Federal Housing Administration, Washington, DC Fiscal Years 2017 and 2016 (Restated) Financial Statements Audit This audit report was reissued on February 13, 2018 to correct the Combined Statement of Budgetary Resources for the period ended September 30, 2017 on page 44. The audit report was previously reissued on November 27, 2017 to correct a number reported for deobligations on page 16 from $206.9 million to $71.9 million. Office of Audit, Financial Audits Division Audit Report Number: 2018-FO-0003 Washington, DC November 15, 2017 To: Dana Wade, General Deputy Assistant Secretary for Housing, H //signed// From: Thomas R. McEnanly, Director, Financial Audits Division, GAF Subject: Audit of the Federal Housing Administration’s Financial Statements for Fiscal Years 2017 and 2016 (Restated) Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector General’s (OIG) final results of our audit of the Federal Housing Administration’s fiscal years 2017 and 2016 (restated) financial statements. HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on recommended corrective actions. For each recommendation without a management decision, please respond and provide status reports in accordance with the HUD Handbook. Please furnish us copies of any correspondence or directives issued because of the audit. The Inspector General Act, Title 5 United States Code, section 8M, requires that OIG post its publicly available reports on the OIG website. Accordingly, this report will be posted at http://www.hudoig.gov. If you have any questions or comments about this report, please do not hesitate to call me at 202- 402-8216. Audit Report Number: 2018-FO-0003 Date: November 15, 2017 Audit of the Federal Housing Administration’s Financial Statements for Fiscal Years 2017 and 2016 (Restated) Highlights What We Audited and Why The Chief Financial Officers Act of 1990 (Public Law 101-576), as amended, requires the Office of Inspector General to audit the financial statements of the Federal Housing Administration (FHA) annually. We audited the accompanying financial statements and notes of FHA as of and for the fiscal years ending September 30, 2017 and 2016 (restated), which are composed of the balance sheets, and the related statements of net cost and changes in net position, and the combined statements of budgetary resources for the years then ended. Additionally, we audited the restatement adjustments made by FHA in fiscal year 2017 to restate its fiscal year 2016 financial statement notes. We conducted these audits in accordance with U.S. generally accepted government auditing standards. What We Found In our opinion, FHA’s fiscal years 2017 and 2016 financial statements were presented fairly, in all material respects, in accordance with the U.S. generally accepted accounting principles for the Federal Government. Our opinion is reported in FHA’s Fiscal Year 2017 Annual Management Report. The results of our audit of FHA’s principal financial statements and notes for the fiscal years ending September 30, 2017 and 2016, including our report on FHA’s internal control and test of compliance with selected provisions of laws and regulations applicable to FHA are presented in this report. Our audit disclosed two material weaknesses, two significant deficiencies in internal controls, and no instances of noncompliance with applicable laws and regulations, which are discussed further in the body of this report. What We Recommend To support reliable financial reporting, we recommend that FHA strengthen its existing system of internal control processes, and policies, and procedures to (1) ensure effective model governance implementation and (2) prevent or detect material misstatements occurring in the financial statements and notes in a timely manner. Additionally, we recommend that FHA deobligate $270.7 million to recapture funds with invalid obligations. Table of Contents Independent Auditor’s Report................................................................................3 Material Weaknesses ...............................................................................................9 Finding 1: Weaknesses Were Identified in FHA’s Modeling Processes ..................... 9 Finding 2: FHA’s Controls Over Financial Reporting Had Weaknesses ................. 16 Significant Deficiencies ..........................................................................................25 Finding 3: FHA’s Controls Related to Partial Claims Had Improved, but Weaknesses Remained .................................................................................................... 25 Finding 4: Weaknesses Were Identified in Selected FHA Information Technology Systems ............................................................................................................................. 28 Scope and Methodology .........................................................................................32 Followup on Prior Audits ......................................................................................34 Appendixes ..............................................................................................................36 A. Schedule of Funds To Be Put to Better Use ............................................................ 36 B. Auditee Comments and OIG’s Evaluation ............................................................. 37 C. FHA’s Fiscal Years 2017 and 2016 Financial Statements and Notes ................... 40 2 U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT OFFICE OF INSPECTOR GENERAL Independent Auditor’s Report General Deputy Assistant Secretary Federal Housing Administration In our audit of the fiscal years 2017 and 2016 (restated) financial statements of the Federal Housing Administration (FHA), a component of the U.S. Department of Housing and Urban Development (HUD), we found • The financial statements and notes were presented fairly, in all material respects, in accordance with U.S. generally accepted accounting principles. • There were two material weaknesses in internal control over financial reporting. • There were two significant deficiencies in internal control over financial reporting. • There were no instances of reportable noncompliance with certain provisions of laws and regulations that apply to FHA. The following sections and appendixes discuss in more detail (1) our conclusions, including additional information, (2) management’s responsibilities, (3) our responsibilities, (4) management’s response to findings, (5) the current status of prior-year findings, and (6) a schedule of funds to be put to better use. Report on the Financial Statements We audited the accompanying financial statements of FHA, which are composed of the balance sheets as of September 30, 2017 and 2016 (restated), and the related statements of net cost and changes in net position, the combined statements of budgetary resources for the years then ended, and the related notes to the financial statements. Management’s Responsibilities FHA management is responsible for preparing and fairly presenting these financial statements in accordance with U.S. generally accepted accounting principles. These responsibilities include designing, implementing, and maintaining internal control to ensure that FHA prepares and fairly presents financial statements that are free from material misstatement, whether due to fraud or error. Management is also responsible for (1) evaluating the effectiveness of internal control over financial reporting; (2) providing a statement of assurance on the overall effectiveness of internal control over financial reporting, including providing reasonable assurance that the broad control objectives of the Federal Managers’ Financial Integrity Act (FMFIA) are met; and (3) ensuring compliance with other applicable laws and regulations. 3 Auditor’s Responsibilities Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with U.S. generally accepted auditing standards and the standards applicable to financial audits contained in the Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. We also conducted our audits in accordance with Office of Management and Budget (OMB) Bulletin No. 17-03, Audit Requirements for Federal Financial Statements. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to FHA’s preparation and fair presentation of the financial statements to design audit procedures that are appropriate in the circumstances but not to express an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management as well as evaluating the overall presentation of the financial statements. We are also responsible for (1) obtaining a sufficient understanding of internal control over financial reporting to plan the audit, (2) testing compliance with selected provisions of laws and regulations that have a direct and material effect on the financial statements and applicable laws for which OMB Bulletin 17-03 requires testing, and (3) applying certain limited procedures with respect to the required supplementary information (RSI) and all other accompanying information included with the financial statements. We did not evaluate all internal controls relevant to operating objectives as broadly established by FMFIA, such as those controls relevant to preparing statistical reports and ensuring efficient operations. We limited our internal control testing to testing controls over financial reporting. Because of inherent limitations in internal control, misstatements due to error or fraud or noncompliance may still occur and not be detected. We also caution that projecting our audit results to future periods is subject to risk that controls may become inadequate because of changes in conditions or that the degree of compliance with controls may deteriorate. In addition, we caution that our internal control testing may not be sufficient for other purposes. We did not test compliance with all laws and regulations applicable to FHA. We limited our tests of compliance to certain provisions of laws and regulations that have a direct and material effect on the financial statements and those required by OMB Bulletin 17-03 that we deemed to be applicable to FHA’s financial statements for the fiscal years ending September 30, 2017 and 2016. We caution that noncompliance with laws and regulations may occur and not be detected by these tests and that such testing may not be sufficient for other purposes. We believe that the audit evidence we have obtained was sufficient and appropriate to provide a basis for our audit opinion. 4 Opinion on Financial Statements In our opinion, the financial statements referred to above presented fairly, in all material respects, the financial position of FHA as of September 30, 2017 and 2016 (restated), and its net costs, changes in net position, and budgetary resources for the years then ended in accordance with U.S. generally accepted accounting principles. Emphasis of Matter As discussed in notes 1 and 7 to the financial statements, the loan guarantee liability (LGL) is an estimate of the net present value of future claims, net of future premiums, and future recoveries from loans insured as of the end of the fiscal year. This estimate is developed using econometric models that integrate historical loan-level program and economic data with regional house price appreciation forecasts to develop assumptions about future portfolio performance. In 2017, FHA made a few model methodology changes. These changes included changing the methodology for (1) calculating for the net present value of the future cash flows using a single path (President’s Economic Assumption released in March 2017) instead of using an average of 100 paths for claim and prepayments, which was the methodology used in 2016, and (2) discounting the timing of the cash flows from the end of the year to the middle of the year for certain programs. We caution our readers to be cognizant of the fact that the comparability of the LGL numbers in 2017, when compared to those in 2016, could be impacted because of the changes. Our opinion was not modified with respect to this matter. Other Matters Fiscal Year 2016 Financial Statements and Notes In our report, dated November 14, 2016, we expressed an opinion that FHA’s financial statements for fiscal year 2016 fairly presented the financial position of FHA’s financial statements as of September 30, 2016, and its net costs, changes in net position, and budgetary resources for the years then ended in accordance with generally accepted accounting principles. However, in fiscal year 2017, as discussed in note 21 to the financial statements, a material error was identified in the 2016 Note 7 - Direct Loans and Loan Guarantees and Note 12 - Gross Costs, which required correction of the balances in fiscal year 2017. With the exception of the differences that FHA attributed to the timing of information being transferred between systems as discussed in finding 2, note 7 was restated to correct balances reported for the home equity conversion program (HECM) current-year endorsements, the cumulative current outstanding balance, and maximum potential liability, and the single family forward guaranteed loans outstanding and new guaranteed loans disbursed. Note 7 was also restated to correct the allocation of the technical/default reestimates between the subsidy expense and interest expense components. Additionally, note 12 was restated to correct gross cost with the public to adjust the allocation of reestimate and interest expenses. For these reasons, the opinion expressed in the 2016 audited financial statements was no longer appropriate because the accompanying notes to the financial statements as published at that time contained material misstatements. Accordingly, our opinion on the audited financial statements for 2016 is withdrawn because it can no longer be relied upon and is replaced by the auditor’s report on the restated financial statements. Required Supplementary Information U.S. generally accepted accounting principles require that FHA management’s discussion analysis and other required supplementary information be presented to supplement the financial statements. Such information, although not a part of the financial statements, is required by the Federal 5 Accounting Standards Advisory Board, which considers it to be an essential part of financial reporting for placing the financial statements into an appropriate operational, economic, or historical context. We have applied certain limited procedures to the management discussion and analysis and other required supplementary information in accordance with U.S. generally accepted government auditing standards, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management’s responses to our inquiries, the financial statements, and other knowledge we obtained during our audit of the financial statements. We do not express an opinion or provide assurance on this information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide assurance. Other Information The message from the FHA Commissioner is presented for additional analysis is are not a required part of the financial statements or required supplementary information. This information has not been subjected to the auditing procedures applied in the audit of the financial statements, and, accordingly, we do not express an opinion or provide assurance on it. Report on Internal Control Over Financial Reporting and Compliance Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards Report on Internal Control Over Financial Reporting In planning and performing our audit of the financial statements, we considered FHA’s internal control over financial reporting to determine the appropriate audit procedures for expressing our opinion on the financial statements but not for expressing an opinion on the effectiveness of FHA’s internal control. Accordingly, we do not express an opinion on the effectiveness of FHA’s internal control. A deficiency in internal control 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 and correct misstatements on a timely basis. A material weakness is a deficiency or a combination of deficiencies in internal control, such that there is a reasonable possibility that a material misstatement of FHA’s financial statements will not be prevented or detected and corrected on a timely basis. A significant deficiency is a deficiency or combination of deficiencies in internal control that is less severe than a material weakness yet important enough to merit attention by those charged with governance. Our consideration of internal control was for the limited purpose described in the first paragraph of this section and was not designed to identify all deficiencies in internal control that might be material weaknesses or significant deficiencies. Therefore, other deficiencies in internal control that might be material weaknesses or significant deficiencies may exist that were not identified. We identified four deficiencies in internal control, described below. We consider two to be material weaknesses and two to be significant deficiencies. Weaknesses Were Identified in FHA’s Modeling Processes In 2017, we identified a number of weaknesses in FHA’s modeling processes. Specifically, these weaknesses were related to FHA’s ineffective model documentation, model governance, and modeling practices. All of these weaknesses were a direct result of FHA’s failure to ensure that well-controlled modeling processes were implemented. As a result, FHA failed to prevent or detect 6 $631.8 million in total errors to its model output results, which support FHA’s LGL line item in its financial statements. Further, given unresolved concerns regarding the predictive capability of the single-family model, along with not following established policies and procedures and best practices for model coding, all of these concerns could impact the reliability of FHA’s liabilities for loan guarantees (LLG) estimates. FHA’s Controls Over Financial Reporting Had Weaknesses In fiscal year 2017, some of the control deficiencies in financial reporting identified in 2016 continued, and new control deficiencies were identified. Specifically, these new control deficiencies included issues related to the timing of the recognition of the credit subsidy expense and unrecorded accruals. In addition, FHA had material note disclosure errors in note 7 of the financial statements. These note errors included (1) inaccurate disclosure of the loan endorsement amounts for the 2017 and 2016 single-family and HECM programs and (2) incorrect allocation of LGL reestimates between the subsidy expense and interest expense components in fiscal year 2016. These conditions occurred because FHA did not have effective monitoring and processes in place to ensure (1) that accounting events were recorded in a timely manner, (2) that accrual methodologies were reviewed on a regular basis for completion and accuracy, and (3) the accuracy of data reported in the financial statements. As a result, $382 million in accounting adjustments had to be made to correct the errors in FHA’s accounting records, and $23.7 billion in restatements were made to fiscal year 2016 endorsement amounts in note 7. Additionally, FHA may have missed an opportunity to put $270.7 million of its unobligated funds to better use because invalid obligations were not always deobligated on time. FHA’s Controls Related to Partial Claims Had Improved, but Weaknesses Remained In fiscal year 2017, FHA began billing noncompliant lenders for partial claims when the lenders had not provided FHA with the related promissory note (second mortgage note) when the note was not provided within 60 days of executing the partial claim. FHA began billing lenders between 2 and 59 days after the 60-day expiration period. While this was a marked improvement from waiting until 6 months after the expiration period, it was not always immediately after as we had previously recommended. A delay in FHA management’s reaching agreement to change the billing policy and procedures was a contributing factor in FHA’s delay in fully implementing the controls in a timely manner. Unnecessary delays in implementing the collection process from noncompliant lenders with unsupported partial claims is not a good cash management practice and does not help improve the health of the Mutual Mortgage Insurance fund. FHA should continue to implement its policy and ensure that the implementation is fully carried out. Weaknesses Were Identified in Select FHA Information Technology Systems The Asset Disposition and Management System (ADAMS) application and the source applications used in the credit reform estimation and reestimation process contained security vulnerabilities. These conditions occurred because of a lack of contract oversight and insufficient coordination between the Office of the Chief Information Officer (OCIO) and FHA. As a result, the confidentiality, integrity, and availability of critical information may be negatively impacted. In addition, the information used to provide input to the FHA financial statements could be adversely affected. We also determined that remediation of weaknesses previously reported with the Single Family Premium Collection Subsystem – Periodic (SFPCS-P), Single Family Acquired Asset Management System (SAMS), Single Family Insurance System (SFIS), and Single Family 7 Insurance System Claims Subsystem (Claims) are in progress and expected to be fully remediated — within the agreed-upon timeframes. Report on Compliance As part of obtaining reasonable assurance about whether FHA’s financial statements were free from material misstatement, we performed tests of their compliance with certain provisions of laws and regulations, noncompliance with which could have a direct and material effect on determining financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and, accordingly, we do not express such ai opinion. The results of our tests disclosed no instances of noncompliance that would be reportable under U.S. generally accepted government auditing standards or 0MB audit guidance. This report is intended for the information and use of the management of FHA, 0MB, the U.S. Government Accountability Office, and Congress and is not intended to be and should not be used by anyone other than these specified parties. However, this report is a matter of public record, and its distribution is not limited. The purpose of the Report on Internal Control Over Financial Reporting and the Report on Compliance sections of this report is solely to describe the scope of our testing of internal control and compliance and the result of that testing and not to provide an opinion on the effectiveness of FHA’s internal control or compliance. These reports are an integral part of an audit performed in accordance with Government Auditing Standards in considering FHA’s internal control and compliance. Accordingly, these reports are not suitable for any other purpose. In addition to this report and providing specific recommendations to FHA management, we noted other matters involving internal control over financial reporting and FHA’s operation that we are reporting to FHA management in a separate management letter. Kim ny R. Ranhl Acting Assistant Inspector General for Audit Washington, DC November 14, 2017 8 Material Weaknesses Finding 1: Weaknesses Were Identified in FHA’s Modeling Processes In 2017, we identified a number of weaknesses in FHA’s modeling processes. Specifically, these weaknesses were related to FHA’s ineffective model documentation, model governance, and modeling practices. All of these weaknesses were a direct result of FHA’s failure to ensure that well-controlled modeling processes were implemented. As a result, FHA failed to prevent or detect $631.8 million in total errors to its model output results, which support FHA’s LGL line item in its financial statements. Further, given unresolved concerns regarding the predictive capability of the single-family model, along with not following established policies and procedures and best practices for model coding, all of these concerns could impact the reliability of FHA’s LGL estimates. Current-Year Status of Prior-Year Audit Matters In fiscal year 2016, we reported that FHA had not fully implemented an effective model risk management governance framework. Specifically, FHA had not established or finalized policies and procedures related to its modeling processes. In our fiscal year 2017 audit follow-up, we noted that in response to our finding, FHA finalized its Credit Reform Board Charter and Model Risk Management Guidelines in August 2017, 1 and addressed some of the model governance deficiencies noted last year. However, due to late completion, we have not validated FHA’s full implementation of the model governance framework. Additionally, none of the prior-year issues had been fully remediated. The current-year status of each of the prior year findings are noted below: • In fiscal year 2016, FHA’s model assumption documentation for the single-family and HECM programs was not consolidated into a single document, and FHA did not have a model risk rating policy that included a model scoring or prioritization process. In fiscal year 2017, FHA consolidated the assumption documentation for the single-family and HECM programs into one document. FHA also established a model risk rating policy in fiscal year 2017, but FHA did not implement the policy by scoring and prioritizing its models according to their relative level of risk. • During our fiscal year 2016 audit, we also cited FHA for not having defined requirements for performing sensitivity analyses. In addition, FHA did not perform sensitivity analyses on all of the assumptions made for the single-family, HECM, and multifamily programs, contrary to Federal Accounting Standards Advisory Board, Technical Release 6, requirements. In 2017, while FHA had established policies and procedures for performing sensitivity analyses, FHA was not following them. 2 Additionally, as in 2016, 1 The charter and guidelines, which were dated June 28, 2017, were signed by the General Deputy Assistant Secretary for Housing on August 1, 2017. 