were part of the MMI Fund) through fiscal 

year 2016 (the most recently completed report). Additionally, we reviewed 

FHA budget and financial documents containing assessments of the fund. 

Specifically, we reviewed the Department of Housing and Urban 

Development (HUD) appendix from the President’s budgets for fiscal year 

2011 through fiscal year 2018 (the most recent available) and FHA’s 

audited financial statements for fiscal year 2011 through fiscal year 2016 

(the most recent available). We also reviewed FHA documents and prior 

GAO reports describing the mechanisms used to provide supplemental 

resources to the fund, if necessary.

We determined the extent to which the actuarial, budgetary, and financial 

accounting reviews contained information pertinent to assessing the MMI 

Fund’s financial condition, such as the amount of funds needed and 

available to cover expected net future costs on outstanding insurance, the 

amount of funds available to cover unexpected losses, and the projected 

performance of the MMI Fund under alternative economic scenarios. We 

compared the types of information available in the actuarial reviews with 

the types of information in the budgetary and financial accounting reviews 

of the fund, as well as in FHA’s quarterly reports to Congress, focusing on 

information that could help inform whether the MMI Fund is likely to 

remain self-sufficient. Additionally, we interviewed FHA headquarters 

officials about the content and interpretation of the various reviews of the 

fund.

To illustrate the similarities and differences between the MMI Fund’s 

actuarial and budgetary reviews, we summarized information about the 

Appendix I: Objectives, Scope, and 

Methodology

Information Provided by 

Reviews of the MMI Fund
Appendix I: Objectives, Scope, and 

Methodology

Page 36 GAO-18-92 FHA Capital Reserves

two reviews, including their purposes and the sources of their 

requirements (see app. II). In addition, we reviewed recent actuarial 

reports and HUD budget appendixes and spoke with FHA officials to 

understand their similarities and differences. We developed a hypothetical 

illustration of how certain components of the budgetary review are used in 

the actuarial review.

To assess the extent to which the MMI Fund’s capital requirement and 

FHA’s stress testing approach are consistent with principles underlying 

such requirements for other financial institutions, we developed two 

evaluative frameworks and assessed requirements and practices for the 

MMI Fund against them. For the capital requirements framework, we 

reviewed publicly available documents on requirements and capital 

assessment practices from financial regulators and institutions, including 

the Bank for International Settlements, Fannie Mae and Freddie Mac 

(specifically, their capital requirements for private mortgage insurers), the 

Federal Deposit Insurance Corporation, and the Federal Housing Finance 

Agency (FHFA). For the stress testing framework, we reviewed articles on 

principles and practices from financial regulators and institutions, 

including the Bank for International Settlements, the Board of Governors 

of the Federal Reserve System (Federal Reserve), and the International 

Monetary Fund. We included in our frameworks key common elements in 

designing capital requirements and stress tests that could apply to the 

MMI Fund, assuming the fund would continue to operate under federal 

accounting standards and budgeting requirements.

In addition to FHA, we shared the draft frameworks with FHFA, the 

National Association of Insurance Commissioners, and the American 

Academy of Actuaries and interviewed officials from these organizations 

to obtain their input on the frameworks. We chose these organizations 

based on their expertise in financial assessments of housing finance and 

mortgage insurance institutions. We then reviewed publicly available 

reports and documents, including relevant statutory provisions and FHA’s 

annual actuarial reviews and reports to Congress, to assess whether the 

requirements and practices of the MMI Fund were consistent with our 

framework elements.

