1. Commitments and Mortgage Origination.

Commitments were 19 percent below the levels anticipated in the 1998 Budget, and insurance written, 7 percent lower. FHA�s mortgage business has been less robust than estimated in the 1998 Budget.

2. Mortgage Assignments, Property Acquisition and Sales Activity.

a/ Includes foreclosures of HUD-held mortgages.

Budget estimates for total claims are based on the claim rates developed in the Price-Waterhouse Actuarial Review. Because the Review is finalized in the spring and the Budget must be finished in January, the rates normally used for budget purposes are those in the Review of the year before the actual year in the Budget; thus, for the 1998 Budget, the claim rates for the 1995 Actuarial Review were used. Each Review contains claim and prepayment rates for prior and future cohorts of business.

The 1998 Budget included the projected effects of assignment reform and loss mitigation procedures; but lenders have been slower than anticipated to apply these reforms. In 1997 property acquisitions are over 100 percent higher than projected in the 1998 Budget, whereas the use of pre-foreclosure sales and partial claims was lower than estimated. Part of this increase in property claims is due to the slow start to the loss mitigation procedures, but preliminary analysis indicates that another part is due to increasing claims, especially those from Adjustable Rate Mortgages (ARMS). ARMs are relatively recent as a large volume mortgage vehicle, and the claims we are experiencing were not projected in the Actuarial Review claim rates from last year. Property sales were 53 percent higher than in the 1998 Budget, due to the large volume of incoming inventory.

Assignments were 102 percent higher than projected, even though HUD has not accepted new applications since April 1996. When the 1998 Budget was prepared, it was estimated that all applications for assignments filed prior to the termination date of April 26, 1996 would be processed by the end of January 1997. MMI assignments were processed throughout 1997, due to the large volume of last minute filings in 1996; applications for assignment are not counted as an assignment until it is determined that they meet the criteria and are accepted. Proceeds from sales of mortgage notes were 93 percent higher than the 1998 Budget, although only two sales occurred in 1997, rather than the three estimated for 1997 in the 1998 Budget.

3. Financial Activity. Net outlays for all MMI/CMHI accounts (including the off-budget financing account) for 1997 total -$1.8 billion, whereas the 1998 Budget had estimated net outlays at -$2.9 billion. A decrease in negative outlays resulted primarily from the increase in property and assignment claims in 1997, and lower than estimated new endorsements.

3. CHANGES FROM ORIGINAL 1998 BUDGET ESTIMATES

1. Commitments and Mortgage Origination.

Current estimates of commitments and insurance written for 1998 have decreased over the 1998 budget estimates. The 1998 Budget estimates reflected a proposed increase to the FHA insurable loan limits to equal the GSE conforming loan limits, and additional workload was estimated to flow from raising the loan limit. Since this legislative proposal has not yet received Congressional approval, the effects are reflected in the 1999 Budget beginning with the fiscal year 1999 estimates instead. The 1998 estimate in the 1999 Budget also includes a 4 percent reduction in estimated business, resulting from an estimated lower level of refinancing in 1998, while FHA business from home sales remains essentially flat.

2. Mortgage Assignments, Property Acquisitions and Sales Activity.

The 1998 claim figures in the 1999 Budget reflect preliminary claim rates from the materials being prepared for the 1997 MMI Actuarial Review. Because of a condensed production period for the 1997 Review, initial information regarding rates of claim and prepayment have been available far earlier than in prior years. FHA has availed itself of this initial estimate of these rates, as the more current information available, to produce budget estimates which are less sanguine than the 1996 Actuarial Review rates would produce.

3. Financial Activity. Net outlays for all accounts, including the off-budget financing account, in 1998 are estimated at -$2.1 billion, $0.6 billion below the budgeted level. The higher estimated claims and the lower estimated endorsements combine to increase costs and decrease income.

EXPLANATION OF INCREASES AND DECREASES

1. Mortgage Origination. FHA anticipates that it will endorse more insurance in single family mortgages in fiscal year 1999 ($67 billion) than in fiscal year 1998 ($59 billion). Standby commitment authority should be sufficient to cover any foreseeable increase in demand in 1999. The estimated $67 billion in new business includes $8.4 billion and 54,500 units from the legislative proposal to increase the FHA single family loan limit.

2. Mortgage Assignment, Property Acquisitions, and Property Sales. There will be no mortgage assignments in 1999. No notes sales are currently projected for 1999, but may occur then or in future years as inventory warrants. Property acquisitions are projected to be an estimated 7 percent below the 1998 levels, using the 1997 preliminary claim rates from the draft 1997 Actuarial Review, and as the use of the loss mitigation techniques increases. Sales are projected based on the estimated inventory at the end of fiscal year 1998 and estimated acquisitions in fiscal year 1999.
3. Financial Activity. Net outlays in 1999 are estimated at -$2.2 billion for all accounts, including the off-budget financing account. This sum included the additional negative subsidy to be generated by legislation raising the FHA single family loan limit, and authorizing the single family property disposition expanded flexibility.