2 FHA’s Model Risk Management Guidelines states that “The sensitivity of model results to each assumption must be tested to determine materiality and reasonableness.” 9 FHA did not perform a sensitivity analysis on the assumptions used in the single-family, HECM, and multifamily recovery on assets models and on all assumptions in the HECM LLG model. • Finally, in fiscal year 2016, FHA had not established policies and procedures for data management and validation. For example, FHA did not have policies and procedures to address the steps to be taken when inconsistent data are noted, or policies and procedures for verifying the accuracy of data inputs. In fiscal year 2017, FHA developed policies and procedures for data management and validation, which require statistics and trend analysis to be performed to ensure the accuracy of data. However, for the single-family and HECM programs, FHA had performed only a very small number of statistics on a small subset of data and had not performed any trend analyses until we brought this issue to its attention. For the multifamily program, FHA had not performed data validation on all data that were used in the multifamily models. Modeling Errors Not Detected or Prevented In fiscal year 2017, we identified a number of errors in the modeling processes for the single- family, HECM, and multifamily programs. FHA was unaware of these errors until we brought them to its attention or the errors were identified as a result of our inquiry. Examples of errors identified included using (1) an incorrect input dataset for the single-family model, (2) an incorrect methodology for discounting the net present value of future cash flows for the HECM program, (3) an incorrect housing price index-variable in the single-family and HECM models, and (4) incorrect single effective rates for healthcare programs. Incorrect Fair Isaac Corporation dataset used in the single-family LLG model. FHA inadvertently loaded the incorrect Fair Isaac Corporation (FICO) dataset into the single-family LLG model when it initially ran its final single-family LLG estimates. This data error came to light in October 2017 when we could not replicate FHA’s model output results. After research, FHA confirmed that the OIG’s model output results could not match up with FHA because FHA had (1) provided OIG with an incorrect dataset, and (2) imported an incomplete loan FICO dataset into its own estimates, which it attributed to an oversight. When FHA realized its loan FICO import error in late October 2017, it reran its model to rectify the situation. This model processing error, if not corrected, would have caused the single-family LLG amount to be understated by $323.4 million, according to FHA. Incorrect discounting methodology used in the HECM LLG model. When FHA initially ran the final HECM LLG model in fiscal year 2017, FHA used the end-of-year period for discounting the cash flows despite the fact that methodology used for all other programs in 2017 was based on the middle of the year. 3 FHA acknowledged to us that an error had been made and it reran the HECM models using the middle-of-year period. FHA attributed the use of the incorrect discounting period to miscommunication. Had we not identified this error, the HECM LLG would have been overstated by $280 million. 3 FHA used the end-of-year convention for both the HECM and single-family programs in fiscal year 2016. 10 Incorrect housing price index values used in the single-family and HECM LLG models. FHA entered incorrect housing price index values into some of the single-family and HECM LLG models. Had we not identified the error, the liability for loan guarantee for the single-family program would have been understated by $7.8 million, based on FHA’s calculation. 4 FHA did not measure the impact of the error for the HECM program, but based on our analysis, the LLG for the HECM program would have been understated by approximately $13.7 million. Incorrect single effective rates were used for the healthcare programs. FHA used the incorrect single effective rates (SER) 5 for the healthcare programs when it initially ran the LLG and recovery on assets models. According to FHA, its policy is to use a different single effective rate for the healthcare programs than the rate for the multifamily programs. However, instead of using the single effective rate designated for the healthcare programs, FHA inadvertently used the rate designated for the multifamily programs. This occurred because FHA inadvertently copied the single effective rate for multifamily to healthcare programs. After we brought this error to FHA’s attention, FHA corrected the rates for the healthcare programs. Had we not identified this error, the LLG for the healthcare programs would have been overstated by $6.9 million. Relationships of Certain Variables Used in the Single-family Model Not Consistent With Our Expectations FHA may not have fully evaluated the reasonableness of certain relationships in the single- family model, causing us concern. This concern was based on our observation that the relationships of certain variables used in the model were not consistent with our expectations. These inconsistencies, if not fully addressed, could significantly impact FHA’s ability for its model to reliably predict future performance of the single-family portfolio. When developing a model, random samples of loans are used to develop a model’s specifications. There is typically a trade-off between how precisely the model is fit, or trained, using historical loan experience and the ability of the model to reliably predict future outcomes for the loan portfolio. A significant amount of professional judgement is needed to refine the model and establish an appropriate balance between model complexity and model predictability. While FHA generally appeared to exercise professional judgement in developing certain assumptions, there were some instances in which it appeared that FHA did not fully evaluate the reasonableness of certain relationships in the single-family model. Two examples are cited below. 6 • One of the key future cash flows taken into account is the likelihood that a borrower will prepay the loan. Generally, there is a positive relationship between a borrower’s FICO score and the likelihood of prepayment. Borrowers with higher FICO scores are more likely to prepay when compared to borrowers with lower FICO scores. However, FHA used the opposite relationship in the model for borrowers with a FICO score in the 4 Based on our independent assessment, this amount appears to be reasonable. 5 The single effective interest rate is the disbursement-weighted average discount rate for substantially disbursed cohorts. 6 We also identified other unreasonable relationships, which we have provided to FHA. 11 ranges of 550 to 650 and 725 to 750 and did not provide a reasonable explanation of why the identified relationships were logical and to be expected. • The loan-to-value ratio captures the original equity position of each borrower and is a key factor in determining the likelihood of prepayment. The single-family model had unintuitive relationships for certain loan-to-value ratio ranges. In the model, the direction of the likelihood of prepayment changed back and forth for adjacent loan-to-value ratio ranges in an unintuitive manner that was not in line with what would reasonably be expected. In addition, FHA did not incorporate the 97.5 cut-off for the maximum loan- to-value ratio, which is a key design feature of the single-family program. Due to these unreasonable relationships, we have concerns regarding the reliability of the single- family model in predicting the future performance of the single-family portfolio. Our concerns are supported by the analysis that we performed. We tested FHA’s single-family model using different randomly selected groups of loans used to develop relationships, while keeping everything else the same. Simply changing the “training” data over six different model runs produced LLG estimates that changed by $638 million. Although we did not have sufficient time to perform a full statistical analysis on a much larger number of model runs, this variation in the LLG estimates was larger than we would normally expect for randomly generated samples of loans. FHA’s Increased Susceptibility to Modeling Errors Due to Ineffective Modeling Practices In addition to the modeling errors and the use of unreasonable assumptions in the single-family model, we identified a number of modeling practices, which could significantly increase FHA’s risk of continued modeling errors if they are not appropriately addressed. Specifically, we found that (1) modeling documentation did not include necessary information and contained errors, (2) correct datasets were not readily provided upon request so we could replicate the single-family model results, and (3) some of FHA’s coding practices were contrary to best practices. Ineffective model documentation. FHA’s model documentation did not contain necessary information and contained errors. Our efforts to replicate model results were hindered because FHA’s modeling documentation was incomplete and contained errors and not all required datasets were provided. Federal Accounting Standards Advisory Board, Technical Release 6, requires model documentation to be complete and stand on its own so that an independent person could perform the same steps and replicate the same results with little or no outside explanation or assistance. However, we spent a considerable amount of time attempting to replicate FHA’s modeling results because we encountered the following problems: 7 • Information that should have been included in the model documentation was not included. For example, documentation for the single-family and HECM models did not include (1) the timing of developing certain assumptions and the time when data were extracted to develop assumptions, (2) the values for the macro variables needed to execute the main cash flow programs, (3) all input files and datasets required to run the models, (4) an outline of which programs should be executed during each phase of model 7 We provided a detailed list of the problems that we encountered to FHA management during our audit. 12 execution, and (5) descriptions of all of the variables used in the single-family logistic regression models. • Inconsistent information was also included in model documentation for the single-family and HECM programs. For example, the naming convention for variables listed in the HECM model documentation did not agree with the naming convention used in the model. For the single-family program, variables were incorrectly referenced on certain pages of the model documentation. • Model documentation for the single-family program contained errors. Specifically, we found that (1) model documentation did not specify the correct computer specifications for running the model, (2) the variable names in the model documentation did not always agree with the variable names in the model code, and (3) model documentation incorrectly stated that variables were used in a specific model when they were not. Correct datasets for the single-family model were not initially provided. Our efforts to replicate the single-family model results were hindered because required datasets were not provided upon our initial request. For the single-family program, FHA did not initially provide us multiple datasets needed to run the model, and in other cases, we were provided incorrect datasets. In addition, the format of a file was changed within the model code between the interim and final model versions, but the updated file was not provided to us when we were attempting to replicate the results. We believe some of these conditions occurred because FHA did not have adequate controls in place for ensuring that updated or correct files were maintained in a centralized location. Industry best model coding practices were not adopted. Adopting leading industry best coding practices could minimize user error, and increase reliability, and reduce maintenance of FHA’s programming code. For the single-family and HECM programs, we identified a number of model coding practices and techniques which significantly increased FHA’s risk of modeling errors. Specifically, we found that • The single-family model had large sections of duplicated code. This coding practice could lead to errors if the programmer or developer makes a change to the code in one section of the model but not the other sections. Best coding practices suggest that duplicate code be consolidated into one routine that can be called multiple times. • The single-family program code referenced a specific file location in a risky manner. This coding practice introduces increased risk of broken file references when file locations are changed or code is moved to another system. This increases the difficulty of maintaining the code since any update would require that the user identify and change each reference to that specific file location throughout the code. In instances in which the references point to data that are updated regularly, there is a risk that stale data will be used and errors will go undetected since the model would not produce processing errors or warnings. Best coding practices suggest using non-specific (“relative”) file path structures that are independent of a particular file directory structure and can be updated easily by changing as few lines of code as possible. 13 • For the HECM program area, the model’s output filenames changed depending on the date of execution, and the model could not be executed without making manual adjustments to the code that referenced those files. This practice requires significant user intervention. The user has to verify the filenames before running each stage of the model and then update the code to match the filenames. If the filename changes at a later point, an error could be introduced without warning or detection. In addition to increasing the risk of error, this practice lengthens the time that it takes to run the model. Best coding practices suggest that programs be seamlessly executed from start to finish (“end to end”) without significant user intervention along the way. • When values and references were updated in the single-family and HECM programs, FHA had to search throughout the entire program and make conforming changes. This increases the risk of error if the user does not update every value or reference in the programs. Best coding practice is to assign these types of “global” values or references one time and group them together at the beginning of the code to enhance code usability and minimize the risk of user error. Conclusion FHA should continue striving to improve its model governance to ensure the reliability of the LLG estimates. In 2017, FHA developed a model governance framework. While this is a step in the right direction, FHA needs to continue to monitor its activities to ensure full implementation of the model governance framework. With regard to FHA’s controls over its models, we noted that although FHA had some policies and procedures in place to ensure that modeling errors are minimized, it needs to ensure that established policies and procedures are followed. In addition, FHA can benefit from (1) performing additional analysis to identify assumptions that may skew the LLG estimates, (2) improving its modeling documentation, and (3) following best coding practices. Recommendations We recommend that the Director of the Office of Evaluation 1A. Establish and implement an effective quality control process to prevent or detect model processing errors cited in our report and prevent other similar model processing errors in the future. 1B. Reevaluate FHA’s existing model documentation for single-family, HECM, and multifamily models to determine whether their current state is acceptable, so that it provides the intended users a thorough understanding of how the model works and also allows new users to assume responsibility for the model’s use (operational procedures). Based on this review, FHA should make adjustments as needed to the model documentation. At a minimum, these adjustments should include appropriate actions taken to address model documentation deficiencies cited in our report. 1C. Review FHA’s existing model coding for single-family, HECM, and multifamily models and make necessary changes to make them consistent with industry’s best practices in model coding. At a minimum, FHA should implement actions to address model coding deficiencies cited in our report. 14 1D. Establish and implement policies and procedures for assessing and monitoring the reliability of the work performed by FHA’s modeling contractors. 1E. Revisit the model’s ability to predict future performance of the single-family portfolio, based on our concerns expressed in this report regarding relationships of certain variables (such as loan-to-value ratio and FICO scores to prepayment) that are not consistent with our expectations. FHA should provide us an analysis to support its position if it believes that a model design change is not warranted. 1F. Correct the impact of all the modeling errors that we identified in this report. 15 Finding 2: FHA’s Controls Over Financial Reporting Had Weaknesses In fiscal year 2017, some of the control deficiencies in financial reporting identified in 2016 continued, and new control deficiencies were identified. Specifically, these new control deficiencies included issues related to the timing in the recognition of the credit subsidy expense and unrecorded accruals. In addition, FHA had material note disclosure errors in note 7 of the financial statements. 8 These note errors included (1) inaccurate disclosure of the loan endorsement amounts for the 2016 and 2017 single-family and HECM programs and (2) incorrect allocation of LGL reestimates between the subsidy expense and interest expense components in fiscal year 2016. These conditions occurred because FHA did not have effective monitoring and processes in place to ensure (1) that accounting events were recorded in a timely manner, (2) that accrual methodologies were reviewed on a regular basis for completion and accuracy, and (3) the accuracy of data reported in the financial statements. As a result, $382 million9 in accounting adjustments had to be made to correct the errors in FHA’s accounting records, and $23.7 billion 10 in restatements were made to fiscal year 2016 endorsement amounts in note 7. Additionally, FHA may have missed an opportunity to put $270.7 million of its unobligated funds to better use because invalid obligations were not always deobligated on time. Current-Year Status of Prior-Year Audit Matters Weaknesses in Deobligation of Unliquidated Balances Continued In fiscal year 2016, we reported that FHA’s unliquidated balance review process had weaknesses. Specifically, contracts with invalid obligations were not identified clearly and in a timely manner, and excess funds were not deobligated for completed contracts. In connection with our fiscal year 2017 audit follow-up, we noted that although there is now an effective process to identify invalid contract obligations, challenges continued in deobligating these funds. Of the $276.5 million identified as invalid deobligations during the fiscal year 2016 audit, $71.9 million had not been deobligated at the end of fiscal year 2017. In addition, during FHA’s fiscal year 2017 unliquidated balance review, the program offices identified 158 contracts and projects with invalid obligations totaling $299.2 million, but only $28.5 million had been deobligated at the end of fiscal year 2017. The remaining $270.7 million was awaiting action from FHA or the Office of Contracting and Procurement for deobligation. Challenges in Clearing Discrepancies in the Undelivered Order Balances for Management and Marketing Contracts Continued In fiscal year 2016, we reported that FHA’s individual contract undelivered order balances for single-family management and marketing contracts were not accurate on the report used for financial reporting. 11 We found discrepancies in the expenditure amounts for 131 contracts and discrepancies in the obligation amounts for 41 contracts. Before the end of our fiscal year 2016 8 Note 7 was formerly note 6 in the fiscal year 2016 financial statements. 9 The adjustments included $138,000 for management and marketing contracts, $71.7 million for multifamily credit subsidy expense, $14.4 million for property contracts, $75.2 million for supplemental claims and $220.6 million (absolute value of $110.3 million) for reestimates. 10 FHA made restatements in the amount of $47 million for discrepancies for the HECM program and $23.7 billion for discrepancies for single-family program endorsements. 11 The undelivered order balance is the difference between the obligated amount and the expenditure amount. 16 audit, FHA informed us that it had identified another report that contained the accurate undelivered order balances. There was a $2.3 million difference between the total undelivered order balance on the report used for financial reporting and the report that FHA identified as containing the correct balances. During our fiscal year 2017 audit, FHA reported that it had made significant progress in correcting the discrepancies on the report used for financial reporting. According to FHA, as of September 30, 2017, there was only a $138,000 difference between the report used for financial reporting and the report that FHA identified as containing the correct balances. Timing Differences in the Obligation and Disbursement Processing of Multifamily Guaranteed and Direct Loans FHA did not record the subsidy costs associated with the multifamily loan guarantees and direct loans in a timely manner in accordance with generally accepted accounting principles. 