To provide additional perspective on stress tests of the MMI Fund, we 

compared variables in selected economic scenarios from the fiscal year 

2016 actuarial review of FHA’s forward mortgage portfolio with 

corresponding variables in one of the scenarios used by the Federal 

Reserve in its 2016 supervisory stress tests of large banking 

Capital Requirements and 

Stress Tests
Appendix I: Objectives, Scope, and 

Methodology

Page 37 GAO-18-92 FHA Capital Reserves

organizations (see app. III). Specifically, we graphed the projected paths 

of the house price index, 30-year fixed mortgage rate, and unemployment 

rate for the two most stressful MMI Fund scenarios—the Monte Carlo 

simulation path producing the lowest economic value for forward 

mortgages and the Moody’s Analytics’ protracted slump scenario—and 

the Federal Reserve’s severely adverse scenario. We chose to highlight 

the worst simulation path and the Moody’s Analytics protracted slump 

scenarios because they are generally the two most severe scenarios 

used in stress tests of the MMI Fund. The Federal Reserve’s severely 

adverse scenario was the most analogous to the two MMI Fund scenarios 

and has been referenced in Fannie Mae’s and Freddie Mac’s financial 

requirements for private mortgage insurers. We analyzed the similarities 

and differences in the severity, duration, and timing of the three variables 

discussed above. To assess the reliability of FHA’s data on its stress 

scenarios, we compared the data we received from the agency with 

published information in FHA’s actuarial reviews. We determined the data 

were sufficiently reliable for the purposes of illustrating similarities and 

differences with the Federal Reserve’s severely adverse scenario.

To identify key advantages and disadvantages of including both forward 

mortgages and HECMs in the MMI Fund’s capital assessment, we 

reviewed actuarial results for both portfolios from fiscal year 2009 through 

fiscal year 2016. Using information from the actuarial reviews, we 

calculated and compared the separate and combined capital ratios for 

forward mortgages and HECMs to determine the effect of including the 

reverse mortgage portfolio in the MMI Fund capital calculation, as well as 

the potential effects of holding the HECM portfolio to a separate capital 

requirement. We also reviewed discussions in FHA’s annual reports to 

Congress describing the effect of including the forward mortgage and 

HECM portfolios in the same fund. In addition, we interviewed FHA 

officials and other industry participants and stakeholders, including the 

National Reverse Mortgage Lenders Association, Mortgage Bankers 

Association, U.S. Mortgage Insurers, American Bankers Association, and 

the American Association of Retired Persons, about the advantages and 

disadvantages of jointly considering both portfolios in assessing the MMI 

Fund’s capital ratio as well as of alternative approaches.

We conducted this performance audit from August 2016 to November 

2017 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

Consideration of Forward 

Mortgages and HECMs in 

Capital Assessment
Appendix I: Objectives, Scope, and 

Methodology

Page 38 GAO-18-92 FHA Capital Reserves

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives.
Appendix II: Mutual Mortgage Insurance Fund 

Budgetary and Actuarial Reviews

Page 39 GAO-18-92 FHA Capital Reserves

The budgetary and actuarial reviews of the Mutual Mortgage Insurance 

Fund (MMI Fund) serve different purposes, stem from different 

requirements, and are conducted by different entities. See table 5 for a 

summary of these two reviews of the fund.

Table 5: Overview of Budgetary and Actuarial Reviews

Budgetary review Actuarial review

Purpose To estimate the credit subsidy costs of the mortgage 

insurance programs in the Mutual Mortgage 

Insurance Fund (MMI Fund) (initial estimates for new 

loan cohorts and reestimates for existing cohorts) and 

record the amount of funds available in the MMI 

Fund’s financing and capital reserve accounts.

To estimate the economic value of the existing 

forward and reverse mortgage portfolios in the 

MMI Fund. The Federal Housing Administration 

(FHA) uses the combined economic values to 

calculate the fund’s capital ratio (economic value 

divided by insurance-in-force) and assess 

compliance with the MMI Fund’s statutory 2-

percent capital requirement.

Source of requirement Federal Credit Reform Act of 1990 Originally in the Omnibus Budget Reconciliation 

Act of 1990. Subsequently made a requirement 

in the Housing and Economic Recovery Act of 

2008. 

Who conducts it FHA Independent actuary

Where results of review are 

published

Department of Housing and Urban Development 

appendix to the President’s budget.

Actuarial reports on the MMI Fund’s forward and 

reverse mortgage portfolios and annual FHA 

reports to Congress.

Source: GAO. | GAO-18-92

However, the two reviews share some concepts and numbers. For 

example, the actuarial analysis of the MMI Fund’s economic value 

includes an existing capital resources component, which can be 

calculated from information on assets and liabilities presented in the 

budgetary review.1 In addition, both reviews include a calculation of the 

present value of future cash flows on outstanding insurance, though the 

two reviews use different models and economic assumptions to perform 

these calculations.2 Both reviews also provide estimates of the amount of 

 1

The information on assets and liabilities originates from the financial accounting review, 

but is carried over from and presented in a customized form in the President’s budget. 

