GAO/RCED-00-280R FHA Distributive Shares

United States General Accounting Office

Washington, DC 20548

Resources, Community, and

Economic Development Division

B-285175

September 8, 2000

The Honorable Rick Lazio

Chairman, Subcommittee on Housing

and Community Opportunity

Committee on Banking and Financial Services

House of Representatives

Subject: Mortgage Financing: Level of Annual Premiums That Place a Ceiling on

Distributions to FHA Policyholders

Dear Mr. Chairman:

From 1943 to 1990, the programs supported by the Federal Housing Administration’s

(FHA) Mutual Mortgage Insurance Fund paid distributive shares to homeowners who

had voluntarily terminated their mortgages by paying off the mortgage on time, or

early, such as when refinancing.1In 1990, after the Fund began experiencing

substantial losses, the Congress required FHA to stop paying distributive shares until

the Fund had accumulated adequate reserves—current cash plus the net present

value of future cash flows. While not defining what level of reserves are adequate,

the Congress required that the Secretary take steps to ensure that the Fund achieve

minimum reserves equaling 2 percent of the insurance-in-force. Thus, in determining

whether there is a surplus for distributing to borrowers, the Secretary must now take

into account the actuarial status of the entire Fund.2 After several years of improved

Fund performance, the reserve was estimated to have first met the 2-percent

minimum requirement in 1995 and was estimated to have reached 3.66 percent in

1999. FHA has not renewed paying distributive shares and believes that it would only

be prudent to consider doing so if the Fund’s capital ratio exceeded 3 percent.

1

Because the risk of an insurance claim is usually the greatest during the first 7 years of a mortgage,

FHA generally did not pay distributive shares to borrowers who had terminated their mortgages within

7 years of receiving them.

2

In contrast, borrowers who had voluntarily terminated their mortgages within a specified time

period—now 7 years—have received refunds of their up-front insurance premiums regardless of the

actuarial status of the Fund.
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2 GAO/RCED-00-280R Distributive Shares

You asked us to report on the number of borrowers insured by the Mutual Mortgage

Insurance Fund who might have been eligible to receive dividends, or distributive

shares, from their mortgage insurance if FHA had been required to pay distributive

shares in fiscal year 1999. You also asked us to provide information on the amount of

annual premiums these individuals had paid because this amount serves as the

maximum amount of any distributive share they might have been eligible to receive.3

In summary, we found that in fiscal year 1999, between 132,508 and 186,032 FHA

borrowers who had voluntarily terminated their mortgages might have been eligible

for distributive shares if FHA had paid such shares (see table 1). Specifically, 186,032

FHA borrowers who had voluntarily terminated their mortgages in fiscal year 1999

had received their mortgages in fiscal year 1992 or earlier, and these mortgages were

originated in years that produced profitable mortgages. Furthermore, 53,524 of these

borrowers had their loans originated in fiscal year 1992. Some of these borrowers

would not have been eligible for distributive shares because they had their loans for

less than 7 years when they voluntarily terminated them in 1999. The range of

estimates we provide recognizes this. The remaining 132,508 borrowers had loans

originated before 1992.4 Thus, the number of borrowers who voluntarily terminated

their mortgages in 1999 and may have been eligible for distributive shares is

between132,508 and 186,032. Using a similar methodology, we determined that the

total annual premiums paid by these borrowers was between $271 million and $395

million.

3 The amount of any such payment is based on the extent to which the annual premiums paid by a

group of homeowners exceeded the actual cost of insuring that group of homeowners. However, in no

event can the size of a distributive share for an individual homeowner exceed the amount of the annual

premium the homeowner had paid over the life of the mortgage. Some groups of mortgages, especially

those originated in the 1980s, had revenues that were lower than their costs and would thus not have

been eligible to receive any distributive shares.

4

Actually, all of these loans were originated prior to 1980. Loans originated in fiscal years 1980

through 1991 are not included here because either they did not pay annual premiums and/or they were

not profitable. Loans originated between September 1, 1983, and June 30, 1991, did not pay annual

premiums, and loans originated in fiscal years 1980 through 1986 and 1988 through 1991 were not

profitable.
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3 GAO/RCED-00-280R Distributive Shares

Table 1: Data on FHA Borrowers Who Terminated Their Mortgages in Fiscal Year 1999 and Might Have

Been Eligible for Distributive Shares

Eligible mortgages

terminated in fiscal year

1999 and originated in fiscal

year 1991 or earliera

Eligible mortgages terminated

in fiscal year 1999 and

originated in fiscal year 1992

or earlierb

Total number of mortgages 132,508 186,032

Total annual premiums $270,678,146 $394,858,427

Average annual premiums $2,043 $2,123

Note: Includes only those mortgages for which borrowers had paid required annual premiums and had

voluntarily terminated in fiscal year 1999 and which were originated in a year that produced profitable mortgages.

a

Loans originated in fiscal years 1980 through 1991 are not included here because either they did not pay annual

premiums and/or they were not profitable. Thus, only loans originated prior to fiscal year 1980 are included.

Data on loans originated prior to 1975 are from summary FHA data.

b

Includes loans originated prior to fiscal year1980 and in fiscal year 1992.

Source: GAO’s analysis of FHA’s data.

