oversight

Audit of the Federal Housing Administration's Financial Statements for Fiscal Years 2009 and 2008

Published by the Department of Housing and Urban Development, Office of Inspector General on 2009-11-13.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                                                           Issue I)ate
                                                                                  November 13. 2009
                                                                           Audit Case Number
                                                                                   201 0-F’O-0002




TO: David H. Stevens. Assistant Secretary for Housing-Federal Housing Commissioner, I-I


FROM: Ticomas R. McEnanLyl Director. Financial Audits Division, GAF
                              ci
SUBJECT:       Audit of the Federal Housing Administration’s Financial Statements for Fiscal
                  Years 2009 and 2008

        In accordance with the Government Corporation Control Act as amended (31 U.S.C.
9105). the Office of Inspector General engaged the independent certified public accounting firm
of Urbach Kahn and Werlin LLP (UKW) to audit the fiscal year 2009 and 2008 financial
statements of the Federal Housing Administration (FHA). The contract required that the audit be
performed according to generally accepted government auditing standards (GAGAS).

         UKW is responsible for the attached auditor’s report dated November 9. 2009 and the
conclusions expressed in the report. Accordingly, we do not express an opinion on FHA’s
financial statements or conclusions on FHA’s internal controls or compliance with laws.
regulations and government-wide policies. Within 30 days of this report, UKW expects to issue a
separate letter to management dated November 9, 2009 regarding other less significant matters
that came to its attention during the audit.

        This report includes both the Independent Auditor’s Report and FHA’s principal financial
statements. Under Federal Accounting Standards Advisory Board (FASAB) standards. a general-
purpose federal financial report should include as required supplementary information (RSI) a
section devoted to Management’s Discussion and Analysis (MD&A). The MD&A is not
included in this report. FHA plans to separately publish an annual report for fiscal year 2009 that
conforms to FASAB standards.

         The report contains four significant deficiencies in FHA’s internal controls and one
reportable instance of noncompliance with laws and regulations. The report contains 15 new
recommendations. Within 1 20 days oithe report issue date, FHA is required to provide its final
management decision which included a corrective action plan for each recommendation. As part
of the audit resolution process. we will record 15 new recommendation(s) in the Departments
Audit Resolution and Correctise Action Tracking System (ARCATS). We will also endeavor to
work with EHA to reach a mutually acceptable management decision prior to the mandated
deadline. The proposed management decision and correcti\e action plan will he reiewed and
ealuated w itli concurrence from the 01G.

        We appreciate the courtesies and cooperation extended to the UKW and OIG audit staffs
during the conduct of the audit.
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                            Table of Contents
O1G Transmittal Memorandum                                                      1

Independent Auditor’s Report                                                    5

      Appendix A   —   Significant Deficiencies                             11

      Appendix B   —   Management’s Response                               21

      Appendix C   —   UKW’s Assessment of Management’s Response           29

      Appendix D   —   Status of Prior Year Findings and Recommendations   33

Principal Financial Statements                                             35

      Consolidated Balance Sheets                                          37

      Consolidated Statements of Net Cost                                  38

      Consolidated Statements of Changes in Net Position                   39

      Combined Statement of Budgetary Resources                            40

     Notes to the Financial Statements                                     42

     Required Supplementary Information                                    82




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                4
UK Lirbach Kahn &Werlin LLP
&W CERTIFIED PUBLIC ACCOUNTANTS

                              INDEPENDENT AUDITOR’S REPORT



      Inspector General
      United States Department of Housing and Urban Development

      Commissioner
      Federal Housing Administration


      We have audited the accompanying consolidated balance sheets of the Federal Housing
      Administration (FHA), a wholly owned government corporation within the United States
      Department of Housing and Urban Development (HUD), as of September 30, 2009 and
      2008, and the related consolidated statements of net cost, changes in net position, and
      the combined statements of budgetary resources (Principal Financial Statements) for the
      years then ended.

      Summary

      We concluded that FHA’s Principal Financial Statements are presented fairly, in all
      material respects, in conformity with accounting principles generally accepted in the
      United States of America.

      Our consideration of internal control over financial reporting resulted in the following
      matters being identified as significant deficiencies:

         •   Financial system capacity limitations could impact business processing
         •   Effective FHA modernization is critical to address systems risks
         •   Economic conditions and inherent model design increase risks to management
             estimates
         •   FHA should enhance the general ledger system user access management
             processes

     We identified one reportable instance of noncompliance with laws and regulations related
     to the capital requirements for the Mutual Mortgage Insurance Fund.

     This report (including Appendices A through D) discusses: (1) these conclusions and our
     conclusions relating to supplemental information presented in the Annual Management
     Report, (2) management’s responsibilities, (3) our objectives, scope and methodology, (4)
     management’s response and our evaluation of their response, and (5) the current status of
     prior year findings and recommendations.

     Opinion on the Principal Financial Statements

     In our opinion, the Principal Financial Statements referred to above present fairly, in all



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                        INDEPENDENT AUDITOR’S REPORT, Continued

      material respects, the financial position of FHA as of September 30, 2009 and 2008, and
      its net cost, changes in net position, and combined budgetary resources for the years then
      ended, in conformity with accounting principles generally accepted in the United States of
      America.

      As discussed in the footnotes to the Principal Financial Statements, the Loan Guarantee
       Liability (LGL) is a management estimate of the net present value of future claims, net of
      premiums and recoveries, from loans insured as of the end of the fiscal year. This
      estimate is developed using econometric models, which integrate historical data with
      national house price forecasts to develop assumptions about future portfolio performance.
      Endorsements in the last two years make up over half of FHA’s insured single family
      mortgage loans in the Mutual Mortgage Insurance (MMI) Fund. These loans have very
      limited claims experience to support management’s assumptions regarding their future
      performance. Because of this limited experience and the impact of the current economy
      on the housing market, the reliability of the LGL estimate for single family mortgages may
      be significantly affected.

     The MM! Fund includes a Capital Reserve account from which increases in funding to
     cover accrued claim losses are drawn. As of September 30, 2009, this Capital Reserve
     account had $2.6 billion available to cover further increases in the MM! Fund’s Loan
     Guarantee Liability. The Credit Reform Act of 1990 provides for permanent, indefinite
     budget authority should future increases in the Loan Guarantee Liability exceed funds
     available in the Capital Reserve account.

     Consideration of Internal Control

     In planning and performing our audits, we considered FHA’s internal control over financial
     reporting and compliance (internal control) as a basis for designing audit procedures that
     are appropriate in the circumstances and complying with Office of Management and
     Budget (0MB) audit guidance, but not for the purpose of expressing an opinion on the
     effectiveness of FHA’s internal control. Accordingly, we do not express an opinion on
     FHA’s internal control.

     A control deficiency exists when the design or operation of a control does not allow
     management or employees, in the normal course of performing their assigned functions,
     to prevent or detect misstatements on a timely basis. A significant deficiency is a
     deficiency in internal control, or a combination of deficiencies, that adversely affects FHA’s
     ability to initiate, authorize, record, process, or report financial data reliably in accordance
     with generally accepted accounting principles such that there is more than a remote
     likelihood that a misstatement of FHA’s Principal Financial Statements that is more than
     inconsequential will not be prevented or detected by FHA’s internal control. We noted four
     matters, summarized below and more fully described in Appendix A, involving the internal
     control and its operation that we consider to be significant deficiencies:

        Financial system capacity limitations could impact business processing

        The collapse of the commercial subprime mortgage industry has resulted in
        significant increases in FHA’s business volume that strained FHA information
        technology (IT) system resources. During FY2009, FHA’s Office of the
        Comptroller and the HUD Office of Chief Information Officer (OCIO) upgraded
        system capacity and developed an informal written short term capacity
        management plan that identified the actions that had been taken and future

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                    INDEPENDENT AUDITOR’S REPORT, Continued

      activities required. A new mainframe is also scheduled to be installed in FY2O1O.
      However, the reliability of FHA’s financial reporting systems are still at risk and
      the capacity management plan does not document 1) critical mainframe or
      application utilization benchmarks and required responses and 2) clear
      organizational and staff roles and responsibilities for ongoing capacity
      management planning.

      Effective FHA modernization is critical to address systems risks

      The rapid growth in FHA’s business volume, market share and new housing
       program initiatives have highlighted the impact of FHA’s minimal investment in
       new systems development over the last ten years. HUD recently commissioned a
      study that identified numerous deficiencies in the current operating environment
      and prioritized a long list of system modernization initiatives, including the
      replacement of a number of critical FHA business systems. Given their current
      state, FHA’s financial systems will continue to require expensive maintenance
      and monitoring and are likely to pose increasing risk to the reliability of FHA’s
      financial reporting until replacement efforts are completed. FHA and the HUD
      OCIC should commit to a prioritized plan of activities, affirm the enterprise
      architecture required to support the modernization effort, provide resources to the
      modernization efforts, and develop a more detailed modernization
      implementation plan.

     Economic conditions and inherent model design increase risks to management
     estimates

     FHA’s process for estimating the Loan Guarantee Liability for single family
     programs uses assumptions developed through an annual independent actuarial
     study of the Mutual Mortgage Insurance fund. The econometric models
     developed for this study are driven by historical claim payment patterns and
     numerous economic and portfolio variables. The projections for future claim
     payments for endorsements made in the last two years, which represent over
     half of the total liability, are based on very limited direct claim performance.
     Notable changes in the composition of these loans relative to past history and
     drastic changes in the housing market may impact the model’s ability to fully
     incorporate the impact of these changes. Due to significant declines in house
     prices, the liability estimates are also acutely sensitive to small changes in house
     price projections.

     Currently, FHA does not have an effective process to assess and document the
     impact of other potential risk factors or leading indicators, such as delinquencies
     or unemployment data, that may impact program performance and either support
     the reliability of management estimates based on the model, or provide evidence
     to support an adjustment of the model estimates. Federal accounting standards
     allows an agency to integrate management assumptions when current models
     may not be reliable.

     FHA should enhance the general ledger system user access management
     processes

     FHA granted general ledger access rights to system developers and certain
     users to support the implementation of two new Multifamily business systems
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                        INDEPENDENT AUDITOR’S REPORT, Continued

          during FY2009. FHA’s control to detect this access was not effective because the
          FHASL audit logging capability was not properly configured. Inactive user
          accounts were also not removed timely. FHA’s system modernization efforts will
          require ongoing access to FHASL by programmers and non-standard users,
          increasing the risk of inappropriate or unauthorized information being introduced
          or deleted from the agency’s primary financial system of record without adequate
          compensating controls. FHA is developing an enhanced audit log reporting and
          monitoring process.

      Additional detail and the related recommendations for these findings are provided in
      Appendix A of this report.

      A material weakness is a significant deficiency, or combination of significant deficiencies,
      that results in more than a remote likelihood that a material misstatement of the financial
      statements will not be prevented or detected by the entity’s internal control.

      Our consideration of internal control was for the limited purpose described in the first
      paragraph above and would not necessarily identify all deficiencies in internal control that
      might be significant deficiencies or material weaknesses. However, we believe none of the
      significant deficiencies described above is a material weakness.

      Compliance with Laws and Regulations

     The results of our tests of compliance with laws, regulations and government-wide policies
     disclosed one instance of noncompliance that is required to be reported under
     Government Auditing Standards and 0MB Bulletin No. 07-04, Audit Requirements for
     Federal Financial Statements, as amended, as described below. Providing an opinion on
     compliance with laws and regulations and government-wide policies was not an objective
     of our audit and, accordingly, we do not express such an opinion.

             The Cranston-Gonzales National Affordable Housing Act of 1990 required
             that FHA’s Mutual Mortgage Insurance Fund maintain a minimum level of
             capital sufficient to sustain a moderate recession. This capital requirement,
             called the Capital Ratio, is defined as capital resources (assets minus
             current liabilities) less the liability for future claim costs (net of future
             premiums and recoveries), divided by the value of insurance-in-force. The
            Act required FHA to maintain a minimum Capital Ratio of two percent and
             conduct an annual independent actuarial study to calculate this ratio. The
            Housing and Economic Recovery Act of 2008 requires that the Secretary
            submit a report annually to the Congress describing the results of such
            study, assess the financial status of the Fund, recommend adjustments and
            evaluate of the quality control procedures and accuracy of information used
            in the process of underwriting loans guaranteed by the Fund. As of the date
            of our audit, this report had not yet been submitted, but FHA data indicated
            that this ratio fell to 0.53% based on September 30, 2009 amortized loan
            balances.

     Supplementary Information

     The information in the Management’s Discussion and Analysis and Required
     Supplementary Information sections is not a required part of the Principal Financial
     Statements, but is supplementary information required by accounting principles generally

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                       INDEPENDENT AUDITOR’S REPORT, Continued

      accepted in the United States of America. We have applied certain limited procedures,
      which consisted principally of inquiries of management regarding the methods of
      measurement and presentation of the supplementary information. However, we did not
      audit the information and express no opinion on it.

      Management Responsibilities

     Management is responsible for the information in the Annual Management Report,
     including the preparation of: 1) the Principal Financial Statements in conformity with
     accounting principles generally accepted in the United States of America, 2)
     Management’s Discussion and Analysis (including the performance measures), and 3)
     Required Supplementary Information. Management is also responsible for 1) establishing,
     maintaining and assessing internal control to provide reasonable assurance that the broad
     control objectives of the Federal Managers Financial Integrity Act of 1982 (FMFIA) are
     met, 2) ensuring that FHA’s financial management systems substantially comply with the
     Federal Financial Management Improvement Act of 1996 (FFMIA), and 3) complying with
     applicable laws, regulations and government-wide policies.

     Objectives, Scope and Methodology

     Our responsibility is to express an opinion on FHA’s Principal Financial Statements based
     on our audits. We conducted our audits in accordance with auditing standards generally
     accepted in the United States of America, the standards applicable to financial audits
     contained in Government Auditing Standards issued by the Comptroller General of the
     United States, and 0MB Bulletin No. 07-04, as amended. Those standards and 0MB
     Bulletin No. 07-04 require that we plan and perform the audit to obtain reasonable
     assurance about whether the Principal Financial Statements are free of material
     misstatement. An audit also includes examining, on a test basis, evidence supporting the
     amounts and disclosures in the financial statements, assessing the accounting principles
     used and significant estimates made by management, as well as evaluating the overall
     financial statement presentation. We believe our audits provide a reasonable basis for our
     opinion.

     In planning and performing our audits, we also obtained an understanding of FHA and its
     operations, including its internal control over financial reporting (including safeguarding of
     assets) and compliance with laws, regulations and government-wide policies (including
     execution of transactions in accordance with budget authority), determined whether these
     internal controls had been placed in operation, assessed control risk, and performed tests
     of controls in order to evaluate and report on internal control and determine our auditing
     procedures for the purpose of expressing our opinion on the financial statements. We
     limited our internal control testing to those controls necessary to achieve the objectives
     described in 0MB Bulletin No. 07-04 and Government Auditing Standards, which include
     ensuring:
        •   Transactions are properly recorded, processed, and summarized to permit
            the preparation of financial statements in conformity with U.S. generally
            accepted accounting principles, and assets are safeguarded against loss
            from unauthorized acquisition, use, or disposition.
        •   Transactions are executed in accordance with (1) laws governing the use of
            budget authority, (2) other laws and regulations that could have a direct and


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                           INDEPENDENT AUDITOR’S REPORT, Continued

              material effect on the financial statements, and (3) any other laws,
              regulations, and government-wide policies identified by 0MB audit guidance.
      We did not test all internal controls relevant to operating objectives as broadly defined by
      FMFIA, such as those controls relevant to preparing statistical reports and ensuring
      efficient operations. Because of inherent limitations in internal control, misstatements due
      to error or fraud may nevertheless occur and not be detected. We also caution that
      projecting our evaluation to future periods is subject to the risk that controls may become
      inadequate because of changes in conditions or that the degree of compliance with
      controls may deteriorate.
      We are also responsible for testing compliance with selected provisions of laws,
      regulations and government-wide policies that have a direct and material effect on the
      financial statements. We limited our tests of compliance to those laws and regulations
      required by 0MB audit guidance that we deemed applicable to the financial statements for
      the fiscal year ended September 30, 2009. Compliance with FFMIA will be reported on by
      the HUD Office of Inspector General (OIG) in connection with their audit of the
      consolidated financial statements of HUD.

      We limited our tests of compliance to the provisions described above and we did not test
      compliance with all laws and regulations applicable to FHA. We caution that
      noncompliance may occur and not be detected by these tests and that such testing may
      not be sufficient for other purposes.

      FHA Comments and Our Evaluation

     FHA management concurred with three of our four findings and their related
     recommendations. FHA management did not concur that additional information is
     necessary to support the estimate of the Liability for Loan Guarantees. The HUD OCIO did
     not concur that the capacity management controls represented a significant deficiency to
     FHA’s controls over financial reporting. The full text of FHA management’s response is
     included in Appendix B. We did not perform audit procedures on FHA management’s
     written response and accordingly, we express no opinion on it. Our assessment of FHA
     management’s response is included in Appendix C. The current status of prior year
     findings and recommendations is included in Appendix D.

     We also noted other less significant matters involving FHA’s internal control and its
     operation, which we have reported to the management of FHA in a separate letter, dated
     November 9, 2009.

     Distribution

     This report is intended solely for the information and use of the HUD OIG, the
     management of HUD and FHA, 0MB, GAO and the Congress of the United States, and is
     not intended to be and should not be used by anyone other than these specified parties.



                     )LJJ LLP
     Arlington, Virginia
     November 9, 2009


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                                 Independent Auditor’s Report
                               Appendix A-Significant Deficiencies


      In our report dated November 9, 2009, we described the results of our audits of the
      consolidated balance sheets of the Federal Housing Administration (FHA), a wholly
      owned government corporation within the United States Department of Housing and
      Urban Development (HUD), as of September 30, 2009 and 2008, and the related
      consolidated statements of net cost, changes in net position, and the combined
      statements of budgetary resources (Principal Financial Statements) for the years then
      ended. The objective of our audits was to express an opinion on these financial
      statements. In connection with our audits, we also considered FHA’s internal control
      over financial reporting and tested FHA’s compliance with certain provisions of
      applicable laws and regulations that could have a direct and material effect on its
      financial statements. The following sections present additional detail on the internal
      control matters discussed in that report.

     Background

      FHA’s current financial system is comprised of numerous aging information systems
      developed independently over the last thirty years and integrated with the general ledger
     through electronic interfaces. Most of these systems are COBOL-based applications on
     either an IBM or Unisys mainframe. Substantially all of FHA’s source transaction data is
     entered by and transmitted from lenders via electronic data interchange or web
     interfaces. Many of FHA’s business systems are owned by the Office of Single Family
     Housing or the Office of Multifamily Housing and support both HUD and FHA program
     activities. Infrastructure and general support of FHA and HUD systems are provided by
     HUD’s Office of the Chief Information Officer. When FHA’s general ledger system, the
     FHA Subsidiary ledger (FHASL), was implemented in 2003, FHA planned to integrate
     new business applications as modules that would be on the same platform and language
     as FHASL. Due in part to FHA’s declining single family mortgage loan market share and
     reduced IT systems development budgets, few systems were replaced through 2008
     and only two multifamily systems were replaced in FY2009. As a result, the aging
     technologies are becoming more expensive to maintain and these systems are at higher
     risk of not being able to adequately support FHA’s financial reporting needs.

     The collapse of the commercial subprime mortgage loan market and the related credit
     crisis has resulted in a dramatic rise in FHA’s market share and endorsement levels for
     its single family mortgage programs, straining FHA’s information systems’ storage and
     response capabilities. In response, HUD commissioned a study of the market
     environment’s impact on FHA’s loan application and endorsement systems and
     processes. This study, issued in February 2009, not only identified system capacity
     concerns but noted inadequate levels of processing staff to support the expanded
     endorsement and oversight processes. Most of this study’s recommendations were
     aimed at improving business processes and reducing the human capital limitations.

     In addition, new housing initiatives enacted by the Hope for Homeowners Act of 2008
     and the Housing and Economic Reform Act of 2008 have required significant
     programming changes in FHA systems that cost in excess of $20 million during FY2009.
     These efforts further illustrated the inflexibility of the current system architecture. The
     following risks to the reliability of FHA’s financial reporting identified during our audit are
     largely due to the recent growth and change in FHA programs and activities.




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                                          Appendix A
                              Significant Deficiencies, Continued


      1. Financial system capacity limitations could impact business processing

      As a result of increased loan application and endorsement volume, the Unisys
      mainframe began to approach its operating capacity in the fall of 2008. To address the
      degradation on processing performance and high workload on business critical Housing
      systems, HUD increased capacity on the Unisys host platform. In addition, HUD
      upgraded network circuits and expanded internet capacity critical to supporting FHA
      business activities.

     HUD also planned to migrate several large applications from the Unisys mainframe
     platlorm to an Open Systems platform in 2009; however, the implementation did not
     occur as scheduled. Additional application and processing changes (e.g. improved batch
     process scheduling and search databases) were also implemented to optimize the use
     of the processing resources.

     Throughout 2009, FHA and HUD closely monitored system utilization levels and
     increased data/processing capacity as needed. HUD also recently contracted for the
     delivery of a new, larger mainframe (scheduled for full implementation on November 30,
     2009) to replace the existing IBM mainframe. FHA believes the system utilization levels
     are now within acceptable levels and management projects gradual declines in business
     volume for the next few years.

     The Office of the Chief Information Officer developed an informal written short term
     capacity management plan at the end of FY 2009 that identifies the actions that have
     been taken and future activities required. However, because this growth in volume
     developed so quickly, the plan does not document 1) utilization benchmarks and
     required responses and 2) clear organizational and staff roles and responsibilities.
     Without a formalized plan, FHA and OCIO may not be able to sufficiently address further
     capacity issues timely or effectively, which may impact FHA’s ability to process and
     record financial transactions timely and reliably.