12 Specifically, FHA failed to recognize the multifamily loan guarantee and direct loan subsidy costs in the proper period. Additionally, due to manual recording of transactions in several systems by various groups, the risk of inconsistent recording of accounting events among the systems increased. We audited 15 loan guarantee loans with an unpaid principal balance and calculated subsidy costs of $194.5 million and $7.8 million, respectively, and 11 Federal Financing Bank (FFB) direct loans with an unpaid principal balance and calculated subsidy costs of $63.8 million and $7.0 million, respectively, all endorsed between October 1, 2016, and June 30, 2017. Multifamily loan guarantee. The credit subsidy expense for 12 of 15 (85 percent) loan guarantees was not recorded in the period when these loans were endorsed. The subsidy costs of the 12 loans with exception totaled $6.7 million. The delay in recognizing the credit subsidy expense averaged 72 days, including one delay of 269 days. Additionally, the credit subsidy obligation for 4 of the 15 loans (27 percent) was not in the appropriate period. We noted that the delay in recording the obligation for the subsidy cost averaged approximately 49 days, including one delay of 104 days. Multifamily direct loans. The credit subsidy expense for all of the direct loans was not recorded in the period when the loan was disbursed by FFB. We noted that the delay in recognizing the credit subsidy expense for the subsidy cost averaged 71 days, including one delay of 208 days. Additionally, the credit subsidy obligation for 3 of 11 loans (27 percent) was not in the appropriate period, which was when the firm approval was signed. The delay in recording the obligation for the subsidy cost averaged approximately 20 days, including two delays of 29 days. Other issues. FHA did not have an effective process to ensure consistent tracking and recording of loan information between the Development Application Processing System (DAP) and the FHA Subsidiary Ledger (FHASL) Revenue Management (Revenue 12 When FHA issues a firm commitment, the commitment authority is reduced by the loan amount and a subsidy obligation is created against the annual allotment of credit subsidy. When the loan is endorsed, a subsidy cost is recognized. For direct loans, when FHA issues a firm commitment, both the direct loan and subsidy obligations are created against the annual allotment of direct loans and credit subsidy. When the loan is disbursed, a subsidy cost is recognized. 17 Management) system. Nine of the 15 loan guarantees and 9 of the 11 direct loans showed as being endorsed in various periods. DAP is used by the multifamily production field offices and is a comprehensive, automated underwriting system that supports processing and tracking of FHA multifamily housing applications from pre-application through final closing, and it is where all loan characteristics are recorded. Revenue Management is used by the headquarters Office of Multifamily Housing Programs, Financial Operations Division, to track and record the loan history, including financial transactions, such as payments, interest, etc, which are not recorded in DAP. A combination of things contributed to these conditions. Although information was available to FHA, the timing of completion to process the loan package 13 prevented FHA from recording the accounting events at the point of recognition. Obtaining the information from several systems and keying the obligation and expense information, a labor-intensive process, was another contributing factor. FHA did not have controls in place to ensure that proper cut-offs and accruals were established to record accounting events in the proper periods. In addition, as the multifamily production field offices entered loan information into DAP and the Financial Operations Division also entered loan information into Revenue Management, both of which are used to recognize accounting events in the general ledger, there was no process in place to ensure that loan information was consistent among DAP, Revenue Management, and the general ledger. As of September 30, 2017, $71.7 million in credit subsidy expense was accrued on 126 loans that were endorsed and disbursed as of the end of the fiscal year but had not had the expense recognized in the general ledger. As part of the process to identify the loans to include in the accrual, FHA had identified inconsistencies between DAP and Revenue Management and was following up on the differences. Omission of Accrued Liabilities on Property Contracts FHA, as a practice, did not estimate accrued liabilities for expenses incurred but not yet billed by its contractors on its single-family and multifamily property contracts. This was not in accordance with generally accepted accounting principles. 14 We attributed FHA’s omission of the accruals to an oversight. When we brought the issue to FHA’s attention, FHA developed a methodology for estimating an accrual for single-family property expenses, and it was implemented in July 2017. In response to our finding, FHA reported that it booked $14.4 million in accruals for single-family contract expenses in July 2017. FHA currently does not have a plan to estimate an accrual for the multifamily contracts because it believes this amount is immaterial. We will be 13 The Financial Operations Division reviews the loan package and manually enters more than 30 data points from the package into the Revenue Management module of FHASL for loan guarantees and more than 125 data points for direct loans. 14 Paragraph 19 of Statement of Federal Financial Accounting Standards 5, Accounting for Liabilities of The Federal Government, states that a liability is a probable future outflow or other sacrifice of resources as a result of past transactions or events and general purpose federal financial reports should recognize probable and measurable future outflows or other sacrifices of resources arising from transactions and events that are unpaid amounts due as of the reporting date. 18 monitoring the activities of the multifamily property contracts in fiscal year 2018 to determine whether FHA’s assessment on multifamily contracts needs to be revisited. Supplemental Claims Not Accurately Accrued Besides the accrual on property contracts, we also found issues on the accrual of supplemental claims. FHA failed to (1) account for the backlog of unopened, paper- based supplemental claims and (2) properly estimate the average paid supplemental claim amount to use in its quarterly accrual methodology. FHA failed to properly account for the backlog of unopened paper-based supplemental claims in its supplemental claims accrual estimation process. Before March 2016, paper-based supplemental claims received by FHA were opened regularly and imaged into the A43C system by a contractor for review, processing, and payment. However, when FHA’s contract expired in March 2016, boxes of supplemental paper claims remained unopened because FHA was not properly staffed to handle the volume of supplemental claims in-house at the same rate as the previous contractor, thus creating a backlog. These backlogged claims were excluded from the quarterly accrual because the accrual includes the count of the paper-based supplemental claims that have been opened. Based on FHA’s estimate, approximately 4,000 paper-based supplemental claims were being filed with FHA each month, and there was a backlog of approximately 6 months at the end of the first quarter, 4 months at the end of second quarter, and 5 months at the end of third quarter. As a result, FHA’s supplemental claims count used in the accrual estimation process was off by the amount of the backlog at the end of each of the first three quarters of fiscal year 2017. In addition to using the incorrect supplemental claims count, the average quarterly supplemental claims amount used in FHA’s calculation was also incorrect. Although the Single Family Post Insurance Division had taken over the work previously performed by its contractor, FHA was unable to catch up to pay the number of supplemental claims at the pre-March 2016 level. In an effort to catch up on paying claims, FHA was able to process and pay claims for only those under $2,000. Claims of $2,000 and over were not processed or paid and were only opened and imaged. As a result of paying only claims under $2,000 at a pace slower than the pre-March 2016 level, the average claim amount used in the calculation by the Single Family Claims Servicing Branch no longer accurately reflected the true average claim amount during the post-March 2016 period. In August 2017, in response to our inquiry, FHA developed a methodology to account for unopened supplemental claims resulting from the backlog and calculated the average claim amount as $1,421. This average amount is based on the claims paid for the first 6 months of fiscal year 2016, which would also include claim payments of $2,000 and above. The understatement of the quarterly accruals, as a result of FHA’s failure to update the calculation for the unopened claims and the correct average claim, is calculated in the following table. 19 Table 1: Variances noted in quarterly supplemental claims accrual Per books 15 Per audit Fiscal Unpaid Variance year 2017 claims Average Unpaid Average OIG reporting count claim Accrual claims claim accrual (understatement) period amount per FHA count amount calculation (A) (C =A*B) (G = C-F) (B) (D) (E) (F=D*E) Q1 13,090 $622.25 $8,145,253 37,090 16 $1,421.81 $52,734,933 $(44,589,680) Q2 12,025 621.70 7,475,943 28,025 17 1,421.81 39,846,225 (32,370,283) Q3 16,423 584.62 9,601,214 36,423 18 1,421.81 51,786,586 (42,185,371) As of the fourth quarter of 2017, FHA reported that it had almost cleared the backlog of the unopened claims and processed most of the claims under $2,000 for payment. Claims $2,000 and over, which made up the majority of the unpaid claims, were expected to be processed once a new contract is awarded and is in place. Since the majority of the unprocessed claims were over $2,000, the average claim amount used by FHA in the fourth quarter was $2,600. Therefore, FHA’s estimated accrual for the fourth quarter based on 37,386 unprocessed claims was $97.2 million. FHA also accrued $813,000 for 572 unopened supplemental claims, using the $1,421 average claim amount, for a total accrual of $98.0 million as of September 30, 2017. Discrepancies Identified in FHA Systems Loan Endorsement Amounts There were errors in FHA’s reporting of the required financial note disclosures related to its loan guarantees. For the HECM and single-family programs, we found discrepancies in the current-year loan endorsement amounts between the systems that FHA used for financial reporting and the Computerized Home Underwriting Mortgage System (CHUMS), which is the system of record for current-year endorsements for these two loan programs. 19 • Discrepancies for HECM program. For notes reporting, FHA relied on the HECM current year endorsement amount recorded in the Home Equity Reverse Mortgage Information Technology (HERMIT) system, but this number did not agree with the current year 15 Obtained from the general ledger division’s quarterly accrual calculation. 16 Calculated by multiplying the 4,000 claims received per month by the 6 months of the backlog of unopened claims (24,000) and adding the known unpaid claims of $13,090 as of the first quarter. 17 Calculated by multiplying the 4,000 claims received per month by the 4 months of the backlog of unopened claims (16,000) and adding the known unpaid claims of $12,025 as of the second quarter. 18 Calculated by multiplying the 4,000 claims received per month by the 5 months of the backlog of unopened claims (20,000) and adding the known unpaid claims of $16,423 as of third quarter. 19 The endorsement amount for HECM loans is the maximum claim amount and the endorsement amount for single-family loans is the outstanding principal. 20 endorsement amount recorded in the CHUMS. We noted the following differences for fiscal years 2016 and 2017. Table 2. Current year endorsement amounts in CHUMS and HERMIT Current year Current year Current year endorsement amount System endorsement amount endorsement amount as of second quarter fiscal year 2016 fiscal year 2017 fiscal year 2017 CHUMS $14,668,583,075 $8,448,068,569 $17,700,507,981 HERMIT 14,611,593,307 8,440,449,189 17,690,646,482 Difference 56,989,768 7,619,380 9,861,499 After our inquiry, FHA conducted research and determined the 2016 endorsement amount was underreported by $47.7 million because the HERMIT Cohort Summary Report did not include 153 mortgages in the 2016 cohort year. 20 FHA stated that the remaining $9.2 million difference for fiscal year 2016 and the differences for fiscal year 2017 can be attributed to the timing of information being transferred between the two systems. FHA did not provide supporting documentation for us to validate its explanation regarding timing differences as the cause of the variance. • Discrepancies for single-family program. For notes reporting, FHA relied on a Single Family Housing Enterprise Data Warehouse (SFHEDW) query to report the single-family current-year endorsement amount, but this number did not agree with the current-year endorsement amount recorded in CHUMS. We noted the following differences for fiscal years 2016 and 2017. Table 3. Current year endorsement amounts in CHUMS and on SFHEDW query Current year Current year Current year endorsement amount endorsement Amount endorsement amount as of second quarter fiscal year 2016 fiscal year 2017 fiscal year 2017 CHUMS $245,466,130,380 $128,073,490,984 $251,010,304,706 SFHEDW Query 221,755,681,201 245,403,356,141 250,903,805,698 Difference 23,710,449,179 117,329,865,157 106,499,008 FHA attributed discrepancies between CHUMS and SFHEDW to timing differences. According to FHA, CHUMS does not transmit new endorsement amounts to the data warehouse until the second weekend of the following month. Therefore, endorsements that occur in September would not be transmitted to the data warehouse until October. After we identified the fiscal year 2016 and second quarter fiscal year 2017 20 We did not perform any test work to verify that these loans belonged in the 2016 cohort year. 21 discrepancies, FHA decided to run the fiscal year 2017 year-end query later than it had done in the past. However, there was still a difference between CHUMS and SFHEDW, although it was much smaller than the $23.7 billion difference for fiscal year 2016. Additionally, FHA did not provide supporting documentation for us to validate FHA’s explanation regarding timing differences as the cause of the variance. With respect to the $117.3 billion difference for the second quarter of fiscal year 2017, FHA acknowledged that it ran an incorrect database access query for 2017, which contributed to the larger difference. FHA had controls in place to ensure that the loan endorsement amounts on the queries agreed with the reported amounts. However, FHA management failed to detect that the query done in fiscal year 2017 was for the incorrect period. 21 OMB Circular A-123, Management’s Responsibility for Enterprise Risk Management and Internal Control, requires agencies to establish and maintain internal control to ensure the reliability of financial reporting. The Government Accountability Office’s Standards for Internal Control in the Federal Government states that management should design control activities to ensure that transactions are accurately recorded to maintain their relevance and value to management in controlling operations and making decisions. FHA’s failure to reconcile discrepancies in the loan endorsement amount among various FHA systems resulted in the agency’s reporting inaccurate information. Inconsistent Methodology Used To Allocate Reestimates in Fiscal Year 2016 In fiscal year 2016, FHA used an inconsistent methodology to allocate the loan guarantee liability reestimates amount between the subsidy expense and interest expense components. FHA used the end-of-year convention to allocate the reestimates for the single-family 2010-2016 cohorts, while it used the middle-of-year convention for the HECM and multifamily programs and for the single-family 1992-2009 cohorts. OMB Circular A-123, Management’s Responsibility for Enterprise Risk Management and Internal Control, requires agencies to establish and maintain internal control to ensure the reliability of financial reporting. FHA used an inconsistent methodology to allocate the reestimates because it did not have an effective process to ensure that management reviewed and approved formula changes in its reestimates workbook before they were implemented. There was no audit trail to support the formula changes, and FHA could not provide a definitive explanation for the changes. Because FHA used the end-of-year convention instead of the middle-of-year convention for the single-family 2010-2016 cohorts, the subsidy expense component was understated by $110 million, and the interest expense component was overstated by the same amount on the fiscal year 2016 financial statements. 21 The incorrect queries were run for the first three quarters of fiscal year 2017. Had we not identified the error, the same error would have likely occurred in at year-end. 22 Conclusion While considerable progress was made to address the control deficiencies identified last year, FHA should continue striving to improve its controls over financial reporting to minimize the risk of material misstatements in its financial reporting. 22 Additionally, although FHA had developed and implemented procedures to record accounting events via various accrual entries, these procedures and methodologies need to be reviewed on a regular basis to confirm that their uses are still appropriate and reasonable. Recommendations We recommend that the Deputy Assistant Secretary for Finance and Budget 2A. Ensure that the $270.7 million identified as invalid obligations in fiscal year 2017 is deobligated as appropriate. 23 2B. Develop and implement policies, procedures, and controls to ensure that he obligation is recognized when the loan guarantee commitment or the direct loan obligation is made and the subsidy cost expense is recognized when the loan is endorsed for loan guarantees and when the loan is disbursed for direct loans. 2C. Develop and implement a reconciliation process to ensure that the information in various systems is consistent for all accounting events. 2D. Develop and implement (1) a methodology to estimate accrued liabilities for property contracts to account for expenses that had been incurred by contractors but not billed and (2) a process to ensure that an audit trail exists for identifying accruals in the general ledger. 2E. Develop and implement policies and procedures to ensure that the reasonableness and appropriateness of the quarterly supplemental claims accrual estimation methodology is periodically reviewed. 2F. Develop and implement policies, procedures, and controls to ensure that the reported current-year endorsements in HERMIT and SFHEDW agree with the current-year endorsements in CHUMS. 2G. Strengthen existing internal control to ensure that amounts reported on the financial statements agree with the appropriate supporting documentation. 2H. Restate the fiscal year 2016 financial statement notes to correct the inaccurate loan guarantee amounts reported by FHA. 2I. Develop and implement procedures and controls to ensure that management reviews and approves changes in the reestimate workbook before they are 22 Before issuance of this report, in mid-November 2017, OIG identified another financial reporting error related to Note 7. FHA inadvertently posted $187 million of the LGL estimate amount in the multifamily General Insurance/Special Risk Insurance Fund (GI/SRI) instead of single-family GI/SRI. FHA attributed the error to an oversight and properly adjusted the note disclosure error after the issue was brought to FHA’s attention. 23 The final deobligation amount may be less than $270.7 million if final invoices need to be paid for the contracts. 23 implemented and maintains documentation to support the rationale for making changes in the reestimate workbook. 2J. Correct the presentation error related to the allocation of reestimates in FHA’s fiscal year 2017 financial statements. 2K. Assess whether prior-year financial statements need to be restated to correct the impact of the presentation error in the allocation of reestimates identified in fiscal year 2017. 24 Significant Deficiencies Finding 3: FHA’s Controls Related to Partial Claims Had Improved, but Weaknesses Remained In fiscal year 2017, FHA began billing noncompliant lenders for partial claims when the lenders had not provided FHA with the related promissory note (second mortgage note) when the note was not provided within 60 days of executing the partial claim. 24 FHA began billing lenders between 2 and 59 days after the 60-day expiration period. While this was a marked improvement from waiting until 6 months after the expiration period, it was not always immediately after as we had previously recommended. A delay in FHA management’s reaching agreement to change the billing policy and procedures was a contributing factor in FHA’s delay in fully implementing the controls in a timely manner. Unnecessary delays in implementing the collection process from noncompliant lenders with unsupported partial claims is not a good cash management practice and does not help improve the health of the Mutual Mortgage Insurance fund. 25 FHA should continue to implement its policy and ensure that the implementation is fully carried out. FHA Had Made Considerable Improvement in Pursuing Partial Claim Promissory Notes, but Challenges Remained We reported in the fiscal year 2014 audit report that 57,164 partial claims, representing $1.5 billion of the gross loans receivable balance reported on FHA’s balance sheet as of September 30, 2014, were not supported with second mortgage notes within 60 days after the date of execution of the partial claim. By the end of fiscal year 2015, the number of unsupported partial claims had decreased to 12,057, representing $376 million of the gross loans receivable balance. As of fiscal year-end 2016, there were 2,798 partial claims unsupported by second mortgage notes, representing $76 million, and as of fiscal year-end 2017, the number had been reduced to 695 partial claims unsupported by second mortgage notes within 60 days after the date of execution, with a total claim amount of $18 million. In response to our fiscal year 2014 audit recommendations, FHA developed a number of policies and procedures and updated Mortgagee Letter 2015-18 26 with the goal of identifying partial claims with promissory notes missing beyond the prescribed submission period and appropriately billing noncompliant lenders for the amount of partial claims paid plus the incentive fee for failure to submit the required documentation to FHA. Based on FHA’s policy under the Mortgagee Letter and the regulatory requirements, FHA is to send the first reimbursement letter to a noncompliant lender if the promissory note has not been provided 24 The lender must deliver to HUD’s loan servicing contractor, no later than 60 days from the execution date of the partial claim, the original partial claim promissory note and, no later than 6 months from the execution date, the recorded subordinate mortgage. 25 Collecting the amounts for unsupported partial claims in a timely manner improves the status of the Mutual Mortgage Insurance fund by restoring funds paid out as loss mitigation claims. 