The 1998 Budget reflected a transfer of the negative subsidy from new mortgage insurance written, as well as from legislative savings, to the receipt account starting in fiscal year 1998. The 1999 Budget shows the negative subsidy continuing to be disbursed to the Liquidating Account for 1998 and 1999, until arrangements can be made so that the reserves in the Receipt Account will earn interest, as they currently do in the Liquidating Account. It is expected that such arrangements will be in place before fiscal year 2000, when the negative subsidy is shown as going to the Receipt Account

PROGRAM DESCRIPTION AND ACTIVITY

A. MMI/CMHI Funds. The Mutual Mortgage Insurance Fund consists of the basic single family home mortgage program (Section 203(b)), the largest of all the FHA programs.

The Section 203(b) program, enacted in the National Housing Act of 1934, provides mortgage insurance for one- to four-family residences. This program has contributed to expanding the opportunities for homeownership in the United States and will continue to meet the needs of first-time homebuyers, working families, and minority families, as well as underserved communities, especially center city and rural areas. Under the 203(b) program, any person able to meet the cash investment, mortgage payments and credit requirements may obtain an FHA-insured loan from a private lending institution to purchase a home. Since its inception through September 30, 1997, the MMI Fund has insured approximately $897 billion in mortgages for about 21.5 million families.

The Cooperative Management Housing Insurance Fund contains the Cooperative Housing Insurance program (Section 213) which provides mortgage insurance for cooperative housing projects of more than five units which are occupied by members of a cooperative housing corporation. The insurance program can be used for new construction, rehabilitation, acquisition, improvement or repair of a project and resale of individual memberships in the cooperative. Enacted in 1950, this program has been inactive in recent years.

For 1999 legislation, two new legislative authorizations are proposed:

B. LOAN AND MORTGAGE MANAGEMENT ORGANIZATION

1. Implementation of Loss Mitigation Reform. Reform of the FHA single family assignment program for all future insurance endorsements has been enacted. These reforms abolished the old assignment program and encouraged use by mortgage lenders of alternative loss mitigation techniques, which are expected to reduce the dollar value of claims and net outlays. Reduced claim amounts are expected to occur for several reasons:

• Improving the quality of loans which will be accepted for loss mitigation alternatives by lenders will lead to higher recoveries, and lower costs when foreclosures result;

• Reducing the length of time required for HUD to acquire property in cases which previously applied for assignment and failed, will diminish accumulation of arrearages and loss of property value while the application is processed or the loan is assigned; and

• While the number of claims may actually increase, it is expected that the use of less expensive alternatives, such as preforeclosure sales and partial claims, will grow; but that there will be an overall reduction in the more costly claims, such as foreclosures.

The estimated reduction to claims resulting from assignment reform has been slower than anticipated, possibly due to the time required for the industry to adapt to new regulations and retrain staff. It may take considerable time for the behavior of lenders to adjust to new expectations for the appropriate ways of dealing with defaults, now that the assignment program is no longer an option. However, FHA is implementing performance monitoring and providing financial incentives to speed lender acceptance of loss mitigation tools.

1. Increasing Government Equity. As of September 30, 1995, the MMI Fund met the 2 percent capital reserve requirement under assumptions of moderate economic activity over the life of the current loans. The 1996 Actuarial Review and audit shows a capital ratio of

2.54 percent as of September 30, 1996. Even under pessimistic economic assumptions the 1996 Actuarial Review shows that reserves are now sufficient to maintain the capital ratio in fiscal year 2000.

Because of increasing equity, FHA has been able to undertake actions to increase the availability of mortgages to underserved and unserved populations. This year the reduction in the up-front fees for first-time home buyers who receive homeownership counseling was doubled to 50 basis points. To further stimulate activity and reduce disparities between suburban and central city homeownership rates, an additional decrease in up-front fees of 25 basis points has been announced for first-time homebuyers who get counseling and purchase in central cities, making their up-front premium 1.5 percent instead of 2.25 percent, but this further change can only be implemented through pending rulemaking. FHA is examining other ways to increase homeownership, which would make FHA loans more available to a wide spectrum of possible homebuyers, while preserving the viability of the MMI Fund.