     Recommendation

     We recommend the HUD Office of the Chief Information Officer in coordination with the
     Assistant Secretary for Housing, FHA Commissioner:

     1 a.   Continue implementing the short term capacity management plan and further refine
            the plan to address 1) utilization benchmarks and required responses and 2) clear
            organizational and staff roles and responsibilities. (New)


     2. Effective FHA modernization is necessary to address systems risks

     In 2009, HUD commissioned a study to develop an IT Strategy and Improvement Plan
     that would identify strategic IT solutions to meet the agency’s long-term programmatic
     objectives. This study served as a comprehensive IT systems risk assessment for FHA
     and thoroughly illustrates the numerous inefficiencies and limitations of the current
     system architecture. It examined operations at other federal agencies and several
     mortgage, banking, and mortgage insurance operations. The study recommended 33



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                                           Appendix A
                               Significant Deficiencies, Continued


      technology and architecture approaches and 25 specific initiatives, including
      replacement of several of FHA’s largest and most critical business systems. Critical
      objectives of the initiatives were to:
          • Improve fraud detection
          • Improve risk management and loss mitigation
          • Improve program operations
          • Limit mission constraints related to dated technology

      Each initiative was reviewed, evaluated and prioritized based on established risk criteria.
      The efforts to address these system recommendations are expected to take several
      years and cost hundreds of millions of dollars. FHA has taken a first step by appointing a
      full time project management officer. In FY2010, FHA plans to perform a comprehensive
      risk assessment to ensure this plan is consistent with the current OCIO Strategic Plan.
      Given their current state, FHA’s financial systems will continue to require expensive
      maintenance and monitoring and are likely to pose increasing risks to the reliability of
      FHA’s financial reporting and business operations until the modernization efforts are
      completed. The proposed plan should include an effective implementation plan and
      leadership team to ensure that the current systems are replaced within a timeframe that
      does not put FHA’s financial operations and reporting at further risk.

      Recommendations

     We recommend the HUD Office of Chief Information Officer, in coordination with the
     FHA Commissioner, Assistant Secretary for Housing:

         2a. Conduct a risk assessment of the various system initiatives and required
             corrective actions in connection with the OClO Strategic Plan and the IT Strategy
             and Improvement Plan. (Updated)

         2b. Develop a prioritized plan of activities, including the development of the required
             enterprise architecture, into a detailed implementation plan to support the IT
             Strategy and Improvement Plan presented to Congress. (New)


     3, Economic conditions and            inherent    model    design    increase    risks   to
        management estimates

     Management’s current year estimate of the Liability for Loan Guarantee (LLG) for the
     Mutual Mortgage Insurance (MMI) Fund (a) may be optimistic due to an inherent design
     assumption, (b) may not fully reflect the potential impact of recent events, and (c) is
     extremely sensitive to changes in house price forecasts. These factors increase the risk
     of error in the estimate, which could be mitigated by additional data analysis.

     This LLG estimate is based on actuarially developed long term historical claim payment
     patterns over time and is not intended to precisely predict cash flows for any given policy
     year, as the estimate projects cash flows over a thirty-year period. Accordingly,
     management’s estimate is uniquely dependent on the presumption that the performance
     of current loans will be consistent with historical experience, accounting for changes in
     established loan and economic variables, However, FHA has experienced deteriorating


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                                          Appendix A
                              Significant Deficiencies, Continued

      portfolio performance over the Last eight years, resulting in persistent upward revisions to
      its liability estimates. The rapid growth in endorsements makes this year’s estimate even
      more dependent on this historical relationship than in prior years, and increases the risk
      of continued optimistic cash flow projections.

      Although the estimation methodology is designed to compensate for changes in
      identified loan characteristics and future house price appreciation, it only incorporates a
      limited amount of current year data. Recent changes in the composition, loss severity
      and delinquency performance of recent loans relative to past history, and the rapidly
      changing housing market environment raise questions about the model’s ability to fully
      respond to these changes and provide a reliable estimate of future cash flows with the
      same precision as in more stable economic periods.

     The model design also projects claims relative to the borrower’s negative equity position
     and the current declining house price environment results in claim projections that are
     more sensitive to small changes in projected house price indices than in periods of more
     stable or increasing house prices.

     Impact of model design: The Cranston-Gonzales National Affordable Housing Act of
      1990 required that FHA’s MMI Fund obtain an independent actuarial study to assess the
     financial soundness of the fund. FHA’s process for estimating their LLG on single family
     programs uses assumptions developed by this independent actuarial study performed
     each year. The econometric models developed for this study have been tailored to
     address specific factors unique to FHA’s business and are heavily driven by historical
     claim payment patterns, economic projections related to house price appreciation, and
     numerous loan level attributes, such as borrower credit score, age, loan-to-value ratio,
     loan type and seasonality. We examined analyses of portfolio data prepared by FHA
     throughout FY2009 to assess whether this information supported the cash flows
     projected for FY2O1O. We also examined other potential indicators, such as initial
     unemployment claims, which did support the projected level of FY2OIO mortgage claims,
     partly because a large portion of FHA’s defaults are attributable to loss of income, which
     is not the case in more stable economic environments. However, the results were not
     always consistent since the independent actuarial model is based on claims paid and is
     not intended to integrate short term market variations that might be evident through
     leading indicators (e.g. delinquency or unemployment data). This model design
     combined with a quickly changing economic environment impacts the agency’s ability to
     reliably estimate future cash flows. The long term impact of this design is illustrated
     below.

     FHA’s premium rates are designed to be sufficient to meet the claim costs to be paid,
     net of recoveries, on a net present value basis. This net surplus, is referred to a negative
     subsidy, in that the taxpayers are not “subsidizing” the cost of loans endorsed by FHA.
     These subsidy rates are recalculated each year and published in a special Appendix to
     the President’s Budget. The historical data in this Appendix indicates that the net
     surpluses, or negative credit subsidy, of FHA’s MMI fund program endorsements have
     been lower than originally budgeted for 15 of the last 16 years and frequently rise
     notably for the first three years after the year the loans are endorsed. The FY2009
     subsidy reestimate continues this trend. The following chart shows the original budget
     credit subsidy rate, the current credit subsidy rate and the increase attributable to
     macroeconomic or programmatic factors, rather than interest costs, through FY2008.



UK
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                                                Appendix A
                                    Significant Deficiencies, Continued




                                 Budgeted vs. Current Credit Subsidy Rates by Cohort

                5.00



                                                                             —
                                                                                 —   Budgeted
                                                                                     Subsidy Rate


                                                                             *       current
                                                                                     Reestimated
                                                                                     Rate

                                                                                     Technical
                                                                                     Reestimate




            Source: Federal Credit Supplement. Budget of the United States


     Our analysis found that this bias appears to take three years to correct. On average, the
     first reestimate (made in the year after endorsement) was an upward reestimate of 0.92
     percentage points. In the next year, another upward reestimate of 0.24 percentage
     points is made (on average). In the third and subsequent years, an additional upward
     reestimate is made that, on average, is 1.25 percentage points roughly equal to the
                                                                             —



     first two year’s reestimate combined.

     The upward bias for the 2004 2008 cohorts can be largely attributed to the impact of
                                              —



     seller-funded downpayment assistance loans, the effect of which was not fully integrated
     into projections for future claims until 2007 when the weaker performance was
     segregated and quantified during the FY2007 actuarial study. The current year and prior
     year upward reestimates were also impacted by the unexpected and deep recession.
     The cause for the smaller, but consistent, bias in prior cohorts is less clear but may be
     due to a general trend in the mortgage industry during the I 990s toward loosened credit
     standards through lower acceptable loan-to-value ratios and expanded reliance on
     electronic underwriting systems. Accordingly, the model’s dependence on long-term
     historical experience results in optimistic projections given the consistently declining
     portfolio performance.

     This reliance on historical performance may have a significant impact on the most
     current cohorts, Due to the dramatic growth in endorsements over the last two years, the
     projections for future claim payments for these recent loans are based on very limited
     direct claim history of loans endorsed during this time period. The MMI fund’s FY2009
     and FY2008 cohorts comprise almost 62% of the MMI fund’s insurance-in-force and
     53% of FHA’s total insurance-in-force agency-wide. In contrast, the two most current
     cohorts of the MMI fund represented only 27% of the agency’s portfolio at September
     30, 2007. The aggregate projected cash flows for these two cohorts make up almost


UK
                                                                15
                                          Appendix A
                              Significant Deficiencies, Continued

      70% of the total cash flows comprising the September 30, 2009 Liability for Loan
      Guarantees. In contrast, the amount of paid claims for these two cohorts through March
      31, 2009 totaled only $231 million, or less than 0.1% of the $61 billion in total projected
      claims to be paid over the life of these cohorts.

     Impact of recent events: Financial reporting timelines also restrict the amount of
     current year data which can be used in the calculations, but late changes in economic
     forecasts or portfolio performance could result in unexpected relationships between
     actual and projected results.

     A major enhancement to the current year actuarial model was a dynamic loss severity
      model, which used several years of property disposition data to develop varying
      recovery rates by cohort and future policy year. The actuaries did not use any recovery
     data from FY2009 in their analysis. However, FHA recovery rates have dropped over
     20% in FY2009, which is a steeper decline than can be supported solely by the weak
     housing market and changes in house price indices or down payment assistance trends.
     We noted no statistical variables that could isolate the cause of this decline. The
     omission of this recent data resulted in forecasted recovery rates for FY2O1O and
     FY2O1 1 that are significantly higher than FY2009 rates and exceed any forecasted
     rebound in home prices. We would expect to observe improvements in the recovery
     rates in later policy years but believe this recovery should be more gradual. One current
     market study suggested that the market values of distressed properties are more volatile
     than the general market because of the high concentration of properties within a
     geographic area. We believe further evaluation of the correlation of distressed market
     values and FHA’s disposition data could result in improved support for the projected
     trends in recovery rates. Similar analysis by FHA was instrumental in identifying an error
     in the independent actuarial study model that resulted in a $1.6 billion downward
     correction to projected cash flows from future asset dispositions. The accompanying
     financial statements have been corrected for this error.

     Current model sensitivity: In an environment of declining house prices, small changes
     in housing prices can have a profound impact on projected claims because the model
     projects borrowers’ propensity to default based on the level of a borrower’s negative
     home equity. Thus, the projected claim costs can increase dramatically with relative
     small declines in home prices. This can be illustrated by the 27% overestimate ($9.7
     billion vs. $13.3 billion projected) of FY2009 claims caused by the prior year’s overly
     pessimistic forecast for house price declines in the latter half of 2008.

     The Housing and Economic Recovery Act of 2008 requires FHA to submit quarterly
     reports to Congress specifying endorsement volume, composition, variances from
     projections of claims, prepayments and recovery rates, and projected credit subsidy
     rates. We believe documenting management’s conclusions regarding this reporting,
     along with additional analyses by management of certain current and leading indicators,
     would provide additional support for the reasonableness of the near term cash flows or
     identify whether manual modifications to management’s estimate of the LLG are
     necessary to account for recent changes in internal, policy or economic factors not
     integrated into the model or its assumptions.




UK
                                                 16
                                          Appendix A
                              Significant Deficiencies, Continued


      Recommendations

     We recommend that the Assistant Secretary for Housing, FHA Commissioner, in
     coordination with the FHA Comptroller and the Office of Evaluation:

      3a. Continue to analyze trend data on seriously delinquent aged loans and determine
          whether a statistical correlation exists to support this metric as a leading indicator for
          short-term claim payment trends. (New)

      3b. Continue to track and report the reasons for default and as long as “loss of income”
          remains a major factor for default, determine whether another economic indicator,
          such as initial unemployment claims, may be useful to support near term estimates
          for claim payments. (New)

      3c. Continue to analyze property disposition data in order to better support near-term
          projected recovery rates. (New)

      3d. Expand management’s financial cash flow model validation documentation to
          include expanded analyses of seriously delinquent aged loans data, case level
          historical recovery data, and other leading indicators as appropriate. (New)

      3e. Conduct research into available information on inventories and sales of “distressed”
          properties and consider whether such an indicator can be used to assist in
          supporting near-term trends in historical and projected recovery rates. (New)

      3f. Document the final overall management conclusion whether the analyses performed
          suggest whether adjustments to the projected cash flows are warranted, and if so,
          how those adjustments are determined and their resulting value. (New)


     4. FHA should enhance the general ledger system user access management
        processes

     As indicated in the FHA Office of Housing IT Strategy and Improvement Plan, “FHA IT
     systems are a significant constraint on FHA’s ability to rapidly and effectively adjust to
     this new environment. Over the last decade, little investment has been made in
     modernizing FHA’s technology.” An initial step of system modernization was
     implemented in FY2009, with the integration of the Multifamily Endorsement/Premium
     and Claims processes into FHASL. During this implementation, additional developers
     and end-users were provided access to FHASL environments to perform various
     development activities, testing and training functions. We noted that developers had
     access to the production environment in a greater than read-only capacity and end-users
     had access to the development environment. Additionally, we noted that four employees
     had excessive rights within the Multifamily Premiums module of FHASL (i.e.,
     endorsement entry, premium reviewer, termination clerk, and mortgage servicer role)
     and compensating controls preventing the same user from performing incompatible
     functions on the same transaction were not effective. While granting these access levels




UK
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                                         Appendix A
                             Significant Deficiencies, Continued

     may appear to improve the efficiency of system implementation, it increases the risk of
     transactions being inappropriately authorized and processed.

     The monitoring of user business process functions within an application, audit logging, is
     essential in ensuring that only personnel with proper access rights are performing job
     functions. During FY2009, we noted that limited audit logging is performed over
     business functions; and the data elements that are being logged do not appear to be
     consequential to the process. Additionally, the audit logs produced are not reviewed to
     ensure appropriate actions have been taken as required by HUD policy. A plan has been
     developed by the system owner that incorporates identifying the data elements to be
     audited, selecting the capture mechanism, defining reports and filters and establishing
     the review process; however, this has not been implemented completely. The recording
     of auditable events and the periodic review of audit logs is essential to mitigate the risk
     of unauthorized access attempts or inappropriate personnel actions.

     A final component of user access management is the process of removing access no
     longer required by users. One method for completing this process is the disabling or
     removal of accounts after a specified period of inactivity. HUD policy mandates that
     inactive users be deleted after 90 days of inactivity. We noted that approximately 30
     user accounts with active access to FHASL had not logged into the application in more
     than 90 days. FHASL is configured to have passwords automatically expire after 90
     days of inactivity; however, these accounts are not permanently locked and can be reset
     by the user contacting the Help Desk. Accounts are manually deleted if they have been
     inactive for more than twelve months since the beginning of the previous year. In this
     situation, users do not have the ability to contact the Help Desk to reactivate their
     accounts. We noted that this process is manual because FHASL does not have an
     automated mechanism for disabling or removing accounts. By not disabling unused
     accounts timely, there is an increased risk that accounts may be used to gain
     unauthorized access to FHASL.


     Recommendations

     We recommend the Director, Office of Financial Analysis and Reporting, Office of the
     Comptroller:

     4a. Coordinate with Multifamily Insurance Operations Branch to enforce least privilege
         by restricting access only to modules that are needed for the performance of
         specified tasks. (New)

     4b. Identify system roles that are incompatible and develop automated edit checks in
         FHASL to prevent the same person from performing conflicting functions on the
         same transaction. (New)

     4c, Terminate the parallel deployment of the Revenue Management and MFIS/F47
         modules and restrict access to the development environment of FHASL to only
         those individuals with development responsibilities. (New)

     4d. Limit developers’ access to the production environment to read-only, and ensure
         any support or training is completed in a test environment. (New)



UK
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                                            Appendix A
                                Significant Deficiencies, Continued



         4e. Ensure proper implementation of the PeopleSoft application audit logging by
             identifying the data elements and the actions to capture, selecting the capture
             mechanism and defining the filters and reports to be generated to ensure accurate
             and relevant information is produced. (New)

         4f. Establish and implement a formal review process of the audit logs by updating
             policies and procedures to incorporate the generation of the audit logs, the periodic
             review of the logs, and the actions to be taken based on the results in accordance
             with HUD’s Security Policy and NIST standards. (New)

         4g. Implement automated mechanisms or mitigating manual account reviews to ensure
             disabling of accounts that have been inactive for 90 days consistent with HUD’s
             Security Policy. (New)




UK
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                20
                                      Appendix B
                                 Management’s Response



                               US. DEPARTMENT OF HOUSING ANI) URBAN DEVELOPMENT
       *   idUI *                               WASHINGTON, DC 20410-5000


      ASSISTANT SECRETARY FOR HOUSING-
      FEDERAL HOUSING COMMISSIONER
                                                  OCT 272009

       MEMORANDUM FOR:                   Urbach Kahn & Werlin LLP


       FROM:                             George Tomchi III, Acting Deputy Assistant Secretary for
                                         Finance and Budget, HW


      SUBJECT:                           Response to UKW’s Fiscal Year 2009 FHA Audit Report


              Thank you for providing us the opportunity to respond to FHA’s Independent Auditor’s
      Report. I am pleased to present Federal Housing Administration’s (FHA) response to this
      report.

     General Comments

     FHA is pleased that UKW has noted progress in many areas. With regards to findings 1, 2 and
     4, FHA has already or will shortly, begin addressing these recommendations. FHA does not
     agree with the third finding regarding the estimate of the Liability for Loan Guarantees. FHA
     believes its current practices for estimating and reviewing the Liability for Loan Guarantees
     provides the best possible mechanism for estimation.


                                Report on Internal Controls      —   Significant Deficiencies

     1. Financial system capacity limitations could impact business processing

            We will continue to coordinate with the Office of the Chief Information Officer (OCIO)
     to implement a short term capacity management plan and to address 1) established utilization
     benchmarks and required responses and 2) clearly identified organizational and staff roles and
     responsibilities.

     2. Effective FHA modernization is necessary to address systems risks

             We concur that effective FHA modernization is necessary to address systems risks and
     with your recommendations. We will continue to implement our IT Strategy and Improvement
     Plan using resources that the Congress and 0MB make available. We have constituted a team
     to develop all of the analyses and documents required to support this major IT investment,
     including a risk assessment and a prioritized plan of activities, Working with the OCIO, we
     will coordinate system initiatives, corrective action plans, OCIO’s Strategic Plan, HUD and
     federal enterprise architectures, and FHA’s IT Strategy and Improvement Plan.



                                          www.hud.Rov       espanol.hud.gov




UK
                                                   21
                               Appendix B
                     Management’s Response, Continued




      3. Management should support the estimate of the Liability for Loan Guarantees with
         additional analysis


               UKW presents a concern that the Liability for Loan Guarantee (LLG) item in the FHA
      financial statements for single-family mortgage insurance:

             “(a) may be optimistic due to an inherent (actuarial study) design assumption, (b)
             may not fully reflect the potential impact of recent events, and (c) is extremely
             sensitive to changes in house price forecasts.”

     UKW believes that these asserted risk factors “could be mitigated by additional data analysis”
     provided by FHA and used to adjust the LLG from what is otherwise produced using inputs from
     the annual, independent actuarial study. UKW concludes with six recommendations, all of which
     point to a request that FHA consider adding a management adjustment to the LLG calculation
     that ostensibly captures analysis on the most recently available information on delinquencies and
     property dispositions, at the time that the annual financial statements are prepared.

     FHA disagrees with the premise of the UKW recommendation, that the actuarial studies used as
     a basis for the LLG calculations are missing vital information that creates a significant deficiency
     for FHA. FHA also disagrees with the notion that it would be prudent to adjust long-term
     estimates with short-term dynamics.

     Actuarial Study Model Design

     UKW’s criticisms of the modeling approach used by the independent actuarial contractor reflect
     a lack of understanding of basic economic modeling techniques. This misunderstanding occurs
     in two primary areas: the use of historical data in forecasting future events, and behavioral
     modeling as opposed to time-series analysis.

     The use ofhistorical data inforecastingfuture events. Past experience is used to estimate how
     borrowers with different financial, property, and loan characteristics respond to changes in
     economic conditions. Such behavioral responses must then be applied to current and future
     loans and borrowers, and to forecasts of future economic conditions (especially, interest rates
     and house prices). Resulting predictions of insurance claims and loss can be vastly different from
     and inconsistent with historical experience.

     Behavioral parameters that come out of the econometric models developed by the independent
     actuarial contractor have proved quite accurate, even for short-run forecasting. In the process of
     developing the FY 2009 econometric model, the contractor undertook extensive testing and
     comparison of actual experience and previously predicted claim and prepayment experience in
     FY 2009. The contractor examined detailed quarterly performance of loans for all insurance
     cohorts and activity periods since FY 2004, and found that the models did not systematically
     under- or over-estimate claim probabilities. Differences between actual claim and prepayment
     rates and those estimated using the FY 2008 econometric model could be explained by two
     factors: (1) differences between the Global Insight house price appreciation and interest rate




UK
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                              Appendix B
                    Management’s Response, Continued




     forecasts and the actual performance of the U.S. economy in early FY 2009; and (2) the limited
     loan data available for determining the composition of the FY 2009 insured portfolio (two
     quarters) at the time data tabulations were provided to the contractor. In the first case, Global
     Insight predicted a much greater decline in home prices than actually occurred, and a smaller
     drop in interest rates than occurred. Additional comparisons were developed for all cohorts and
     time periods back to FY 2004, to confirm that deviations of predictions from actuals for all
     cohorts in early FY 2009 were affected by deviation of actual economic outcomes from what had
     been predicted by Global Insight in the summer of 2008.

     The use ofbehavioral modeling techniques versus time series modeling. UKW states several
     times in its report that the use of so-called “leading indicators,” such as serious delinquencies and
     reasons for default, would improve the accuracy of the LLG estimates over what is provided by
     the actuarial model. The belief is that changing economic conditions require real-time
     information for accurate forecasts. UKW is concerned that the actuarial contractor has a data cut
     off date of March 31, and thus must use predictions for the second half of the fiscal year in
     question.

     The use of such leading indicators is typical in time-series econometric models that are designed
     for making very short-run forecasts. These models do not explain behavior, based on the
     underlying factors, but simply capture stylized pool-level trend patterns. Indeed, a time-series
     model would itself be subject to errors, and especially because it would fail to capture the
     nuanced differences among borrowers, loan types, and financial incentives that behavioral
     models capture.

     The modeling approach used for the actuarial study does not need “leading indicators” because
     they are included as the exact factors that lead to insurance claims. In developing the
     econometric models, the contractor spent a great deal of time and effort assessing the impact of
     including the exact variables suggested by UKW. In each instance, they did not improve the
     accuracy of the final model. Using judgment rather than statistical evidence, would bias the
     forecasts.

     Econometric Models and Budget Forecasts. UKW shows data on FHA’s budget re-estimates to
     make its point that the econometric models used to estimate the LLG are inherently biased
     toward over-valuing the FHA portfolio. The initial budget estimates provided by FHA to 0MB
     for inclusion in the President’s Budget are made nearly two years before a cohort of loans has
     actually taken shape. With such lead time, they will naturally miss changes in portfolio
     composition and economic conditions. As UKW points out, the budget re-estimation process is
     designed to bring the original estimates in-line both with the characteristics and size of the actual
     insurance cohort, and with the dynamics of actual economic conditions through the life of the
     cohort. HUD is aware of historical, systematic over-valuations of expected budget receipts in the
     initial estimates made for the President’s Budget. Those over-valuations can be explained by a
     number of factors. These factors are subjects for study in the actuarial analysis each year, and
     changes are made to the actuarial models when possible and appropriate.