26 Mortgagee Letter 2015-18 has been superseded by Housing Handbook 4000.1, FHA Single Family Housing Policy Handbook, which was effective September 30, 2016. 25 within 60 days of partial claim execution. However, the process designed as a result did not ensure that FHA sent a reimbursement letter until 6 months after execution of the partial claim. As the issue continued to exist in fiscal year 2015, four causes were reported in our finding in the fiscal year 2015 audit report under Finding 1: Controls To Prevent Misclassification of the Receivables Had Not Been Fully Implemented. One cause related to the untimely document processing by FHA’s loan servicing contractor. The other three causes were related to the timely billing of and collection from noncompliant lenders. In our review for fiscal year 2016, we determined that none of the four causes reported in the fiscal year 2015 audit report had been fully addressed. The cause that related to FHA’s contractor’s not processing documents in a timely manner continued to be a problem. FHA planned to resolve the issue in fiscal year 2017 by procuring three new contracts in place of a single contract. The other three causes related to billing and collection efforts toward noncompliant lenders also continued in fiscal year 2016. When testing the designed process in fiscal year 2016, we noted additional delays in the implementation. We identified two factors that led to delays in collecting partial claims with missing documents. One factor was that FHA made changes to its billing and collection process during fiscal year 2016, and therefore, the new process had not been fully implemented as of the end of fiscal year 2016. The other factor was that FHA sent an extension letter to lenders at the request of the HUD Office of General Counsel and the FHA Commissioner following the issuance of the two reimbursement letters, which further delayed the process. Because of the delays embedded in the process, there was a need to strengthen controls to ensure timely referral for collection of loans receivable with missing promissory notes. Policies and Procedures Had Been Updated To More Closely Align With Regulatory Requirements FHA had improved its policies and procedures for the partial claim promissory note process. FHA is to send letters to lenders requesting reimbursement in the amount of the partial claim plus the incentive fee if they have not provided FHA with partial claim promissory notes within 60 days of executing the partial claim or the recorded secondary mortgage within 6 months of executing the partial claim. FHA is to send these letters to noncompliant lenders at 61-, 91-, 181-, and 211-day intervals. We reviewed five of the 61-day letters, noting that FHA no longer waited 6 months to send the letters. The letters requested payment in the amount of the claim plus the incentive fee. However, the letters were not always sent within a reasonable period after the 60 days expired, as letters were sent between 2 and 59 days after the 60-day expiration period. We also reviewed three of the 91-day letters for lenders that did not send the note or payment after they were billed in the 61-day letter. Although FHA sent the letters relatively close to 30 days after the 61-day letters, they were sent between 24 and 71 days after the 90 days expired. Lastly, we reviewed five of the 181-day letters sent to lenders that did not send to FHA the promissory note, payment, or recorded mortgage within 6 months. These letters were sent between 29 and 45 days after the 26 expiration dates noted in the letter. 27 Although requested, FHA did not provide evidence to show that it sent the 211-day letters or referred noncompliant lenders to the Office of Program Enforcement (OPE) under the new policy. In 2017, during the audit resolution process for fiscal year 2016 and as mentioned above, FHA management agreed to send notices 61 and 91 days after the partial claim paid date for missing promissory notes, and reimbursement letters after 181 and 211 days after the claim paid date for missing notes or mortgages to request payment in the amount of the claim plus the incentive fee. FHA also changed from referring noncompliant lenders to the Mortgagee Review Board after exhausting the use of the letters to referring them to OPE. FHA began implementing this new process in May 2017, sending the first 61-day letters requesting payment. Even though FHA had not yet procured three new contracts or fully implemented the new policies and was still experiencing delays in sending the letters, it has experienced a significant decrease in noncompliant lenders. Since the initial finding was reported in fiscal year 2014, which included 57,164 partial claims representing $1.5 billion, FHA’s number of partial claims unsupported by second mortgage notes within 60 days after execution has decreased to 695 partial claims with a total claim amount of $18 million, of which 498 with a total claim amount of $15 million are considered collectible as of fiscal yearend 2017. Conclusion FHA is no longer waiting until 6 months after execution of partial claims to begin requesting payment from lenders that do not provide the supporting promissory note; however, FHA is not always requesting payment immediately following the expiration periods. Internal controls to rectify the weaknesses in FHA’s controls related to claims that were originally identified in fiscal year 2014 were partially implemented in fiscal year 2017. As of yearend 2017, 498 collectible partial claims with a total claim amount of $15 million were missing promissory notes at least 60 days after the partial claim was executed. Collecting the amounts for unsupported partial claims in a timely manner improves the status of the Mutual Mortgage Insurance fund by restoring funds paid out as loss mitigation claims. As the recommendations from the prior-year audits remain open, we will review the results of the implementation when FHA has fully implemented the management decision. Recommendations No recommendations are made as the prior-year recommendations have not been closed. 27 The 181-day letters noted that FHA was requesting reimbursement for the list, when (1) the 6 months from the date of execution expired during a certain period (expiration dates) and (2) HUD had not previously billed the lender. 27 Finding 4: Weaknesses Were Identified in Selected FHA Information Technology Systems The ADAMS 28 application and the source applications used in the credit reform estimation and reestimation process 29 contained security vulnerabilities. These conditions occurred because of a lack of contract oversight and insufficient coordination between OCIO and FHA. As a result, the confidentiality, integrity, and availability of critical information may be negatively impacted. In addition, the information used to provide input to the FHA financial statements could be adversely affected. We also determined that remediation of weaknesses previously reported with the SFPCS-P, SAMS, SFIS, and Claims are in progress and expected to be fully remediated within the agreed-upon timeframes. ADAMS Software Maintenance Was Not Adequate FHA did not properly oversee its contractor to ensure that it provided proper software maintenance support for its ADAMS application system. Specifically, the contractor (1) used one software product that was no longer supported, (2) used different versions of another software product on the production and disaster recovery servers, and (3) did not properly maintain system security documentation. The deficiencies occurred because FHA did not adequately review the contractor-submitted monthly reports and security documents detailing the software in use and, therefore, was unable to identify, address, and resolve the noted issues. In addition, the contract for ADAMS support did not specify a requirement for the service provider to monitor, manage, maintain, and refresh the ADAMS software environment at an industry- established best practice of the software vendor’s current level of general availability 30 minus one generation or better. The ADAMS contractor also indicated that the servers hosting the production website using the unsupported software product were not upgraded sooner because the relevant website framework was not compatible with the new operating system. The contractor completed the upgrade to the servers on August 18, 2017. Also, the contractor stated that the reason for the different software product versions was an oversight on its part and agreed that the software versions should be in sync between the production and the disaster recovery environments. Lastly, the contractor did not maintain accurate system documentation because it did not meet the contract obligation to comply with National Institute of Standards and Technology, Special Publication 800-53, and HUD Information Technology Security Policy 31 28 ADAMS is a comprehensive data application that receives, stores, and displays case-level information about properties acquired by HUD or already managed by HUD. It allows users to track events and information describing the status of real property from the date of conveyance to HUD through several stages of management, marketing, and disposition to final reconciliation of sale proceeds. 29 Beginning in fiscal year 1992, the Federal Credit Reform Act (FCRA) required that the ultimate cost of credit programs be calculated and the budgetary resources be obtained before new direct loan obligations are incurred or new loan guarantee commitments are made. In meeting the FCRA requirement, FHA estimates the LGL and recovery on assets. FHA’s Office of Evaluation (OE) is responsible for the development, maintenance, and improvement of all program area cash flow models (CFM) used for credit subsidy estimation and reestimation. Annually, OE collects and consolidates data from FHA’s program and accounting systems for use in the CFMs. Data are mainly sourced from Housing Multifamily On-Line Property Integrated Information Suite Data Mart and the Single Family Housing Enterprise Data Warehouse. 30 In the software release life cycle, general availability refers to the marketing phase when all commercialization activities pertaining to the software product have been completed and it is available for purchase. 31 HUD Handbook 2400.25, REV-4.1 28 requirements to accurately document an inventory of information system components. As a result, computer systems running unsupported software are exposed to an elevated risk of cybersecurity dangers, such as malicious attacks or electronic data loss. Servers Used in FHA Credit Subsidy Reform Estimation and Reestimation Process Vulnerable The multifamily and single-family data sources for the credit reform estimation and reestimation process had not been properly protected. Vulnerability scans performed on both applications’ servers identified vulnerabilities requiring remediation. Specifically, five vulnerabilities were identified in the June 2017 scan of the Housing Multifamily On-Line Property Integrated Information Suite Data Mart 32 (HM-OPIIS) servers, and three vulnerabilities were identified in the February 2017 and July 2017 scans of the SFHEDW 33 servers. While OCIO had addressed and remediated two of the five vulnerabilities identified within HM-OPIIS, three remained outstanding. These vulnerabilities have not been addressed because the OCIO and FHA do not agree on who is responsible for addressing and remediating the vulnerabilities. OCIO stated that the remediation for the remaining vulnerabilities falls at the application level. However, HM- OPIIS management believes that the remaining three vulnerabilities fall under the purview of OCIO. Although FHA attempted to remediate the three SFHEDW vulnerabilities identified in the February 2017 scan, the same vulnerabilities were identified in the July 2017 scan. The vulnerabilities identified in July have not been fixed because the SFHEDW information technology support contractor has not been able to determine the cause of the problems. As a result, the confidentiality, integrity, and availability of the data required for the credit reestimation process could be at serious risk if the vulnerabilities identified with HM-OPIIS and SFHEDW are not remediated in a timely manner. Followup on Information System Control Weaknesses Previously Identified in FHA’s SFPCS-P and SAMS In an audit we conducted in fiscal year 2016, 34 we found that the general and application controls over SFPCS-P and SAMS did not fully comply with Federal requirements and HUD’s own security policies. FHA classified SFPCS-P as a low-impact instead of a moderate-impact system, and some software used by SFPCS-P was outdated. In addition, some interface reconciliations of the data between the source system and SFPCS-P and SAMS were insufficient, and SFPCS-P application release documents were not processed and maintained properly by the 32 HM-OPIIS is a data repository, which consolidates and standardizes data from multiple internal and external sources. It is used by field office asset managers, appraisers, and underwriters to more accurately focus default prevention, loss mitigation, and other risk management activities and to prioritize workloads so as to address the highest risk properties first. 33 SFHEDW is an integrated data warehouse that contains critical data from 21 originating source systems, which are mostly owned by the offices within the Office of Single Family Housing. SFHEDW is a key source for HUD employees and contractors who require access to single-family mortgage and insuring data. The system allows queries for reporting to support oversight activities, market and economic assessment, public and stakeholder communication, planning and performance evaluation, policy and guideline promulgation, monitoring, and enforcement. 34 Audit report 2017-DP-0002, Review of Information Systems Controls Over FHA’s Single Family Premiums Collection Subsystem – Periodic and the Single Family Acquired Asset Management System, issued February 9, 2017. This was a limited distribution report because of the sensitive nature of the information reported and was not made available to the public. 29 HUD Application Release Tracking System. Further, HUD had not included SFPCS-P in its disaster recovery exercise for more than 4 years. Also, segregation of duties for SFPCS-P developers and least privilege 35 and segregation of duties requirements for SAMS users were not fully implemented, and SFPCS-P security documents were inaccurate. We followed up on the status of these weaknesses during fiscal year 2017. HUD was addressing the weaknesses identified and implementing appropriate corrective actions. These actions are scheduled to be completed by the end of the first quarter of fiscal year 2019. Followup on Information System Control Weaknesses Previously Identified in FHA’s SFIS and Claims Systems In an audit we conducted in fiscal year 2016, 36 we found that the general and application controls over SFIS and Claims did not fully comply with Federal requirements and HUD’s own security policies. There were inconsistencies between soft error codes identified for claims submitted in May 2015 and the soft error code list maintained by FHA. In addition, for claims reported in the June 2015 suspense report, there were inconsistencies in 341 claims with errors in the initial case data and 2,018 claims with errors in the fiscal data of the application for single-family insurance benefits. OCIO also did not retain the history of software modifications, including the related approvals made throughout the development and life of the Claims system, for more than 5 years. 37 Further, user access controls for SFIS and Claims were not adequately managed. SFIS and Claims management did not adequately implement effective application configuration management for the SFIS and Claims systems. We followed up on the status of these weaknesses during fiscal year 2017. HUD was addressing the weaknesses and implementing appropriate corrective actions. These actions are scheduled to be completed by the end of the first quarter of fiscal year 2018. Conclusion FHA must improve its contract oversight of its application service provider and information security controls over the data sources used in its credit reform estimation and reestimation process to comply with Federal requirements and its own security policies to prevent an increased risk of unauthorized disclosure or modification of FHA system data. 35 HUD’s Information Technology Security Policy requires that program offices and system owners employ the concept of least privilege, allowing only authorized accesses for users (and processes acting on behalf of users), which are necessary to accomplish assigned tasks in accordance with organizational missions and business functions. 36 Audit report 2016-DP-0003, Additional Review of Information System Controls Over FHA Information Systems, issued August 31, 2016. This was a limited distribution report because of the sensitive nature of the information reported and was not made available to the public. 37 OCIO used the National Archives and Records Administration General Records Schedule 3.1 for General Technology Management Records as a guide to limit the retention of operational history of system changes to 5 years. However, the schedule also states that when the business need requires longer retention of the information, it should be saved and protected. The FHA Office of Finance and Budget requires operational change and configuration history for all system configuration and changes during the life cycle of the Claims system. 30 Recommendations Recommendations are included in a separate Office of Inspector General (OIG) audit report. Therefore, no recommendations are reported here. 31 Scope and Methodology In accordance with the Chief Financial Officers Act of 1990, as amended, OIG is responsible for conducting the annual financial statement audit of FHA. The scope of this work includes the audit of FHA’s balance sheets as of September 30, 2017 and 2016, and the related statements of net costs and changes in net position, the combined statements of budgetary resources for the years then ended, and the related notes to the financial statements. We conducted this audit in accordance with U.S. generally accepted government auditing standards and OMB Bulletin 17- 03, Audit Requirements for Federal Financial Statements. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. To fulfill these responsibilities, we • Examined, on a test basis, evidence supporting the amounts and disclosures in the principal financial statements. • Assessed the accounting principles used and the significant estimates made by management. • Evaluated the overall presentation of the principal financial statements. • Obtained an understanding of internal controls over financial reporting (including safeguarding assets) and compliance with laws and regulations (including the execution of transactions in accordance with budget authority). • Tested and evaluated the design and operating effectiveness of relevant internal controls over significant cycles, classes of transactions, and account balances. • Tested FHA’s compliance with certain provisions of laws and regulations; governmentwide policies, noncompliance with which could have a direct and material effect on the determination of financial statement amounts; and certain other laws and regulations specified in OMB Bulletin 17-03, including the requirements referred to in FMFIA. • Considered compliance with the process required by FMFIA for evaluating and reporting on internal controls and accounting systems. • Performed other procedures we considered necessary in the circumstances. We considered internal controls over financial reporting by obtaining an understanding of the design of FHA’s internal controls, determined whether these internal controls had been placed into operation, assessed control risk, and performed tests of controls to determine our auditing procedures for expressing our opinion on the principal financial statements. We also tested compliance with selected provisions of applicable laws, regulations, and government policies that may materially affect the principal financial statements. With respect to internal controls related to performance measures to be reported in FHA’s Fiscal Year 2017 Annual Management Report, we obtained an understanding of the design of 32 significant internal controls as described in OMB Bulletin 17-03. We performed limited testing procedures as required by the American Institute of Certified Public Accountants’ auditing standards at AU-C, section 730, Required Supplementary Information, and OMB Bulletin 17-03. Our procedures were not designed to provide assurance on internal controls over reported performance measures, and, accordingly, we do not provide an opinion on such controls. We did not evaluate the internal controls relevant to operating objectives as broadly defined by FMFIA. We limited our internal controls testing to those controls that are material in relation to FHA’s financial statements. Because of inherent limitations in any internal control structure, misstatements may occur and not be detected. We also caution that projection of any evaluation of the structure to future periods is subject to the risk that controls may become inadequate because of changes in conditions or that the effectiveness of the design and operation of policies and procedures may deteriorate. Our consideration of the internal controls over financial reporting would not necessarily disclose all matters in the internal controls over financial reporting that might be significant deficiencies. We noted certain matters in the internal control structure and its operation that we consider significant deficiencies under OMB Bulletin 17-03. 