3. Changes to the Means of Disposition of HUD-Held Single Family Property. Legislation is being proposed to allow HUD to choose from a broad range of options for disposing of single family claims. Foreclosure, the prevailing practice for dealing with most mortgages going to claim, is expensive, time consuming, and allows properties to deteriorate. FHA plans on being out of retail property sales by 1999, by letting a multiyear contract to sell HUD-held properties. This alternative is available to the Department under current statute. New legislation will allow HUD additional alternatives to settle claims, including accepting notes in lieu of properties, where it is advantageous to the Fund. Although the legislation is proposed for enactment in 1999, and hence scored for budget purposes then, it is planned for initial implementation in fiscal year 2002, with a phase-in period through 2003. The interim between 1999 and 2002 will allow HUD and the mortgage lenders and servicers time to work out conditions, restrictions, and the like, permit HUD to issue regulations, and allow lenders to complete systems modifications and training required by the changes. The legislative changes are expected to produce $527 million in budget scoring savings in 1999.

4. Increasing the FHA Loan Limit. The proposed legislation to increase the maximum mortgage amount insured under the FHA single family programs to be equal to the GSE conforming mortgage loan limit will help further the objective of making homeownerhip attainable for working families. Families will be able to qualify for mortgages earlier, with a wider choice in the quality of homes and neighborhoods that are available to them. This proposal reflects the National Homeownership Strategy, to increase the proportion of Americans who own their homes. The Budget estimates reflect this proposal as generating $8.4 billion in new FHA mortgages insured for 54,500 families in 1999, and an additional $228 million in negative subsidy from the this new business scored as PAYGO, with corresponding PAYGO savings each year thereafter. The Budget estimates are intended to be conservative; the volume impact of the proposal can be expected to be in the range of 50,000 to 100,000 additional FHA loans per year.

5. Performance Indicators One of the overall strategic objectives of the Department is to increase homeownership opportunities, especially in Central Cities, through a variety of tools, such as expanding access to mortgage credit. The MMI performance goals for this objective are to:

1. Increase the share of first-time homebuyers in each HUD Field Office by 1 percent per year over fiscal year 1995;
1. Close sale of 95 percent of Single Family properties on hand as of October 1, 1998, less leased properties, plus 95 percent of projected acquisitions for October 1, 1998 to May 31, 1999; this goal remains the same for fiscal years 1998 and 1999;
1. Reduce FHA�s cost of providing mortgage insurance by increasing the net recovery

on REO sales. The goal cannot be set until a financial advisor is retained, and

analysis is performed on current practices and procedures to find where

improvements are possible and cost effective; and

1. Reduce FHA�s cost of providing mortgage insurance by increasing the percentage of

Cross program goals for HUD, also part of the homeownership objective, to which the MMI fund is expected to contribute materially are as follows:

1. Increase the overall rate of homeownership to 67.5 percent in the year 2000. At the end of 1998, the homeownership rate is expected to be 67 percent, and at the end of 1999 67.5 percent; and
1. Increase the homeownership rate in Central Cities to 52.2 percent in the year 2000. The interim goals are 51 percent for 1998 and 52.5 percent for 1999.

The MMI Fund helps communities and States establish a full continuum of housing and services designed to assist homeless individuals and families achieve permanent housing and self-sufficiency to the extent possible, by setting aside a portion of properties being sold for purchase by non-profits at a 30 percent discount, and offering to finance the purchase under the direct loan account. These properties can be used for transitional housing or for resale to low-income families.

FHA is also implementing the management reform goals. These strategic objectives are reorganizing by functions and consolidating and/or privatizing activities where appropriate, modernizing outdated financial management systems, refocusing and retraining staff to carry out our revitalized mission, creating an Enforcement Authority, and replacing the present top-down bureaucracy with a customer-friendly structure.

As part of the Strategic Plan, HUD also is committed to improve customer service and develop partnerships with industry and interest groups. FHA is involved heavily in outreach, including access to information in the WEB. Working Groups set up to work with industry include for MMI the Single Family Mortgage Insurance Underwriting Outreach Group, and the Housing Counseling Working Group. The homeownership centers which have been set up to handle single family loans have provided quicker and more efficient service.

FHA has been a major factor in expanding homeownership since its start in 1934. In 1997, first-time homebuyers were 76 percent of FHA purchase transactions (excluding refinancings.) FHA also provides the primary homeownership opportunity for central cities� residents. New initiatives are expanding this opportunity, including reduced premiums for first-time homebuyers with counseling, and reforms to single family property dispositions. The offer of premium reductions of 50 basis points to those who have received homeownership counseling and an additional 25 basis point reduction for those with counseling who purchase in central cities is expected to increase homeownership among first-time buyers, especially minorities, and homebuyers in underserved areas. FHA is committed to increasing the homeownership rate to 67.5 percent by the year 2000. Within the limitations of financial market and economic conditions, and with the cooperation of all partners, FHA will do everything it can to reach the goal.