     First is the design of econometric models used prior to 2004 to predict loan performance (claims
     and prepayments). Previous actuarial contractors used a single house-price path without




UK
                                                 23
                                Appendix B
                      Management’s Response, Continued




       adequate consideration of the dispersion of actual, individual house price paths around the
       average. Without a full measure of such dispersion, claim-rate predictions are too low and
       prepayment predictions too high. That problem was corrected when the current contractor was
       engaged for the FY 2004 actuarial study.

       Next was the continued growth of seller-funded downpayments for FHA-insured homebuyers.
       They started in 1999 and grew to over 35 percent of all FHA-insured homepurchase loans by
       FY 2007. The differential claim experience of such loans could not be included in statistical
       models until there was sufficient data to prove that such a differential existed and was not simply
      the result of other factors. A behavioral factor for downpayment source was added in the FY
      2005 actuarial study, and it proved extremely valuable in identifying the heightened risk of
      seller-funded-downpayment loans. Even then, FHA did not predict the continued growth of that
      sub-portfolio as a share of overall insurance endorsements. Thus, LLG and budget calculations
      involved lags for a number of years. The share of downpayment assisted loans among FHA
      endorsements finally peaked in FY 2007, declined somewhat in FY 2008, and then was reduced
      to zero by the second quarter of FY 2009. UKW itself identifies the seller-funded-downpayment
      assisted loans as a primary source of any over-estimate of value in the 2004-2007 period. The
      continuous growth of that business into FY2007 is something that is only known with hindsight.

      The final factor identified by FHA as having caused a positive bias in budget estimates for a
      number of years was the changing geographic concentration of FHA insurance during the recent
      housing boom. That boom was fueled by easy conventional mortgage credit, which relegated
      FRA to an ever-smaller share of a growing mortgage market. FHA was virtually shut out of
      major markets like California, missing both the extreme run-up of prices in those markets, and
      the resulting, precipitous decline in prices in the same localities. This phenomenon affected FHA
      budget and LLG estimates because the house price forecasts being used were national forecasts,
      Home values in FHA’s portfolio did not grow as fast as did national price indices during the
      boom, and they did not fall as hard when national price indices came back down. The result was
      an over-valuation of the FHA portfolio through FY 2007, but then an undervaluation in FY 2008.
     For FY 2009, FHA and the actuarial consultant began the process of migrating to use of local,
     metropolitan area home price forecasts, which are now available for purchase from private
     vendors. That process will be completed in the FY 2010 cycle. For now, what prevents any
     material undervaluation is that, each year, the entire outstanding portfolio is marked-to-market at
     the beginning of the forecast period. That process uses a combination of metropolitan area and
     non-metropolitan area home price indices from the Federal Housing Finance Agency. Also, the
     FY 2009 cohort is a dominant force in the FHA portfolio because of its sheer size. That cohort
     represents the national housing market, as FHA is now playing a significant role in all markets.

     It is not possible to anticipate or pre-emptively correct for all changes that occur either within the
     portfolio, or in the broader economy. FHA works diligently with the actuarial contractor to
     identify and understand deviations between projected performance and actual performance each
     year. This is a dynamic process that leads to continuous improvements in modeling techniques.
     When factors causing these deviations are identified and measured, they are factored into the
     actuarial model and resulting LLG calculations.




UK
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                                  Appendix B
                        Management’s Response, Continued




          Accounting for the Impact of Recent Events

          UKW suggests that there is information in near-term movements in seriously delinquent rates
          and property recoveries that may require adjustments to the LLG calculations. Again, this
         presumes that there is something in short-term fluctuations that should override the behavioral
         basis of the econometric-model forecasts. There might be some basis for this approach, were the
          LLG calculation akin to private sector loss reserve accounting. The LLG calculation, however, is
         not a short-run liability. It represents the net present value of expected net losses over a 30-year
         time period, Thus, it would be imprudent to adjust it for short-run phenomena that may or may
         not provide any actual, independent information from what is produced by the actuarial models.
         Because the LLG accounts for 30-years of forecasted claims and prepayments, it can provide for
         measured loss reserves that are far greater than what would be required under private sector
         standards, The fact that it is forward looking over a 30-year period means that any deviations of
         actual performance from predicted in the first year of the forecast period are not meaningful in
         determining whether FHA has enough dedicated reserves to pay for claims before the next
         annual LEG calculation. The LLG calculation will nearly always over-reserve for any near-term
         events.

         As the national housing market continued to show signs of distress this past year, FHA
         commissioned its actuarial contractor to build an econometric model of the expected losses from
         insurance claims. That model captures borrower, property, and loan characteristics, and thus
         provides forecasts that are consistent with the claim and prepayment projections. Results portend
         historically high loss seventies in the near term, with movement back to more normal rates in the
         future. Using instead some indicators from recent property disposition recoveries and losses
         would be a mistake of the same order as would using short-term delinquency statistics for
         predicting claim rates.

        Sensitivity to flouse Price Forecasts

         UKW is also concerned that the econometric models at the heart of the actuarial study and LEG
         calculations is sensitive to economic forecasts, FHA insures a portfolio of loans with much less
        equity than does the conventional mortgage market. FHA has also, historically, served a lower-
        income clientele than does the prime, conventional mortgage market. The issue with the over
        prediction of claims in FY 2009 from the FY 2008 actuarial study was primarily due to the
        severe decline in home prices that had been predicted by Global Insight in the summer of 2008,
        A national house price decline of any magnitude is indeed an event not seen since the Great
        Depression. It in itself is a stressful situation for a national mortgage insurance portfolio and so
        the FHA portfolio should have been sensitive to a national house price decline of over 8 percent
        UKW would be concerned if the econometric model predictions were not sensitive to economic
        forecasts.

        This year, IHS Global Insight is again forecasting a one year house price decline of over 8
        percent, essentially moving last year’s forecast ahead by one year. If the national average home
        price declines by 8 percent, there will be many communities with declines on the order of 10 to
        20 percent. Those are significant events that will, if they transpire, result in high levels of
        insurance claims.




UK
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                             Appendix B
                   Management’s Response, Continued




     Operational Problems with the UKW Recommendations

     FHA and its actuarial-study and financial-analysis contractors work under very tight timeframes
     to provide inputs for the LLG calculations. The annual financial statements have hard deadlines,
     and the auditors require significant amounts of data, analysis, documentation, and discussion in
     the process. Adding any process of management review of additional data sources would be
     difficult from a process standpoint given the tight timeframes.

     Conclusion

     While FHA management will continue to track and analyze trend data on delinquencies,
     foreclosures, REO dispositions and recoveries, and general economic conditions, it does not
     agree additional management judgment based on short-term analyses should be in the calculation
     of the LLG for the annual financial statements. FHA continues to prefer working with the
     actuarial study contractor to identify research and study issues that could improve the
     econometric modeling and forecasting each year.


     4.   FHASL user access management processes need to be enhanced

             We concur that user access management processes need to be enhanced and with your
     recommendations. The Office of the Financial Analysis and Reporting, working with the Office
     of Systems and Technology in the Office of FHA Comptroller, will develop and execute plans to
     correct the conditions noted in your recommendations.




UK
&w                                            26
                                    Appendix B
                          Management’s Response, Continued




                                  U.s. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
       *       *
                                                  WASKNOTON, DC 204 0.3B)O


      OFFiCE OF THE CFIFFF \FORMAflON OFF ICER


                                                  NDY 0 2 2009


      MEMORANDUM FOR:                      Urbach Kahn & Werlin LLP

      FROM:                            eiiis, Chief In?ormation Officer, Q

      SUBJECT:                             Response to Draft Independent Auditors’ Report on FHA Financial
                                             Statement Internal Controls

              Thank you for giving us the opportunity to respond to the Draft Independent Auditor’s
      Report on FHA Financial Statement Internal Controls. The Office of the Chief Information
      Officer has reviewed the report and provides the comments below on the recommendation
      addressed to us.

                                    Report on Internal Controls    —   Significant Deficiencies

           1. Financial system capacity limitations could impact business processing

          The Office of the Chief Information Officer (OCIO) does not concur with characterization of
     this recommendation as a “significant deficiency.” The need for proactive system capacity
     management is acknowledged; however OCIO has capacity benchmarks in place and conducts
     ongoing reviews. Infrastructure contractors, as part of contract deliverables, provide reports on
     systems capacity metrics. Trends are routinely presented to senior OCIO management and with
     direction provided to address particular concerns. OCIO has designated a specific IT modernization
     team which is already coordinating closely with FT-IA on its transformation effort. This team, in
     conjunction with Housing’s office of Systems and Technology is addressing issues, setting
     priorities, and making decisions to move forward. The process integration with FHA’s overall
     effort, throughout all levels of OCTO, is established and functioning.

            We look forward to working with you and your staff to resolve and close-out this
     recommendation. Should you have any questions or need additional information please contact
     Steve Hill at 2O24O2-8346.


     Attachment




UK
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                28
                                    Appendix C
                      UKW’s Assessment of Management’s Response



     UKW has obtained and reviewed FHA management’s response to the findings and
     recommendations made in connection with our audit of FHA’s 2009 Principal Financial
     Statements, which is included as Appendix B. We did not perform audit procedures on
     FHA or HUD’s written response to the findings and recommendations and accordingly,
     we express no opinion on them. Our assessment of management’s responses is
     discussed below.

     Assessment of management’s response to significant deficiency Nos. 1, 2 and 4:

     As indicated in Appendix B, FHA management concurred with our findings and
     recommendations, but did not provide specific information regarding planned corrective
     actions or information needed to assess whether management will be able to effectively
     implement our recommendations.

     The HUD OCIO did not concur with our assessment of the finding related to capacity
     management as a significant deficiency. Our audit assessment of control findings is not
     limited to the status as of the end of the fiscal year. We believe the FHA systems
     presented a significant risk to the reliability of FHA’s financial reporting throughout
     FY2009 due to the dramatic growth in business volume in endorsements. Extraordinary
     efforts by FHA systems staff were required to ensure the continuity of operations,
     including the acquisition of a new mainframe computer. We believe that until the new
     mainframe computer is fully operational, the system environment, inclusive of the
     deficiencies in the capacity management plan, presents a significant risk to the
     continuing operation of critical FHA business systems.

     Assessment of management’s response to significant deficiency No. 3:

     We appreciate management’s thorough discussion of FHA’s risks in the current market
     and how those risks were considered in the Liability for Loan Guarantees (LLG).
      However, management’s response indicates that they may have misinterpreted the
     intent of our finding and recommendations. Management appears to be concerned that
     we recommend the models be changed to incorporate short term indicators. The
     purpose of our recommendations was to encourage management to better document its
     consideration of the extraordinary economic environment affecting the housing market
     and how those risks affect the reliability of the resulting calculated liability. This is
     consistent with the guidance in Federal Financial Accounting and Auditing Technical
     Release 6, which states that “In certain limited instances, informed opinion may be used
     to support cash flow projections in the absence of historical data.”

     The following paragraphs contain our assessment of the specific disagreements in
     management’s response.

     Actuarial Study Model Design The use of historical data in forecasting future events
                                   —




     We agree that the independent actuarial study methodology has been enhanced over
     the last seven years. Inclusion of credit scores and additional loan attribute variables,
     especially seller-funded downpayment assistance, has improved the predictiveness of
     claim and prepayment rates. However, we are concerned that the actuarial study’s
     reliance on historical data to forecast borrower behavior may not sufficiently reflect the
     uncertainties in the current economic conditions. We continue to believe it is prudent for


UK
&w                                              29
                                   Appendix C
               UKW’s Assessment of Management’s Response, Continued

      FHA management to thoroughly document its considerations that validate and
     supplement the results of the actuarial study and other calculated assumptions in light of
     the economic environment. Management’s response itself is the kind of analytical
     documentation being recommended. For example, the response states that the
     independent actuarial contractor “undertook extensive testing and comparison of actual
     experience and previously predicted claim and prepayment experience in FY
     2009... ,and found that the models did not systematically under- or over-estimate claim
     probabilities.” Formalizing the documentation of the results of that testing and
     management’s consideration of the results would provide additional validation of the
     results of the model’s estimation.

     Actuarial Study Model Design The use of behavioral modeling techniques versus time
                                    —




     series modeling
     Management’s response states that leading indicators are typically used in time-series
     models for making short-run forecasts and that the actuarial study model incorporates
     such factors. It further states that “In developing the econometric models, the contractor
     spent a great deal of time and effort assessing the impact of including the exact
     variables suggested by UKW. In each instance, they did not improve the accuracy of the
     final model.” Once again, documenting the results and conclusions of such analysis
     would better support management’s reliance of the model’s assumptions and output. We
     emphasize and concur with FHA’s comment that the FY2009 cohort should correlate
     better with national house price forecasts due to its large size and relative market share,
     but claim and recovery cash flows from this cohort will not be significant in the near term.

     Actuarial Study Model Design Econometric models and budget forecasts
                                    —




      Management’s response explains that the historical, systematic over-valuations of
     expected budget receipts in the initial Presidential Budget estimates were caused by 1)
     the pre-2004 econometric model’s use of a single house price path, 2) the growth of
     seller-funded downpayment loans without a specific behavioral factor in the model, and
     3) the changing geographic concentration of FHA insurance during the housing boom.
     The response concludes that “It is not possible to anticipate or preemptively correct for
     all changes that occur either within the portfolio, or in the broader economy,. .When
     factors causing these deviations are identified and measured, they are factored into the
     actuarial model and resulting LLG calculations.” This approach to improving the
     econometric model is appropriate. However, as noted by management, it results in a
     model that lags portfolio and economic changes. In the current, fast-changing
     environment, our recommendations would provide a way for management to document
     their consideration of such changes in a more prospective manner.

     Accounting for the Impact of Recent Events
     Management’s response asserts that the LLG calculation of the net present value of
     expected net losses over a 30-year period is superior to a calculation using the near-
     term movements in seriously-delinquent rates and property recoveries. As we explained
     above, our concern is that the actuarial study’s reliance on historical data to forecast
     borrower behavior may not sufficiently reflect the uncertainties in the current economic
     conditions. Changes in the timing of claims, as may be indicated by seriously-delinquent
     rates, and the amount of property recoveries do affect net present value calculations
     even for a 30-year calculation period.




UK
&w                                               30
                                 Appendix C
             UKW’s Assessment of Management’s Response, Continued

     !2piationaI Problems with UKW Recommendations
     We recognize that our recommendations may require some additional analyses that
     would require more work. However, as we point out in several examples above,
     management is already performing such analyses and would need only to better
     document their consideration. Furthermore, as the economy and the housing market
     stabilize, the necessity for additional analytics should recede.




UK
                                           31
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                32
                                       Appendix D
                  Status of Prior Year Findings and Recommendations

     Our assessment of the current status of reportable conditions and material weaknesses
     identified in prior year audits is presented below:

                                                                              Fiscal Year 2009
              FY 2008 Finding/Recommendation                       Type             Status
     la. The FHA Commissioner, Assistant Secretary for         Significant   Partially
          Housing, coordinate with the HUD Secretary and       Deficiency    Resolved. FHA
         the HUD Gb to conduct a risk assessment of the        2008          plans to perform
         various systems initiatives and required corrective                 risk assessment
         actions in connection with the OCIO Strategic Plan                  of modernization
         and document how HUD’s/FHA’s IT resources will                      in FY2O1O. See
          be appropriately allocated in fiscal year 2009 to                  significant
         address the Department’s and FHA’s highest                          deficiency 1.
         system_priorities.
     lb. The FHA Comptroller document the revised              Significant   Resolved.
          Multifamily business processes, identify and         Deficiency
         assess key internal controls and perform tests of     2008
         those controls commensurate with the inherent risk
         for a new system in conjunction with the agency’s
         0MB Circular No. A-123 Management Control
         Program and ensure the system’s compliance with
         0MB Circular No. A-130, Management of Federal
         Information_Resources.
     lc. The FHA Comptroller develop an automated              Significant   Partially
         process for HECM claims and establish an              Deficiency    Resolved. See
         automated interface with FHASL and ensure such        2008          Management
         interfaces are included in the overall system                       Letter
         functional_requirements_document.
     id. The FHA Comptroller should ensure the identified      Significant   Resolved.
         deficiencies in the controls over the HECM notes      Deficiency
         servicing system are corrected before proceeding      2008
         with the Type II review.
     le.The FHA Comptroller should ensure the control          Significant   Resolved.
         testing of the HECM notes system to be performed      Deficiency
         under AICPA SAS No. 70, Type II is expanded to        2008
         test for compliance with systems requirements
         unique_to_the_federal_government.
     if. The FHA Comptroller should ensure that any            Significant   Partially
         HECM system replacement is initiated in               Deficiency    Resolved.
         accordance with HUD system development life           2008          Contract awarded
         cycle guidelines and established           program                  to outsource all
         timelines.                                                          HECM data
                                                                             processing. See
                                                                             Management
                                                                             Letter.
     1g. The FHA Comptroller should work with OClO to          Significant   Not yet resolved.
         correct the Generic Debt system interfaces to         Deficiency    See Management
         ensure FHASL properly balances the financing          2008          Letter.
         accounts at the cohort level. (New)



UK
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                                           Appendix D

           Status of Prior Year Findings and        Recommendations, Continued




                                                                             Fiscal Year 2009

            FY 2007 FindinglRecommendation                         Type            Status

     lb. Coordinate with HUD’s Acting Chief Information           Material       Resolved.
         Officer and the Acting Deputy Assistant Secretary       Weakness
         for Single Family Housing to establish a                  2007
         comprehensive system functional requirements
         document in accordance with HUD guidance for
         the new HECM system based on anticipated future
         volumes_of transactions.
     ld. Complete a full assessment of the effectiveness of       Material       Resolved.
         the existing controls (including an Independent         Weakness
         Type II review of the service provider under AICPA        2007
         Statement on Auditing Standards No. 70, Service
         Organizations) over the notes database given the
         sensitivity of the data and the anticipated growth in
         reported_assigned_note_balances_and_transactions.
     le. Develop and implement automated system                   Material   Partially resolved.
         interfaces between the current HECM claims and          Weakness      HECM claims
         notes systems and FHASL, if the new system(s)             2007         interface not
         cannot be implemented timely.                                       developed due to
                                                                               outsourcing of
                                                                              processing. See
                                                                               Management
                                                                                   Letter.




UK
&w                                             34
             Principal Financial Statements




 PRINCIPAL
 FINANCIAL
STATEMENTS




    35
Principal Financial Statements




                         (THIS PAGE LEFT BLANK iNTENTIONALLY)




                                         36
                                                                               _________




                                                                                     Principal Financial Statements

                         FEDERAL HOUSING ADMINISTRATION
         (AN AGENCY OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT)
                           CONSOLIDATED BALANCE SHEETS
                             As of September 30, 2009 and 2008
                                    (Dollars in Millions)

                                                                                    FY2009            FY2008
ASSETS
  Intragovernmental
    Fund Balance with U.S. Treasury (Note 3)                                    $        30,130   $      12,590
    Investments (Note 4)                                                                 10,635          19,254
    Other Assets (Note 7)                                                                    16              21
  Total Intragovernmental                                                                40,781          31,865


  Investments (Note 4)                                                                      145             48
  Accounts Receivable, Net (Note 5)                                                          16             128
  Loans Receivable and Related Foreclosed Property, Net (Note 6)                          4,446           5,506
  Other Assets (Note 7)                                                                     129             134
TOTAL ASSETS                                                                    $     45,517      $     37,681


LIABILITIES
  Intragovernmental
    Borrowings from U.S. Treasury (Note 9)                                      S         4,420   $      4,832
    Other Liabilities (Note 10)                                                           1,913           1,530
  Total Intragovernmental                                                                 6,333          6,362


  Accounts Payable (Note 8)                                                                639             585
  Loan Guarantee Liability (Note 6)                                                      34,022         19,486
  Debentures Issued to Claimants (Note 9)                                                    14             52
  Other Liabilities (Note 10)                                                              416             438
TOTAL LIABILITIES                                                                    41,424            26,923


NET POSITION
  Unexpended Appropriations (Note 16)                                                      832            411
  Cumulative Results of Operations                                                       3,261          10,347
TOTAL NET POSITION                                                                       4,093         10,758


TOTAL LIABILITIES AND NET POSITION                                             $     45,517       $    37,681


                      The accompanying notes are an integral part of these statements.




                                                    37
Principal Financial Statements

                              FEDERAL HOUSING ADMINISTRATION
             (AN AGENCY OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT)
                           CONSOLIDATED STATEMENTS OF NET COST
                                 As of September 30, 2009 and 2008
                                        (Dollars in Millions)




                                                        MMI/CMHI            GI/SRI           11411
   FY2009
   lntragovernniental Gross Costs (Note 12)             $       167     $        131   $              5   $       303
   Less: lntragovernmental Earned Revenue (Note 13)           1,756             392                   -         2,148
  Intragoverninental Net Costs                               (1,589)           (261)                  5        (1,845)


   Gross Costs with the Public (Note 12)                      9,072            5,302                 12        14,386
   Less: Earned Revenue from the Public (Note 13)                47               71                  -           118
  Net Costs with the Public                                   9,025            5,231                 12        14,268
  NET PROG RAM COST (SURPLUS)                           S     7,436    $      4,970    $             17   $    12,423




                                                       MMIJCMHI             Cl/SRI           H4H              Total
   FY2008
  lntragovernrnental Gross Costs (Note 12)              $       175    $        138    $              -   S       313
  Less: Intragovernmental Earned Revenue (Note 13)            1,320              73                   -         1.393
  lntragovernrnental Net Costs                               (1,145)             65                   -        (1,080)


  Gross Costs with the Public (Note 12)                      9,495            1,569                            11,064
  Less: Earned Revenue from the Public (Note 13)                  9              68                                   77
  Net Costs with the Public                                  9,486            1.501                   -        10,987
  NET PROGRAM COST (SURPLUS)                            $    8,341     S      1,566    $              -   $     9,907



                          The accompanying notes are an integral part of these statements.




                                                        38
                                                                                            Principal Financial Statements

                             FEDERAL HOUSING ADMINISTRATION
            (AN AGENCY OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT)
                        CONSOLIDATED STATEMENTS OF NET POSITION
                                As of September 30, 2009 and 2008
                                       (Dollars in Millions)




                                                 FY2009                FY2009             FY2008               FY2008
                                                Cumulative                               Cumulative
                                                Results of            Unexpended         Results of           Unexpended
                                                Operations        Appropriations         Operations       Appropriations


BEGINNING BALANCES                          $        10,347       $           411    $        20,031      $           544


BUDGETARY FINANCING SOURCES
 Appropriations Received (Note 16)                                          7,554                                    627
 Other Adjustments (Note 16)                                  -               (59)                    -               (49)
 Appropriations Used (Note 16)                        6,929                (6,929)               435                 (435)
 Transfers-Out (Note 15 and Note 16)                   (347)                 (145)              (613)                (276)


OTHER FINANCING SOURCES
 Transfers In/Out (Note 15)                          (1,260)                    -               387                        -




 Imputed Financing (Note 12)                                15                  -                  14                   -




TOTAL FINANCING SOURCES                     S         5,337       $          421     $          223       $         (133)


NET (COST) SURPLUS OF OPERATIONS                    (12,423)                    -             (9,907)                   -




ENDING BALANCES                             $         3,261       $          832     $        10,347      $          411



                        The accompanying notes are an integral part of these statements.