2

For example, the budgetary review must use a unique discount rate for each loan cohort, 

which reflects the interest rate at the time the budget for the cohort was developed or 

when the underlying loans were disbursed. In contrast, the actuarial review uses a single 

discount rate across all cohorts. The different discount rates across the two reviews can 

result in substantially different results. For example, according to FHA’s fiscal year 2014 

report to Congress, applying budgetary discount rates to that year’s actuarial review of the 

MMI Fund’s forward mortgage portfolio would have resulted in an economic value of $7.59 

billion, compared with the actuarial assessment of $5.93 billion—a difference of $1.66 

billion. 

Appendix II: Mutual Mortgage Insurance 

Fund Budgetary and Actuarial Reviews
Appendix II: Mutual Mortgage Insurance Fund 

Budgetary and Actuarial Reviews

Page 40 GAO-18-92 FHA Capital Reserves

resources the MMI Fund has, in excess of what is needed to cover 

estimated credit subsidy costs (that is, the net present value of expected 

future cash flows on outstanding insurance). Figure 3 provides a 

simplified, hypothetical illustration of the relationship between the MMI 

Fund’s budgetary and actuarial reviews.

Figure 3: Hypothetical Illustration of Budgetary and Actuarial Review Components 

(dollars in billions)

Note: Similarly shaded boxes represent conceptually similar or identical figures.

a

Under the Federal Credit Reform Act of 1990, the financing account must hold sufficient funds to 

cover the estimated credit subsidy cost of each loan guarantee. Since the Federal Housing 

Administration (FHA) collects the insurance premiums needed to cover these costs over time rather 

than immediately upon loan disbursement, the act authorizes FHA (as it does other federal credit 

agencies) to borrow the funds from the Department of the Treasury (Treasury). FHA pays back the 

borrowed funds to Treasury with interest using insurance premiums collected over time and proceeds 

from any downward reestimates in FHA’s long-term insurance costs.
Appendix III: Comparison of Economic 

Scenarios Used in Mutual Mortgage Insurance 

Fund and Federal Reserve Supervisory Stress 

Tests

Page 41 GAO-18-92 FHA Capital Reserves

We compared selected economic scenarios used in stress tests of the 

Federal Housing Administration’s (FHA) Mutual Mortgage Insurance Fund 

(MMI Fund) with the severely adverse scenario developed by the Board 

of Governors of the Federal Reserve System (Federal Reserve) for its 

supervisory stress tests of large banking institutions.1 (Under the direction 

of the Federal Housing Finance Agency, the housing enterprises Fannie 

Mae and Freddie Mac incorporated the Federal Reserve scenario into 

financial criteria that private mortgage insurance companies must meet to 

be an approved insurer of mortgages acquired by the housing 

enterprises.)2 Our analysis focused on scenarios used in the fiscal year 

2016 actuarial review of the MMI Fund’s forward mortgage portfolio (the 

most recently completed review) and the Federal Reserve’s 2016 

supervisory stress tests, because these scenarios all used projections of 

economic variables beginning in calendar year 2016. We examined 

similarities and differences in the severity, duration, and timing of these 

scenarios’ projections of three variables most pertinent to the MMI Fund’s 

economic value: single-family home prices, 30-year fixed mortgage 

 1

The Federal Reserve has two related supervisory programs that involve stress testing. 

First, the Dodd-Frank Wall Street Reform and Consumer Protection Act implements 

statutory company-run and supervisory stress test requirements, known as the DoddFrank Act Stress Tests (DFAST), for Federal Reserve-supervised banking institutions with 

more than $10 billion in total consolidated assets. DFAST projects how banking 

institutions’ capital levels would fare in hypothetical stressful economic and financial 

scenarios. Second, the Federal Reserve conducts a Comprehensive Capital Analysis and 

Review (CCAR), which uses DFAST information to assess the capital adequacy and 

capital planning processes for bank holding companies with total consolidated assets of 

$50 billion or more. CCAR generally does not require stress tests in addition to those 

conducted under DFAST. For additional information on these programs, see GAO, 

Federal Reserve: Additional Actions Could Help Ensure the Achievement of Stress Test 

Goals, GAO-17-48 (Washington, D.C.: Nov. 15, 2016).