33 Followup on Prior Audits The current fiscal yearend status of open recommendations from prior-year reports on FHA’s financial statements are provided below. Specifically, we identified seven unimplemented recommendations from prior-year reports. FHA should continue to track these recommendations under the prior-year report numbers in accordance with departmental procedures. Each of these open recommendations and its status is shown below. Federal Housing Administration Fiscal Years 2016 and 2015 Financial Statements Audit, 2017-FO-0002 With respect to FHA not having effective monitoring and processing controls over its unliquidated obligation balances and using inaccurate data to report on its undelivered orders, we recommend that the Acting FHA Comptroller 1.a. Establish and implement policies and procedures to ensure that accurate data are used to report the undelivered order balances for management and marketing contracts. (Final action target date is November 30, 2017; reported in the Audit Resolution and Corrective Actions Tracking System (ARCATS) as 2017-FO-0002-002-C.) 1.b. Ensure that the $276.5 million identified as invalid obligations in fiscal years 2015 and 2016 are deobligated as appropriate. (Final action target date is November 30, 2017; reported in ARCATS as 2017-FO-0002-002-D.) With respect to FHA not fully implementing controls to collect the amounts for unsupported partial claims, we recommend that the Office of Single Family Housing 1.c. Revise FHA’s internal control procedures to realign with its regulatory requirements so that the first reimbursement letter is sent immediately after 60 days instead of after 6 months and establish a timeframe for collection once partial claims are referred to the Mortgagee Review Board. (Final action target date is December 28, 2017; reported in ARCATS as 2017-FO-0002-003-B.) 1.d. Request payment in the amount of the claims paid, plus incentive, from mortgagees that have not provided the original note within the prescribed deadline for the $55.3 million. (Final action target date is December 28, 2017; reported in ARCATS as 2017-FO-0002- 003-C.) Federal Housing Administration Fiscal Years 2015 and 2014 Financial Statements Audit, 2016-FO-0002 With respect to FHA not fully implementing controls to prevent misclassification of the receivables, we recommend that the Office of Single Family Housing 2.a. Start the billing process for the claims paid, plus incentive, in which the lender has not provided the original note and security instrument within the prescribed deadlines for the $291 million. (Final action target date is November 30, 2016; reported in ARCATS as 2016-FO-0002-001-C.) 34 Federal Housing Administration Fiscal Years 2014 and 2013 Financial Statements Audit, 2015-FO-0001 With respect to FHA’s not establishing appropriate receivables for legal settlements and partial claims notes, we recommended that the Director of Single Family Asset Management 3.a. Initiate the billing process for the claims paid, plus incentive, where the lender has not provided the original of the note and security instrument within the prescribed deadlines for the $1.5 billion. (Final action target date was October 31, 2015; reported in ARCATS as 2015-FO-0001-001-F.) Federal Housing Administration Fiscal Years 2013 and 2012 Financial Statements Audit, 2014-FO-0002 With respect to undelivered orders for property-related contracts being reviewed annually and deobligated promptly, we recommended that the FHA Comptroller 4.a. Review and deobligate, as appropriate, the $43 million in expired property-related contracts once they have been closed out by the contracts office. (Final action target date was October 15, 2015; reported in ARCATS as 2014-FO-0002-001-C.) 35 Appendixes Appendix A Schedule of Funds To Be Put to Better Use Recommendation Funds to be put to better number use 1/ 2.A. $270,747,281 Totals 270,747,281 1/ Recommendations that funds be put to better use are estimates of amounts that could be used more efficiently if an OIG recommendation is implemented. These amounts include reductions in outlays, deobligation of funds, withdrawal of interest, costs not incurred by implementing recommended improvements, avoidance of unnecessary expenditures noted in preaward reviews, and any other savings that are specifically identified. 36 Appendix B Auditee Comments and OIG’s Evaluation Ref to OIG Auditee Comments Evaluation Comment 1 Comment 2 37 Auditee Comments and OIG’s Evaluation Ref to OIG Auditee Comments Evaluation Comment 3 Comment 4 38 OIG Evaluation of Auditee Comments Comment 1 OIG accepts the response of concurrence with the recommendations. FHA’s continued efforts in improving its controls over the modeling process will improve the reliability of the estimation process and reliability of financial information related to the loan guarantee liability. Comment 2 OIG accepts the response of concurrence with the recommendations. FHA should continue their efforts to improve their internal controls over financial reporting in order to improve the reliability of the financial statements. Comment 3 OIG accepts the response of concurrence with the finding and previous year’s recommendations. FHA’s continued efforts to bill noncompliant lenders will continue to improve the status of the MMI fund. Comment 4 OIG accepts the response of concurrence with the finding and recommendation and looks forward to working with FHA to reach a mutually acceptable management decision to close out the recommendations during the audit resolution process. 39 Appendix C FHA’s Fiscal Years 2017 and 2016 Financial Statements and Notes 40 catastrophic FEDERAL HOUSING ADMINISTRATION (AN AGENCY OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT) CONSOLIDATED BALANCE SHEETS As of September 30, 2017, and 2016 (Dollars in Millions) FY 2017 FY 2016 ASSETS Intragovernmental Fund Balance with U.S. Treasury (Note 3) $ 29,112 $ 20,820 Investments (Note 5) 30,841 36,397 Total Intragovernmental $ 59,953 $ 57,217 Cash and Other Monetary Assets (Note 4) $ 40 53 Investments (Note 5) $ 44 31 Accounts Receivable, Net (Note 6) 220 242 Loans Receivable and Related Foreclosed Property, Net (Note 7) 18,819 17,742 TOTAL ASSETS $ 79,076 $ 75,285 LIABILITIES Intragovernmental Accounts Payable (Note 8) $ 2 $ 7 Borrowings (Note 9) 29,141 30,873 Other Liabilities (Note 10) 1,673 2,765 Total Intragovernmental $ 30,816 $ 33,645 Accounts Payable (Note 8) $ 514 $ 495 Loan Guarantee Liability (Note 7) 20,616 (806) Other Liabilities (Note 10) 636 854 TOTAL LIABILITIES $ 52,582 $ 34,188 NET POSITION Unexpended Appropriations (Note 16) $ 459 $ 415 Cumulative Results of Operations 26,035 40,682 TOTAL NET POSITION $ 26,494 $ 41,097 TOTAL LIABILITIES AND NET POSITION $ 79,076 $ 75,285 The accompanying notes are an integral part of these statements. 41 catastrophic FEDERAL HOUSING ADMINISTRATION (AN AGENCY OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT) CONSOLIDATED STATEMENTS OF NET COST For the Periods Ended September 30, 2017 and 2016 (Dollars in Millions) FY 2017 FY 2016 Single Family Forward Intragovernmental Gross Costs $ 765 $ 791 Less: Intragovernmental Earned Revenue 805 662 Intragovernmental Net Costs $ (40) $ 129 Gross Costs With the Public $ (919) $ (18,764) Less: Earned Revenues 10 14 Net Costs With the Public $ (929) $ (18,778) Single Family Forward Net Cost (Surplus) $ (969) $ (18,649) HECM Intragovernmental Gross Costs $ 235 $ 234 Less: Intragovernmental Earned Revenue 830 403 Intragovernmental Net Costs $ (595) $ (169) Gross Costs With the Public $ 21,908 $ (305) Less: Earned Revenues - 1 Net Costs With the Public $ 21,908 $ (306) HECM Net Cost (Surplus) $ 21,313 $ (475) Multifamily Intragovernmental Gross Costs $ 114 $ 111 Less: Intragovernmental Earned Revenue 23 32 Intragovernmental Net Costs $ 91 $ 79 Gross Costs With the Public $ (1,512) $ (389) Less: Earned Revenues 67 52 Net Costs With the Public $ (1,579) $ (441) Multifamily Net Cost (Surplus) $ (1,488) $ (362) Healthcare Intragovernmental Gross Costs $ 40 $ 85 Less: Intragovernmental Earned Revenue 16 53 Intragovernmental Net Costs $ 24 $ 32 Gross Costs With the Public $ (322) $ (129) Less: Earned Revenues $ 1 $ 1 Net Costs With the Public $ (323) $ (130) Healthcare Net Cost (Surplus) $ (299) $ (98) Salaries and Administrative Expenses Intragovernmental Gross Costs $ 27 $ 17 Less: Intragovernmental Earned Revenue - - Intragovernmental Net Costs $ 27 $ 17 Gross Costs With the Public $ 523 $ 591 Less: Earned Revenues - - Net Costs With the Public $ 523 $ 591 Adminstrative and Contracts Net Cost (Surplus) $ 550 $ 608 Net Cost of Operations $ 19,107 $ (18,976) The accompanying notes are an integral part of these statements. 42 catastrophic FEDERAL HOUSING ADMINISTRATION (AN AGENCY OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT) CONSOLIDATED STATEMENTS OF NET POSITION For the Periods Ended September 30, 2017 and 2016 (Dollars in Millions) CUMULATIVE RESULTS OF OPERATIONS (Note 16) FY 2017 FY 2016 Beginning Balance $ 40,682 $ 19,046 Adjustments Corrections of Errors - 835 Beginning Balance, As Adjusted $ 40,682 $ 19,881 Budgetary Financing Sources: Appropriations Used 4,429 3,393 Non-Exchange Revenue 2 - Other Financing Sources (Nonexchange) Transfers In/Out Without Reimbursement 426 480 Imputed Financing From Costs 13 15 Other (412) (2,063) Total Financing Sources $ 4,458 $ 1,825 Net Cost of Operations (19,107) 18,976 Net Change (14,647) 20,801 Cummulative Results of Operation $ 26,035 $ 40,682 Unexpended Appropriations (Note 16) Beginning Balance 415 $ 871 Budgetary Financing Sources Appropriations Received 4,473 3,437 Other Adjustments (Recissions, etc) - (500) Appropriations Used (4,429) (3,393) Total Budgetary Financing Sources $ 44 $ (456) Unexpended Appropriation $ 459 $ 415 Net Position $ 26,494 $ 41,097 The accompanying notes are an integral part of these statements. 43 catastrophic FEDERAL HOUSING ADMINISTRATION (AN AGENCY OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT) COMBINED STATEMENT OF BUDGETARY RESOURCES For the Period Ended September 30, 2017 (Dollars in Millions) FY 2017 FY 2017 FY 2017 Budgetary Non-Budgetary Total Budgetary Resources: Unobligated balance brought forward, October 1 $ 37,758 $ 16,411 $ 54,169 Adjustment to unobligated balance brought forward, October 1 (+ or -) - 234 234 Unobligated balance brought forward, October 1, as adjusted 37,758 16,645 54,403 Recoveries of prior year unpaid obligations 11 82 93 Other changes in unobligated balance (+ or -) (425) - (425) Unobligated balance from prior year budget authority, net 37,343 16,727 54,070 Appropriations (discretionary and mandatory) 4,473 - 4,473 Borrowing authority (discretionary and mandatory) - 8,376 8,376 Spending authority from offsetting collections (discretionary and 13,289 34,665 47,954 mandatory) Total budgetary resources $ 55,105 $ 59,768 $ 114,873 Status of Budgetary Resources: Obligations incurred $ 23,217 $ 34,975 $ 58,192 Unobligated balance, end of year: Apportioned 69 6,272 6,341 Unapportioned 31,761 18,521 50,282 Unexpired unobligated balance, end of year 31,830 24,793 56,623 Expired unobligated balance, end of year 58 - 58 Total unobligated balance, end of year 31,888 24,793 56,681 Total budgetary resources 55,105 59,768 114,873 Change in Obligated Balance: Unpaid obligations, brought forward, October 1 (gross) $ 346 $ 2,650 $ 2,996 Uncollected customer payments from Federal sources, brought forward, (35) - (35) October 1 (-) Obligated balance, start of year (net), before adjustments (+ or -) 311 2,650 2,961 Obligated balance, start of year (net), as adjusted 311 2,650 2,961 Obligations incurred 23,217 34,975 58,192 Outlays (gross) (-) (23,160) (34,181) (57,341) Change in uncollected customer payments from Federal sources (+ or -) (13) - (13) Recoveries of prior year unpaid obligations (-) (11) (82) (93) Unpaid obligations, end of year (gross) 393 3,362 3,755 Uncollected customer payments from Federal sources, end of year (48) - (48) Obligated balance, end of year (net) $ 345 $ 3,362 $ 3,707 Budget Authority and Outlays, Net: Budget authority, gross (discretionary and mandatory) $ 17,762 $ 43,040 $ 60,802 Actual offsetting collections (discretionary and mandatory) (-) (13,275) (44,469) (57,744) Change in uncollected customer payments from Federal sources (13) - (13) Budget authority, net (discretionary and mandatory) 4,473 (1,429) 3,044 Outlays, gross (discretionary and mandatory) 23,160 34,181 57,341 Actual offsetting collections (discretionary and mandatory) (-) (13,275) (44,469) (57,744) Outlays, net (discretionary and mandatory) 9,885 (10,288) (403) Less Distributed offsetting receipts (-) (1,078) - (1,078) Agency outlays, net (discretionary and mandatory) $ 8,807 $ (10,288) $ (1,481) The accompanying notes are an integral part of these statements 44 catastrophic FEDERAL HOUSING ADMINISTRATION (AN AGENCY OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT) COMBINED STATEMENT OF BUDGETARY RESOURCES For the Period Ended September 30, 2016 (Dollars in Millions) FY 2016 FY 2016 FY 2016 Budgetary Non-Budgetary Total Budgetary Resources: Unobligated balance brought forward, October 1 $ 16,733 $ 33,986 $ 50,719 Adjustment to unobligated balance brought forward, October 1 (+ or -) - (3) (3) Unobligated balance brought forward, October 1, as adjusted 16,733 33,983 50,716 Recoveries of prior year unpaid obligations 241 463 704 Other changes in unobligated balance (+ or -) (681) - (681) Unobligated balance from prior year budget authority, net 16,293 34,446 50,739 Appropriations (discretionary and mandatory) 3,431 - 3,431 Borrowing authority (discretionary and mandatory) - 13,077 13,077 Spending authority from offsetting collections (discretionary and 25,010 19,800 44,810 mandatory) Total budgetary resources $ 44,734 $ 67,323 $ 112,057 Status of Budgetary Resources: Obligations incurred $ 6,976 $ 50,911 $ 57,887 Unobligated balance, end of year: Apportioned 70 5,574 5,644 Unapportioned 37,648 10,838 48,486 Unexpired unobligated balance, end of year 37,718 16,412 54,130 Expired unobligated balance, end of year 40 - 40 Total unobligated balance, end of year 37,758 16,412 54,170 Total budgetary resources $ 44,734 $ 67,323 $ 112,057 Change in Obligated Balance: Unpaid obligations, brought forward, October 1 (gross) $ 564 $ 2,485 $ 3,049 Uncollected customer payments from Federal sources, brought forward, (15) - (15) October 1 (-) Obligated balance, start of year (net), before adjustments (+ or -) 549 2,485 3,034 Adjustment to obligated balance, start of year (net) (+ or -) - 3 3 Obligated balance, start of year (net), as adjusted 549 2,488 3,037 Obligations incurred 6,976 50,911 57,887 Outlays (gross) (-) (6,953) (50,286) (57,239) Change in uncollected customer payments from Federal sources (+ or -) (20) - (20) Recoveries of prior year unpaid obligations (-) (241) (463) (704) Unpaid obligations, end of year (gross) 346 2,650 2,996 Uncollected customer payments from Federal sources, end of year (35) - (35) Obligated balance, end of year (net) $ 311 $ 2,650 $ 2,961 Budget Authority and Outlays, Net: Budget authority, gross (discretionary and mandatory) $ 28,441 $ 32,876 $ 61,317 Actual offsetting collections (discretionary and mandatory) (-) (24,991) (29,027) (54,018) Change in uncollected customer payments from Federal sources (20) - (20) Recoveries of prior year paid obligations (discretionary and mandatory) 1 - 1 Budget authority, net (discretionary and mandatory) 3,431 3,849 7,280 Outlays, gross (discretionary and mandatory) 6,953 50,286 57,239 Actual offsetting collections (discretionary and mandatory) (-) (24,991) (29,027) (54,018) Outlays, net (discretionary and mandatory) (18,038) 21,259 3,221 Less Distributed offsetting receipts (-) (2,000) - (2,000) Agency outlays, net (discretionary and mandatory) $ (20,038) $ 21,259 $ 1,221 The accompanying notes are an integral part of these statements. 45 catastrophic NOTES TO THE FINANCIAL STATEMENTS September 30, 2017 Note 1. Significant Accounting 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 (31 U.S.C. § 9101 et seq.), 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 Housing 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 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, healthcare facilities, property improvements, manufactured homes, and reverse mortgages, also referred to as Home Equity Conversion Mortgages (HECM). The objectives of activities carried out by FHA relate directly to the development of affordable housing. FHA categorizes its insurance programs as Single Family (including Title 1), Multifamily, Healthcare, and HECM. Single Family activities support initial or continued home ownership; Title I activities support manufactured housing and property improvement. Multifamily and Healthcare 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 insurance 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 MMI 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. To comply with the FHA Modernization Act of 2008, activities related to most Single Family programs, including HECM, endorsed in Fiscal Year 2009 and going forward, are in the MMI 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 required FHA to modify existing programs and initiated the H4H program and fund, which guaranteed loans for three years. No new H4H loans have been guaranteed since FY 2011. 46 catastrophic For the Loan Guarantee Program at FHA, there are Single Family and Multifamily activities in both the MMI/CMHI and GI/SRI funds. The H4H fund only contains Single Family activity. The following table illustrates how the primary Single Family program activities for FHA 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/SRI 234(c), HECM N/A MMI 203(b) 203(b), 234(c), HECM In fiscal year 2010, FHA received appropriations for the Energy Innovation and Transformation Initiative programs. The Energy Innovation program is intended to catalyze innovations in the residential energy efficiency sector that have the ability to be replicated and to help create a standardized home energy efficient retrofit market. The appropriation for the Transformation Initiative was for combating mortgage fraud. 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 Statement of Budgetary Resources (SBR), is based on concepts and guidance provided by the Office of Management and Budget (OMB) Circular A-11, 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 principal program funds, revolving funds, 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 sheet, statement of net cost, and statements of changes in net position. The SBR is prepared on a combined basis as required by OMB Circular A-136, Financial Reporting Requirements, Revised. 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 Securities Held Outside of Treasury. 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 interest method in accordance with the Statement of Federal Financial Accounting Standards (SFFAS) No. 1 Accounting for Selected Assets and Liabilities, paragraph 71. 47 catastrophic 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 the claim amount paid by FHA on defaulted insured loans. Securities Held Outside of Treasury represent marketable stock received as part of a settlement and held outside of the U.S. Treasury through a Treasury authorized broker. 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 Statement 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 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. FHA has two general fund receipt accounts. FHA’s receipt accounts are general fund receipt accounts and these amounts are not earmarked for the FHA’s credit programs. The first is used for the receipt of amounts paid from the GI/SRI financing account when there is negative subsidy from the original estimate or a downward reestimate. They are available for appropriations only in the sense that all general fund receipts are available for appropriations. Any assets in these accounts are non-entity assets and are offset by intragovernmental liabilities. At the end of the fiscal year, the fund balance in this general fund receipt account is transferred to the U.S. Treasury general fund. The second general fund receipt account is used for the unobligated balance transferred from GI/SRI liquidating account and loan modifications. Similar to the general fund receipt account used for the GI/SRI negative subsidy and downward reestimates, the amounts in this account are not earmarked for FHA’s credit programs and are returned to Treasury at the end of the fiscal year. Any assets in this account are non-entity assets and are offset by intragovernmental liabilities. Negative subsidy and downward reestimates in the MMI/CMHI fund are transferred to the Capital Reserve account. Capital Reserve balances are accumulated for unanticipated losses. The liquidating account 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 GI/SRI liquidating account can receive permanent indefinite authority to cover any resource shortages. 48 catastrophic Loans Receivable and Related Foreclosed Property, Net FHA’s loans receivable include mortgage notes assigned (MNA), also described as Secretary-held notes, purchase money mortgages (PMM), notes related to partial claims, and direct loans relating to the Federal Financing Bank Risk Share program. Under the requirements of the FCRA, PMM notes are considered to be direct loans while 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. The majority of MNAs are HECM notes. HECM loans, while not in default, are assigned to HUD when they reach 98% of their maximum claim amount. 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. Partial claims notes arise when FHA pays a loss mitigation amount to keep a borrower current on their loan. FHA, in turn, records a loan receivable which takes a second position to the primary mortgage. 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 with these assets, primarily from 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. Pre-Credit Reform loans receivable and related foreclosed property in inventory are recorded at net realizable value which is based on recovery rates net of any selling expenses (see Note 7). Loan Guarantee Liability The net potential future losses related to FHA’s central business of providing mortgage insurance are reflected in the Loan Guarantee Liability in the consolidated balance sheet. 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 7). 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 GI/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 GI/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 49 catastrophic 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 associated with loans receivable and related 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 7, 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 7, 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. FHA 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 Housing activities. Current HUD policy concerning SFFAS No. 10, Accounting for Internal Use Software, indicates that HUD 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 has several procurement actions in place and incurred expenses for software development are transferred to HUD to comply with departmental policy. Appropriations FHA receives appropriations for certain operating expenses for its program activities. Additionally, FHA receives appropriations for GI/SRI positive subsidy, upward re-estimates, and permanent indefinite authority to cover any shortage of resources in the liquidating account. Full Cost Reporting SFFAS No. 4, Managerial Cost Accounting Concepts and Standards and SFFAS No. 30, Inter-Entity Cost Implementation: Amending SFFAS 4, Managerial Cost Accounting Standards and Concepts to account for costs assumed by other Federal organizations on their behalf, require 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. HUD allocates each responsibility segment’s share of the program costs or resources provided by other federal agencies. As a responsibility segment of HUD, FHA’s portion of these costs was $13 million for fiscal year 2017 and $15 million for fiscal year 2016, and it was included in FHA’s financial statements as an imputed cost in the Consolidated Statement of Net Cost, and as imputed financing in the Consolidated Statement of Changes in Net Position. 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 50 catastrophic 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 OMB Circular A-136, and in accordance with SFFAS No. 1. 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. FHA's budgetary resources include current 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 offsetting 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. 51 catastrophic 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, 2017 and 2016 are as follows: (Dollars in millions) FY 2017 FY 2016 Intragovernmental: Fund Balance with Treasury $ 19 $ 35 Total Intragovernmental 19 35 Cash and Other Monetary Assets 26 29 Total Non-Entity Assets 45 64 Total Entity Assets 79,030 75,221 Total Assets $ 79,075 $ 75,285 FHA’s non-entity assets consist of escrow monies collected by FHA from the borrowers of its loans. Cash and other monetary assets that are collected from FHA borrowers consist of escrow monies that 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 maintenance expenses on behalf of the borrowers. In FY 2016, escrow monies deposited at minority-owned banks were reported as other assets in Note 2 – Non-Entity Assets and in Note 7 – Other Assets. 