                                                       39
                                                              _______________        _______________       _______________




Principal Financial Statements

                                FEDERAL HOUSING ADMINISTRATION
               (AN AGENCY OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT)
                         COMBINED STATEMENT OF BUDGETARY RESOURCES
                                      As of September 30, 2009
                                        (Dollars in Millions)


                                                                       FY2009            FY2009                 FY2009
                                                                      Budgetary       Non-Budgetary              Total
BUDGETARY RESOURCES
Unobligated Balance, brought forward, October 1                   $        19,547     $        8,148        $       27,695
Recoveries of prior year unpaid obligations                                    26                 10                    36
Budget Authority:
   Appropriations                                                           7,554                                    7,554
   Borrowing authority                                                                           470                   470
   Spending authority from offsetting collections (gross):
      Earned
         Collected (Note 18)                                                2,363             31,233                33,596
         Change in receivables from Federal sources                          (152)                 1                  (151)
Nonexpenditure transfers, net (Note 19)                                       (58)                     -               (58)
Permanently not available                                                    (364)              (883)               (1,247)
TOTAL BUDGETARY RESOURCES                                         $       28,916      $      38,979         $      67,895

STA TUS OF BUDGETARY RESOURCES
Obligations incurred, Direct (Note 20)                            $        17,515     $      12,180         $       29,695
Unobligated balance-Apportioned                                               575             5,875                  6,450
Unobligated balance-Not available                                          10,826            20,924                 31,750
TOTAL STATUS OF BUDGETARY RESOURCES                               $       28,916      $     38,979          $      67,895

Change in Obligated Balances
Obligated balance, net:
   Unpaid obligations, brought forward, October 1                 $           863     $        1,596        $        2,459
   Uncollected customer payments from Federal sources,                       (238)                (2)                 (240)
   brought   forward,   October   1




Total, unpaid obligated balance, brought forward, net                         625              1,594                 2,219
Obligations incurred (Note 20)                                             17,515             12,180                29,695
Gross outlays                                                             (17,512)           (12,302)              (29,814)
Recoveries of prior-year unpaid obligations, actual                           (26)               (10)                  (36)
Change in uncollected customer payments-Federal sources                       152                 (1)                  151
Total, unpaid obligated balance, net, end of period                           754              1,461                 2,215
Obligated balance, net, end of period:
   Unpaid obligations (Note 17)                                              840               1,464                2,304
   Uncollected customer payments from Federal sources                        (86)                 (3)                 (89)
Total, unpaid obligated balance, net, end of period                          754               1,461                2,215
Net outlays:
   Gross outlays                                                           17,512            12,302         $      29,814
   Offsetting collections (Note 18)                                        (2,363)          (31,233)              (33,596)
   Less: Distributed offsetting receipts                                      183                  -                  183
NET OUTLAYS                                                       $       14,966     $     (18,931)        $      (3,965)


                             The accompanying notes are an integral part of these statements




                                                             40
                                                                   ___________
                                                                                   ____   ___________
                                                                                                     ____        ___________
                                                                                                                                ____




                                                                                                      Principal Financial Statements

                                FEDERAL HOUSING ADMINISTRATION
               (AN AGENCY OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT)
                         COMBINED STATEMENT OF BUDGETARY RESOURCES
                                      As of September 30, 2008
                                        (Dollars in Millions)


                                                                            FY2008               FY2008                  FY2008
                                                                           Budgetary          Non-Budgetary               Total
 BUDGETARY RESOURCES
 Unobligated Balance, brought forward, October 1                       S        22,843        S       4,077          $       26,920
 Recoveries of prior year unpaid obligations                                        72                   19                      91
 Budget Authority:
    Appropriations                                                                 627                                          627
    Borrowing authority                                                                                 940                     943
    Spending authority from offsetting collections (gross):
       Earned
         Collected (Note 18)                                                     1,636               14,160                 15,796
         Change in receivables from Federal sources                                (25)                 (42)                   (67)
 Nonexpenditure transfers, net (Note 19)                                           (41)                      -                 (41)
 Permanently not available                                                        (294)                (690)                  (984)
 TOTAL BUDGETARY RESOURCES                                             $       24,821         $     18,464           $     43,285
STA TUS OF BUDGETARY RESOURCES
Obligations incurred, Dfrect (Note 20)                                 S         5,274        $      10,316          S      15,590
Unobligated balance-Apportioned                                                    365                2,622                  2,987
Unobligated balance-Not available                                               19,182                5,526                 24.708
TOTAL STATUS OF BUDGETARY RESOURCES                                $           24,821     $         18,464       $         43,285
change in Obligated Balances
Obligated balance, net:
   Unpaid obligations, brought forward, October 1                  5              954     $           1,342      $           2,296
   Uncollected customer payments from Federal sources,                           (263)                  (44)                  (307)
   brought_forw
               ard,_October
                              _1




Total, unpaid obligated balance, brought forward, net                             691                1,298                    1,989
Obligations incurred (Note 20)                                                  5,274               10,316                  15,590
Gross outlays                                                                  (5,293)             (10,043)                (15,336)
Recoveries of prior-year unpaid obligations, actual                               (72)                 (19)                     (91)
Change in uncollected customer payments-Federal sources                            25                   42                       67
Total, unpaid obligated balance, net, end of period                               625                1,594                   2,219
Obligated balance, net, end of period:
   Unpaid obligations (Note 17)                                                   863                1,596                   2.459
   Uncollected customer payments from Federal sources                            (238)                  (2)                   (240)
Total, unpaid obligated balance. net. end of period                               625                1,594                   2,219
Net outlays:
   Gross outlays                                                   S            5,293     $         10,043       $          15,336
   Offsetting collections (Note 18)                                            (1,636)             (14.160)                (15,796)
   Less: Distributed offsetting receipts                                        1,511                    -                   1,511
NETOUTLAYS                                                         S           2,146      S        (4,117)       S         (1.971)


                           The accompanying notes are an integral part of these statements.




                                                              41
Principal Financial Statements


                     NOTES TO THE FINANCIAL STATEMENTS
                                              September 30, 2009


Note 1. Significant Accountin2 Policies

Entity and Mission

The Federal Housing Administration (FHA) was established under the National Housing Act of 1934 and became
a wholly owned government corporation in 1948 subject to the Government Corporation Control Act. as
amended. While FHA was established as a separate Federal entity, it was subsequently merged into the
Department of Housing and Urban Development (HUD) when that department was created in 1965. FHA does
not maintain a separate staff or facilities; its operations are conducted, along with other 1-lousing activities, by
HUD organizations. FHA is headed by HUD’s Assistant Secretary for Housing/Federal Housing Commissioner,
who reports to the Secretary of HUD. FHA’s activities are included in the Housing section of the HUD budget.

FHA administers a wide range of activities to make mortgage financing more accessible to the home-buying
public and to increase the availability of affordable housing to families and individuals, particularly to the nation’s
poor and disadvantaged. FHA insures private lenders against loss on mortgages, which finance Single Family
homes, Multifamily projects, health care facilities, property improvements, manufactured homes, and reverse
mortgages, also referred to as Home Equity Conversion Mortgages (HECM). The objectives of the activities
carried out by FHA relate directly to developing affordable housing.

FHA categorizes its programs as Single Family (including Title I), Multifamily and HECM. Single Family
activities support initial or continued home ownership; Title I activities support manufactured housing and
property improvement. Multifamily activities support high-density housing and medical facilities. HECM
activities support reverse mortgages which allow homeowners 62 years of age or older to convert the equity in
their homes into lump sum or monthly cash payments without having to repay the loan until the loan terminates.

FHA supports its operations through five funds. The Mutual Mortgage Insurance fund (MMI), FHA’s largest
fund, provides basic Single Family mortgage insurance and is a mutual insurance fund, whereby mortgagors,
upon non-claim termination of their mortgages, share surplus premiums paid into the MM! fund that are not
required for operating expenses and losses or to build equity. The Cooperative Management Housing Insurance
fund (CMHI), another mutual fund, provides mortgage insurance for management-type cooperatives. The
General Insurance fund (GI). provides a large number of specialized mortgage insurance activities, including
insurance of loans for property improvements, cooperatives, condominiums, housing for the elderly, land
development, group practice medical facilities, nonprofit hospitals, and reverse mortgages. The Special Risk
Insurance fund (SRI) provides mortgage insurance on behalf of mortgagors eligible for interest reduction
payments who otherwise would not be eligible for mortgage insurance. Beginning in Fiscal Year 2009, activities
related to most Single Family programs, including HECM, endorsed in Fiscal Year 2009 and going forward, are
now in the MM! fund. The Single Family activities in the GI fund from Fiscal Year 2008 and prior remain in the
GI fund. The HOPE for Homeowners (H4H) program began on October 1, 2008 for Fiscal Year 2009 as a result
of The Housing and Economic Recovery Act of 2008. This legislation requires FHA to modify existing programs
and initiated the H4H program.




                                                         42
                                                                                        Principal Financial Statements

 Basis of Accounting

 The principal financial statements are presented in conformity with accounting principles generally accepted in
 the United States of America (GAAP) applicable to Federal agencies as promulgated by the Federal Accounting
 Standards Advisory Board (FASAB), The recognition and measurement of budgetary resources and their status
 for purposes of preparing the Combined Statements of Budgetary Resources (SBR), is based on concepts and
 guidance provided by Office of Management and Budget (0MB) Circular A-Il, Preparation, Submission, and
 Execution of the Budget and the Federal Credit Reform Act of 1990. The format of the SBR is based on the SF
 133, Report on Budget Execution and Budgetary Resources.

 Basis of Consolidation

 The accompanying principal financial statements include all Treasury Account Fund Symbols (TAFSs)
 designated to FHA, which consist of three principal program funds, six revolving funds, two general funds and a
 deposit fund. All inter-fund accounts receivable, accounts payable, transfers in and transfers out within these
 TAFSs have been eliminated to prepare the consolidated balance sheets, statements of net cost, and statements of
 changes in net position. The SBR is prepared on a combined basis as required by 0MB Circular A-136.
 Financial Reporting Requirements.

 Fund Balance with U.S. Treasury

 Fund balance with U.S. Treasury consists of amounts collected from premiums, interest earned from Treasury,
 recoveries and appropriations. The balance is available to fund payments for claims, property and operating
 expenses and of amounts collected but unavailable until authorizing legislation is enacted (see Notes 2 and 3).

 Investments

FHA investments include investments in U.S. Treasury securities. Multifamily risk sharing debentures and
investments in private-sector entities where FHA is a member with other parties under the Accelerated Claims
Disposition Demonstration program (see Note 4).

Under current legislation, FHA invests available MMI/CMHI capital reserve fund resources in excess of its
current needs in non-marketable market-based U.S. Treasury securities. These U.S. Treasury securities may not
be sold on public securities exchanges, but do reflect prices and interest rates of similar marketable U.S. Treasury
securities. Investments are presented at acquisition cost net of the amortized premium or discount. Amortization
of the premium or discount is recognized monthly on investments in U.S. Treasury securities using the effective
interest rate method.

FHA implemented the Accelerated Claims Disposition Demonstration program (the 601 program) to shorten the
claim filing process, obtain higher recoveries from its defaulted guaranteed loans, and support the Office of
Housing’s mission of keeping homeowners in their home. To achieve these objectives. FHA transfers assigned
mortgage notes to private sector entities in exchange for cash and equity interest. With the transfer of assigned
mortgage notes under the 601 program. FHA obtains ownership interest in the private-sector entities. To comply
ith the requirement of Opinion No. 18 issued by the Accounting Principles Board (APB 18). FHA uses the
equity method of accounting to measure the value of its investments in these entities. The equity method of
accounting requires FHA to record its investments in the entities at cost initially. Periodically, the carrying
amount of the investments is adjusted for cash distributions to FHA and for FHA’s share of the entities’ earnings
or losses.

Multifamily Risk Sharing Debentures [Section 542(c)] is a program available to lenders where the lender shares
the risk in a property by issuing debentures for claim amount paid by FHA on defaulted insured loans. If FHA’s
risk is over 50%. IIUD must review and approve the underwriting standards, terms. and conditions of the loan. If
the loan defaults FHA pays the lender the initial settlement. On the settlement date the lender issues FRA a




                                                        43
 Principal Financial Statements
 debenture for the amount of the settlement at thc note rate (determined by the U.S. Treasury) thus sharing the risk
 in the property.

 Credit Reform Accounting

 The Federal Credit Reform Act (FCRA) established the use of program, financing, general fund receipt and
 capital reserve accounts to separately account for transactions that are not controlled by the Congressional budget
 process. It also established the liquidating account for activity relating to any loan guarantees committed and
 direct loans obligated before October 1, 1991 (pre-Credit Reform). These accounts are classified as either
 budgetary or non-budgetary in the Combined Statements of Budgetary Resources. The budgetary accounts
 include the program, capital reserve and liquidating accounts. The non-budgetary accounts consist of the credit
 reform financing accounts.

  In accordance with the Statement of Federal Financial Accounting Standards (SFFAS) No. 2, Accounting for
 Direct Loans and Loan Guarantees, the program account receives and obligates appropriations to cover the
 subsidy cost of a direct loan or loan guarantee and disburses the subsidy cost to the financing account. The
 program account also receives appropriations for administrative expenses. The financing account is a non-
 budgetary account that is used to record all of the cash flows resulting from Credit Reform direct loans, assigned
 loans, loan guarantees and related foreclosed property. It includes loan disbursements, loan repayments and fees,
 claim payments, recoveries on sold collateral, borrowing from the U.S. Treasury, interest, negative subsidy and
 the subsidy cost received from the program account.

The general fund receipt account is used for the receipt of amounts paid from the Gl/SRI financing account when
there is negative subsidy from the original estimate or a downward reestimate. The receipt account is a general
fund receipt account and amounts are not earmarked for the FHA’s credit programs. They are available for
appropriations only in the sense that all general fund receipts are available for appropriations. Any assets in this
account are non-entity assets and are offset by intragovernmental liabilities. At the beginning of the following
fiscal year, the fund balance in the general fund receipt account is transferred to the U.S. Treasury general fund.
Negative subsidy and downward reestimates in the MMI/CMHI fund are transferred to the Capital Reserve
account.

The liquidating account is a budget account that is used to record all cash flows to and from FHA resulting from
pre-Credit Reform direct loans or loan guarantees. Liquidating account collections in any year are available only
for obligations incurred during that year or to repay debt. Unobligated balances remaining in the GI and SRI
liquidating funds at year-end are transferred to the U.S. Treasury’s general fund. Consequently, in the event that
resources in the GI/SRI liquidating account are otherwise insufficient to cover the payments for obligations or
commitments, the FCRA provides that the G/SRl liquidating account can receive permanent indefinite authority
to cover any resource shortages.

Loans Receivable and Related Foreclosed Property, Net

FIIA’s loans receivable include mortgage notes assigned (MNA), also described as Secretary-held notes, and
purchase money mortgages (PMM). Under the requirements of the FCRA, PMM notes are considered to be direct
loans hile MNA notes are considered to be defaulted guaranteed loans. The PMM loans are generated from the
sales on credit of FHA’s foreclosed properties to qualified non-profit organizations. The MNA notes are created
when FHA pays the lenders for claims on defaulted guaranteed loans and takes assignment of the defaulted loans
for direct collections. In addition, Multifamily and Single Family performing notes insured pursuant to Section
221 (g)(4) of the National Housing Act may be assigned automatically to FHA at a pre-determined point.

In accordance with the FCRA and SFFAS No. 2. Credit Reform direct loans, defaulted guaranteed loans and
related foreclosed property are reported at the net present value of expected cash flows associated ith these
assets. primarily estimated proceeds less selling and maintenance costs. The difference between the cost of these
loans and property and the net present value is called the allowance for subsidy (AFS). Pre-Credit Reform loans




                                                       44
                                                                                       Principal financial Statements
 receivable and foreclosed property in inventory are recorded at net realizable value, which is based on historical
 recovery rates net of any selling expenses (see Note 6).

 Loan Guarantee Liability

 The net potential future losses related to FFIA’s central business of providing mortgage insurance are reflected in
 the Loan Guarantee Liability in the consolidated balance sheets. As required by SFFAS No. 2, the Loan
 Guarantee Liability includes the Credit Reform related Liabilities for Loan Guarantees (LLG) and the pre-Credit
 Reform Loan Loss Reserve (LLR) (see Note 6).

 The LLG is calculated as the net present value of anticipated cash outflows and cash inflows. Anticipated cash
 outflows include lender claims arising from borrower defaults, (i.e.. claim payments). premium refunds, property
 costs to maintain foreclosed properties arising from future defaults and selling costs for the properties.
 Anticipated cash inflows include premium receipts, proceeds from asset sales and principal and interest on
 Secretary-held notes.

FHA records loss estimates for its Single Family LLR (includes MMI and Gl/SRI) to provide for anticipated
losses incurred (e.g., claims on insured mortgages where defaults have taken place but claims have not yet been
filed). Using the net cash flows (cash inflows less cash outflows), FHA computes an estimate based on
conditional claim rates and loss experience data, and adjusts the estimate to incorporate management assumptions
about current economic factors.

FHA records loss estimates for its Multifamily LLR (includes CMHI and Gl/SRI) to provide for anticipated
outflows less anticipated inflows. Using the net present value of claims less premiums, fees, and recoveries. FHA
computes an estimate based on conditional claim rates, prepayment rates. and recovery assumptions based on
historical experience.

Use of Estimates

The preparation of the principal financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results may differ from those estimates.

Amounts reported for net loans receivable and related foreclosed property and the Loan Guarantee Liability
represent FHA’s best estimates based on pertinent information available.

To estimate the allowance for subsidy (AFS) associated with loans receivable and related to foreclosed property
and the liability for loan guarantees (LLG), FHA uses cash flow model assumptions associated with loan
guarantee cases subject to the Federal Credit Reform Act of 1990 (FCRA), as described in Note 6, to estimate the
cash flows associated with future loan performance. To make reasonable projections of future loan performance,
FHA develops assumptions, as described in Note 6, based on historical data, current and forecasted program and
economic assumptions.

Certain programs have higher risks due to increased chances of fraudulent activities perpetrated against FHA.
FHA accounts for these risks through the assumptions used in the liabilities for loan guarantee estimates. FIIA
develops the assumptions based on historical performance and management’s judgments about future loan
performance.

General Property, Plant and Equipment

FHA does not maintain separate facilities. HUD purchases and maintains all property. plant and equipment used
by FHA. along with other Office of Ilousing activities.




                                                        45
 Principal Financial Statements
 Current HUD policy concerning SFFAS No. 10, Accounting for Internal Use Software, indicates that IIUD will
 either own the software or the functionality provided by the software in the case of licensed or leased software.
 This includes “commercial off-the-shelf’ (COTS) software, contractor-developed software, and internally
 developed software, FHA had several procurement actions in place and had incurred expenses for software
 development. FHA identified and transferred those expenses to HUD to comply with departmental policy.

 Appropriations

FHA receives annual appropriations for Working Capital and Administrative Contract expenses for its
MMI/CMHI, Gl/SRI, and H4H program activities. Additionally. FHA receives appropriations for G1/SRI
positive subsidy, upward reestimates, and permanent indefinite authority to cover any shortage of resources in the
liquidating account. The MMI/CMHI fund obtains appropriations for upward reestimates from the Capital
Reserve account.

Full Cost Reporting

SFFAS No. 4, Managerial Cost Accounting Concepts and Standards, requires that Federal agencies report the full
cost of program outputs in the financial statements. Full cost reporting includes all direct, indirect, and inter-
entity costs. For purposes of HUD’s consolidated financial statements, HUD identifies each responsibility
segment’s share of the program costs or resources provided by other Federal agencies. As a responsibility
segment of HUD, FRA’s portion of these costs was $15 million for fiscal year 2009 and $14 million for fiscal
year 2008, and was included in FHA’s financial statements as an imputed cost in the Consolidated Statements of
Net Cost, and an imputed financing in the Consolidated Statements of Changes in Net Position.

In a separate effort, FHA conducts time allocation surveys of all Office of Housing operational managers. These
surveys determine FHA’s direct personnel costs associated with the Housing Salaries and Expenses (S&E)
transfer in from HUD and where to allocate these costs between the MMI/CMHI and GI/SRI programs. The
HUD Chief Financial Officer (CFO) office also conducts surveys to determine how the department’s fiscal year
overhead, Office of Inspector General, and Working Capital Fund costs should be accounted for by responsibility
segments. This data is an integral part of the FHA direct cost S&E allocation prepared for financial statement
reporting.

Distributive Shares

As mutual funds, excess revenues in the MMI/CMHI Fund may be distributed to mortgagors at the discretion of
the Secretary of HUD. Such distributions are determined based on the funds’ financial positions and their
projected revenues and costs. No distributive share distributions have been declared from the MMI fund since the
enactment of the National Affordable Housing Act (NAHA) in 1990.

Liabilities Covered by Budgetary Resources

Liabilities of federal agencies are required to be classified as those covered and not covered by budgetary
resources, as defined by 0MB Circular A- 136, and in accordance with SFFAS No. 1. Selected Assets and
Liabilities. In the event that available resources are insufficient to cover liabilities due at a point in time, FHA has
authority to borrow monies from the U.S. Treasury (for post-1991 loan guarantees) or to draw on permanent
indefinite appropriations (for pre-1992 loan guarantees) to satisfy the liabilities. Thus, all of FHA’s liabilities are
considered covered by budgetary resources.

Statement of Budgetary Resources

The Statement of Budgetary Resources has been prepared as a combined statement and as such, intra-entity
transactions have not been eliminated. Budget authority is the authorization provided by law to enter into
obligations to carry out the guaranteed and direct loan programs and their associated administrative costs, which
would result in immediate or future outlays of federal funds. FRA’s budgetary resources include current



                                                          46
                                                                                      Principal Financial Statements
budgetary authority (i.e.. appropriations and borrowing authority) and unobligated balances brought forward from
multi-year and no-year budget authority received in prior years, and recoveries of prior year obligations.
Budgetary resources also include spending authority from offetting collections credited to an appropriation or
fund account.

