under a stress scenario for similar loans and FHA
default statistics. Standard & Poor’s Structured
Finance group conducted a study indicating that
Title I delinquencies and foreclosures may warrant
reserve levels for ratings of ‘A’ to ‘AAA’ closer to
26.5%-45%. These reserves apply generally to con-
duit programs. The nature of programs adminis-
tered by state and local HFAs lends itself to less
onerous reserve levels.
However, Standard & Poor’s will look for the
higher reserve levels if an individual program’s loss-
es and foreclosures support the study. The FHA
reserve can be counted when meeting this guideline
under certain circumstances: the lender’s entire
FHA reserve must be dedicated to the loans made
under the trust estate; the lender states the intention
to file a claim on default as opposed to proceeding
against the loan security; and other reserves must
be available to supplement the 10% not covered by
FHA. Reserve requirements may be met with cash
with over-collateralization or contributions, LOCs,
or over-collateralization. If over-collateralization is
in the form of mortgages, Standard & Poor’s will
assume that 15%—24% (or if warranted, 26.5%-
45%) of the mortgage assets will be unavailable,
based on default.
A minimum liquidity reserve of 2% of loans also
should be maintained so that bond debt service can
be paid during the months between default and
claims payment.
FHA Title I Program Administration
The quality of underwriting and servicing under
the FHA Title I program is integral to credit quali-
ty. Standard & Poor’s will review the lenders’
underwriting, quality control, collections, and serv-
icing and claims denial rate to assess the health of
the portfolio and the probability of successful and
timely claims payment. Standard & Poor’s general-
ly looks for underwriting procedures that are con-
sistent with FHA regulations. Failure to comply
with FHA regulations can result in loans being
rejected for insurance; therefore, compliance proce-
dures are reviewed carefully. Servicing and collec-
tion procedures are subject to the same guidelines
as other single-family programs. Loan payments
should be held in fully insured accounts and imme-
diately transferred to the trustee should they
exceed the insured amount. Systems should be in
place to monitor loan payments on a monthly
basis, and exception reports should be generated
monthly to pinpoint delinquent loans. Once a loan
is delinquent, procedures should be in place that
are consistent with FHA regulations. Claims
should be filed at the earliest possible date permit-
ted under the program. Since claims cannot be filed
after the loan has been in default for nine months,
the system should have a built-in trigger to
announce this final deadline. Selected loan files will
be reviewed for completeness of documentation
and evidence of loan compliance. This is especially
important, since only on default will HUD review
a loan file for compliance. The historical claims
denial rate should be low. To the extent that the
denial rates are excessive, less credit will be given
to the FHA reserve.
A master servicer, such as a state HFA or strong
local HFA, is considered a necessity in a nonre-
course or recourse program with unrated or nonin-
vestment-grade lenders. Standard & Poor’s expects
the HFA to monitor the performance of the lenders
and have procedures in place to remove lenders for
poor performance. Prior to the rating, and ongoing,
Standard & Poor’s will meet with the lender or
master servicer to review its procedures, the status
of reserves, and portfolio quality.PIL Revenue Bond Cash Flows
The cash flow simulations for PIL revenue bond
issues are the same as those for single-family issues.
All loans are assumed to have a 15-to 20-year term,
unless documents clearly restrict the percentage of
shorter-term loans to the amounts reflected in the
cash flows. If loan payment deferments, as defined
in the regulations, are to be allowed, the maximum
amount of such deferments should be reflected in
the cash flows. If a portion of the loans to be origi-
nated will have a lower mortgage rate than the rest
of the portfolio, the source of the subsidy, and how
it will be used to buy up the rate, must be reflected
clearly in cash flows and documents. If no subsidy
exists, cash flows should be run assuming that only
the lower interest-rate loans are originated.
Finally, if any program assets are to be used to
provide lenders participating in a recourse FHA
Title I program with a repurchase credit, these
assets should not be reflected in the cash flows. A
repurchase credit is a feature of certain older Title I
programs that allows a lender to repurchase a given
amount of defaulted loans for less than the out-
standing balance of the loan. A reserve usually is
established to provide sufficient liquid funds to
compensate for the credit. Standard & Poor’s
assumes that the full amount of repurchase credits
available will be used, thus fully drawing down the
reserve. Therefore, inclusion of the reserve in the
cash flows would overstate revenues and assets in
the worst-case scenario.■Property Improvement Loanshttp://www.standardandpoors.com 249