52 catastrophic 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, 2017 and 2016: (Dollars in millions) FY 2017 FY 2016 Fund Balances: Revolving Funds $ 28,000 $ 19,699 Appropriated Funds 269 245 Other Funds 843 876 Total $ 29,112 $ 20,820 Status of Fund Balance with U.S. Treasury: Unobligated Balance Available $ 6,044 $ 5,643 Unavailable 19,314 12,180 Obligated Balance Not Yet Disbursed 3,754 2,997 Total $ 29,112 $ 20,820 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 annual or multi-year program accounts that 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 canceled and any remaining resources are returned to the U.S. Treasury. Other Funds FHA’s other funds include the general fund receipt accounts established under the FCRA and the deposit funds for the receipt of bid deposits for asset sales. Additionally, the capital reserve account is included with these funds and is used to retain the MMI/CMHI negative subsidy and downward credit subsidy re-estimates transferred from the financing account. If subsequent upward credit subsidy re-estimates 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 OMB 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. 53 catastrophic Note 4. Cash and Other Monetary Assets (Dollars in millions) FY 2017 FY 2016 With the Public: Escrow Monies Deposited at Minority-Owned Banks $ 26 $ 29 Deposits in Transit 14 24 Total $ 40 $ 53 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 renovation expenses. These escrow monies are deposited at the U.S. Treasury (see Note 2), invested in U.S. Treasury securities (see Note 5 - GI/SRI Investments) or deposited at minority-owned banks. Deposits in Transit Deposits in Transit is cash that has not been confirmed as being received by the U.S. Treasury. Once the U.S. Treasury has confirmed that this cash has been received, the cash will be moved from Deposits in Transit to Fund Balance with U.S. Treasury. In FY 2016, Escrow Monies Deposited at Minority-Owned Banks were reported as Other Assets in Note 2 – Non- Entity Assets and with Deposits in Transit in Note 7 – Other Assets. 54 catastrophic Note 5. 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, 2017 were as follows: (Dollars in millions) Amortized (Premium) FY 2017 Cost / Discount, Net Investments, Net Market Value MMI/CMHI Investments $ 30,744 $ 51 $ 30,795 $ 30,747 MMI/CMHI Accrued Interest 46 46 Total $ 30,744 $ 51 $ 30,841 $ 30,793 The cost, net amortized premium/discount, net investment, and market values as of September 30, 2016 were as follows: Amortized (Premium) FY 2016 Cost / Discount, Net Investments, Net Market Value MMI/CMHI Investments $ 36,311 $ 54 $ 36,365 $ 36,389 MMI/CMHI Accrued Interest 32 32 Total $ 36,311 $ 54 $ 36,397 $ 36,421 Investments in Private-Sector Entities Investments in Private Sector Entities as of September 30, 2017 and 2016 were as follows: Beginning New Ending (Dollars in millions) Balance Acquisitions Redeemed Balance FY 2017 Securities Held Outside of Treasury $ - $ 13 $ - $ 13 Risk Sharing Debentures $ 31 $ - $ - $ 31 Total $ 31 $ 13 $ - $ 44 FY 2016 Risk Sharing Debentures $ 31 $ - $ - $ 31 Total $ 31 $ - $ - $ 31 55 catastrophic Note 6. Accounts Receivable, Net Accounts receivable, net, as of September 30, 2017 and 2016 are as follows: Gross Allowance Net (Dollars in millions) FY 2017 FY 2016 FY 2017 FY 2016 FY 2017 FY 2016 With the Public: Receivables Related to $ 12 $ 9 $ (1) $ (1) $ 11 $ 8 Credit Program Assets Premiums Receivables - 1 - - - 1 Partial Claims Receivables 18 77 (8) (23) 10 54 Generic Debt Receivables 301 264 (300) (264) 1 - Settlements Receivables 109 141 - - 109 141 Miscellaneous Receivables 89 38 - - 89 38 Total $ 529 $ 530 $ (309) $ (288) $ 220 $ 242 Receivables Related to Credit Program Assets These receivables include asset sale proceeds receivables and rent receivables from FHA’s foreclosed properties. Premium Receivables These amounts consist of the 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. Partial Claim Receivables Partial Claim receivables represents partial claims paid by FHA to mortgagees as part of its loss mitigation efforts to bring delinquent loans current for which FHA does not yet have the promissory note recorded. Generic Debt Receivables These amounts are mainly comprised of receivables from various sources, the largest of which are Single Family Partial Claims, Single Family Indemnifications, and Single Family Restitutions. Settlement Receivables FHA receives signed consent judgments that are approved by the courts but which funds have not been received. Miscellaneous Receivables Miscellaneous receivables include late charges and penalties receivables on delinquent premium receivables, refund receivables from overpayments of claims, 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. 56 catastrophic Note 7. Direct Loans and Loan Guarantees, Non-Federal Borrowers Direct Loan and Loan Guarantee Programs Administered by FHA include: Single Family Forward Mortgages Multifamily Mortgages Healthcare Mortgages Home Equity Conversion Mortgages (HECM) FHA reports its insurance operations in four overall program areas: Single Family Forward mortgages, Multifamily mortgages, Healthcare mortgages, and Home Equity Conversion Mortgages (HECM). FHA operates these programs primarily through four insurance funds: Mutual Mortgage Insurance (MMI), General Insurance (GI), Special Risk Insurance (SRI), and Cooperative Management Housing Insurance (CMHI), with the MMI fund being the largest. There is a fifth fund, Hope for Homeowners (H4H), which became operational in fiscal year 2009 which contains minimal activity. FHA encourages homeownership through its Single Family Forward programs (Section 203(b), which is the largest program, and Section 234) with its mortgage insurance programs. These programs insure mortgage lenders against losses from default, enabling those lenders to provide mortgage financing on favorable terms to homebuyers. Multifamily Housing Programs (Section 213, Section 221(d)(4), Section 207/223(f), and Section223(a)(7)) provide FHA insurance to approved lenders to facilitate the construction, rehabilitation, repair, refinancing, and purchase of multifamily housing projects such as apartment rentals, and cooperatives. Healthcare programs (Section 232 and Section 242) enable low cost financing of healthcare facility projects and improve access to quality healthcare by reducing the cost of capital. The HECM program provides eligible homeowners who are 62 years of age and older access to the equity in their property with flexible terms. FHA Direct Loan and Loan Guarantee Programs and the related loans receivable, foreclosed property, and Loan Guarantee Liability as of September 30, 2017 and 2016 are as follows: Direct Loan Programs: Starting in FY 2015, FHA began a Federal Financing Bank (FFB) Risk Share program, an inter-agency partnership between HUD, FFB and various Housing Finance Authorities (HFAs). The FFB Risk Share program provides funding for multifamily mortgage loans insured by FHA. Under this program, FHA records a direct loan with the public as an asset on its balance sheet, and conversely, borrowing from FFB as a liability. The program does not change the basic structure of Risk Sharing; it only substitutes FFB as the funding source. The HFAs originate and service the loans, and share in any losses. In FY 2017, FHA changed the way it estimates its direct loan allowance for subsidy and credit subsidy re-estimates for these risk share loans. The cash flow model for FFB direct loan program is developed by collecting and consolidating data from FHA’s program and accounting systems. The model is based upon trends and assumptions of historical data and analysis but, where necessary, management’s judgment. The model uses actual data through August of the current fiscal year and projections are used to estimate the direct loan cash flows for the following month of September. The model estimates total loan commitments and the percentage of commitments that will be disbursed prior to the end of the fiscal year. Previously, FHA used the estimated direct loan values from its models to calculate the allowance for subsidy and credit subsidy re-estimates. In FY 2017, FHA analyzed the estimated direct loans disbursed compared to actual loans disbursed at September 30th. Based on this information, management determined that an adjustment was necessary to better estimate the Direct Loan value. FHA calculated the ratio of the allowance for subsidy to the 57 catastrophic direct loan unpaid principal balance per the cash flow models and applied that ratio to the actual direct loans disbursed to estimate the allowance for subsidy and credit subsidy re-estimate. 58 catastrophic Direct Loans Obligated (Pre-1992): (Dollars in Millions) GI/SRI - Multifamily Total September 30, 2017 Loan Receivables $ 8 $ 8 Interest Receivables 13 13 Allowance (4) (4) Total Value of Assets $ 17 $ 17 September 30, 2016 GI/SRI - Multifamily Total Loan Receivables $ 8 $ 8 Interest Receivables 12 12 Allowance (4) (4) Total Value of Assets $ 16 $ 16 Direct Loans Obligated (Post-1991): (Dollars in Millions) MMI/CMHI - Single Family GI/SRI - Multifamily Total September 30, 2017 Loan Receivables $ - $ 1,193 $ 1,193 Interest Receivables - 4 4 Allowance - 37 37 Total Value of Assets $ - $ 1,234 $ 1,234 September 30, 2016 MMI/CMHI - Single Family GI/SRI - Multifamily Total Loan Receivables $ - $ 554 $ 554 Interest Receivables - 1 1 Allowance (3) 27 24 Total Value of Assets $ (3) $ 582 $ 579 59 catastrophic Total Amount of Direct Loans Disbursed (Post- 1991): (Dollars in Millions) FY 2017 FY 2016 Direct Loan Programs GI/SRI Multifamily/Healthcare $ 639 $ 451 GI/SRI Subtotal $ 639 $ 451 Subsidy Expense for Direct Loans: September 30, 2017 GI/SRI Total Multifamily/Healthcare FFB Financing $ (76) $ (76) Defaults 1 1 Fees and Other Collections (18) (18) Other 21 21 Subtotal $ (72) $ (72) September 30, 2016 GI/SRI Total Multifamily/Healthcare FFB Financing $ (68) $ (68) Defaults 4 4 Fees and Other Collections (9) (9) Other 21 21 Subtotal $ (52) $ (52) 60 catastrophic Subsidy Expense for Re-estimates: (Dollars in millions) FY 2017 Technical Reestimate MMI/CMHI $ (6) GI/SRI 67 Total $ 61 FY 2016 GI/SRI 64 Total $ 64 Total Direct Loan Subsidy Expense: FY 2017 FY 2016 Direct Loan Programs MMI/CMHI $ (6) $ - GI/SRI $ (5) $ 13 Total $ (11) $ 13 Subsidy Rates for Direct Loans by Program and Component September 30, 2017 Fees and Other Finance Default Other Total Collections GI/SRI Multifamily FFB -13.92% 0.01% -0.97% 3.69% -11.19% September 30, 2016 Fees and Other Finance Default Other Total Collections GI/SRI Multifamily FFB 0.00% 2.61% -7.06% 0.00% -4.45% 61 catastrophic Schedule for Reconciling Subsidy Cost Allowance Balances: Beginning Balance, Changes, and Ending Balance FY 2017 FY 2016 Beginning balance of the subsidy cost allowance $ (24) $ (30) Add: subsidy expense for direct loans disbursed during the reporting years by component -Financing (76) (68) - Default costs (net recoveries) 1 4 - Fees and other collections (18) (9) - Other subsidy costs 21 21 Total of the above subsidy expense components $ (72) $ (52) Adjustments: - Fees received 3 1 - Subsidy allowance amortization (4) 28 - Other (4) - nding balance of the subsidy cost allowance before reestimat $ (101) $ (53) Add or subtract subsidy reestimates by component: - Technical/default reestimate -Subsidy Expense Component 110 46 -Interest Expense Component 3 2 -Total of the above reetimate components 113 $ 48 Adjustment of prior years' credit subsidy reestimates (49) (19) Total Technical/Default Reestimate $ 64 $ 29 Ending balance of the subsidy cost allowance $ (37) $ (24) 62 catastrophic Loan Guarantee Programs: Defaulted Guaranteed Loans from Pre-1992 Guarantees (Allowance for Loss Method): (Dollars in Millions) FY 2017 MMI/CMHI GI/SRI Total Guaranteed Loans Single Family Forward Loan Receivables $ 19 $ - $ 19 Foreclosed Property 5 9 14 Allowance for Loan Losses (4) (4) (8) Subtotal $ 20 $ 5 $ 25 Multifamily/Healthcare Loan Receivables $ - $ 1,614 $ 1,614 Interest Receivables - 231 231 Allowance for Loan Losses - (682) (682) Subtotal $ - $ 1,163 $ 1,163 HECM Loan Receivables $ - $ 3 $ 3 Interest Receivables - 1 1 Foreclosed Property - (2) (2) Allowance for Loan Losses - (1) (1) Subtotal $ - $ 1 $ 1 Total Guaranteed Loans $ 20 $ 1,169 $ 1,189 (Dollars in Millions) FY 2016 MMI/CMHI GI/SRI Total Guaranteed Loans Single Family Forward Loan Receivables $ 21 $ - $ 21 Foreclosed Property 7 9 16 Allowance for Loan Losses (5) (3) (8) Subtotal $ 23 $ 6 $ 29 Multifamily/Healthcare Loan Receivables $ - $ 1,780 $ 1,780 Interest Receivables - 230 230 Foreclosed Property - 1 1 Allowance for Loan Losses - (818) (818) Subtotal $ - $ 1,193 $ 1,193 HECM Loan Receivables $ - $ 4 $ 4 Interest Receivables - 2 2 Foreclosed Property - (2) (2) Allowance for Loan Losses - (5) (5) Subtotal $ - $ (1) $ (1) Total Guaranteed Loans $ 23 $ 1,198 $ 1,221 *HECM loans, while not defaulted, have reached 98% of the maximum claim amount and have been assigned to FHA. 63 catastrophic Defaulted Guaranteed Loans from Post-1991 Guarantees: (Dollars in Millions) FY 2017 MMI/CMHI GI/SRI H4H Total Guaranteed Loans Single Family Forward Loan Receivables $ 11,160 $ 416 $ 5 $ 11,581 Interest Receivables - - - - Foreclosed Property 1,437 35 - 1,472 Allowance (6,133) (225) (5) (6,363) Subtotal $ 6,464 $ 226 $ - $ 6,690 Multifamily/Healthcare Loan Receivables $ - $ 645 $ - $ 645 Interest Receivables - (1) - (1) Foreclosed Property - 1 - 1 Allowance - (272) - (272) Subtotal $ - $ 373 $ - $ 373 HECM Loan Receivables $ 6,992 $ 3,701 $ - $ 10,693 Interest Receivables 4,176 1,981 - 6,157 Foreclosed Property 36 79 - 115 Allowance (5,052) (2,597) - (7,649) Subtotal $ 6,152 $ 3,164 $ - $ 9,316 Total Guaranteed Loans $ 12,616 $ 3,763 $ - $ 16,379 (Dollars in Millions) FY 2016 MMI/CMHI GI/SRI H4H Total Guaranteed Loans Single Family Forward Loan Receivables $ 10,320 $ 350 $ 5 $ 10,675 Interest Receivables 5 - - 5 Foreclosed Property 2,817 74 1 2,892 Allowance (7,326) (241) (5) (7,572) Subtotal $ 5,816 $ 183 $ 1 $ 6,000 Multifamily/Healthcare Loan Receivables $ - $ 735 $ - $ 735 Foreclosed Property - 1 - 1 Allowance - (365) - (365) Subtotal $ - $ 371 $ - $ 371 HECM Loan Receivables $ 4,472 $ 3,593 $ - $ 8,065 Interest Receivables 2,351 1,830 - 4,181 Foreclosed Property 36 132 - 168 Allowance (1,580) (1,279) - (2,859) Subtotal $ 5,279 $ 4,276 $ - $ 9,555 Total Guaranteed Loans $ 11,095 $ 4,830 $ 1 $ 15,926 *HECM loans, while not defaulted, have reached 98% of the maximum claim amount and have been assigned to FHA. 64 catastrophic Guaranteed Loans Outstanding: (Dollars in Millions) Outstanding Amount of Principal of Outstanding Guaranteed Loans, Principal Loan Guarantee Programs Face Value Guaranteed Guaranteed Loans Outstanding (FY 2017): MMI/CMHI Single Family Forward $ 1,272,515 $ 1,153,875 Multifamily/Healthcare 640 605 MMI/CMHI Subtotal $ 1,273,155 $ 1,154,480 GI/SRI Single Family Forward $ 8,120 $ 5,414 Multifamily/Healthcare 128,163 117,604 GI/SRI Subtotal $ 136,283 $ 123,018 H4H Single Family - 257 $ 81 $ 74 H4H Subtotal $ 81 $ 74 Total $ 1,409,519 $ 1,277,572 Guaranteed Loans Outstanding (FY 2016): RESTATED MMI/CMHI Single Family Forward $ 1,210,295 $ 1,100,046 Restated Multifamily/Healthcare 617 590 Restated MMI/CMHI Subtotal $ 1,210,912 $ 1,100,636 Restated GI/SRI Single Family Forward $ 9,310 $ 6,482 Restated Multifamily/Healthcare 118,319 108,744 GI/SRI Subtotal $ 127,629 $ 115,226 Restated H4H Single Family - 257 $ 90 $ 83 H4H Subtotal $ 90 $ 83 Total $ 1,338,631 $ 1,215,945 Restated 65 catastrophic New Guaranteed Loans Disbursed (FY 2017): (Dollars in Millions) Outstanding Amount of Principal of Outstanding Guaranteed Loans, Principal Face Value Guaranteed MMI/CMHI Single Family Forward $ 250,904 $ 248,286 Multifamily/Healthcare 22 22 MMI/CMHI Subtotal $ 250,926 $ 248,308 GI/SRI Single Family Forward $ 98 $ 97 Multifamily/Healthcare 16,786 16,710 GI/SRI Subtotal $ 16,884 $ 16,807 Total $ 267,810 $ 265,115 New Guaranteed Loans Disbursed (FY 2016): RESTATED MMI/CMHI Single Family Forward $ 245,466 $ 242,905 Restated Multifamily/Healthcare 85 85 MMI/CMHI Subtotal $ 245,551 $ 242,990 GI/SRI Single Family Forward $ 107 $ 106 Multifamily/Healthcare 12,117 12,062 GI/SRI Subtotal $ 12,224 $ 12,168 Total $ 257,775 $ 255,158 Restated 66 catastrophic 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, FHA has insured 1,052,332 HECM loans with a maximum claim amount of $252 billion. Of these 1,052,332 HECM loans insured by FHA, 580,093 loans with a maximum claim amount of $148 billion are still active. As of September 30, 2017, the insurance-in-force (the outstanding balance of active loans) was $105 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 FHA. Home Equity Conversion Mortgage Loans Outstanding (not included in the balances in the previous table) (Dollars in Millions) Cumulative Current Maximum Current Year Outstanding Potential Loan Guarantee Programs Endorsements Balance Liability FY 2017 MMI/CMHI $ 17,691 $ 72,968 $ 110,252 GI/SRI - $ 30,629 $ 37,330 Total $ 17,691 $ 103,597 $ 147,582 RESTATED FY 2016 MMI/CMHI $ 14,659 $ 70,375 $ 105,196 Restated GI/SRI - 34,294 42,948 Total $ 14,659 $ 104,669 $ 148,144 Restated 67 catastrophic Loan Guarantee Liability, Net: (Dollars in Millions) FY 2017 MMI/CMHI GI/SRI H4H Total LLR Single Family Forward $ 9 $ - $ - $ 9 Multifamily/Healthcare - (1) - (1) Subtotal $ 9 $ (1) $ - $ 8 LLG Single Family Forward $ (2,143) $ 339 $ 18 $ (1,786) Multifamily/Healthcare (17) (4,108) - (4,125) HECM 15,187 11,332 - 26,519 Subtotal $ 13,027 $ 7,563 $ 18 $ 20,608 Loan Guarantee Liability Total $ 13,036 $ 7,562 $ 18 $ 20,616 FY 2016 MMI/CMHI GI/SRI H4H Total LLR Single Family Forward $ 1 $ - $ - $ 1 Multifamily/Healthcare - (1) - (1) Subtotal $ 1 $ (1) $ - $ - LLG Single Family Forward $ (7,683) $ 79 $ 16 $ (7,588) Multifamily/Healthcare (24) (3,141) - (3,165) HECM 3,460 6,487 - 9,947 Subtotal $ (4,247) $ 3,425 $ 16 $ (806) Loan Guarantee Liability Total $ (4,246) $ 3,424 $ 16 $ (806) 68 catastrophic Subsidy Expense for Loan Guarantees by Program and Component: (Dollars in millions) FY 2017 MMI/CMHI GI/SRI Total Single Family Forward Defaults $ 6,073 $ 5 $ 6,078 Fees and Other Collections (19,523) (8) (19,531) Other 2,359 - 2,359 Subtotal $ (11,091) $ (3) $ (11,094) Multifamily/Healthcare Defaults $ 1 $ 208 $ 209 Fees and Other Collections (2) (882) (884) Subtotal $ (1) $ (674) $ (675) HECM Defaults $ 1,250 $ - $ 1,250 Fees and Other Collections (1,308) - (1,308) Subtotal $ (58) $ - $ (58) Total (11,150) (677) (11,827) FY 2016 MMI/CMHI GI/SRI Total Single Family Forward Defaults $ 5,585 $ 5 $ 5,590 Fees and Other Collections (16,457) (8) (16,465) Other 1,791 - 1,791 Subtotal $ (9,081) $ (3) $ (9,084) Multifamily/Healthcare Defaults $ 2 $ 176 $ 178 Fees and Other Collections (5) (653) (658) Subtotal $ (3) $ (477) $ (480) HECM Defaults $ 844 $ - $ 844 Fees and Other Collections (945) - (945) Subtotal $ (101) $ - $ (101) Total $ (9,185) $ (480) $ (9,665) 69 catastrophic Subsidy Expense for Modification and Re-estimates: (Dollars in millions) Total Technical FY 2017 Modifications Reestimate MMI/CMHI $ - $ 21,112 GI/SRI - 3,693 Total $ - $ 24,805 FY 2016 MMI/CMHI $ - $ (7,897) GI/SRI - (289) Total $ - $ (8,186) Total Loan Guarantee Subsidy Expense: Total Loan Guarantee Subsidy Expense: (Dollars in millions) FY 2017 FY 2016 MMI/CMHI $ 9,962 $ (17,082) GI/SRI 3,017 (769) Total $ 12,979 $ (17,851) 70 catastrophic Subsidy Rates for Loan Guarantee Endorsements by Program and Component: Fees and Other (Percentage) Defaults Collections Total Budget Subsidy Rates for FY 2017 Loans Guarantees: MMI/CMHI Single Family SF - Forward 2.42 (7.78) (5.36) SF - HECM 7.06 (7.39) (0.33) SF - Neg Equity Refi/ Short Refinance 8.27 (8.27) - GI/SRI Multifamily Apartments - NC/SC 1.49 (4.25) (2.76) Apartments- Refinance 0.52 (4.31) (3.79) Healthcare FHA Full Insurance - Health Care 2.52 (8.37) (5.85) Hospitals 1.14 (6.66) (5.52) Fees and Other (Percentage) Defaults Collections Total Budget Subsidy Rates for FY 2016 Loan Guarantees: MMI/CMHI Single Family SF - Forward 2.27 (6.07) (3.80) SF - HECM 5.76 (6.45) (0.69) SF - Neg Equity Refi/ Short Refinance 10.02 (10.02) - GI/SRI Multifamily Apartments - NC/SC 2.42 (5.15) (2.73) Apartments - NC/SC 04/01/2016 1.91 (4.29) (2.38) Apartments Refinance 0.29 (4.96) (4.67) Apartments Refinance - 04/01/16 0.31 (3.92) (3.61) Healthcare FHA Full Insurance - Health Care 4.00 (7.43) (3.43) Hospitals 3.23 (6.45) (3.22) 71 catastrophic Schedule for Reconciling Loan Guarantee Liability Balances: RESTATED FY 2017 FY 2016 (Dollars in Millions) LLR LLG LLR LLG Beginning Balance of the Loan Guarantee Liability $ - $ (806) $ 7 $ 15,276 Add: Subsidy Expense for guaranteed loans disbursed during the reporting fiscal years by component: Default Costs (Net of Recoveries) - 7,537 - 6,612 Fees and Other Collections - (21,723) - (18,068) Other Subsidy Costs - 2,359 - 1,791 Total of the above subsidy expense components - (11,827) - (9,665) Adjustments: Fees Received $ - $ 14,567 $ - $ 14,018 Foreclosed Property and Loans Acquired - 8,743 - 11,148 Claim Payments to Lenders - (21,185) - (22,423) Interest Accumulation on the Liability Balance - 274 - (189) Other - 47 - 814 Ending Balance before Reestimates $ - $ (10,187) $ 7 $ 8,979 Add or Subtract Subsidy Reestimates by Component: Technical/Default Reestimate Subsidy Expense Component $ 7 $ 3,400 $ (7) $ (5,062) Restated Interest Expense Component 1,579 1,549 Restated Adjustment of prior years' credit subsidy reestimates - 25,817 - (6,272) Total Technical/Default Reestimate 7 30,796 (7) (9,785) Ending Balance of the Loan Guarantee Liability $ 7 $ 20,609 $ - $ (806) Administrative Expense: (Dollars in Millions) FY 2017 FY 2016 MMI/CMHI 534 586 GI/SRI - - H4H - Total 534 586 72 catastrophic Other Information on Foreclosed Property: Additional information on FHA foreclosed property as of September 30, 2017 and 2016 is as follows: The above chart references the average holding period for FHA foreclosed property, and the total number of foreclosed properties on-hand as September 30, 2017. Foreclosed properties are primarily Single Family properties. Defaulted Guaranteed Loans (Pre-92 and Post-91) Restrictions on the use/disposal of foreclosed property: The balance relating to foreclosures as of September 30, 2017 is comprised of only Single Family properties. There are no Multifamily properties currently in inventory. The Secretary has the authority under the National Housing Act (12 U.S.C 1710 (g)) to manage or dispose of eligible HUD-owned property assets in a manner that will provide affordable, safe and sanitary housing to low-wealth families, preserve and revitalize residential neighborhoods, expand homeownership opportunities, minimize displacement of tenants residing in rental or cooperative housing, and protect the financial interest of the Federal government. Single Family properties may be sold to eligible entities (24 CFR 291.303) through public asset sales. Eligibility of bidders will be determined by the Secretary and included in the bid package with a notice filed in the Federal Register. In addition, HUD must ensure that its policies and practices in conducting the single family property disposition program do not discriminate on the basis of disability (24 CFR 9.155(a)). 73 catastrophic Credit Reform Valuation Methodology FHA values its Credit Reform LLG and related receivables from notes and property inventories at the net present value of their estimated future cash flows. To apply the present value computations, FHA divides loans into cohorts and “risk” categories. Multifamily and Health Care 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 into product groupings, which are referred to as risk categories in federal budget accounting. Each risk category has characteristics that distinguish it from others, including loan performance patterns, 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. That second category is for HECM loans, which joined the MMI Fund group of programs in 2009. The single family GI/SRI loans are grouped into four risk categories. There are 15 different multifamily risk categories and three health care categories. The cash flow estimates that underlie present value calculations are determined using the significant assumptions detailed below. Significant Assumptions – FHA developed economic and financial models in order to estimate the present value of future program cash flows. The models incorporate information on the expected magnitude and timing of each cash flow. 