Unobligated balances associated with appropriations that expire at the end of the fiscal year remain available for
obligation adjustments, but not for new obligations, until that account is canceled. When accounts are canceled,
five years after they expire, amounts are not available for obligations or expenditure for any purpose.

FHA funds its programs through borrowings from the U.S. Treasury and debentures issued to the public. These
borrowings and debentures are authorized through a permanent indefinite authority at interest rates set each year
by the U.S. Treasury and the prevailing market rates.




                                                       47
 Principal Financial Statements

 Note 2. Non-entity Assets

Non-entity assets consist of assets that belong to other entities but are included in FHA’s consolidated balance
sheets. To reflect FHA’s net position accurately, these non-entity assets are offset by various liabilities. FHA’s
non-entity assets as of September 30, 2009 and 2008 are as follows:

                (Dollars in Millions)                                         FY 2009        FY 2008
                lntragovernmental:
                            Fund Balance with U.S. Treasury               $        202   $       1,551
                            Investments in U.S. Treasury Securities                  4               8
                Total Intragovernmental                                            206           1,559

                           Other Assets                                             92            103
               Total Non-entity Assets                                             298          1,662
               Total Entity Assets                                              45,219         36,019
               Total Assets                                               $    45,517    $    37,681

FHA’s non-entity assets consist of FHA’s U.S. Treasury deposit of negative credit subsidy in the GI/SRI general
fund receipt account and of escrow monies collected by FHA from the borrowers of its loans.

According to the FCRA, FHA transfers negative credit subsidy from new endorsements and downward credit
subsidy reestimates from the Gl/SRJ financing account to the GI/SRI general fund receipt account. At the
beginning of each fiscal year, fund balance in the GI/SRI general fund receipt account is transferred into the U.S.
Treasury’s general fund.

Other assets consisting of escrow monies collected from FHA borrowers are either deposited at the U.S. Treasury
or Minority-owned banks or invested in U.S. Treasury securities. Subsequently, FHA disburses these escrow
monies to pay for property taxes, property insurance or maintenance expenses on behalf of the borrowers.




                                                          48
                                                                                          Principal Financial Statements

  Note 3. Fund Balance with U.S. Treasury

  FHA’s fund balance with U.S. Treasury was comprised of the following as of September 30. 2009 and 2008:

               (Dollars in Millions)                                    FY 2009               FY 2008
                Fund Balances:
                       Revolving Funds                              S       29.141        $        10,746
                       Appropriated Funds                                      750                    308
                       Other Funds                                             239                  1,536
                Total                                               $      30,130         $       12,590

               Status of Fund Balance with U.S. Treasury:
                      U nobligated Balance:
                                    Available                       $        6.450        $        2,987
                                    Unavailable                             21,376                 7,144
                      Obligated Balance not yet Disbursed                    2.304                 2,459
               Total                                                $      30,130         $      12,590

 Revolving Funds

 FHA’s revolving funds include the liquidating and financing accounts as required by the FCRA. These funds are
 created to finance a continuing cycle of business-like operations in which the fund charges for the sale of products
 or services. These funds also use the proceeds to finance spending. usually without requirement of annual
 appropriations.

 Appropriated Funds

FHA’s appropriated funds consist of the program accounts created by the FCRA. Annual or multi-year program
accounts expire at the end of the time period specified in the authorizing legislation. For the subsequent five fiscal
years after expiration, the resources are available only to liquidate valid obligations incurred during the unexpired
period. Adjustments are allowed to increase or decrease valid obligations incurred during the unexpired period
that were not previously reported. At the end of the fifth expired year, the annual and multi-year program
accounts are cancelled and any remaining resources are returned to the U.S. Treasury.

Other Funds

FRA’s other funds include the general fund receipt accounts established under the FCRA. Additionally, included
with these funds is the capital reserve account that is used to retain the MMI/CMHI negative subsidy and
downward credit subsidy reestimates transferred from the financing account. If subsequent upward credit subsidy
reestimates are calculated in the financing account or there is shortage of budgetary resources in the liquidating
account, the capital reserve account will return the retained negative subsidy to the financing account or transfer
the needed funds to the liquidating account, respectively.

Status of Fund Balance with U.S. Treasury

Unobligated Fund Balance with U.S. Treasury represents Fund Balance with U.S. Treasury that has not been
obligated to purchase goods or services either because FHA has not received apportionment authority from 0MB
to use the resources (unavailable unobligated balance) or because FHA has not obligated the apportioned
resources (available unobligated balance). Fund Balance with U.S. Treasury that is obligated, but not yet
disbursed, consists of resources that have been obligated for goods or services but not yet disbursed either because
the ordered goods or services have not been delivered or because FHA has not yet paid for goods or services
received by the end of the fiscal year.




                                                        49
Principal Financial Statements

Note 4. Investments

Investment in U.S. Treasury Securities

As discussed in Note 1, all FHA investments in Treasury securities are in non-marketable securities issued by the
U.S. Treasury. These securities carry market-based interest rates. The market value of these securities is
calculated using the bid amount of similar marketable U.S. Treasury securities as of September 30th. The cost,
net amortized premium/discount, net investment, and market values of FHA’s investments in U.S. Treasury
securities as of September 30. 2009 were as follows:

                                                            Amortized
                                                            (Pre mium)/         Inve stme nt,
    (Dollars in Millions)                  Cost            Discount, Net            Net           Market Value

     MMI/CMHI Investments              $      10,464    $             83    $           10,547   $       11,860
     GI/SRI Investments                            4                   -                     4                4
                        Subtotal    $         10,468    $             83   $            10,551   $       11,864

    ?vLMIICMHI Accrued Interest                    -                   -   $               84    $          84
    Total                           $        10,468     $            83    $           10,635    $      11,948


The cost, net amortized premium/discount, net investment, and market values as of September 30, 2008 were as
follows:
                                                        Amortized
                                                       (Pre mium)!       Investme nt,
     (Dollars in Millions)             Cost          Discount, Net           Net          Market Value

    MMIICMHI Investments            $        18,958     $             55   $            19,013   $       20,214
    GI/SRI Investments                            8                    -                     8                8
                       Subtotal     $        18,966    $              55   $            19,021   $       20,222

   MMI/CMHI Accrued Interest                      -                    -    $            233      $         233
   Total                           $         18,966    $             55    $          19,254     $      20,455




                                                       50
                                                                                           Principal Financial Statements

Investments in Private-Sector Entities

The following table presents financial data on FHA’s investments in Section 601 and Risk Sharing Debentures as
of September 30, 2009 and 2008:
                                                              Share of
                                  Beginning      New          Earnings     Return of                       Ending
     (Dollars in ii11ions)         Balance    Acquisitions   or Losses    Investment   Redeemed            Balance
      FY 2009
      601 Program             $          18   $         -    $      (4) $        (2)   $          -    S          12
      Risk Sharing Debentures            30           137            -            -             (34)             133
     Total                     $         48   $      137     $     (4)    $      (2)   $        (34)   $        145

     FY2008
      601 Program             $          41   $         -    $      (4)   $     (19)   $           -   S         18
      Risk Sharing Debentures            80             -            -            -             (50)             30
     Total                     $        121   $         -    $      (4) S       (19)   $        (50)   $         48



The fiscal year for the Section 601 Program investments is from December Ito November 30 for 2008. The
condensed, audited financial statements reported $58 million in assets. $58 million in liabilities and partner’s
capital. and ($17) million in net income for these investments.




                                                        51
 Principal Financial Statements

 Note 5. Accounts Receivable, Net

 Accounts receivable. net. as of September 30, 2009 and 2008 are as follows:

                                            Gross                  Allowance                         Net
     (Dollars in Millions)           FY 2009     FY 2008      FY 2009     FY2008           FY 2009         FY 2008
     With the Public:
      Receivables Related to        S     17     $     55     $     (7)   $      (3)       $    10         $    52
       Credit Program Assets
      Premiums Receivable                  2            2            -            -              2               2
      Generic Debt Receivables            75           72          (75)           -              -              72
      Miscellaneous receivables            4            2            -            -              4               2
     Total                          $     98     $    131    $     (82)   $      (3)       $    16         $   128


Receivables Related to Credit Program Assets

These receivables include asset sale proceeds receivable and rents receivable from FHA’s foreclosed properties.

Premiums Receivable

These amounts consist of the up-front and periodic premiums due to FHA from the mortgagors at the end of the
reporting period. The details of FHA premium structure are discussed in Note 13 Earned Revenue/Premium
                                                                                       —




Revenue.

Generic Debt Receivables

These amounts are mainly composed of receivables from various sources the largest of which are Single Family
Partial Claims, Single Family Indemnifications, and Single Family Restitutions.

Miscellaneous Receivables

Miscellaneous receivables include late charges and penalties receivable on premiums receivable, refunds
receivable from overpayments of claims and distributive shares and other immaterial receivables.

Allowance for Loss

The allowance for loss for these receivables is calculated based on FHA’s historical loss experience and
management’s judgment concerning current economic factors.

Reclassification of HECM Credit Reform Asset Receivables and Generic Debt Allowance

In Fiscal Year 2009. HECM Fee Receivables were reclassified from the Accounts Receivable in Note 5 to the
Defaulted Guaranteed Loans in Note 6 to better reflect the nature of the receivables. The Generic Debt Allowance
was reclassified from the Allowance for Subsidy in Note 6 to the Allowance for Loss in Note 5 to better reflect
the value of the Generic Debt Receivables.




                                                      52
                                                                                                     Principal Financial Statements

Note 6. Direct Loans and Loan Guarantees, Non-Federal Borrowers

FHA Direct Loan and Loan Guarantee Programs and the related loans receivable, foreclosed property, and Loan
Guarantee Liability as of September 30. 2009 and 2008 are as follows:

  1)irect Loan and Loan Guarantee Programs Administered by FHA Include:

  MMJ/CMHI Direct Loan Program
  G1/SRI Direct Loan Program
  MMI/CMHI Loan Guarantee Program
  GI/SRI Loan Guarantee Program
  H4H Loan Guarantee Program

For the Loan Guarantee Program at FHA, in both the MMI/CMHI and GI/SRI funds there are Single Family and
Multifamily activities. The H4H fund only contains Single Family activity.

To comply with the FHA Modernization Act of 2008, activities related to most Single Family programs, including
HECM and Section 234(c), endorsed in Fiscal Year 2009 and going forward, are now in the MMI fund. The
Single Family activities in the GI fund from Fiscal Year 2008 and prior remain in the GI fund. The following
table illustrates how the primary Single Family program activities for Fl-IA are now distributed between
MMI/CMHI and GI/SRI funds based on the year of endorsement:

            Fund                Loans Endorsed in Fiscal Years                 Loans Endorsed in Fiscal Years
                                       2008 and Prior                                2009 and Onward
             GI                        234(c), HECM                                         N/A
            MM!                            203(b)                                  203(b), 234(c), HECM

Direct Loan Program

            (Dollars in Millions)                    MMI/CMHI   -              Cl/SRI-
             FY2009                                 Single Family
                                                                -             Multifamily              Total
            Direct Loans
                   Loan Receivables             $                    -    $                 13   $              13
                   Interest Receivables                              1                       4                   5
                   Allowance                                        (4)                     (9)                (13)
            Total Direct Loans                  $                   (3) $                    8 $                 5
            FY2008                                                                                     Total
            Direct Loans
                    Loan Receivables            S                    1    $                 13   $              14
                    Interest Receivables                             -                      4                    4
                    Allowance                                       (4)                  (5l                    (9)
           Total Direct Loans                   S                   (3) S               12 $                     9




                                                          53
Principal Financial Statements

Defaulted Guaranteed Loans from Pre-1992 Guarantees (Allowance for Loss Method):

             (Dollars in Millions)
             FY2009                                     MMI/CMIII               Cl/SRI                 Total
             Guaranteed Loans
                 Single Family (Excluding HECM)
                    Loan Receivables                $           19 $                       8 $                   27
                    Interest Receivables                         3                         3                      6
                    Allowance forLoan Losses                   (12)                       (7)                   (19)
                    Foreclosed Property                         16                         2                     18
                 Subtotal                           $          26 S                        6 $                  32
                 Multifamily
                    Loan Receivables                $                   -   $        2,668         $        2,668
                    Interest Receivables                                -              199                    199
                    Allowance for Loan Losses                           -           (2,162)                (2,162)
                 Subtotal                           $                   -   $         705 $                  705
                 HECM*
                    Loan Receivables                $                   -   $                  5   $             5
                    Interest Receivables                                -                  2                     2
                    Allowance for Loan Losses                           -                 (1)                   (1)
                    Foreclosed Property                                -                   2                     2
                 Subtotal                           $                  -    $              8 $                   8

             Total GuaranteedLoans                  $          26           $            719       $           745



            (Dollars in Millions)
            FY2008                                      MMIJCMHI                Cl/SRI                 Total
            Guaranteed Loans
                Single Family (Excluding HECM)
                   Loan Receivables                 $           16 $                       9 $                 25
                   Interest Receivables                          3                         3                     6
                   Allowance for Loan Losses                    (2)                       (6)                   (8)
                   Foreclosed Property                           9                         6                    15
                Subtotal                            $          26 $                      12 $                  38
                Multifamily
                   Loan Receivables                 $               -       $        2,787 $                2,787
                   Interest Receivables                                                179                    179
                   Allowance for Loan Losses                        -                 (738)                  (738)
                Subtotal                            $               -       $       2,228 $                2,228
                HECM*
                   Loan Receivables                 $               -       $              5       $             5
                   Interest Receivables                             -                     2                      2
                   Allowance for Loan Losses                       -                       -                     -




                   Foreclosed Property                             -                       I
                Subtotal                           $               -        $             8        $            8

            Total Guaranteed Loans                 $           26           $       2,248          $      2,274

*HECM loans, while not defaulted, have reached 98% of the maximum claim amount and have been assigned to
FRA,




                                                   54
                                                                                                                           Prinçjpa/Financial Statements

  Defaulted Guaranteed Loans from Post-1991 Guarantees:

              (Dollars in Millions)
              FY2009                                             MMI/CMIH                            CL/SRI                         Total
              Guaranteed Loans
                  Single Family (Excluding HECM)
                     Loan Receivables                        $          560                     S                 31           $              591
                     Interest Receivables
                     Foreclosed Property                               4,875                                  281                           5,156
                     Allowance for Subsidy Cost                       (3,165)                                (187)                         (3,352)
                 Subtotal                                   $         2,270                     S             126          $               2,396
                 Multifamily
                     Loan Receivables                       $                       -           $             594          $                  594
                     Foreclosed Property                                            -                              -                                  -



                    Allowance for Subsidy Cost                                      -                        (292)                           (292)
                 Subtotal                                $                          -        $               302 $                           302
                   HECM*
                     Loan Receivables                    $                          -       S                 772          S                 772
                     Interest Receivables                                           -                         418                            418
                     Foreclosed Property                                            -                          31                             31
                     Allowance for Subsidy Cost                                     -                        (223)                          (223)
                  Subtotal                               $                          -       $                998           $                998

            Total Guaranteed Loans                       $           2,270                  $           1,426              $           3,696


            (Dollars in Millions)
            P12008                                           MMJ/CMHI                               GI/SRI                         Total
            Guaranteed Loans
                Single Family (Excluding HECM)
                   Loan Receivables                     $              403                  $              39 $                             442
                   Interest Receivables                                         -                           1                                     1
                   Foreclosed Property                               4,053                                398                           4,451
                   Allowance for Subsidy Cost                       (2,219)                              (313)                         (2,532)
                Subtotal                             $              2,237 $                              125 $                         2,362
                Multifamily
                   Loan Receivables                  $                      -           $                    356       $                    356
                   Foreclosed Property                                      -                                 2                               2
                  Allowance for Subsidy Cost                                -                            (263)                             (263)
               Subtotal                              $                      -           $                    95        $                    95
               HECM*
                  Loan Receivables                   S                      -           $                565           $                   565
                  Interest Receivables                                   -                               277                               277
                  Foreclosed Property                                    -                                   13                              13
                  Allowance törSubsidv Cost                             -                                 (89)                              (89)
               Subtotal                             $                   -               $                766 $                             766

           Total Guaranteed Loans                   $               2,237               $                986           $              3,223

*HECM loans, while not defaulted, have reached 98% of the maximum claim amount
                                                                               and have been assigned to
FHA.




                                                    55
Principal Financial Statements

Guaranteed Loans Outstanding:

    (Dollars in Millions)                      Outstanding              Amount of
                                                Principal of          Outstanding
    Loan Guarantee Programs                  Guaranteed Loans,    Principal Guaranteed

    Guaranteed Loans Outstanding (FY 2009)
          MMI/CMHI
           Single Family                     $          711,426   $           674,263
           Multifamily                                      401                   375
          MMI/CMHI Subtotal                  $         711,827    $          674,638

         GI/SRI
          Single Family                                  25,898                23,088
          Multifamily                                    66,463                59,515
         G1/SRI Subtotal                     $          92,361    $           82,603

         H4H
          Single Family 257 -                                4                      4
         H4H Subtotal                        $               4    S                 4

         FY2009 Total                        $         804,192    $          757,245

    Guaranteed Loans Outstanding (FY 2008)
         MMI/CMHI
          Single Family                      $         479,579    $           447,299
          Multifamily                                      416                    353
         MMI/CMHI Subtotal                   S        479,995     $          447,652

         01/SRI
           Single Family                                30,346                 27,685
           Multifamily                                  62,855                 56,384
         GI/SRI Subtotal                     $         93,201     $           84,069

         FY2008 Total                        $        573,196     $          531,721




                                                 56
                                                                                -




                                                                       Principal Financial Statements

New Guaranteed Loans Disbursed:

   (Dollars in Millions)                            Outstanding                Amount of
                                                     Principal of            Outstanding
   Loan Guarantee Programs                        Guaranteed Loans,      Principal Guaranteed

   New Guaranteed Loans Disbursed (FY 2009)
        MMI/CMHI
         Single Family                            $          330,342        $          328,054
         Multifamily                                              43                        43
        MMIJCMHI Subtotal                         $         330,385         $         328,097

        G1/SRI
         Single Family                                           234                       232
         Multifamily                                           6,708                     6,690
        GI/SRI Subtotal                       $               6,942      $              6,922

        H4H
          Single Family 257-                                      4                          4
        114H Subtotal                         $                   4      $                   4

        FY 2009 Total                         $            337,331       $           335,023

   New Guaranteed Loans Disbursed (FY 2008)
       MMI/CMHI
        Single Family                         $             171,811      $            167,338
        Multifamily                                              14                        14
       MMI/CMHI Subtotal                      $            171,825      $            167,352

       GI/SRI
        Single Family                                         9,449                     9.204
        Multifamily                                           3,458                     3,446
       G1/SRI Subtotal                        $             12,907      $             12,650

       FY2008 Total                           $            184,732      $            180,002




                                                  57
Principal Financial Statements


Home Equity Conversion Mortgage (HECM)

HECM (reverse mortgages) are not included in the previous tables due to the unique nature of the program. Since
the inception of the program. Fl-IA has insured 571,709 HECM loans with a maximum claim amount of $123
billion. Of these 571,709 HECM loans insured by FHA. 452,196 loans with a maximum claim amount of $103
billion are still active. As of September 30, 2009 the insurance in force (the outstanding balance of active loans)
was $60 billion. The insurance in force includes balances drawn by the mortgagee; interest accrued on the
balances drawn, service charges, and mortgage insurance premiums. The maximum claim amount is the dollar
ceiling to which the outstanding loan balance can grow before being assigned to Fl-IA.

home Equity Conversion Mortgage Loans Outstanding (not included in the balances in the previous table)

     (Dollars in Millions)

                                                                 I                  Cumulative

                                         Current Year                Outstanding                     Potential
     Loan Guarantee Programs             Endorsements                 Balance                        Liability

     FY 2009 MMI/CMHI                    $     30,080                $     15,524                $        29,442
             GI/SRJ                      $          -                $     44,353                $        73,058
                                 Total   $    30,080                 $    59,877                 $      102,500

     FY 2008 GI/SRI                      $     24,166                $     43,741                $        77,736
                                 Total   $    24,166                 S    43,741                 $       77,736




                                                        58
                                                                                    Principal Financial Statements

Loan Guarantee Liability, Net:

(Dollars in Millions)

 FY2009                                    MMI/CMHI              Cl/SRI              H4H              Total
    LLR
      Single Family (Excluding HECM)   S               14    S              1   $             -   S             15
      Multifamily                                       -                 121                 -                121
    Subtotal                           $              14     $         122      $             -   $           136

    LLG
     Single Family (Excluding KECM)    $          27,301     $            838   $             I   $      28,140
     Multifamily                                       (5)            (158)                   -               (163)
     HECM                                           1,156            4,753                    -           5,909
    Subtotal                           $          28,452     $       5,433      $             1   S     33,886

Loan Guarantee Liability Total         $      28,466         $       5,555      $             1   $     34,022


 FY2008                                    MMIICMHI              GIISRI              1-1411           Total
    LLR
     Single Family (Excluding HECM)    $              20     S             2    5             -   $             22
     Multifamily                                        -                 160                 -                160
    Subtotal                           $              20     $        162       S             -   $           182

    LLG
     Single Family (Excluding HECM)    $          17,384     $         757      S             -   $      18,141
     Multifamily                                      (4)             (354)                   -               (358)
     HECM                                               -            1,521                    -           1,521
    Subtotal                           S          17,380     $       1,924      $             -   $     19,304

Loan Guarantee Liability Total         $      17,400         $      2,086       $             -   $     19,486




                                             59
Principal Financial Statements

Subsidy Expense for Loan Guarantees by Program and Component:

      (Dollars in millions)
      FY2009                                          MMI/CMIH                    GIISRI                     H4H                       Total
            Single Family (Excluding HECM)
                 Defaults                         S          9,990            S              10          $                 1       $           10,001
                 Fees and Other Collections                (13,637)                         (12)                           -               (13,649)
                 Other                                      3,496                                1                         -                   3,497
            Subtotal                              $          (151) $                         (1) $                     1           $            (151)

            Multifamily
                 Defaults                         S                   I       S             193          S                 -       $             194
                 Fees and Other Collections                       (2)                      (338)                           -                    (340)
                 Other                                                -                          -                         -                           -




         Subtotal                                 $               (1) $                (145) $                             -       S            (146)

         HECM
                 Defaults                         $         1,043             $                  -   $                 -           $           1,043
                 Fees and Other Collections                (1,457)                               -                     -                   (1,457)
                 Other                                                -                          -                     -                               -




         Subtotal                                 $         (414) S                              -   $                 -           $           (414)

     Total                                    $             (566) $                    (146) $                     1               S           (711)