2

Fannie Mae and Freddie Mac are private, federally chartered companies that provide 

liquidity to the home mortgage market. In September 2008, they were placed into federal 

conservatorships. Under the direction of the Federal Housing Finance Agency, Fannie 

Mae and Freddie Mac issued major revisions to their Private Mortgage Insurer Eligibility 

Requirements (PMIER) in 2015 (effective for new applicants and existing approved 

insurers in April and December 2015, respectively). Among other things, the PMIERs

require approved insurers to establish, maintain, and certify compliance with a capital plan 

that forecasts their future financial requirements, as determined under the PMIERs, based 

upon projections under both an expected scenario and a stress scenario consistent with 

the macroeconomic assumptions of the Federal Reserve’s severely adverse scenario.

Appendix III: Comparison of Economic 

Scenarios Used in Mutual Mortgage 

Insurance Fund and Federal Reserve 

Supervisory Stress Tests
Appendix III: Comparison of Economic 

Scenarios Used in Mutual Mortgage Insurance 

Fund and Federal Reserve Supervisory Stress 

Tests

Page 42 GAO-18-92 FHA Capital Reserves

interest rates, and unemployment rates.3 These comparisons should be 

treated as illustrative because the MMI Fund and Federal Reserve stress 

tests have different intended uses and time horizons. For example, the 

Federal Reserve stress scenarios last 3 years and one quarter, whereas 

the MMI Fund scenarios last nearly 12 years. In addition, because both 

the MMI Fund and Federal Reserve stress scenarios change from year to 

year, the similarities and differences we discuss are not representative of 

those that might be observed for other time periods.

The following analysis compares the projected quarterly paths of the 

three variables under two economic scenarios used in stress tests of 

FHA’s forward mortgage portfolio—the Monte Carlo simulation path 

producing the lowest economic value for forward mortgages (MMI Fund 

worst simulation path) and the modified Moody’s Analytics protracted 

slump scenario (MMI Fund protracted slump)—with the projected paths of 

the variables under the Federal Reserve’s severely adverse scenario.4

We chose to highlight these MMI Fund stress scenarios because they 

generally have been the two most adverse scenarios considered in the 

actuarial reviews and are therefore the most analogous to the Federal 

Reserve’s severely adverse scenario. The projections for the MMI Fund 

scenarios and the Federal Reserve scenario start 6 months apart (third 

quarter and first quarter of calendar year 2016, respectively). We treated 

the starting quarter of each scenario as the first quarter of the 

comparative analysis.

As shown in figure 4, the MMI Fund and Federal Reserve scenarios differ 

in terms of the severity, duration, and timing of projected changes in 

 3

Consistent with the more heterogeneous composition of bank portfolios compared with 

FHA’s mortgage insurance portfolio, the Federal Reserve stress scenarios use 28 

macroeconomic and financial variables, including measures of equity prices and financial 

market volatility not directly relevant to the economic value of the MMI Fund. The Federal 

Reserve’s severely adverse scenario is informed by periods of severe economic 

conditions the United States has experienced since World War II.

4

According to FHA officials, the variables constituting each Monte Carlo simulation path 

(house price index, mortgage interest rate, and unemployment rate) are designed to move 

in logically consistent ways. As a result, the simulation path producing the lowest 

economic value may not include the most adverse path for each individual variable. FHA’s

actuarial contractor modified the Moody’s Analytics protracted slump scenario in a manner 

that made it more stressful. Specifically, while the original Moody’s Analytics scenario 

assumed a sharp decline in the house price index, followed by a rapid increase back to its 

pre-decline level, the modified version assumed a more gradual increase in the house 

price index after the initial decline.

House Price Index
Appendix III: Comparison of Economic 

Scenarios Used in Mutual Mortgage Insurance 

Fund and Federal Reserve Supervisory Stress 

Tests

Page 43 GAO-18-92 FHA Capital Reserves

house prices (as measured by house price indexes).5 All other things 

being equal, falling house prices negatively affect the MMI Fund because 

they increase the number of mortgage foreclosures and the severity of 

insurance losses on those foreclosures.6 The MMI Fund protracted slump 

and Federal Reserve severely adverse scenarios assume similar sharp 

declines in house prices during the first 2 years—about negative 20 

percent and negative 23 percent, respectively. However, under the MMI 

Fund protracted slump scenario, house prices begin to recover in the third 

year and rise steadily thereafter, ending 15 percent higher than they were 

at the start of the scenario. In contrast, under the Federal Reserve 

scenario, house prices decline about an additional 2 percentage points, 

then recover slightly before the scenario ends in the fourth year.