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 the start of that year. • Claim Amount: The estimated amount of the claim payment relative to the unpaid principal balance at the time the claim occurs. • Recovery Rates: The estimated percentage of a claim payment or defaulted loan balance that is recovered through disposition of a mortgage note or underlying property. In FY 2017, FHA implemented a change in its discounting methodology used to estimate the net present value of the Single Family and HECM cash flows. This change in estimate was due to FHA’s analysis of the timing of cash flows that supported using the Middle of the Year (MOY) discount factor with the single effective rate. Previously, FHA used End of Year (EOY) discounting to estimate the net present value of Single Family and HECM cash flows. 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 internal business systems. Economic assumptions: Independent forecasts of economic conditions are used in conjunction with loan-level data to generate Single Family, Multifamily, and Health Care claim and prepayment rates. OMB provides the central economic assumptions used, such as interest rates, house price appreciation and the discount rates used against the cash flows. Other sources are used to distribute the central assumptions geographically. Reliance on historical performance: FHA relies on the historical performance of its insured portfolio to generate behavioral response functions that are applied to economic forecasts to generate future performance patterns for the 74 catastrophic outstanding portfolio. Changes in legislation, program requirements, tax treatment, and economic factors all influence loan performance. FHA assumes that its portfolio will continue to perform consistently with its historical experience, respecting differences due to current loan characteristics and forecasted economic conditions. 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. Such changes cannot be reflected in LLG calculations because of uncertainty over their nature and outcome. Discount rates: The disbursement-timing-weighted interest rate on U.S. Treasury securities of maturity comparable to the guaranteed loans term creates 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 maturities comparable to cash flow timing for the loan guarantee is used in the present value calculation. This latter methodology is referred to as the basket-of-zeros discounting methodology. OMB provides these rates to all Federal agencies for use in preparing credit subsidy estimates and requires their use under OMB Circular A-11, Part 4, and “Instructions on Budget Execution.” The basket-of-zeros discount factors are also disbursement weighted. Analysis of Change in the Liability for Loan Guarantees FHA has estimated and reported on LLG calculations since fiscal year 1992. Over this time, FHA’s reported LLG values have shown measurable year-to-year variance. That variance is caused by four factors: (1) adding a new year of insurance commitments each year; (2) an additional year of actual loan performance data used to calibrate forecasting models, (3) revisions to the methodologies employed to predict future loan performance, and (4) programmatic/policy changes that affect the characteristics of insured loans or potential credit losses. Described below are the programs that comprise the majority of FHA’s loan guarantee business. These descriptions highlight the factors that contributed to changing LLG estimates for FY 2017. Overall, FHA’s liability increased from the fiscal year 2016 estimates. Mutual Mortgage Insurance (MMI) – On net, the MMI Fund LLG increased to $13,053 million at the end of fiscal year 2017. The increase in liability can be attributed to HECM loans. The major factor affecting the HECM LLG estimate is house price appreciation through its impacts on claim and recovery rates. MMI Single Family Forward (SFF): In FY2016, the SFF LLG was modeled first by using actuarial models to estimate the conditional claim and prepayment rates for each loan. The models use a spread of historical data to generate claim and prepayment probabilities based on various borrower and loan-specific factors. A Monte Carlo simulation framework was used to generate the stochastic loan performance output; 100 equally likely paths were constructed, each resulting in a single estimate of the expected claim and prepayment likelihood. The average of these 100 paths for claim and prepayment were used when calculating LLG in the Cash Flow Model (CFM). The CFM discounts all cohort years using the latest Single Effective Rate (SER) specific to each cohort; in accordance with Federal Credit Reform Modeling guidelines. Compared with the FY16 LLG, the FY17 LLG estimate uses a single path (President’s Economic Assumption released in March 2017) to compute the expected net present value of the future cash flows. In addition, the FY17 LLG includes Single Family Loan Sale (SFLS) as one of the exit options when claims occur, while in the FY16, SFLS was not considered in the LLG calculations. MMI Home Equity Conversion Mortgage (HECM): Like the SFF program, in FY2016, the HECM LLG was modeled first by using actuarial models to estimate the "termination" probability for each loan. A HECM termination event was grouped into three (3) categories; borrower death, borrower move out of subject property or borrower refinance of subject property. A Monte Carlo simulation framework was used to generate the stochastic loan performance output; 100 equally likely paths were constructed, each resulting in a single estimate of the expected termination rate for each HECM loan. The average of these 100 paths for termination rates was used when 75 catastrophic calculating LLG in the Cash Flow Model (CFM). The CFM discounts all cohort years using the latest Single Effective Rate (SER) specific to each cohort; in accordance with Federal Credit Reform Modeling guidelines. Compared with the FY16 LLG, the FY17 LLG estimate uses a single path (President’s Economic Assumption released in March 2017) to compute the expected net present value of the future cash flows. GI/SRI (HECM) - HECM endorsements from fiscal years 1990-2008 remain in the GI/SRI Fund. Estimation of the GI/SRI HECM LLG is consistent with that of the MMI HECM LLG estimation. The liability for these loans increased to $11,671 million at the end of FY 2017. This liability is driven more by long term house price appreciation forecasts than short term forecasts. The majority of the remaining GI/SRI HECM loans have adjustable interest rates which impacts the LLG through its influence on unpaid balances, claim and recovery rates. GI/SRI Section 223(f) - Section 223(f) of the National Housing Act permits FHA mortgage insurance for the refinance or acquisition of existing multifamily rental properties consisting of five or more units. Under this program, FHA may insure up to 85 percent of the lesser of the project’s appraised value or its replacement cost. Projects insured under the program must be at least three years old. The Section 223(f) program is the largest multifamily program in the GI/SRI fund with an insurance-in-force of $35.1 billion. The Section 223(f) liability is negative, meaning that the present value of expected future premium revenues is greater than the present value of expected future (net) claim expenses. The 223(f) liability decreased this year by $489 million, from ($1,075) million to ($1,563) million, due to lower claim expectations as well as increased insurance-in-force. GI/SRI Section 223(a)(7) - Section 223(a)(7) gives FHA authority to refinance FHA-insured loans. Under this program, the refinanced principal amount of the mortgage may be the lesser of the original amount of the existing mortgage or the remaining unpaid principal balance of the loan. Loans insured under any sections of the National Housing Act may be refinanced under 223(a)(7), including those already under 223(a)(7). The Section 223(a)(7) program has an insurance-in-force of $19.9 billion. The Section 223(a)(7) liability is negative, meaning that the present value of expected future premium revenues is greater than the present value of expected future (net) claim expenses. The 223(a)(7) liability decreased this year by $26.2 million, from ($604) million to ($630) million. GI/SRI Section 221(d)(4) - Section 221(d)(4) of the National Housing Act authorizes FHA mortgage insurance for the construction or substantial rehabilitation of multifamily rental properties with five or more units. Under this program, FHA may insure up to 90 percent of the total project cost. This is the third largest multifamily program in the GI/SRI fund with an insurance-in-force of $16.9 billion. The Section 221(d)(4) liability decreased by $222.5 million this year, from ($110.5) million to ($333) million. GI/SRI Section 232 Health Care New Construction - The Section 232 NC program provides mortgage insurance for construction or substantial rehabilitation of nursing homes and assisted-living facilities. FHA insures a maximum of 90 percent of the estimated value of the physical improvements and major movable equipment. The Section 232 NC program has an insurance-in-force of $3.1 billion. The Section 232 NC liability decreased by $14.8 million this year, from ($83) million to ($98) million due to lowered claim expectations. GI/SRI Section 232 Health Care Purchasing or Refinancing - The Section 232 Refinance program provides mortgage insurance for two purposes: purchasing or refinancing of projects that do not need substantial rehabilitation, and installation of fire safety equipment for either private, for-profit businesses or non-profit associations. For existing projects, FHA insures a maximum of 85 percent of the estimated value of the physical improvements and major movable equipment. The Section 232 Refinance program has an insurance-in-force of $25 billion. The Section 232 Refinance liability decreased by $64.6 million this year, from ($743.1) million to ($807.7) million due to an increase in insurance-in-force and a decrease in claim expectations. GI/SRI Section 242 Hospitals - The Section 242 Hospitals program provides mortgage insurance for the construction, substantial rehabilitation, or refinance of hospitals and/or the purchase of major hospital equipment to either private, for-profit businesses or non-profit associations. FHA insures a maximum of 90 percent of the 76 catastrophic estimated replacement cost of the hospital, including the installed equipment. The Section 242 program has an insurance-in-force of $7.3 billion. The Section 242 liability decreased by $27 million this year from ($179) million to ($206) million due to higher premium revenue caused by decreased prepayment expectations as well as lower claims expected. Risks to LLG Calculations LLG calculations for most major programs now use Monte Carlo simulations and stochastic economic forecasts. What is booked as an LLG value is the average or arithmetic “mean” value from a series of projections that view loan portfolio performance under a large variety of possible economic circumstances. The individual economic scenario forecasts are designed to mimic the types of movements in factors such as home prices, interest rates, and apartment vacancy rates that have actually occurred in the historical record. By creating a large number of these scenarios, each independent of the others, one creates a universe of potential outcomes that define the possible set of LLG values in an uncertain world. Using the mean value across all forecast scenarios is valuable for providing some consideration for “tail risk.” Tail risk occurs in most loan guarantee portfolios because potential losses under the worst scenarios are multiples of potential gains under the best scenarios. The inclusion of tail events in the mean- value calculation creates an addition to LLG, which is the difference between the mean value from the simulations and the median value. The median is the point at which half of the outcomes are worse and half are better. By booking a mean value rather than a median, FHA is essentially providing some additional protection in its loss reserves against adverse outcomes. At the same time, booking an LLG based on a mean value results in a better than even chance future revisions will be in the downward direction. The uncertainty built into Monte Carlo forecasts is only for economic risk, and not for model risk. All LLG values are fundamentally dependent upon forecasts of insured-loan performance. Those forecasts are developed through models that apply statistical, economic, financial, or mathematical theories, techniques, and assumptions to create behavioral-response functions from historical data. All such models involve risk that actual behavior of borrowers and lenders in the future will differ from the historical patterns embedded in the forecasting models. Model risk also emanates from the possibility that the computer code used to create the forecasts has errors or omissions which compromise the integrity and reliability of projections. Each year, HUD works with its contractors to evaluate the forecasting models for reasonableness of results on a number of dimensions. Model risk is also addressed through a continuous cycle of improvement, whereby lessons learned from the previous round of annual portfolio valuations—in the independent actuarial studies, LLG valuations, and President’s Budget—are used as a basis for new research and model development in the current year. For Multifamily programs, LLG risk comes from claims, recoveries and premiums. Claims and recoveries are dependent on continued rental-income trends and rental-price growth. Premiums are driven by FHA policy and industry demand for FHA products. Generally, risk comes from market, economic, and demographic influences such as changes in local employment conditions, the supply of rental housing in each market where FHA has a presence, population growth, and household formation. FHA’s policy of insuring loans pre-construction in its 221(d)(4) program subject LLG calculations to risk from their capability to operate post-construction. For Healthcare programs (Sections 232 and 242), LLG risk comes principally from health-care reimbursement rates from Medicare and Medicaid. In addition, the financial health of State and Municipal government entities also is a source of LLG risk, as many of the FHA-insured projects benefit, in part, from periodic cash infusions from those entities. Risk also varies as does the quality of business management at each facility, and from the supply of medical care in each community relative to demand and the abilities of facility management to adapt to changing technologies and the competitive landscape. These are factors for which it is difficult to predict future trends. 77 catastrophic For the SFF mortgage programs, LLG risk comes from claims, recoveries and premiums. Claims and recoveries are largely dependent on house price appreciation and local market conditions such as demand to supply ratio, the proportion of foreclosure properties. Premiums are driven by FHA policy, industry demand for FHA products and interest rate outlook which determines the incentive of refinances. Generally, risk comes from portfolio characteristics, market and prevailing economic conditions. For both HECM programs (GI/SRI and MMI cohorts), LLG risk comes from claims, recoveries and premiums. Claims and recoveries are largely dependent on house price appreciation and borrower behavior such as home maintenance and ability to meet property tax and insurance obligations. Premiums are driven by FHA policy and interest rates which determine the growth of HECM unpaid principal balances (UPB). Generally, risk comes from portfolio characteristics, market and prevailing economic conditions. 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. MMI Single Family LLR - For the single-family portfolio, the aggregate liability for the remaining pre-credit reform loans in FY 2017 is $9.0 million. GI/SRI Multifamily & Healthcare LLR - For the multifamily and healthcare portfolio, the remaining insurance-in- force for pre-credit reform loans is $197.6 million. The aggregate liability for the remaining pre-credit reform loans in FY 2017 is ($847) thousand, which is a $153 thousand increase from the ($1) million estimate in FY 2016. The year-over-year increase in aggregate liability is due to a $55 million decline in insurance-in-force as both measures move closer to zero. 78 catastrophic Note 8. Accounts Payable Accounts Payable as of September 30, 2017 and 2016 are as follows: (Dollars in millions) FY 2017 FY 2016 Intragovernmental: Claims Payable to Ginnie Mae $ 1 $ 7 Miscellaneous Payables to HUD 1 - Total $ 2 $ 7 FY 2017 FY 2016 With the Public: Claims Payable $ 284 $ 311 Premium Refunds Payable 124 141 Single Family Property Disposition Payable 28 21 Miscellaneous Payables 78 22 Total $ 514 $ 495 Claims Payables Claims payables represent 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 Payables Premium refund payables are refunds of previously collected Single Family premiums that will be returned to the borrowers resulting from prepayment of the insured mortgages. Single Family Property Disposition Payables Single family property disposition payables includes management and marketing contracts and other property disposition expenses related to foreclosed property. Miscellaneous Payables 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. 79 catastrophic Note 9. Debt The following tables describe the composition of Debt held by FHA as of September 30, 2016 and 2017: (Dollars in millions) FY 2016 FY 2017 Beginning Balance Net Borrowings Ending Balance Beginning Balance Net Borrowings Ending Balance Other Debt: Borrowings from FFB 102 452 554 554 633 1,187 Borrowings from U.S. Treasury 26,921 3,398 30,319 30,319 (2,364) 27,954 Total $ 27,023 $ 3,850 $ 30,873 $ 30,873 $ (1,731) $ 29,141 FY 2016 FY 2017 Classification of Debt: Intragovernmental Debt $ 30,873 $ 29,141 Debt Held by the Public - $ - Total $ 30,873 $ 29,141 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 GI/SRI 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 re-estimates from the GI/SRI financing account to the GI/SRI receipt account or when available cash is less than claim payments due. During fiscal year 2017, FHA’s U.S. Treasury borrowings carried interest rates ranging from 1.67 percent to 7.36 percent. The maturity dates for these borrowings occur from September 2018 – September 2030. Loans may be repaid in whole or in part without penalty at any time prior to maturity. Borrowings from Federal Financing Bank: Starting in FY 2015, FHA began a Federal Financing Bank (FFB) Risk Share program, an inter-agency partnership between HUD, FFB and the Housing Finance Authorities (HFAs). The FFB Risk Share program provides funding for multifamily mortgage loans insured by FHA. Under this program, FHA borrows from the FFB to disburse direct loans. 80 catastrophic Note 10. Other Liabilities The following table describes the composition of Other Liabilities as of September 30, 2017 and 2016: (Dollars in millions) FY 2017 Current Intragovernmental: Receipt Account Liability $ 1,673 Total $ 1,673 With the Public: Trust and Deposit Liabilities $ 46 Multifamily Notes Unearned Revenue 250 Premiums collected on unendorsed cases 243 Miscellaneous Liabilities 97 Total $ 636 FY 2016 Current Intragovernmental: Receipt Account Liability $ 2,765 Total $ 2,765 With the Public: Trust and Deposit Liabilities $ 64 Multifamily Notes Unearned Revenue 247 Premiums collected on unendorsed cases 345 Miscellaneous Liabilities 198 Total $ 854 81 catastrophic Receipt Account Payable Liability The receipt account payable liability is created from downward credit subsidy re-estimates in the GI/SRI 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 maintenance expenses on behalf of the borrowers. The earnest money becomes part of the sale proceeds or is returned to any unsuccessful bidders. Multifamily Notes Unearned Revenue Multifamily Notes unearned revenue primarily includes the deferred interest revenue on Multifamily notes that are based on work out agreements with the owners. The workout agreements defer payments from the owners for a specified time but, the interest due on the notes is still accruing and will also be deferred until payments resume. Premiums Collected on Unendorsed Cases Premiums collected on unendorsed cases are mortgage insurance premium amounts collected by FHA for cases that have yet to be endorsed. Miscellaneous Liabilities Miscellaneous liabilities mainly include disbursements in transit (cash disbursements pending Treasury confirmation), unearned premium revenue, and any loss contingencies that are recognized by FHA for past events that warrant a probable, or likely, future outflow of measurable economic resources. 82 catastrophic Note 11. Commitments and Contingencies 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 an effect on FHA’s consolidated financial statements as of September 30, 2017. Activity with Ginnie Mae As of September 30, 2017, the Government National Mortgage Association (“Ginnie Mae”) held defaulted FHA- insured mortgage loans. These loans, acquired from defaulted mortgage-backed securities issuers, had the following balances: FY 2017 FY 2016 (in Millions) (in Millions) Mortgages Held for Investment & Foreclosed Property (Pre-claim) 3,137 3,950 Short Sale Claims Receivable 47 94 “Ginnie Mae” may submit requests for claim payments to FHA for some or all of these loans. Subject to all existing claim verification controls, FHA would pay such claims to Ginnie Mae, another component of HUD, upon conveyance of the foreclosed property to FHA. Any liability for such claims, and offsetting recoveries, has been reflected in the Liability for Loan Guarantees on the accompanying financial statements based on the default status of the insured loans. Impact of Hurricanes Harvey, Irma and Maria As the result of damages incurred by hurricanes Harvey, Irma and Maria, FHA expects claims and losses in those areas. While immediate department efforts have been focused on providing relief to displaced residents, HUD is continuing to assess what impact the storms will have on FHA’s financial position. The President declared major disaster declarations in the areas that were directly affected by the hurricanes. In response, the Federal Emergency Management Agency (FEMA) is operating an Individual Assistance Program to assist residents with accessing available housing and addressing other immediate needs while recovering from the devastation. HUD has implemented several policies and programs to assist lenders, property owners and residents. Homeowners in FHA-insured loans are eligible for a variety of relief measures including FHA Section 203(h) loans for disaster victims. For the Single Family portfolio, HUD Handbook 4000.1, Section III.A.3.c.ii authorizes an initial moratorium on foreclosures of properties within a Presidentially-Declared Major Disaster Area (PDMDA) for a ninety (90) day period from the date of each PDMDA declaration. The initial moratorium applies to the initiation of foreclosures and foreclosures already in process. HUD Mortgagee Letter 2017-15 extends the initial 90-day foreclosure moratorium for FHA-insured homeowners for an additional 90 days due to the extensive damage and continuing needs in hard-hit areas. In addition, HUD recently announced an additional 19 regulatory and administrative waivers to further assist communities accelerate recovery efforts. At this time, the expected loss from the damage caused by hurricanes Harvey, Irma and Maria cannot be reasonably estimated. FHA has identified approximately 923,982, Single Family Forward and Home Equity Conversion Mortgage (HECM) properties within the affected areas that account for 10.7 percent of FHA’s total active Single 83 catastrophic Family insured portfolios. The largest concentration of potentially affected properties is 551,283 in Florida, with the remaining 257,952 and 124,747 in Texas and Puerto Rico, respectively. As HUD assesses the status of each project and case with lenders, additional guidance may be issued and legislative relief may be sought, if necessary, to mitigate the claims and losses against the insurance funds. 