     FY2008                                           MMI/CMHI                    Cl/SRI                     H4H                       Total
        Single Family (Excluding HECM)
                 Defau Its                    $             4.545         $                284       S                 -       $               4,829
                 Fees and Other Collections                (6,600)                     (339)                           -                   (6.939)
                Other                                       1,620                            -                         -                       1,620
        Subtotal                              $             (435) $                        (55) $                      -       $               (490)

        Multifamily
                Defaults                      $                   1       S                151       $             -           $                152
                Fees and Other Collections                     (1)                     (227)                       -                           (228)
                Other                                             -                          -                     -                               -




        Subtotal                              S                   -       $                (76) $                  -           S                (76)

        HECM
                Defaults                      $                   -       S                486       $             -           $                486
                Fees and Other Collections                        -                    (948)                       -                           (948)
                Other                                             -                          -                     -                              -




        Subtotal                              $                   -       $           (462) $                      -           $           (462)

    Total                                     $            (435) S                    (593) $                      -           $         (1,028)




                                                             60
                                                                                        Principal Financial Statements

Subsidy Expense for Modifications and Reestimates:


           (Dollars in millions)
                                                                                        Tee h iiical
           FY2009                                        Total Modifications           Rees ti mate
                    MMI/cMHI                           $                 (362) $                   7,275
                    Gl/SRI                                                 (6)                     3,139
           Total                                       $                (368) $                  10,414

          FY2008
                   MMI/CMHI                          $                         -   $               8,650
                   GIJSRI                                                      -
                                                                                                   1,709
          Total                                    $                           -   $            10,359


Total Loan Guarantee Subsidy Expense:

          (Dollars in millions)                              FY2009                    FY2008
                   MMJ/CMHI                        $                   6,347       $              8,215
                   Gl/SRI                                             2,987                       1,116
                   H4K                                                     I                           -



          Total                                    $                  9,335        $             9,331




                                              61
Principal   Financial Statements

Subsidy Rates for Loan Guarantee Endorsements by Program and Component:
                                                                                        Fees and
                                                                                         Other
    (Percentage)                                                          Dethults     Collections    Other         Total

    Budget Subsidy Rates for FY 2009 Loan Guarantees:


     MMI/CMHI
      Single Family Forward (October 1 June 30)
                                -                        -                      3.03         (4.13)          1.06      (004)
      Single Family Forward (July 1 September 30)
                                -                -                              3.04         (4.13)          1.03      (0.06)
      Single Family- HECM                                                       3.45         (4.82)          -         (1.37)
      Multifamily Section 213 (October I June 30)
                        -                                    -                  3.03         (4.13)      1.06          (0.04)
      Multifamily Section 213 (July 1 September 30)
                        -                            -                          3.04         (4.13)      1.03          (0.06)

     GI/SRI
       Multifamily      -   Section 221(d)(4)                                  4.14          (5.24)          -        (1,10)
      Multifamily       -   Section 207/223(f)                                 1.47          (4.76)          -        (3.29)
      Multifamily       -   Section 223(a)(7)                                  1.47          (4.76)          -        (3.29)
      Multifamily       -   Section 232                                        3.39          (5.48)          -        (2.09)
      Section242                                                               2.63          (5.14)          -        (2.51)

     H4H
      Single Family Section 257 -                                             22.40          (8.41)     (0.61)        13.38


                                                                                        Fees and
                                                                                         Other
   (Percentage)                                                           Defiiults    Collections    Other         Total

   Budget Subsidy Rates for FY2008 Loan Guarantees:

    MMI/CMHI
     Single Family Section 203(b) (October 1 July 13)
                            -                                    -             2.45         (3.71)      0.95          (0.31)
     Single Family Section 203(b) (July 14- September 30)
                            -                                                  2.99         (4.07)      0.93          (0.15)
     Multifamily Section 213
                    -                                                          1.96         (3.86)      1.00          (0.90)

    GI/SRI
     Multifamily Section 22l(d)(4)
                    -                                                         4.46          (5.29)       -           (0.83)
     Multifamily Section 207/23(f)
                    -                                                          1.98         (4.73)       -           (2.75)
     Multifamily Section 223(a)(7)
                    -                                                         1.98          (4.73)       -           (2.75)
     Multifamily- Section 232                                                 3.73          (5.31)       -           (1.58)
     Section 242                                                              2.33          (4.99)       -           (2.66)
     Single Family- HECM                                                      2.00          (3.90)       -           (1.90)
     Single Family Section 234(c)
                            -                                                 2.68          (3.56)       -           (0.88)




                                                                     62
                                                                                                           Principal Financial Statements

Schedule for Reconciling Loan Guarantee Liability Balances:

 (Dollars in Millions)                                                            FY 2009                               FY 2008
                                                                              LLR                LLG              LLR             LLG
  Beginning Balance of the Loan Guarantee Liability                       S      182         $   19,304       S      371      S    7,060
 Add:         Subsidy Expense for guaranteed loans disbursed
              during the reporting fiscal years by component:
                            Default Costs (Net of Recoveries)                       -             11,238                  -         5,467
                      Fees and Other Collections                                    -            (15,446)                          (8,1 15)
                      Other Subsidy Costs                                           -              3,497                  -         1,620
           Total of the above subsidy expense components                            -              (711)                  -       (1,028)
 Adjustments:
           Fees Received                                                                           8,771                            5,468
           Foreclosed Property and Loans Acquired                                                  3,907                            4,683
           Claim Payments to Lenders                                                             (10,481)                          (8,486)
           Interest Accumulation on the Liability Balance                                          1,079                              161
           Other                                                                                    (254)                             (66)
 Ending Balance before Reestimates                                               182             21,615             371            7,792
 Add or Subtract Subsidy Reestimates by Component:
              i’echnicaVDefault Reestimate
                        Subsidy Expense Component                                (46)              5,364            (189)          10,369
                        Interest Expense Component                                  -              1,367                            1,141
              Adjustment of prior years’ credit subsidy reestimates                 -              5,540                  -             2
 Total Technical/Default Reestimate                                              (46)            12,271            (189)          11,512


 Ending Balance of the Loan Guarantee Liability                       $         136          $ 33,886        $      182       $   19,304

Administrative Expense:

                    (Dollars in Millions)                               FY 2009                          FY 2008
                    MMI/CMHI                                          $       275                      S       228
                    Gl/SRI                                                    294                              277
                    H4H                                                             16                               -




                    Total                                             $           585                $            505


Other Information on Foreclosed Property:

Additional information on FHA foreclosed property as of September 30, 2009 and 2008 is as follows:

                                                                          FY2009                           FY2008
                  Number of properties in the foreclosure process                       66                           67
                  Number of properties held                                      39.671                         37.890
                  Average holding period for properties held                  7 Months                        7 Months




                                                                63
Principal Financial Statements

Pre-Credit Reform Valuation Methodology

FHA values its Pre-Credit Reform related notes and properties in inventory at net realizable value, determined on
the basis of net cash flows. To value these items, FHA uses historical claim data, revenues from premiums and
recoveries, and expenses of selling and maintaining property. In fiscal year 2009, FHA refined the methodology
used to value its Multifamily G1/SRI Pre-Credit Reform notes to better reflect the Allowance for Loan Losses.
Prior to 2009, FHA used one loss rate for all Multifamily notes to calculate the allowance. Beginning in 2009, a
separate loss rate was used for the Mark-to-Market program notes. This change in rate resulted with a much
larger allowance these notes.

The majority of FHA’s Pre-Credit Reform liability relates to the Mark-to-Market program. A separate analysis was
conducted to adjust the loan loss estimate for anticipated reductions for these project-based Section 8 rental
assistance subsidies administered by the Office of Affordable Housing Preservation (OAHP). All projects that are
required to submit financial statements and have submitted annual financial statements within the past two years,
received Section 8 assistance, expected to expire in the next five years, and had contract rents exceeding 100
percent of fair market value were included. In the analysis, the gross rent for these projects was reduced to bring
the contract rent for assisted units to fair market levels. The effects of this rent reduction on projects’ financial
health was assessed and a revised loan principal balance was computed based on a sustainable debt service level.
A potential claim was calculated based on this reduction of loan principal.

Credit Reform Valuation Methodology

FRA values its Credit Reform LLG and related receivables on notes and properties in inventory at the net present
value of their estimated future cash flows.

To apply the present value computations, FHA divides the loans into cohorts and risk categories. Multifamily
cohorts are defined based on the year in which loan guarantee commitments are made. Single Family mortgages
are grouped into cohorts based on loan endorsement dates for the GI/SRI and MMI fund. Within each cohort
year, loans are subdivided by risk categories. Each risk category has characteristics that distinguish it from others,
including risk profile, premium structure, and the type and quality of collateral underlying the loan. For activity
related to fiscal years 1992-2008, the MMI fund has one risk category and for activity related to fiscal years 2009
and onward, the MMI fund has two risk categories. The single family GI/SRI loans are grouped into four risk
categories. HECM loans are considered a separate risk category. There are thirteen different multifamily risk
categories.

The cash flow estimates that underlie the present value calculations are determined using the significant
assumptions detailed below.

Significant Assumptions FHA developed financial models in order to estimate the present value of future
                            —




program cash flows. The models incorporate information on the cash flows’ expected magnitude and timing. The
models rely heavily on the following loan performance assumptions:

    •   Conditional Termination Rates: The estimated probability of an insurance policy claim or non-claim
        termination in each year of the loan guarantee’s term given that a loan survives until that year.

   •    Recovery Rates: The estimated percentage of a claim payment that is recovered through disposition of a
        mortgage note or underlying property.

   •    Claim Amount: The estimated amount of the claim payment relative to the unpaid principal balance at the
        time the claim occurs.




                                                         64
                                                                                        Principal Financial Siatenients

 Additional information about loan performance assumptions is provided below:

 Sources of data: FHA developed assumptions for claim rates. prepayment rates, claim amounts, and recoveries
 based on historical data obtained from its systems.

 Economic assumptions: Forecasts of economic conditions used in conjunction with loan-level data to generate
 Single Family and Multifamily claim and prepayment rates were obtained from Global Insights (formerly DRI)
 forecasts of U.S. annual economic figures. 0MB provides other economic assumptions used, such as discount
 rates.

 Actuarial Review: An independent actuarial review of the MMI fund each year produces conditional claim and
 prepayment rates that are used as inputs to the Single Family LLG calculation,

 Reliance on historical performance: FHA relies on the average historical performance of its insured portfolio to
 forecast future performance of that portfolio. Changes in legislation, subsidy programs, tax treatment and
 economic factors all influence loan performance. FHA assumes that its portfolio will continue to perform
 consistently with its historical experience given a set of forecasted economic conditions throughout the remaining
 life of existing mortgage guarantees. which can be as long as 40 years for Multifamily programs and affect loan
 performance accordingly.

Current legislation and regulatory structure: FHA’s future plans allowed under current legislative authority have
been taken into account in formulating assumptions when relevant. In contrast, future changes in legislative
authority may affect the cash flows associated with FHA insurance programs. These changes cannot be reflected
in LLG calculations because of uncertainty over their nature and outcome.

Discount rates: The disbursement weighted interest rate on U.S. Treasury securities of maturity comparable to the
guaranteed loan term is the discount factor used in the present value calculation for cohorts 1992 to 2000. For the
2001 and future cohorts, the rate on U.S. Treasury securities of maturity comparable to the term of each cash flow
for the loan guarantee is used in the present value calculation. This methodology is referred to as the basket of
zeros discounting methodology. 0MB provides these rates to all Federal agencies for use in preparing credit
subsidy estimates and requires their use under 0MB Circular A-li, Part 4, “Instructions on Budget Execution.”
The basket of zeros discount factors are also disbursement weighted.

Impact of Economic Conditions on the LLG

Projections of future economic conditions directly impact the valuation of FHA’s Credit Reform LLG. As
identified and described in the FY 2009 Actuarial Review of MMIF Excluding HECMs, different future economic
paths create different expectations for the performance of the MMI Fund over time. The Actuarial Review
presents a base case and five alternative economic scenarios, each with different outcomes for the economic value
of the MMI Fund. This economic sensitivity analysis illustrates the risks involved in estimating the value of the
Fund in a declining economic environment. FHA management recognizes the potential for alternative outcomes
from what is represented in the Credit Reform LLG value represented here. The LLG was derived using the
Actuarial Review base case scenario, which uses IHS Global Insighfs August 2009 economic forecasts.

Analysis of Change in the Liability for Loan Guarantees

Fl-IA has estimated and applied credit subsidy rates to each FHA loan guarantee program since fiscal year 1992.
Over this time FHA’s credit subsidy rates have varied. The variance is caused by three factors: (I) additional loan
performance data underlying the credit subsidy rate estimates, (2) revisions to the calculation methodology used
to estimate the credit subsidy rates, and (3) revisions on expected claims and prepayments derived from the
revised Actuarial Review of the MMI Fund. Loan performance data, which reflect mortgage market performance
and FHA policy direction, are added as they become available. Revisions to the estimation methodology result
from legislative direction and technical enhancements.



                                                        65
Principal Financial Statements

FHA estimated the credit subsidy rates for the 2009 cohort in December 2007. At the time of budget submission.
the rates reflected prevailing policy and loan performance assumptions based on the most recent information
available at that time. The annual credit subsidy reestimates allow FHA to adjust the LLG and subsidy expense to
reflect the most current and accurate credit subsidy rate.

Described below are the programs that comprise the majority of FHA’s fiscal year 2009 business. These
descriptions highlight the factors that contributed to changing credit subsidy rates and the credit subsidy
reestimates. Overall, FHA’s liability increased from the fiscal year 2008 estimates.

Mutual Mortgage Insurance (MM —During fiscal year 2009, FHA continued to experience increased claim rates
due to the nationwide decrease in house price appreciation, which resulted in increased claims and lower proceeds
from the sale of foreclosed properties. Moreover, due to the HECM and 234(c) programs moving from Gl/SRI to
MMI and shrinkage of capital availability in the conventional mortgage market, the MM! fund has experienced a
surge in new endorsements during fiscal year 2009. This caused a significant increase in the volume of insurance-
in-force, coupled with the increase in expected claims and lowered sales proceeds. the liability for MM! increased
from $17,384 million at the end of fiscal year 2008 to $28,456 million at the end of fiscal year 2009.

GI/SRJ Home Equity Conversion Mortgage (HECM) The HECM activity from fiscal years 1992-2008 remains
                                                       -




in the G1/SRI fund, The HECM liability for these years increased from $1 ,52 I million at the end of fiscal year
2008 to $4,753 million at the end of fiscal year 2009. This increase in liability is primarily due to the drop in
house price appreciation projections. The drop in house price appreciation projections results in lower recoveries
from future HECM assigned assets which increases the liability.

GI/SRI Section 22](d)(4) The Section 221(d)(4) program was established to provide mortgage insurance for the
                            -




construction or substantial rehabilitation of Multifamily rental properties with five or more units. Under this
program, HUD may insure up to 90 percent of the total project cost and is prohibited from insuring loans with
HUD-subsidized interest rates. The Section 221(d)(4) program is the largest Multifamily program in the G1/SR1
fund. The Section 221 (d)(4) liability increased by $26 million in FY 2009.

Mark-to-Market The Mark to Market (M2M) program was established by legislation to assess rents at the time
                 -




of Section 8 Assistance contract renewal. If rents are above market levels, the project is referred to OAHP.
OAHP then evaluates the project for potential financial restructuring to determine if the project could survive
given the lower revenues from reduced rents. The pool of loans eligible for M2M restructuring is comprised of
active insured loans with Section 8 Assistance contracts, which also meet all eligibility requirements such as
financial statements submitted within the last 2 years and assistance contracts expiring within the next 5 years.
While new Section 8 assistance contracts are not being offered to any properties, which reduces the number of
active insured loans with section 8 contracts, the number of projects that meet M2M eligibility criteria may
actually’ increase from year to year. A loan can fail one or more of the eligibility criteria one year but become
eligible the following year. During fiscal year 2009, the M2M liability increased primarily due to an increase in
the active insurance in force for the program.

GI/SRJ Section 234(’c,) The Section 234(c) program insures loans for condominium purchases. Like HECM. the
                        -




activity from fiscal year 1992-2008 remains in the GI/SRI fund. One of the many purposes of EHA’s mortgage
insurance programs is to encourage lenders to make affordable mortgage credit available for non-conventional
forms of ownership. Condominium ownership, in which the separate owners of the individual units jointly own
the development’s common areas and facilities, is one particularly popular alternative.         In fiscal year 2009.
Section 234(c) continued to experience increased claim rates due to the nationwide decrease in house price
appreciation, which resulted in increased claims and lower proceeds from the sale of foreclosed properties. This
resulted in an increase in the liability from $502 million at the end of fiscal year 2008 to $694 million at the end
of fiscal year 2009 in the GI/SRI fund.




                                                           66
                                                                                        Principal Financial Statements

 Note 7. Other Assets

 The following table presents the composition of Other Assets held by FHA as of September 30. 2009 and 2008:

         (Dollars in Millions)
                                                                              FY2009               FY2008
         Intragovernmental:
          Advances to HUD for Working Capital Fund Expenses               $        16          $         21
         Total                                                            S        16          S         21

         With the Public:
          Escrow Monies Deposited at Minority-Owned Banks                 $        92          $       103
          Undistributed Charges                                                    37                   31
         Total                                                            S       129          $       134

Advances to EIUD for Working Capital Fund Expenses

The Working Capital Fund was established by HUD to consolidate, at the department level, the acquisition of
certain property and equipment to be used by different organizations within HUD. Advances to HLJD for
Working Capital Fund expenses represent the amount of payments made by FHA to reimburse the HUD Working
Capital Fund for its share of the fund’s expenses prior to the receipt of goods or services from this fund.

Escrow Monies Deposited at Minority-Owned Banks

FHA holds in trust escrow monies received from the borrowers of its Multifamily mortgage notes to cover
property repairs and renovations expenses. These escrow monies are deposited at the U.S. Treasury (see Note 2),
invested in U.S. Treasury securities (see Note 4 G1/SRI Investments) or deposited at minority-owned banks.
                                               -




Undistributed Charges

Undistributed charges include FHA disbursements processed by the U.S. Treasury but the identification of the
specific FHA operating area associated with the disbursement has not been determined by the end of the reporting
period. When the FHA operating area that initiated the disbursement is identified, the undistributed charges are
reclassified by recognizing new expenses or by liquidating previously established accounts payable.




                                                     67
 Principal Financial Statements

Note 8. Accounts Payable

Accounts Payable as of September 30. 2009 and 2008 are as follows:

                 (Dollars in Millions)
                                                                         FY2009          FY2008
                 With the Public:
                  Claims Payable                                     $       331     $       316
                  Premium Reftinds and Distributive Shares Payable           173             174
                  Miscellaneous Pavables                                     135              95
                 Total                                               $       639     $       585

Claims Payable

Claims payable represents the amount of claims that have been processed by FHA, but the disbursement of
payment to lenders has not taken place at the end of the reporting period.

Premium Refunds and Distributive Shares Payable

Premium refunds payable are refunds of previously collected Single Family premiums that will be returned to the
borrowers resulting from prepayment of the insured mortgages. Distributive shares payable represent the amount
of excess revenues in the liquidating account of the CMHI fund that is to be distributed to the mortgagors at the
discretion of the Secretary of HUD.

Miscellaneous Paya bles

Miscellaneous payables include interest enhancement payables, interest penalty payables for late payment of
claims, generic debt payables and other payables related to various operating areas within FHA.




                                                       68
                                                                                                            Principal Financial Statements

Note 9. Debt

The following tables describe the composition of Debt held by FHA as of September 30. 2009 and 2008:

   (Dollars in Millions)                                           FY2008                                            FY2009
                                            Beginning                   Net              Ending               Net              Ending
                                                Balance            Borrowing             Balance            Borrowing          Balance

   Agency Debt:
           Debentures Issued to Claimants   $             70   $              (18)   $             52   $           (38)   $             14
   Other Debt:
           Borrowings from U.S. Treasury            4.573                     259            4.832                (412)            4.420
   Total                                    $       4,643      $              241    $       4,884      S         (450)    $       4,434


                                                                                                            FY2009             FY2008
   Classification of Debt:
          Intragovemmental Debt                                                                         S        4,420     $       4,832
          Debt held by the Public                                                                                   14                52
   Total                                                                                                S        4,434     $       4,884



Debentures Issued to Public

The National Housing Act authorizes FHA, in certain cases, to issue debentures in lieu of cash to settle claims.
FHA-issued debentures bear interest at rates established by the U.S. Treasury. Interest rates related to the
outstanding debentures ranged from 4.00 percent to 10.375 percent in fiscal year 2009 and 4.00 percent to 12.875
percent in fiscal year 2008. Lenders may redeem FHA debentures prior to maturity in order to pay mortgage
insurance premiums to FHA, or they may be called with the approval of the Secretary of the U.S. Treasury.

The par value of debentures outstanding, not including accrued interest, was September 30 was $14 million in
fiscal year 2009 and $51 million in fiscal year 2008. The fair values for fiscal years 2009 and 2008 were $15 and
$74 million, respectively.

Borrowings from U.S. Treasury

In accordance with Credit Reform accounting, FHA borrows from the U.S. Treasury when cash is needed in its
financing accounts. Usually, the need for cash arises when FHA has to transfer the negative credit subsidy
amounts related to new loan disbursements and existing loan modifications from the financing accounts to the
general fund receipt account (for cases in GIJSRI funds) or to the capital reserve account (for cases in MMI/CMHI
funds). In some instances, borrowings are also needed to transfer the credit subsidy related to downward
reestimates from the GI/SRI financing account to the Gl/SRI receipt account or when available cash is less than
claim payments due.

During fiscal year 2009. FHA’s U.S. Treasury borrowings carried interest rates ranging from 3.71 percent to 7.34
percent. In fiscal year 2008. they carried interest rates ranged from 2.33 percent to 7.34 percent. The maturity
dates for these borrowings occur from September 2017 September 2028. Loans may be repaid in whole or in
                                                                    —




part without penalty at any time prior to maturity.




                                                                   69
Principal Financial Statements

Note 10. Other Liabilities

The following table describes the composition of Other Liabilities as of September 30, 2009 and 2008:

                (Dollars in Millions)

               FY2009                               Current            Non-Current           Total
               Intragove rnmental:
                Receipt Account Liability       $         1,913    $                 -   $         1,913
               Total                            $        1,913     $                 -   $        1,913

               With the Public:
                Trust and Deposit Liabilities   $           116    $                 -   S            116
               Undistributed Credits                         64                      -                 64
               Miscellaneous Liabilities                   236                       -               236
               Total                            $          416     $                 -   $           416

               FY2008                               Current            Non-Current           Total
               Intragove rnme ntal:
                Receipt Account Liability       $         1,530    $                 -   $         1,530
               Total                            $        1,530     $                 -   $        1,530

               With the Public:
               Trust and Deposit Liabilities    $          152     $                 -   $           152
               Undistributed Credits                        49                       -                49
               Miscellaneous Liabilities                   224                  13                   237
               Total                            $         425      $            13       $           438

Special Receipt Account Liability

The special receipt account liability is created from negative subsidy endorsements and downward credit subsidy
in the GI/SRI special receipt account.