For several reasons, actual distributions are likely to be less than the amount of

premiums paid. First, for some groups of borrowers, the amount by which revenues

exceed the costs associated with them may be less than the full amount of the annual

premiums they paid. According to FHA’s chief actuary, it would be reasonable to

assume that rebates would have been equal to about 2 percent of the original value of

the mortgage for eligible borrowers if FHA had paid distributive shares in 1999. Since

the average value of the mortgages of eligible borrowers was about $35,500,5the

average distributive share would be about $710.6In comparison, borrowers who

terminated their mortgages last year paid, on average, between $2,043 and $2,123 in

annual premiums. Second, any distributions are likely to be less than the total

amount calculated because the Department of Housing and Urban Development

(HUD) is not always able to locate eligible recipients. HUD officials said that,

historically, HUD has located 80 to 90 percent of the eligible recipients but expected

the Department would have better success now because of improved databases.

Scope and Methodology

To determine the number of insured borrowers who might have been eligible to

receive distributive shares in fiscal year 1999 and the amount of annual premiums

they had paid, we determined how many homeowners had received their mortgages

in fiscal year 1992 and in earlier years, had paid annual premiums, and had voluntarily

terminated their mortgage in 1999. We obtained data for fiscal years 1975 through

1999 from FHA’s A-43 database, which provides current and historical information on

5

This is a weighted average for loans originated prior to fiscal year 1980 and in fiscal year 1992. For

loans originated between fiscal years 1975 and 1979 and in fiscal year 1992, the weighted average is

based on the proportion of terminating loans that originated in a given eligible year. This calculation

assumes that loans terminating in 1999 were typical of all loans originating in a given year.

6

In the future, FHA might include in the cost of each group of mortgages contributions toward the

capital reserve, and therefore the amount of any distribution could be lower than it had been in the

past.
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4 GAO/RCED-00-280R Distributive Shares

the mortgage loans that FHA insures. We used data reported by

PricewaterhouseCoopers in 1999 on the economic value or profitability of mortgages

by year of origination to identify the years between 1975 and 1999 in which mortgages

that were profitable originated. All data on loans originated prior to 1975 that were

prepaid in fiscal year 1999 were provided by FHA in summary form. FHA also

provided summary data, including data on annual insurance premiums, for loans

originated in fiscal years 1975 through 1979. Using FHA summary data for borrowers

who originated their mortgages in these years and terminated them in 1999 would

have resulted in a 7-percent lower average annual premium than our data show for

these years. We did not reconcile the differences between the summary data FHA

provided and the results of our analysis of FHA’s A-43 database. We also reviewed

program regulations and handbooks concerning distributive shares.

We performed our work from July through August 2000 in accordance with generally

accepted government auditing standards.

Agency Comments and Our Evaluation

We provided a draft copy of this report to HUD for its review and comment. HUD had

concerns in four areas of the draft report. First, HUD stated that our report appeared

to strongly imply that FHA should have been paying distributive shares since the

Mutual Mortgage Insurance Fund reached the congressionally mandated minimum

capital ratio of 2 percent in 1995. This certainly was not intended, so we clarified the

report to show that before distributive shares may be declared, the Secretary must

first determine that the Fund had accumulated adequate reserves, but what

constitutes an adequate capital ratio is not defined. We also added information to

reflect FHA’s belief that a capital ratio in excess of 3 percent would be prudent before

considering reinstituting distributive shares.

Second, HUD stated that we appeared to inaccurately estimate in many respects the

number of persons who may have been qualified for distributive share payments in

fiscal year 1999. Of particular concern was the exclusion of data on loans originated

prior to 1975. HUD provided summary data for these years, which we have included

in the report.

Third, HUD was concerned that we seemed to assume that it is proper to pursue a

very aggressive method of calculating the amount of each distributive share. HUD

suggested that eligible borrowers should be restricted to those who received

mortgages in years where the mortgages produced sufficient profits to set aside funds

equal to 2 percent of their outstanding loan balance. We did not use this criteria

because the law specifies that the Secretary shall take into account the actuarial

status of the entire Fund when determining whether there is a surplus for

distribution. Using FHA’s criteria would make loans originated in fiscal year 1992

ineligible. We provide an estimate that excludes loans originated in fiscal year 1992.

In addition, we note that in the future FHA might include in the cost of each group of

borrowers contributions toward the capital reserve and that therefore the amount of

distributions could be lower than it had been in the past.
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5 GAO/RCED-00-280R Distributive Shares

Fourth, HUD stated that the report does not clearly explain FHA’s existing refund

policy for borrowers who prepay within 7 years of loan origination. We have added

information to make clear FHA’s continuing practice of refunding up-front mortgage

insurance premiums.

HUD’s comments are in enclosure I.

----

We are sending copies of this report to interested congressional committees and the

Honorable Andrew M. Cuomo, Secretary of Housing and Urban Development. We

will also make copies available to others upon request.

Please call me on (202) 512-7631 if you or your staff have any questions about this

report. Key contributors to this report were Nancy Barry, DuEwa Kamara, Mathew

Scire, and Salvatore Sorbello, Jr..

Sincerely yours,

Stanley J. Czerwinski

Associate Director, Housing and

Community Development Issues
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