 5

The MMI Fund stress scenarios use projections of the Federal Housing Finance 

Agency’s purchase-only house price index. This index is based on data from sales of the 

same single-family properties at different points in time (making it a repeat sales index) for 

properties whose mortgages have been purchased or securitized by the housing 

enterprises Fannie Mae and Freddie Mac. The Federal Reserve’s stress tests use 

projections of CoreLogic’s Home Price Index, a repeat sales index that is based on data 

from properties with enterprise- and nonenterprise-backed mortgages. 

6

Among other things, falling house prices may result in more borrowers with mortgage 

balances that exceed the value of their homes (negative equity position). In the event they 

cannot stay current on their mortgage payments, the negative equity position of these 

borrowers may limit their ability to avoid foreclosure by selling or refinancing their homes. 

Falling house prices also increase loss severity—the size of the loss relative to the 

insurance claim—because lower housing values reduce FHA’s ability to offset claim 

payments with proceeds from the sale of foreclosed properties.
Appendix III: Comparison of Economic 

Scenarios Used in Mutual Mortgage Insurance 

Fund and Federal Reserve Supervisory Stress 

Tests

Page 44 GAO-18-92 FHA Capital Reserves

Figure 4: Projected Percentage Change in House Price Index under Selected MMI Fund Actuarial and Federal Reserve 

Supervisory Stress Test Scenarios Starting in 2016

Note: The MMI Fund scenarios are from stress tests of the fund’s forward mortgage portfolio. The 

MMI Fund scenarios use projections of the Federal Housing Finance Agency’s national purchase-only 

house price index. The Federal Reserve scenario uses projections of CoreLogic’s national Home 

Price Index. Each trend line represents the projected percentage change in the house price index 

relative to the actual index level in the quarter preceding the stress period. The MMI Fund scenarios 

make projections for the third quarter of 2016 through the fourth quarter of 2027. The Federal 

Reserve scenario makes projections for the first quarter of 2016 through the first quarter of 2019.

The MMI Fund worst simulation path features a substantially different 

house price path than the other two scenarios. It shows a small initial 

increase in house prices over the first 2 years, before projecting an 

extended 6-year decline, resulting in a peak-to-trough drop of about 18 

percent. Thereafter, house prices recover somewhat, but end up about 10 

percent below their level at the start of the scenario.

The projected path of 30-year fixed mortgage interest rates also differs 

among the three stress scenarios. Changes in mortgage interest rates 

can have varying effects on the MMI Fund. On the one hand, lower 

interest rates can negatively affect the fund by incentivizing borrowers to 

prepay their mortgages (for example, through refinancing), which reduces 

Thirty-Year Mortgage 

Interest Rate
Appendix III: Comparison of Economic 

Scenarios Used in Mutual Mortgage Insurance 

Fund and Federal Reserve Supervisory Stress 

Tests

Page 45 GAO-18-92 FHA Capital Reserves

the fund’s income from insurance premiums. On the other hand, if 

coupled with conditions that increase foreclosure risk (such as low house 

price growth), higher interest rates can negatively affect the fund by 

reducing prepayments, resulting in more mortgages remaining in the fund 

that could lead to foreclosures and insurance claims.

As shown in figure 5, the three scenarios exhibit differences in the 

severity and timing of interest rate changes and the overall volatility of the 

interest rate path.7 The mortgage interest rate under the Federal 

Reserve’s severely adverse scenario increases by about 1 percentage 

point over the first year, then essentially levels off through the end of the 

scenario in the fourth year. In contrast, the MMI Fund protracted slump 

scenario projects an initial 1.5 percentage point decline in the interest rate 

over about the first 2 years, followed by an extended increase that leaves 

the interest rate almost 2 percentage points higher at the end of the 12-

year scenario than it was at the start. The MMI Fund worst simulation 

path features the most dramatic interest rate changes of the three 

scenarios. It begins with a sharp increase of more than 3.5 percentage 

points over about the first 2 years, then assumes several up and down 

spikes over about the next 10 years, before ending with an interest rate 

about 3 percentage points higher than it was at the start of the scenario.