Trust and Deposit Liabilities

Trust and deposit liabilities include mainly escrow monies received by FHA for the borrowers of its mortgage
notes and earnest money received from potential purchasers of the FHA foreclosed properties. The escrow
monies are eventually disbursed to pay for insurance, property taxes, and maintenance expenses on behalf of the
borrowers. The earnest money becomes part of the sale proceeds or is returned to any unsuccessful bidders.

Undistributed Credits

Undistributed credits represent FHA collections processed by U.S. Treasury, but the identification of the specific
operating area associated with the collections has not been determined at the end of the reporting period. When
the FHA operating area that is entitled to the collections is identified, the undistributed credits are reclassified by
recognizing revenue or by liquidating previously established accounts receivable.




                                                           70
                                                                                      Principal Financial Statements

Miscellaneous Liabilities

Miscellaneous liabilities include mainly other unearned revenue from Single Family and Multifamily operations.
It also may include loss contingencies that are recognized by FHA for past events that warrant a probable, or
likely, future outflow of measurable economic resources.

Note 11. Commitments and Contingencies

Bankrupt Mortgagees
On August 24. 2009, one of FHA’s largest mortgage lenders and servicers filed for Chapter 11 bankruptcy
protection. The organization was seized on August 4. 2009 by the Federal Bureau of Investigation and other
federal and state regulators. The organization originated about 7.5% of FHA’s nearly 2.5 million endorsements
during FY 2008 and the first ten months of FY2009. A review of the lender’s endorsement files by FHA’s
Quality Assurance Division (QAD) completed in July 2009 detected 28 types of loan origination deficiencies that
will be presented to the FHA Mortgagee Review Board. As of May 31, 2009, over 28% of their portfolio was in
default, significantly higher than other lenders. Other federal investigators are continuing their review of
allegations of corporate and loan file fraud. The ultimate resolution of these actions cannot be determined at this
time and the accompanying financial statements do not include any specific provisions related to this closure.

During FY2009, various financial institutions, mortgage brokers and servicers ceased operations due to their weak
financial condition. The mortgage loans held by these institutions are transferred to other accredited servicers
without material cost to FHA.

Litigation

FHA is party in various legal actions and claims brought by or against it. In the opinion of management and
general counsel, the ultimate resolution of these legal actions will not have a material effect on FHA’s
consolidated financial statements as of September 30, 2009. However, there are pending or threatened legal
actions where judgment against FHA is reasonably possible with an estimated potential loss of $23 million.


Pending or Threatened Litigation Against FHA

(Dollars in millions)
                           FY 2009              FY 2008
Expected Outcome        Estimated Loss       Estimated Loss
Probable                        -                   -




Reasonably Possible           $23                  $3




                                                        71
Principal Financial Staeinenls

Note 12. Gross Costs
                                                                              2008 are as follows:
Gross costs incurred by FHA for the fiscal years ended September 30, 2009 and

     (Dollars in Millions)                             FY 2009                            FY 2008
                                      MMIJCMHI         GI/SRI             H4H        MMI/CMHI G1/SRI              H411

     Intragovemmental:
                                       $     160   $        123       $              $    167     $    127    $          -

     Interest Expense                                                            -




                                               7              8                             6            8               -


     Imputed Costs                                                               -




                                                                                5           2            3               -




     Other Expenses                            -                 -




                                       $     167   $        131       $         5    $    175 $        138 $             -

     Total

     With the Public:
                                              275 $         294 5               II   $     226    $     274   5
     Salaiy and Administrative Expenses $
                                                                                                                         -




                                            6.347         2.987                  1       8.215        1.116              -


     Subsidy Expense
                                            2,398           563                          1,108         251               -


     Interest Expense                                                            -




                                                (7)       1.438                              5         (49)              -


     Bad Debt Expense                                                            -




                                                (5)          (44)                          (69)       (123)              -


     Loan Loss Reserve Expense                                                   -




                                               64             64                            10         100               -

     Other Expenses                                                              -




                                        $   9,072 $       5,302 $               12   $   9,495    $   1,569 $            -


     Total

Interest Expense
                                                                             ings from the U.S. Treasury in the
Intragovernmental interest expense includes interest expense on borrow
                                                                                   the interest rates provided by the
financing account. Interest expense is calculated annually for each cohort using
                                                                            e on debentures issued to claimants to
U.S Treasury. Interest expense with the public consists of interest expens
                                                                                ates.
settle claim payments and interest expense on the annual credit subsidy reestim

imputed Costs/Imputed Financing
                                                                                     ted and allocated to Fl-IA by the
Imputed costs represent FHA’s share of the departmental imputed cost calcula
                                                                                 erial Cost Accounting Concepts and
HUD CFO office. Federal agencies are required by SFFAS No. 4, Manag
                                                                                       behalf. The HUD CFO receives
Standards, to account for costs assumed by other Federal organizations on their
                                                                                         costs, federal employee health
its imputed cost data from the Office of Personnel Management (OPM) for pension
                                                   receives  Federal   Employees’    Compe    nsation Act (FECA) costs
benefits (FEHB) and life insurance costs. It also
                                                uently , using its internally  develo  ped  allocation basis. HUD CFO
from the Department of Labor (DOL). Subseq
                                                             offices.   The   impute  d  costs  reported  by FHA in its
allocates the imputed cost data to each of its reporting
                                                                    financi ng  in its  Statem  ents of  Changes in Net
Statements of Net Cost are equal to the amounts of imputed
Position.

Salary and Administrative Expenses
                                                                          for FHA personnel costs and FHAs
Salary and administrative expenses include EHA’s reimbursement to HUD
payments to third party contractors for administrative contract expenses.

Subsidy Expense
                                                                                expense from new endorsements.
Subsidy expense, positive and negative. consists of credit subsidy
                                                                                    e incurred by the Church Arson
modifications, and annual credit subsidy reestimates and the subsidy expens
                                                                                 Government of a direct loan or loan
program. Credit subsidy expense is the estimated long-term cost to the U.S.
                                                                                 flows associated with the direct loan
guarantee, calculated on a net present value basis of the estimated future cash
                                                                                 the expense of a HUD program
or loan guarantee. Subsidy expense incurred by the Church Arson program is




                                                                 72
                                                                          Principal Financial Statements
administered by the Office of Community Planning and Development (CPD) even though its cost is funded
through a FHA program account.

Bad Debt Expense

Bad debt expense represents the provision for loss recorded for uncollectible amounts related to FHA’s pre-1992
accounts receivable and credit program assets. FHA calculates its bad debt expense based on the estimated
change of these assets’ historical loss experience and FRA management’s judgment concerning current economic
factors.

Loan Loss Reserve Expense

Loan loss reserve expense is recorded to account for the change in the balance of the loan loss reserve liabilities
associated with FHA’s pre-1992 loan guarantees. The loan loss reserve is provided for the estimated losses
incurred by FHA to pay claims on its pre-1992 insured mortgages when defaults have taken place but the claims
have not yet been filed with FHA.

Other Expenses

Other expenses with the public include only those associated with the FHA pre-1992 loan guarantees. They
consist of net losses or gains on sales of FHA credit program assets, insurance claim expenses, fee expenses, and
other miscellaneous expenses incurred to carry out FHA operations. Other intragovernmental expenses include
FHA’s share of HUD expenses incurred in the Working Capital Fund and expenses from intra-agency
agreements.




                                                      73
Principal Financial Statements

Note 13. Earned Revenue

Earned revenues generated by FHA for the fiscal years ended September 30, 2009 and 2008 are as follows:

           (Dollars in Millions)                                  FY 2009                   FY 2008
                                                          NI M i/CM HI Cl/SRI       NI M I/CM III GI/SRI

           intragove rumental:
           Interest Revenue from Deposits at U.S. Treasury $     990 $      392     $      424   $     73
           Interest Revenue from MMI/CMHI Investments            633            -          896             -




           Gain on Sale ofMMI/CMHI Investments                    133           -            -             -




                                                           S    1,756   $   392     S    1,320 $       73

           With the Public:
           Insurance Premium Revenue                      $       16 $       20     $       10 $       21
           Income from Notes and Properties                       31         31             (1)        41
           Other Revenue                                            *        20              -             6
           Total                                          $       47 $       71     $        9   $     68

interest Revenue

Intragovernmental interest revenue includes interest revenue from deposits at the U.S. Treasury and investments
in U.S. Treasury securities. FHA’s U.S. Treasury deposits are generated from post-1991 loan guarantees and
direct loans in the financing accounts. FHA’s investments in U.S. Treasury securities consist of investments of
surplus resources in the MMI/CMH1 liquidating accounts and of escrow monies collected from borrowers in the
G1/SRI liquidating accounts.

Interest revenue with the public is generated mainly from FHA’s acquisition of pre-1992 performing MNA notes
as a result of claim payments to lenders for defaulted guaranteed loans. Interest revenue associated with the post-
1991 MNA notes is included in the Allowance for Subsidy (AFS) balance.

Premium Revenue

According to the FCRA accounting, FHA’s premium revenue includes only premiums associated with the pre
 1992 loan guarantee business. Premium revenue for post-1991 loan guarantee cases is included in the balance of
the LLG. The FHA premium structure, set by the National Affordable Housing Act and published in the Code of
Federal Regulations, which became effective July 1991, includes both up-front premiums and annual periodic
premiums.

Up-front Premiums

The up-front premium rates, which are set by legislation, vary according to the mortgage type and the year of
origination. The pre-1992 up-front premiums in the MMI fund were recorded as unearned revenue upon
collection and are recognized as revenue over the period in which losses and insurance costs are expected to
occur. Other FHA funds’ unearned revenue is recognized monthly as revenue on a straight-line basis.

Cain on Sale of MMIICMHI Investments

This gain occurred as a result of the sale of investments before maturity in the MMI/CMHI Capital Reserve
account because the sales price of the investments was greater than the book value of the investments at the time
of the sale.




                                                           74
                                                                                           Principal Financial Statements
    The FHA up-front premium rates in fiscal year
                                                  2009 were:

                                                Premium Rate
                           Single Family        1.75%
                           Multifamily          0.45 %, 0.50%, 0.57% or 0.80%
                           HECM                 2.00% (Based on Maximum Claim Amount)
   Periodic Premiums

   The periodic premium rate is used to calcu
                                              late monthly or annual premiums receivabl
   also legislated, vary by mortgage type and                                           e. These rates. which are
                                               program. The FHA periodic premium rate
   Single Family and Multifamily were:                                                     in fiscal year 2009 for


                                                 Mortgage Term 15         Mortgage Term More
                                                  Years or Less             Than 15 Years
                          Single Family       0.25%                      0.50%
                          Multifamily         0.45 %, 0.50%, 0.57%       0.45 %, 0.50%, 0.57%
                                              or 0.80%                   or 0.80%
                          HECM                0.50% (All Terms)
  For Title I, the maximum insurance prem
                                            ium paid for guaranteed cases endorsed in
  equal to 0.50 percent of the loan amount                                               years 1992 through 2001 is
                                               multiplied by the number of years of the
  insurance premium for a Title I Property Impr                                             loan term. The annual
                                                ovement loan is 0.50 percent of the loan
 insurance charge is paid. The annual insu                                               amo  unt until the maximum
                                            rance premium of a Title I Manufactured Hou
 tiers by loan term until the maximum insuranc                                             sing  loan is calculated in
                                               e charge is paid. For guaranteed cases endo
 the Title 1 annual insurance premium is 1.00                                               rsed  in fiscal year 2009.
                                              percent of the loan amount until maturity.
 Income from Notes and Property

 Income from Notes and Property includes reve
                                              nue associated with FHA pre-1992 loan guar
 includes revenue from Notes and Properties                                                 antees. This income
                                            held, sold, and gains associated with the sale.
 Other Revenue

Other revenue includes revenue associated
                                            with FHA pre-1992 loan guarantees. FHA
late charges and penalty revenue, fee inco                                           ’s other revenue consists of
                                           me, and miscellaneous income generated from
                                                                                        FHA operations.



Note 14. Gross Cost and Earned Revenue
                                       by Budget Functional Classification
FHA cost and earned revenue reported on the
                                            Statements of Net Cost is categorized unde
classification (BFC) for Mortgage Credit (371                                          r the budget functional
                                              ). All FHA U.S. Treasury account sym
department code 86” for Department of Hou                                               bols found under the
                                          sing and Urban Development appear with
                                                                                   the Mortgage Credit BFC.




                                                      75
 Principal Financial Statements

 Note 15. Transfers

 Transfers in/out incurred by FHA for the fiscal years ended September 30, 2009 and 2008 are as follows:

             (Dollars in Millions)
             FY 2009
             Budgetary Financing Sources   Cumulative Results           Unexpended
                                             of Ope rations            Appropriations                 Total
             Treasury                      S             (347)       $              (86)          S           (433)
             HUD                                                 -                    (59)                      (59)
             Total                          $            (347)       $               (145)        $           (492)


             Other Financing Sources       Cumulative Results             Unexpended                  Total
                                             of Ope rations              Appropriations
             JreasLuy                       S          (1,730)       $                        -   $       (1.730)
             HUD                                          470                                 -                470
            Total                           $          (1,260)       $                        -   $       (1,260)




            FY2008
            Budgetary Financing Sources    Cumulative Results           Unexpended                    Total
                                             of Ope rations            Appropriations
             Treasury                      S             (613)       $             (235)          $           (848)
             HUD                                             -                      (41)                       (41)
            Total                          $             (613)       $             (276)          $           (889)


            Other Financing Sources        Cumulative Results             Unexpended                  Total
                                             of Operations               Appropriations
            Treasury                       $             (19)        $                    -       $           (19)
            RU!)                                         406                              -                   406
            Total                          $             387         $                    -       $           387

Transfers Out to U.S. Treasury

Transfers out to U.S. Treasury consists of negative subsidy from new endorsements, modifications and downward
credit subsidy reestimates in the Gl/SRI general fund receipt account, and the prior year unobligated balance of
budgetary resources in the 01/SRI liquidating account.

Transfers In/Out From HUD

FHA does not receive an appropriation for S&E: instead the FHA amounts are appropriated directly to HUD. In
order to recognize the S&E in FHA’s Statement of Net Cost, a Transfer In from HUD is recorded with the
recognition of FHA S&E costs. FHA continues to make a non-expenditure Transfer Out to HLJD for Working
Capital Fund Expenses.




                                                        76
                                                                                                   I’rincipal Financial Statements

 Note 16. Unexpended Appropriations

 Unexpended appropriation balances at September 30, 2009 and 2008 are as follows:

     (Dollars in Millions)
                             Beginning         Appropriations    Other       Appropriations Transfers-Out           Ending
     FY 2009                     Balance         Received     Adjustments        Used                           Balance
      Positive Subsidy       $         15        $      470    $        -      $         (7)   $          -     $     478
      Working Capital and             310               195           (59)            (1 15)            (59)             272
      Contract Expenses
      Reestimates                          -          6,793             -           (6,793)               -                  -




      GIISRI Liquidating               86                96             -              (14)             (86)              82
     Total                   S        411        $    7,554    S      (59)     S    (6,929)    $       (145)    S        832

     FY2008
      Positive Subsidy       $         28        $        8    $        -      $       (21)    $          -     $         15
      Working Capital and             293               205           (49)             (98)             (41)             310
      Contract Expenses
     Reestimates                           -            301             -            (301)                -                  -



     G1/SRI Liquidating              223               113              -             (15)            (235)               86
     Total                   $       544         $     627     $      (49)     $     (435)     S      (276)    $         411

As required under FCRA, FHA receives appropriations to cover expenses or fund shortages related to its loan
guarantee and direct loan operations.

FHA receives appropriations in the annual program accounts for administrative and contract expenses. The
Gl/SRI no-year program account also receives appropriations for positive credit subsidy and upward reestimates.
Additionally, FRA obtains permanent indefinite appropriations to cover any shortfalls for its GI/SRI pre-1992
loan guarantee operations.

When appropriations are first received, they are reported as unexpended appropriations. As these appropriations
are expended, appropriations used are increased and unexpended appropriations are decreased. Additionally,
unexpended appropriations are decreased when: administrative expenses, and working capital funds are
transferred out to HUD; the year-end unobligated balance in the GI/SRI liquidating account is returned to the U.S.
Treasury; appropriations are rescinded; or other miscellaneous adjustments are required.




                                                               77
 Principal Financial Statements

Note 17. Budgetary Resources

The SF-133 and the Statement of Budgetar
                                          y Resources for fiscal year 2008 have
2008 actual amounts included in the Prog                                        been reconciled to the fiscal year
                                           ram and Financing Schedules presented
States Government. There were no sign                                               in the Budget of the United
                                            ificant reconciling items. Informati
Statement of Budgetary Resources will                                            on   from the fiscal year 2009
                                      be presented in the fiscal year 2011 Bud
Budget will be transmitted to Congress                                         get of  the U.S. Government. The
                                         on the first Monday in February 2011
Government Printing Office and online                                            and   will be available from the
                                      at that time.
Obligated balances for the period ended
                                        September 30, 2009 and 2008 are as follo
                                                                                 ws:
        Unpaid Obligations

                   (Dollars in Millions)
                   Undelivered Orders                          FY 2009            FY 2008
                    MMI/CMH1                               S          638     $          795
                    G1/SRI
                                                                      475                526
                    H4H
                                                                        1
                   Undelivered Orders Subtotal          $
                                                                                               -



                                                                    1,114     $        1,321
                  Accounts Payable
                   MMI/CMHI                             $            857     $           793
                   GI/SRI
                                                                     333                 345
                  Accounts Payable Subtotal            $           1,190     S         1,138
                  Unpaid Obligations Total
                                                       $           2,304     $         2,459




                                                  78
                                                                                                              Principal Financial Siaiements

 Note 18. Budgetary Resources              -   Collections

 The following table presents the composition of FHAs collections for the period ended September 30. 2009 and
 2008:

      (Dollars in Millions)
      FY2009                              MMIJCMHI                         G1/SRI                   H4H                            Total
      Collections:
       Premiums                          $     8.084                   $            664     $                       -   $             8.748
       Notes                                        9                               378                             -                   387
       Property                                3.418                                 180                            -                 3,598
       Interest Earned from U.S Treasury       2,008                                392                             -                 2,400
       Subsidy                                   926                                  13                            1                   940
      Reestimates                             10,491                              6,793                             -                17,284
      Other                                       44                                195                             -                   239
      Total                              $    24,980                   $          8,615     S                   1       $            33,596

      (Dollars in Millions)
      FY2008                                      MMIJCMHI                 GI/SRI                   H4H                        Total
     Collections:
      Premiums                          $                  4.239    S              1,219    $                   -       $             5,458
      Notes                                                     9                    331                        -                       340
      Property                                             2,900                     153                        -                     3,053
      Interest Earned from U.S Treasury                    1,273                      73                        -                     1,346
      Subsidy                                                435                      21                        -                       456
     Reestirnates                                          4,560                    301                         -                     4,861
     Other                                                    71                    211                         -                       282
     Total                              S                 13,487    $             2,309     $                   -       S            15,796

Note 19. Budgetary Resources           —   Non-expenditure Transfers

The following table presents the composition of FHA’s non-expenditure transfers through September 30, 2009
and 2008:

               (Dollars in Millions)
               FY2009                                 MMIICMHI                     Cl/SRI                       Total
               Transfers:
                Working Capital Expenses              $         (58)          $                 -         $                 (58)
               Total                                  $         (58)          $                 -         S                 (58)

               (Dollars in Millions)
               FY2008                                 MMIJCMHI                     Cl/SRI                       Total
               Transfers:
                Working Capital Expenses              $         (25)          $            (16)           $                 (41)
               Total                                  $         (25)          $            (16)           S                 (41)




                                                               79
Principal Financial Statements

Note 20. Budgetary Resources       —   Obligations

The following table presents the composition of FHA’s obligations for the period ended September 30, 2009 and
2008:

 (Dollars in Millions)
 FY 2009                                              MMIICMLII              Cl/SRI          11411                Total
 Obligations:
  Claims                                              $     8,780        $       1,685   $                -   $     10,465
  Single Family Property Management Contracts                 166                    7                    -            173
 Contract Obligations                                          73                   52                5                130
  Subsidy                                                     926                  205                1              1,132
 Downward Reestimates                                         108                   19                    -            127
 Upward Reestimates                                        10,384                6,793                    -         17,177
 Interest on Borrowings                                       160                  125                    -            285
 Other                                                         50                  156                -                206
 Total                                                S   20,647     S          9,042    $            6       S    29,695



(Dollars in Millions)
FY2008                                               MMIICMHI                Cl/SRI          11411                Total
Obligations:
 Claims                                               $     6,494     $         1,146    $            -       $      7,640
 Single Family Property Management Contracts                  411                  21                 -                432
Contract Obligations                                           47                  79                20                146
 Subsidy                                                      435                 643                 -              1,078
Downward Reestimates                                            5                 897                 -                902
Upward Reestimates                                          4,555                 301                 -              4,856
Interest on Borrowings                                        167                 134                 -                301
Other                                                          94                 141                 -                235
Total                                                 5   12,208     S         3,362     $           20       5    15,590




                                                     80
                                                                                             Principal Financial Statements

Note 21. Reconciliation of Net Cost of Operations to Bud2et

This note (formerly the Statement of Financing) links the proprietary data to the budgetary data. Most
transactions are recorded in both proprietary and budgetary accounts. However, because different accounting
bases are used for budgetary and proprietary accounting, some transactions may appear in only one set of
accounts. The Reconciliation of Net Cost of Operations to Budget is as follows for the periods ending September
30, 2009 and 2008:

(Dollars in Millions)                                                                                   FY 2009          FY 2008
RESOURCES USED TO FINANCE A CT! VITIES
 Obligations Incurred                                                                               $     29.695 $         15.590
 Spending Authority from Offsetting Collections and Reco\eries                                           (33.481)         (15.820)
 OflettingReceipis                                                                                           (183)         (L511)
 Transfersln/Out                                                                                          (1.260)             387
 Imputed Financing from Costs Absorbed by Others                                                              15               14
TOTAL RESOURCES USED TO FINANCE ACTIVITIES                                                      S         (5,214) S        (1,340)

RESOURCES THA TDO NOT FUND THE NET COST OF OPERA TIONS
 Undelivered Orders and Adjustments                                                             $            209     $        (87)
 Revenue and Other Resources                                                                              31,343           15,784
 Purchase ofAssets                                                                                       (10.903)         (10,419)
 Appropriation for prior year Re-estimate                                                                (17,176)          (4,856)
TOTAL RESOURCES NOT PART OF NET COST OF OPERATIONS                                              $          3,473     $       422

TOTAL RESOURCES USED TO FINANCE THE NET COST (SURPLUS) OF OPERATIONS S                                    (1,741) $          (918)

COMPONENTS OF THE NET COST (SURPLUS) OF OPERA TIONS THAT WILL NOT
REQUIRE OR GENERATE RESOURCES IN THE CURRENT PERIOD
Upward Re-estimate of Credit Subsidy Expense                                                    S         14.054     $     11.6 11
 Downward Re-estimate ofCredit Subsidy Expense                                                            (1.784)             (99)
 Changes in Loan Loss Reserve Expense                                                                         (49)           (192)
 Changes in Bad Debt Expenses Related to Uncollectible Pre-Credit Reform Receivables                       1,431              (44)
Reduction of Credit Subsidy Expense from Endorsements and Modifications of Loan Guarantees                (1,084)          (1,047)
Gains or Losses on Sales ofCredit Program Assets                                                              73              101
Other                                                                                                      1,523              495
TOTAL COMPONENTS OF THE NET COST (SURPLUS) OF OPERATIONS THAT VILL
NOT REQUIRE OR GENERATE RESOURCES IN THE CURRENT PERIOD                                         S        14,164      $    10,825

NET COST (SURPLUS) OF OPERATIONS                                                                S        12,423      $     9,907




                                                                 81
 Principal Financial Statements

Required Supplementary Information

Schedule A: Intragovernmental Assets

FHAs lntragovernmental assets, by federal entity. are as follows for the periods ending September 30. 2009 and
2008:

                     (Dollars in millions)     Fund Balance       Investments in
                                                 with U.S.         U.S. Treasury
                                                                                   Other Assets
                     Agency                      Treasury           Secunties
                     FY2009
                      U.S. Treasury            $       30,130     $      10,635     $                   -



                      HUD                                   -
                                                                               -                   16
                     Total                     $       30,130    $       10,635     $              16

                     FY2008
                      U.S. Treasury            $       12,590    $       19,254     $               -




                      HUD                                   -                 -                    21
                     Total                     $       12,590    $       19,254    $               21




Schedule B: Intragovernmental Liabilities

FHA’s Intragovernmental liabilities, by federal entity. are as follows on September 30, 2009 and 2008:

                       (Dollars in Millions)
                                                   Borrowings fmm
                       Agency                                                  Other Liabilities
                                                    U.S. Treasury
                      FY2009
                       U.S. Treasury               $            4,420         $           1,913
                      Total                        $            4,420         $           1,913

                      FY2008
                       U.S. Treasury               $            4,832         $           1.530
                      Total                        $            4,832         $           1,530




                                                           82
                                                                                                                                           Principal Financial Statements

 Required Supplementary Information

 Schedule C: Comparative Combining Statement of Budgetary Resources by FHA Program
 September 30, 2009 and 2008:

  (Dollars in Millions)                                    MNIIJCMHI                          GI/SIU                                   11411                                     Total
                                                         2009     2008                    2009      2008                2009                        2008                  2009           2008

  BUDGETAR YRESOUR (ES
   Unoblisated Balance Carried Forward
       Beginning ofperiod                              $26833         $25,499         $     853       $ 1.421       $              9            $                  -     $27,695     $26,920
  Recoveries of Prior Year Obligations                          17           49              19            42                          -
                                                                                                                                                                              36          91
  Budget Authority:
     Appropriations received                                146             77            6,947          520              461                          30                  7,554           627
     Borrowing Authority                                     85            235              385          708                           -                           -         470           943
  Spending Authority from Offsetting Collections:
     Earned
        Collected                                       24.980   13,487  8,615   2,309                                             I                                     33.596
                                                                                                                                                               -                  15,796
        Receivable from Federal Sources                   (147)     (29)     (4)    (38)                                           -                           -           (151)     (67)
  Net Transfers                                             (58)    (25)            (16)      -                                    -                           -             (58)    (41)
  Permanently Not Available                               (586)    (252)  (661)   (732)                                            -                           -         (1,247)    (984)
 TOTALBUDGETARY RESOURCES                              S5l,270 $39,041 S16,154 $ 4.214 S                                  471                  $       30               567,895 $43,285

 STA TUS OF BUDGETAR YRESOURCES
  Obligations Incurred              $20,647                          $12,208       $ 9,042        $ 3,362       $          6                   $       20               $29,695     $15,590
  Unobligated Balance-Apportioned     5.644                            2,179          341             798                465                           10                 6,450       2,987
  Unobligated Balance Not Available  24,979                           24,654        6,771              54                          -                           -         31,750      24,708
 TOTALSTATUS OFBUDGE’I’ARYRESOURCES $51,270                          $39,041      $16,154         $ 4,214       S        471                   $      30                $67,895     $43,285

 CIL4NGE IN OBLIGA TED BAL4NCES
   Obligated Balance. Net, Beginning of Period:
    Unpaid Obligations Carried Forward                $ 1,589        $ 1,435      $      870      $      861 $                 -            $              -            $ 2,459    $ 2,296
    Receivable from Federal Sources Carried Forward      (234)          (263)              (6)            (44)                 -
                                                                                                                                                           -               (240)      (307)
    Obligations Incurred                               20,647         12,208           9,042           3,362               6                          20                 29,695     15,590
    Gross Outlays                                     (20,721)       (12,005)         (9,088)         (3,311)             (5)                        (20)               (29,814)   (15,336)
  Obligated Balance Transfers, Net:
  RecoveriesofPriorYearObligations                        (17)             (49)            (19)         (42)                   -                           -                (36)          (91)
  Change in Receivable from Federal Sources               147               29               4           38                    -                       -                    151            67
  Obligated Balance, Net, End of Period:
    Unpaid Obligations                                  1,498          1,589              805           870                1                           -                 2,304       2,459
    Receivable from Federal Sources                       (87)          (234)              (2)           (6)               -                           -                   (89)       (240)
  Outlays:
        Disbursements                                 $20,721        $12,005      $ 9,088
                                                                                   $ 3,311 $                               5                          20
                                                                                                                                           $                           $29,814 $15,336
        Collections                                   (24.980)       (13,487)
                                                                           (8,615)  (2,309)                               (1)                          -                (33,596) (15,796)
        Subtotal                                        (4,259)       (1.382) 473    1.002                                 4                          20                 (3.782)    (460)
  Less: OffsettingReceipts                                                    183    1.511
                                                            -               -                                              -                           -                    183    1,511
NE’f OUTLAYS                                          $ (4,259) $ (1,482) S 290 $ (509) S                                 4                          20
                                                                                                                                           S                           S (3965) $ (1,971)




                                                                      83
Principal Financial Statements

Required Supplementary Information

Schedule D: Comparative Combining Budgetary Resources by Appropriation for the MMI/CMHI
Program
September 30, 2009:

 (Dollars in Millions)
                                                                                                                              Capital MMI/CMHI
                                                         Program Liquidating Financing                                        Reserve   Total

 BUDGE TAR YRESOURCES
 Unobligated Balance Carried Forward
     Beginning of period                                 $         48              S     50             $      7,651      $      19,084              $     26,833
 Recoveries of Prior Year Obligations                                  9                        -                  8                         -                 17
 Budget Authority:
    Appropriations received                                       146                           -                                                             146
    Borrowing Authority                                                    -
                                                                                                -                 85                                           85
 Spending Authority from Offsetting Collections:
    Earned
       Collected                                                                         15                   22,914              2,05I                   24,980
       Receivable from Federal Sources                                                        -
                                                                                                                      -            (147)                    (147)
 Net Transfers                                                 10.326                         -
                                                                                                                      -         (10.384)                     (58)
 Permanently Not Available                                        (23)                        -                 (563)                     -                 (586)
TOTAL BUDGEFARY RESOURCES                            $        10,506 $                  65              $    30,095 $           10,604           S       51,270

STA TUS OFBUDGETARYRESOURES
 Obligations Incurred                                $        10,456           $         35             $     10,156      S              -       $        20,647
 Unobligated Balance-Apportioned                                  16                     19                    5,609                     -                 5,644
 Unob ligated Balance Not Available                               34                     I1                   14.330            10.604                    24.979
TOTALSTATUS OFBUDGEFARYRISOURCES                     $       10,506            $        65          $        30,095       $    10,604            $       51,270

CHANGE IN OBLIGA TED BA LANCES
 Obligated Balance. Net, Beginning of Period:
   Unpaid Obligations Carried Forward                S            66           S       205          $          1,318 $                   -       5         1,589
   Receivable from Federal Sources Carried Forward                     -                    -                      (2)            (232)                     (234)
   Obligations Incurred                                       10,456                    35                    10,156                  -                   20,647
   Gross Outlays                                             (10,425)                  (40)                  (10,256)                -                   (20,721)
 Obligated Balance Transfers, Net:
 Recoveries ofPrior Year Obligations                              (9)                     -                      (8)                 -                       (17)
 Change in Receivable from Federal Sources                         -                      -                       -                147                       147
 Obligated Balance. Net. End of Period:
   Unpaid Obligations                                             88                   2(X)                   1,210                  -                     1.498
  Receivable from Federal Sources                                  -                      -                      (2)               (85)                      (87)
 Outlays:
       Disbursements                                 $        10,425           $        40 S                 10,256 $                -           $        20.721
       Collections                                                 -                   (15)                 (22.914)            (2,051)                  (24,980)
       Subtotal                                               10,425                    25                  (12,658)            (2,051)                   (4.259)
 Less: Offsetting Receipts                                         -                     -                        -                  -                         -


NFTO1J[LAYS                                          $       10,425            $       25           $       (12,658) $         (2,051) $                 (4,259)




                                                             84
                                                                                                                                            Principal Financial Statements

  Required Supplementary Information

 Schedule D: Comparative Combining Budgetary Resources by Appropriation for the
                                                                                MMI/CMHI
 Program
 September 30. 2008:

  (Dollars in Millions)
                                                                                                                                                    Capital MMIICMHI
                                                             Program Liquidating Financing                                                          Reserve   Total
  BUDGETAR YRESOLIRCES
    Unobligated Balance Carried Forward
       Beginning of period                                   $                47               S         64                      2.993
                                                                                                                         $                          5     22,395                 $      25,499
   Recoveries of Prior Year Obligations                                       13                         23                         13                                                         49
   Budget Authority:
      Appropriations received                                                 77                                                                                                           77
      Borrowing Authority                                                                                                         235                                                     235
   Spending Authority from Offsetting Collections:
      Earned
         Collected                                                                                       13                    12.185                      1,289
                                                                                   -
                                                                                                                                                                                       13,487
         Receivable from Federal Sources                                           -                         *
                                                                                                                                        -                    (29)                         (29)
   Net Transfers                                                       4.531                            15                              -                 (4,571)                         (25)
   Permanently Not Available                                             (17)                                                    (235)
                                                                                                             -
                                                                                                                                                                     -                   (252)
 TOTAL BUDGETARY RESOURCES                               5            4,651                $       115               $        15,191 $                   19,084              $        39,041

 STA TUS OF BUDGETARYRESOURCES
  Obligations Incurred                                   5             4,603               5         65              $          7.540           $                    -       $         12,208
  Unobligated Balance-Apportioned                                          4                         50                         2,125                                -                  2,179
  Unob ligated Balance Not Available                                      44                                                    5.526                    19.084
                                                                                                            -
                                                                                                                                                                                       24.654
 TOTALSTATUSOFBUDGETARYRESOURCES                         $            4,651                $       115               $        15,191                    19,084
                                                                                                                                                $                            $        39,041

 CHANGE IN OBLIGA TED BALA N(’ES
  Obligated Balance, Net. Beginning of Period:
    Unpaid Obligations Carried Forward                   $                71               $       212               $          1,152 $                          -       $              1.435
   Receivable from Federal Sources Carried Forward                                                                                 (2)
                                                                               -                         -
                                                                                                                                                          (261)                          (263)
   Obligations Incurred                                                4,603                        65                         7,540                             -                    12.208
   Gross Outlays                                                      (4.595)                      (49)                       (7,361)                            -                   (12.005)
  Obligated Balance Transfers. Net:
  Recoveries of Prior Year Obligations                                  (13)                       (23)                          (13)                            -                       (49)
  Change in Receivable from Federal Sources                                -
                                                                                                        -                           -                       29                            29
  Obligated Balance, Net. End of Period:
   Unpaid Obligations                                                    66                        205                         1,318                          -                        1.589
   Receivable from Federal Sources                                         -
                                                                                                        -                         (2)                     (232)                         (234)
  Outla\ s:
       Disbursements                                 $                4,595            $           49            $             7,361        $                -           $            12,005
       Collections                                                                                 (13)                      (12,185)                   (1.289)
                                                                          -
                                                                                                                                                                                     (13.487)
       Subtotal                                                       4.595                         36                        (4,824)                   (1.289)                       (1.482)
 Less: Offsetting Receipts                                                -                          -                             -                         -                             -

NEOUTLAYS                                            S            4,595                $           36            $           (4,824) $                  (1,289) $                    (1,482)




                                                                 85
Principal Financial Statements

Required Supplementary Information

Schedule E: Comparative Combining Budgetary Resources by Appropriation for the GIJSRI Program
September 30, 2009:

 (Dollars in Millions)
                                                                                                                                      GI/SRI
                                                             Program                      Liquidating           Financing              Total

B UD GETAR YRESOURCES
  Unobligated Balance Carried Forward
     Beginning of period                                 $             88             $           269       S           496       $          853
 Recoveries of Prior Year Obligations                                         8                     8                     3                   19
 Budget Authority:
    Appropriations received                                        6,850                           97                         -            6,947
    Borrowing Authority                                                                                 -               385                  385
 Spending Authority from Offsetting Collections:
    Earned
       Collected                                                                                  298                 8,317                8,615
       Receivable from Federal Sources                                                             (5)                    1                   (4)
 Net Transfers
 Permanently Not Available                                           (36)                        (305)                 (320                (661)
TOTAL BUDGEFARYRFS OURCIS                            S            6,910 $                        362 $               8,882 $             16,154

STA TUS OFBUDGETARYRESOURCES
 Obligations Incurred                                $             6,843          $               175       $         2,024       $       9,042
 Unobligated Balance-Apportioned                                      20                           56                   265                 341
 Unobligated Balance Not Available                                    47                          131                 6,593               6,771
TOTAL STATUS OFBUDGE[ARYRESOURCFS                    $            6,910           $              362        $        8,882        $     16,154

CHA NGE IN OBLIGA TED BA LANCES
 Obligated Balance. Net. Beginning of Period:
   Unpaid Obligations Carried Forward                $                98          $               494 $                278        S         870
   Receivable from Federal Sources Carried Forward                         -                       (5)                   (1)                   (6)
   Obligations Incurred                                            6,843                          175                 2,024               9,042
   Gross Outlays                                                  (6,851)                        (191)               (2,046)             (9,088)
 Obligated Balance Transfers, Net:
 Recoveries ofPrior Year Obligations                                  (8)                          (8)                   (3)                (19)
 Change in Receivable from Federal Sources                                -                         5                    (1)                  4
 Obligated Balance, Net, End ofPeriod:
  Unpaid Obligations                                                 82                          470                   253                 805
   Receivable from Federal Sources                                        -                         -                    (2)                   (2)
 Outlays:
       Disbursements                                 $            6,851           S               191 $              2,046 $              9,088
       Collections                                                        -                      (298)              (8,317)              (8,615)
       Subtotal                                                   6,851                          (107)              (6.271)                 473
 Less: OlYsetting Receipts                                             -                           -                      -                 183
NETOUTLAYS                                           $            6,851           S             (107) $             (6,271) $              290




                                                             86
                                                                                                                      Principal Financial Statements


 Required Supplementary Information

 Schedule E: Comparative Combining Budgetary Resources by Appropriation for the GIJSRI Program
 September 30, 2008:

 (Dollars in Millions)
                                                                                                                                                   GIISRI
                                                             Program                     Liquidating                  Financing                     Total

 B UDGE TA R YRESOURCES
  Unobligated Balance carried Forward
      Beginning of period                                $          102              S           235              $          1.084             S        1,421
  Recoveries of Prior Year Obligations                                9                           27                             6                         42
  Budget Authority:
     Appropriations received                                       407                            113                                  -                 520
     Borrowing Authority                                                     -                      3                         705                        708
  Spending Authority from Offsetting Collections:
     Earned
        Collected                                                            -                   334                        1,975                      2,309
        Receivable from Federal Sources                                      -                     4                          (42)                       (38)
  Net Transfers                                                     (16)                                  -                        -                     (16)
  Permanently Not Available                                         (32)                        (244)                        (456)                      (732)
 TOTALBUDGE[ARYR1SOURCES                                 $         470 S                        472 S                      3,272 S                    4,214

STA TUS OF B UDGE TA R YRESOIIRCES
 Obligations Incurred                                S             383           $               203          $             2,776          $           3,362
 Unobligated Balance-Apportioned                                    33                           269                          496                        798
 Unobligated Balance Not Available                                  54                                -                            -                      54
TOTALSTATUSOFBUDGKfARYRESOURCES                          $        470                5          472           $            3,272           $          4,214

CHANGE IN OBLIGA TED BALANCES
  Obligated Balance. Net, Beginning ofPeriod:
    Unpaid Obligations Carried Forward               $             100           $               571          $              190 $                       861
   Receivable from Federal Sources Carried Forward                       -                            -                      (44)                        (44)
   Obligations Incurred                                            383                           203                       2,776                       3.362
   Gross Outlays                                                  (376)                         (253)                     (2,682)                     (3.311)
 Obligated Balance Transfers. Net:
 Recoveries of Prior Year Obligations                               (9)                          (27)                         (6)                       (42)
 Change in Receivable from Federal Sources                              -                         (5)                         43                         38
 Obligated Balance, Net, End of Period:
   Unpaid Obligations                                              98                           494                          278                        870
   Receivable from Federal Sources                                     -                         (5)                          ( I)                       (6)
 Outlays:
       Disbursements                                 S            376            $              253 $                      2.682 $                    3,311
       Collections                                                   -                         (334)                      (1.975)                    (2.309)
       Subtotal                                                   376                           (81)                         707                      1.002
 Less: Offsetting Receipts                                          -                             -                            -                      1,511
NEI’ OUTLAYS                                         $            376            $              (81) $                      707            $          (509)




                                                             87
                                             ______




Principal Financial State,nents

Required Supplementary Information

Schedule F: Comparative Combining Budgetary Resources by Appropriation for the H4H Program
September 30. 2009:

     (Dollars in Millions)
                                                                                                                               114H
                                                                 Program                       Financing                       Total
    B (IDGE TAR YRESOURCES
     Unobligated Balance carried Forward
         Beginning of period                                 $                      9$                                                           9
     Recoveries of Prior Year Obligations
     Budget Authority:
        Appropriations received                                            461                                                          461
        Borrowing Authority
     Spending Authority from Offsetting Collections:
        Earned
           Collected                                                                                               1                             1
           Receivable from Federal Sources
     Net Transfers
     Permanently Not Available
    TOTAL BUDGEFARY RESOURCES                               $          470                 S                   I           $           471

    STATUS OFBUDGETARYRESOURCES
    Obligations Incurred                                    $            6                 $                   -           $             6
    Unobligated Balance-Apportioned                                    464                                     1                       465
    Unobligated Balance Not Available                                              -                           -                                -


   TOTALSTATUSOFBUDGEFARYRESOURCFS                       $             470             $                   1           $               471

   CHANGE IN OBLIGA TED BALANCES
    Obligated Balance, Net. Beginning of Period:
      Unpaid Obligations Carried Forward                 $                      -      $                       -       $
      Receivable from Federal Sources Carried Forward                           -                              -                             -



      Obligations Incurred                                                  6                                  -                         6
      Gross Outlays                                                        (5)                             -                            (5)
    Obligated Balance Transfers, Net:
    Recoveries ofPrior Year Obligations                                        -
                                                                                                                                            -


    Change in Receivable from Federal Sources                                  -                           -                                -



    Obligated Balance, Net, End of Period:
     Unpaid Obligations                                                     I                              -



     Receivable from Federal Sources                                        -                              -                             -



    Outlays:
         Disbursements                                  $                  5           $                   -           S                 5
         Collections                                                       —                           (I)                              (1)
         Subtotal                                                          5                           (1)                               4
    Less:Offsetting Receipts                                               -                               -                             -


   NFTOITLAYS                                           $                  5           $               (1) S                            4




                                                        88
                                                                                                Principal Financial Statements

Required Supplementary Information

Schedule F: Comparative Combining Budgetary Resources by Appropriation for the H4H Program
September 30, 2008:

   (Do1lai in Millions)
                                                                                                                 H411
                                                                Program                  Financing               Total

   BUD GE TAR YRESOIJRCES
    Unobhgated Balance Carried Forward
        Beginning ofpcriod                                  s                    -s                      -s
    Recoveries ofPrior Year Obligations
    Budget Authority:
       Appropriations received                                             30                                             30
       Borrowing Authority
    Spending Authority from Offsetting Collections:
       Earned
          Collected
          Receivable from Federal Sources
    Net Transfers
    Permanently Not Available
   TOTAL BU GETARV ROURC                                 $                30         $                   -   $           30

   STA TUS OF BUDGE TAR YRESOURCES
    Obligations Incurred                                 S                 20        $                   -   $            20
    Unobligated Balance-Apportioned                                        10                            -                10
    Unobligated Balance Not Available                                            -




   TOTAL STATUS OFBUDGEFARYRfSOURC                       S                30         S                   -   $           30

   CHANGE IN OBLIGA TED BALANCES
    Obligated Balance, Net. Beginning of Period:
      Unpaid Obligations Carried Forward                 S                   -       $               -       S                -



      Receivable from Federal Sources Carried Forward                        -                       -                        -



      Obligations Incurred                                                 20                        -                    20
      Gross Outlays                                                       (20)                       -                   (20)
    Obligated Balance Transfers, Net:
    Recoveries ofPrior Year Obligations                                      -                       -                     -




    Change in Receivable from Federal Sources                                -                       -                     -



    Obligated Balance, Net. End of Period:
     Unpaid Obligations                                                     -                        -                     -




     Receivable from Federal Sources                                        -                        -                     -




    Outlays:
          Disbursements                                 $                 20         S               -       $           20
          Collections                                                       -                        -                     -




          Subtotal                                                        20                         -                   20
    Less: Offsetting Receipts                                               ..                       -                     -




  NC[ OUTlAYS                                           S             20             S               -       S           20




                                                        89