 7

The initial values of the three scenarios differ because of previously noted differences in 

the start dates of the MMI Fund and Federal Reserve scenarios and because we used the

first projected value from each scenario as the starting point of our comparison.
Appendix III: Comparison of Economic 

Scenarios Used in Mutual Mortgage Insurance 

Fund and Federal Reserve Supervisory Stress 

Tests

Page 46 GAO-18-92 FHA Capital Reserves

Figure 5: Projected 30-Year Fixed Mortgage Interest Rate under Selected MMI Fund Actuarial and Federal Reserve 

Supervisory Stress Test Scenarios Starting in 2016

Note: The MMI Fund scenarios are from stress tests of the fund’s forward mortgage portfolio. The 

MMI Fund scenarios make projections for the third quarter of 2016 through the fourth quarter of 2027.

The Federal Reserve scenario makes projections for the first quarter of 2016 through the first quarter 

of 2019. The initial values of the three scenarios differ because of the differences in the scenarios’

starting dates and because we used the first projected value from each scenario as the starting point 

of the comparison.

As shown in figure 6, all three scenarios feature a steep increase and 

subsequent decline in the unemployment rate, but the timing and duration 

of the changes differ.8 All other things being equal, increases in the 

unemployment rate adversely affect the MMI Fund because of the 

negative effect that job loss has on a borrower’s ability to make monthly 

mortgage payments and avoid foreclosure. The unemployment rate under 

the Federal Reserve severely adverse scenario and the MMI Fund 

protracted slump scenario follows similar paths. Both start with nearly 

 8

The initial values of the three scenarios differ because of previously noted differences in 

the start dates of the MMI Fund and Federal Reserve scenarios and because we used the

first projected value from each scenario as the starting point of our comparison.

Unemployment Rate
Appendix III: Comparison of Economic 

Scenarios Used in Mutual Mortgage Insurance 

Fund and Federal Reserve Supervisory Stress 

Tests

Page 47 GAO-18-92 FHA Capital Reserves

identical increases of about 4 percentage points within the first 2 years, 

followed by declines of roughly 1 percentage point over the subsequent 

six quarters, at which juncture the Federal Reserve scenario ends. In the 

longer MMI Fund protracted slump scenario, the unemployment rate 

continues to fall gradually through the 12th year, ending about 1 

percentage point lower than it was at the beginning of the scenario. In 

contrast, the MMI Fund worst simulation path features a more gradual 

and less even increase in the unemployment rate—about a 3.25 

percentage point rise over about the first 5 years. The unemployment rate 

then slides below the starting level by year 10, before rebounding past the 

starting level by the end of the scenario.

Figure 6: Projected Unemployment Rate under Selected MMI Fund Actuarial and Federal Reserve Supervisory Stress Test 

Scenarios Starting in 2016

Note: The MMI Fund scenarios are from stress tests of the fund’s forward mortgage portfolio. The 

MMI Fund scenarios make projections for the third quarter of 2016 through the fourth quarter of 2027. 

The Federal Reserve scenario makes projections for the first quarter of 2016 through the first quarter 

of 2019. The initial values of the three scenarios differ because of the differences in the scenarios’

starting dates and because we used the first projected value from each scenario as the starting point 

of the comparison.
Appendix IV: Comments from the Department 

of Housing and Urban Development

Page 48 GAO-18-92 FHA Capital Reserves

Appendix IV: Comments from the 

Department of Housing and Urban 

Development
Appendix IV: Comments from the Department 

of Housing and Urban Development

Page 49 GAO-18-92 FHA Capital Reserves
Appendix V: GAO Contact and 

Staff Acknowledgments

Page 50 GAO-18-92 FHA Capital Reserves

Daniel Garcia-Diaz, (202) 512-8678, GarciaDiazD@gao.gov

In addition to the contact named above, Steven Westley (Assistant 

Director), Winnie Tsen (Analyst in Charge), Stephen Brown, Marcia 

Carlsen, William Chatlos, Robert Dacey, Emei Li, John McGrail, Angela 

Pun, Jennifer Schwartz, Jena Sinkfield, and Frank Todisco made key 

contributions to this report.

Appendix V: GAO Contact and Staff 

Acknowledgments

GAO Contact

Staff 

Acknowledgments

(101059)
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