84 catastrophic Note 12. Gross Costs Gross costs incurred by FHA for the period ended September 30, 2017 and 2016 are as follows: (Dollars in millions) Single Family Administrative FY 2017 Forward HECM Multifamily Healthcare Expenses Total Intragovernmental: Interest Expense $ 765 $ 235 $ 114 $ 40 $ - $ 1,154 Imputed Cost - - - - 13 13 Other Expenses - - - - 15 15 Total $ 765 $ 235 $ 114 $ 40 $ 28 $ 1,182 With the Public: Salary and Administrative Expense $ - $ - $ - $ - $ 520 $ 520 Subsidy Expense (11,093) (58) (547) (201) - (11,899) Re-estimate Expense 9,358 16,286 (686) (91) - 24,867 Interest Expense 997 5,112 (117) (7) - 5,985 Interest Accumulation Expense (213) 569 (62) (23) - 271 Bad Debt Expense 5 (2) (136) - - (133) Loan Loss Reserve 8 - - - - 8 Other Expenses 19 1 36 - 3 59 Total $ (919) $ 21,908 $ (1,512) $ (322) $ 523 $ 19,678 Total Gross Costs $ (154) $ 22,143 $ (1,398) $ (282) $ 551 $ 20,860 Administrative FY 2016 RESTATED Single Family Forward HECM Multifamily Healthcare Expenses Total Intragovernmental: Interest Expense $ 791 $ 234 $ 115 $ 81 $ - 1,221 Imputed Cost - - - - 15 15 Other Expenses - - (4) 4 2 2 Total $ 791 $ 234 $ 111 $ 85 $ 17 $ 1,238 With the Public: Salary and Administrative Expense $ - $ - $ - $ - $ 584 $ 584 Subsidy Expense (9,083) (102) (400) (131) - (9,716) Re-estimate Expense (7,970) (300) 49 (10) - (8,231) Restated Interest Expense (1,474) (60) 7 41 - (1,486) Restated Interest Accumulation Expense (254) 157 (74) (28) - (199) Bad Debt Expense (3) - 8 - - 5 Loan Loss Reserve (6) - - (1) - (7) Other Expenses 26 - 21 - 7 54 Total $ (18,764) $ (305) $ (389) $ (129) $ 591 $ (18,996) Total Gross Costs $ (17,973) $ (71) $ (278) $ (44) $ 608 $ (17,758) 85 catastrophic Interest Expense Intragovernmental interest expense includes interest expense on borrowings from the U.S. Treasury in the financing account. Interest expense is calculated annually for each cohort using the interest rates provided by the U.S Treasury. Interest expense with the public consists of interest expense on debentures issued to claimants to settle claim payments and interest expense on the annual credit subsidy re-estimates. Interest Accumulation Expense Interest accumulation expense is calculated as the difference between interest revenue and interest expense. For guaranteed loans, the liability for loan guarantees is adjusted with the offset to interest accumulation expense. Imputed Costs/Imputed Financing Imputed costs represent FHA’s share of the departmental imputed cost calculated and allocated to FHA by the HUD CFO office. Federal agencies are required to report imputed costs under SFFAS No. 4, Managerial Cost Accounting Concepts and Standards, and SFFAS No. 30, Inter-Entity Cost Implementation: Amending SFFAS 4, Managerial Cost Accounting Standards and Concepts to account for costs assumed by other Federal organizations on their behalf. The HUD CFO receives its imputed cost data from the Office of Personnel Management (OPM) for pension costs, federal employee health benefits (FEHB) and life insurance costs. It also receives Federal Employees’ Compensation Act (FECA) costs from the Department of Labor (DOL). Subsequently, using its internally developed allocation basis, HUD CFO allocates the imputed cost data to each of its reporting offices. The imputed costs reported by FHA in its Statements of Net Cost are equal to the amounts of imputed financing in its Statements of Changes in Net Position. Salary and Administrative Expenses Salary and administrative expenses include FHA’s reimbursement to HUD for FHA personnel costs and FHA’s payments to third party contractors for administrative contract expenses. Beginning in fiscal year 2010 and going forward, FHA is only using the MMI program fund to record salaries and related expenses. Re-estimate Expense Re-estimate expense captures the cost associated with revisions to the liability for loan guarantee. A re-estimate is calculated annually. Subsidy Expense Subsidy expense, positive and negative, consists of credit subsidy expense from new endorsements, and modifications. Credit subsidy expense is the estimated long-term cost to the U.S. Government of a direct loan or loan guarantee, calculated on a net present value basis of the estimated future cash flows associated with the direct loan or loan guarantee. 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 FHA management’s judgment concerning current economic factors. 86 catastrophic 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 expenses from intra-agency agreements. 87 catastrophic Note 13. Earned Revenue Earned revenues generated by FHA for the period ended September 30, 2017 and 2016 are as follows: (Dollars in millions) Single Family FY 2017 Forward HECM Multifamily Healthcare Total Intragovernmental: Interest Revenue from Deposits at U.S. Treasury $ 552 $ 804 $ 23 $ 16 $ 1,395 Interest Revenue from MMI/CMHI Investments 253 26 - - 279 Total Intragovernmental $ 805 $ 830 $ 23 $ 16 $ 1,674 With the Public: Insurance Premium Revenue $ - $ - $ 1 $ - $ 1 Income from Notes and Properties 9 - 43 1 53 Other Revenue 1 - 23 - 24 Total With the Public $ 10 $ - $ 67 $ 1 $ 78 Total Earned Revenue $ 815 $ 830 $ 90 $ 17 $ 1,752 Single Family FY 2016 Forward HECM Multifamily Healthcare Total Intragovernmental: Interest Revenue from Deposits at U.S. Treasury $ 537 $ 391 $ 32 $ 53 $ 1,013 Interest Revenue from MMI/CMHI Investments 125 12 - - 137 Total Intragovernmental $ 662 $ 403 $ 32 $ 53 $ 1,150 With the Public: Insurance Premium Revenue $ 1 $ - $ 1 $ - $ 2 Income from Notes and Properties 11 - 42 1 54 Other Revenue 2 1 9 - 12 Total With the Public $ 14 $ 1 $ 52 $ 1 $ 68 Total Earned Revenue $ 676 $ 404 $ 84 $ 54 $ 1,218 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/CMHI Capital Reserve account. 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. 88 catastrophic Premium Revenue According to the FCRA accounting, FHA’s premium revenue includes only premiums associated with the pre-1992 loan guarantee business. Premiums for post-1991 guarantee loans are included in the balance of the LLG. The FHA premium structure includes both up-front premiums and annual periodic premiums. Up-front Premiums The up-front premium rates vary according to the mortgage type and the year of origination. The FHA up-front premium rates in fiscal year 2017 were: Upfront Premium Rates 10/01/2016 - 9/30/2017 Single Family 1.75% Multifamily 0.25%, 0.50%, 0.65%, 0.80% or 1.00% HECM Standard 2.50% (Based on Maximum Claim Amount) HECM Saver 0.50% (Based on Maximum Claim Amount) Annual Periodic Premiums The periodic premium rate is used to calculate monthly or annual premiums. These rates also vary by mortgage type and program. The FHA annual periodic premium rates in fiscal year 2017 were: Annual Periodic Premium Rates Single Family 10/01/2016 -1/25/2017 0.80%, 0.85%, 1.00% or 1.05% 01/26/17 to present 1.30%,1.35%, 1.50% or 1.55% Multifamily 0.45%, 0.57%, 0.65% or 0.70% HECM (Standard and Saver) 1.25% For Title I, the maximum insurance premium paid for guaranteed cases endorsed in years 1992 through 2001 is equal to 0.50 percent of the loan amount multiplied by the number of years of the loan term. The annual insurance premium for a Title I Property Improvement loan is 0.50 percent of the loan amount until the maximum insurance charge is paid. The annual insurance premium of a Title I Manufactured Housing loan is calculated in tiers by loan term until the maximum insurance charge is paid. Income from Notes and Property Income from Notes and Property includes revenue associated with FHA pre-1992 loan guarantees. This income includes revenue from Notes and Properties held, sold, and gains associated with the sale. Other Revenue Other revenue includes revenue associated with FHA pre-1992 loan guarantees. FHA’s other revenue consists of late charges and penalty revenue, fee income, and miscellaneous income generated from FHA operations. 89 catastrophic 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 under the budget functional classification (BFC) for Mortgage Credit (371). All FHA U.S. Treasury account symbols found under the department code “86” for Department of Housing and Urban Development appear with the Mortgage Credit BFC. 90 catastrophic Note 15. Transfers In and Other Financing Sources Transfers In and Other Financing Sources incurred by FHA for the periods ended September 30, 2017 and 2016 are as follows: (Dollars in millions) Cumulative Unexpended FY 2017 Results of Total Appropriations Operations Transfers In: HUD $ 426 $ - $ 426 Non Exchange Revenue HUD $ 2 $ - $ 2 Other Financing Sources: Treasury $ (412) $ - $ (412) Cumulative Unexpended FY 2016 Results of Total Appropriations Operations Transfers In: HUD $ 480 $ - $ 480 Non Exchange Revenue HUD $ - $ - $ - Other Financing Sources: Treasury $ (2,063) $ - $ (2,063) Transfers In from HUD FHA does not receive an appropriation for salaries and expense; instead the FHA amounts are appropriated directly to HUD. To recognize these costs in FHA’s Statement of Net Cost, a Transfer In from HUD is recorded based on amounts computed by HUD. Non Exchange Revenue Non Exchange revenue consist of late fees incurred on Multifamily and Single Family premiums. Non-Exchange Revenue was not reported in FY 2016. Other Financing Sources Transfers out to U.S. Treasury consist of negative subsidy from new endorsements, modifications and downward credit subsidy re-estimates in the GI/SRI general fund receipt account. 91 catastrophic Note 16. Unexpended Appropriations Unexpended appropriation balances at September 30, 2017 and 2016 are as follows: (Dollars in millions) Beginning Appropriations Other Appropriations FY 2017 Balance Received Adjustments Used Transfers-Out Ending Balance Positive Subsidy $ 2 $ - $ - $ - $ - $ 2 Contract Expenses $ 233 $ 130 $ - $ (108) $ - 255 Reestimates $ - $ 4,318 $ - $ (4,318) $ - - GI/SRI Liquidating $ 180 $ 25 $ - $ (3) $ - 202 Total $ 415 $ 4,473 $ - $ (4,429) $ - $ 459 Beginning Appropriations Other Appropriations FY 2016 Balance Received Adjustments Used Transfers-Out Ending Balance Positive Subsidy $ 454 $ - $ (452) $ - $ - $ 2 Contract Expenses 260 130 (48) (109) - 233 Reestimates - 3,282 - (3,282) - - GI/SRI Liquidating 157 25 - (2) - 180 Total $ 871 $ 3,437 $ (500) $ (3,393) $ - $ 415 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 MMI program account for administrative and contract expenses. The GI/SRI no-year program account also receives appropriations for positive credit subsidy and upward re-estimates. Additionally, FHA 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; appropriations are rescinded; or other miscellaneous adjustments are required. 92 catastrophic Note 17. Budgetary Resources The SF-133 and the Statement of Budgetary Resources for fiscal year 2016 have been reconciled to the fiscal year 2016 actual amounts included in the Program and Financing Schedules presented in the fiscal year 2018 Budget of the United States Government. In FY 2016, FHA recorded $234 million in borrowing authority in the President’s Budget that was not included in the Statement of Budgetary Resources. The resources were recorded as an adjustment to the beginning balance in FY 2017 SBR. Information from the fiscal year 2017 Statement of Budgetary Resources will be presented in the fiscal year 2019 Budget of the U.S. Government. The Budget will be transmitted to Congress on the first Monday in February 2018 and will be available from the Government Printing Office and online at that time. Obligated balances as of September 30, 2017 and 2016 are as follows: Unpaid Obligations (Dollars in Millions) Undelivered Orders FY 2017 FY 2016 MMI/CMHI $ 1,895 $ 1,598 GI/SRI 912 597 H4H 1 1 Undelivered Orders Subtotal $ 2,808 $ 2,196 Accounts Payable MMI/CMHI $ 752 $ 670 GI/SRI 195 130 Accounts Payable Subtotal $ 947 $ 800 Total $ 3,755 $ 2,996 93 catastrophic Note 18. Budgetary Resources - Collections The following table presents the composition of FHA’s collections for the period ended September 30, 2017 and 2016: (Dollars in Millions) FY 2017 MMI/CMHI GI/SRI H4H Total Collections: Premiums $ 13,431 $ 866 $ 1 $ 14,298 Notes 1,269 806 - 2,075 Property 3,385 196 - 3,581 Interest Earned from U.S. Treasury 1,193 471 - 1,664 Subsidy 11,151 - - 11,151 Reestimates 20,369 4,720 - 25,089 Collections from settlements 150 - - 150 Other 104 (368) - (264) Total $ 51,052 $ 6,691 $ 1 $ 57,744 FY 2016 MMI/CMHI GI/SRI H4H Total Collections: Premiums $ 13,201 $ 853 $ 1 $ 14,055 Notes 1,584 574 1 2,159 Property 4,134 232 1 4,367 Interest Earned from U.S. Treasury 730 390 - 1,120 Subsidy 9,185 - - 9,185 Reestimates 18,969 3,282 - 22,251 Collections from settlements 679 - - 679 Other 185 16 1 202 Total $ 48,667 $ 5,347 $ 4 $ 54,018 94 catastrophic Note 19. Budgetary Resources – Obligations The following table presents the composition of FHA’s obligations for the period ended September 30, 2017 and 2016: (Dollars in Millions) September 30, 2017 MMI/CMHI GI/SRI H4H Total Obligations Claims $ 15,694 $ 2,676 $ 1 $ 18,371 Property Expenses 613 49 - 662 Interest on Borrowings 904 230 - 1,134 Subsidy 11,152 800 - 11,952 Downward Reestimates 1,672 402 - 2,074 Upward Reestimates 18,691 4,318 - 23,009 Administrative Contracts 133 - - 133 FFB Direct Loans - 951 - 951 Other 9 (103) - (94) Total $ 48,868 $ 9,323 $ 1 $ 58,192 September 30, 2016 MMI/CMHI GI/SRI H4H Total Obligations Claims $ 18,567 $ 2,981 $ 2 $ 21,550 Property Expenses 605 44 - 649 Interest on Borrowings 931 278 - 1,209 Subsidy 9,184 569 - 9,753 Downward Reestimates 15,461 1,463 - 16,924 Upward Reestimates 3,508 3,282 - 6,790 Administrative Contracts 121 - - 121 FFB Direct Loans - 688 - 688 Other 98 105 - 203 Total $ 48,475 $ 9,410 $ 2 $ 57,887 95 catastrophic Note 20. Reconciliation of Net Cost of Operations to Budget 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 period ended September 30, 2017 and 2016: (Dollars in Millions) FY 2017 FY 2016 Resources Used to Finance Activities: Obligations Incurred 58,192 57,890 Less: Spending Authority from Offsetting Collections (57,850) (54,742) Obligations Net of Offsetting Collections and Recoveries 342 3,148 Less: Distributed Offsetting Receipts (1,078) (2,000) Net Obligations (736) 1,148 Other Resources: Transfers In/Out Without Reimbursement 426 481 Imputed Financing Sources 13 15 Other (412) (2,063) Net Other Resources Used to Finance Activities 26 (1,567) Total Resources Used to Finance Activities (710) (419) Resources Used to Finance Items not Part of the Net Cost of Operations: Change in Budgetary Resources Obligated for Goods, Services, and Benefits Ordered but not yet Provided (611) (150) Budgetary Offsetting Collections and Receipts that do not Affect Net Cost of Operations 58,835 56,036 Resources that Finance the Acquisition of Assets or Liquidation of Liabilities (53,062) (50,134) Appropriations for prior Year Re-estimate (4,318) (6,829) Other Resources or Adjustments to Net Obligated Resources that do not Affect Net Cost of Operations 413 1,567 Total Resources Used to Finance Items Not Part of the Net Cost of Operations 1,256 490 Total Resources Used to Finance the Net Cost of Operations 546 71 - Components of the Net Cost of Operations that will Not Require or Generate Resources in the Current Period: - Upward Reestimate of Credit Subsidy Expense 23,214 5,561 Downward Reestimate of Credit Subsidy Expense 7,662 (15,297) Reduction of Credit Subsidy Expense (11,857) (9,716) Changes in Loan Loss Reserve Expense 9 (7) Changes in Bad Debt Expenses (133) 5 Gains or Losses on Sales of Credit Program Assets 40 25 Other (375) 382 Total Components of Net Cost of Operations That Will Not Require or Generate Resources in the Current Period 18,561 (19,047) Net Cost of Operations 19,107 (18,976) Net Cost of Operations from SNC 19,107 (18,976) 96 catastrophic Note 21. Restatement of FHA’s Fiscal Year 2016 Financial Statement Notes In FY 2017, discrepancies were noted in the presentation of FHA’s FY 2016 Note 7 Direct Loans and Loan Guarantees and Note 12 Gross Costs that required correction of balances reported in the FY 2017 comparative financial statements. Corrections were made in Note 7 to HECM current year endorsements, cumulative Current Outstanding Balance and Maximum Potential Liability and the Single Family Forward Guaranteed Loans Outstanding and New Guaranteed Loans Disbursed. For Note 12, updates were made to Gross Cost with the Public to adjust the allocation of Re-estimate and Interest expenses. The HECM Current Year Endorsements amount of $14,612 million reported in FY 2016 did not include 153 active cases due to the 2016 cohort year field not being populated on the HECM Cohort Summary Report that caused the reported endorsement amount to be understated by $48 million. The associated HECM cumulative Current Outstanding Balance and Maximum Potential Liability, were also understated by $20 million and $47 million, respectively. The cases associated with the missing cohorts have been corrected to include the proper cohort for future reporting. The source report for the cumulative Single Family Forward Guaranteed Loans Outstanding and New Guaranteed Loans Disbursed is run monthly from the Single Family Housing Enterprise Data Warehouse (SFHEDW) to obtain the cumulative and year-to-date balances of Outstanding Principal of Guaranteed Loans (face value) and the Amount of Outstanding Principal Guaranteed as of the end of the period. The report for FY 2016 as of September 30th was inadvertently run prior to the SFHEDW being updated with the activity for the month of September so the amounts reported for FY 2016 only captured the cumulative and fiscal year to date balances through August. This caused the cumulative amounts reported for both Single Family Forward Outstanding Principal of Guaranteed Loans and the Amount of Outstanding Principal Guaranteed for the Mutual Mortgage Insurance (MMI) Fund to each be understated by $3 billion and for the General Insurance/Special Risk Insurance to be overstated by $108 million and $93 million, respectively. The Outstanding Principal of Guaranteed Loans and the Amount of Outstanding Principal for FY 2016 New Guaranteed Loans Disbursed were also understated by $24 billion and $23 billion, respectively. The $23 billion understatement for the Amount of Outstanding Principal is based on the ratio of FY 2017 Amount of Outstanding Principal to Outstanding Principal of Guaranteed Loans to provide a reasonable estimate in the absence of report actual. An alternate report from the SF insurance system will be used to report these balances going forward. The discount factor used to calculate the FY 2016 financial statement re-estimate for Single Family Forward loans was inconsistent with the discount factor used for other programs. The discount factor for SF Forward loans used an end of year (EOY) vice middle of year (MOY) discount factor causing the subsidy expense component to be understated by $110 million and the interest expense component to be overstated by the same amount in the Schedule for Reconciling Loan Guarantee Liability Balances. Since both the subsidy and interest expenses are reported as gross costs, these amounts were also understated and overstated respectively, in Note 12 costs reporting. The discount factor for SF Forward loans was updated to MOY which will be used for future re-estimate calculations to be consistent with all other programs. Due to the imminent publishing of the FY 2017 audited financial statements, the FY 2016 notes restatements will be presented comparatively. 97 catastrophic Required Supplementary Information Schedule A: Intragovernmental Assets FHA's Intra-governmental assets, by Federal entity, are as follows on September 30, 2017 and 2016: (Dollars in Millions) Fund Balance Investments in with U.S. U.S. Treasury Accounts FY 2017 Treasury Securities Receivable Other Assets Total U.S. Treasury $ 29,112 $ 30,841 $ - $ - $ 59,953 Total $ 29,112 $ 30,841 $ - $ - $ 59,953 Fund Balance Investments in with U.S. U.S. Treasury Accounts FY 2016 Treasury Securities Receivable Other Assets Total U.S. Treasury $ 20,820 $ 36,397 $ - $ - $ 57,217 Total $ 20,820 $ 36,397 $ - $ - $ 57,217 Schedule B: Intragovernmental Liabilities FHA's Intra-governmental liabilities, by Federal entity, are as follows on September 30, 2017 and 2016: (Dollars in Millions) Accounts Other FY 2017 Payable Borrowings Liabilities Total Federal Financing Bank $ - $ 1,187 $ - $ 1,187 U.S. Treasury - 27,954 1,673 29,627 HUD 2 - - 2 Total $ 2 $ 29,141 $ 1,673 $ 30,816 Accounts Other FY 2016 Payable Borrowings Liabilities Total Federal Financing Bank $ - $ 555 $ - $ 555 U.S. Treasury $ - $ 30,318 $ 2,765 $ 33,083 HUD 7 - - 7 Total $ 7 $ 30,873 $ 2,765 $ 33,645 98 catastrophic Required Supplementary Information Schedule C: Comparative Combining Statement of Budgetary Resources by FHA Program for Budgetary September 30, 2017: Dollars in Millions MMI/CMHI MMI/CMHI GI/SRI Budgetary Capital Reserve Program Program Other Total Budgetary Resources: Unobligated balance brought forward, October 1 $ 37,220 $ 80 $ - $ 458 $ 37,758 Unobligated balance brought forward, October 1, as adjusted 37,220 80 - 458 37,758 Recoveries of prior year unpaid obligations - 8 - 3 11 Other changes in unobligated balance (+ or -) (18,698) 18,691 - (418) (425) Unobligated balance from prior year budget authority, net 18,522 18,779 1 41 37,343 Appropriations (discretionary and mandatory) - 130 4,318 25 4,473 Spending authority from offsetting collections (discretionary & mandatory) 13,112 - - 177 13,289 Total budgetary resources $ 31,635 $ 18,909 $ 4,319 $ 242 $ 55,105 Status of Budgetary Resources: Obligations incurred - 18,824 4,318 75 23,217 Apportioned - 46 1 22 69 Unapportioned 31,635 1 - 125 31,761 Unexpired unobligated balance, end of year 31,635 47 1 147 31,830 Expired unobligated balance, end of year - 39 - 19 58 Total unobligated balance, end of year 31,635 47 1 205 31,888 Total budgetary resources $ 31,635 $ 18,909 $ 4,319 $ 242 $ 55,105 Change in Obligated Balance: Unpaid obligations, brought forward, October 1 (gross) - 138 1 207 346 Uncollected customer payments from Federal sources, brought forward, October 1 (-) (34) - - (1) (35) Obligated balance, start of year (net), before adjustments (+ or -) (34) 137 1 207 311 Adjustment to obligated balance, start of year (net) (+ or -) - - - - - Obligated balance, start of year (net), as adjusted (34) 137 1 207 311 Obligations incurred - 18,824 4,318 75 23,217 Outlays (gross) (-) - (18,797) (4,318) (45) (23,160) Change in uncollected customer payments from Federal sources (+ or -) (14) - - 1 (13) Recoveries of prior year unpaid obligations (-) - (8) - (3) (11) Unpaid obligations, end of year (gross) - 156 1 236 393 Uncollected customer payments from Federal sources, end of year (48) - - - (48) Obligated balance, end of year (net) $ (48) $ 156 $ 1 $ 236 $ 345 Budget Authority and Outlays, Net: Budget authority, gross (discretionary and mandatory) 13,112 130 4,318 202 17,762 Actual offsetting collections (discretionary and mandatory) (-) (13,099) - - (176) (13,275) Change in uncollected customer payments from Federal sources (discretionary and mandatory) (+ or -) (14) - - 1 (13) Budget authority, net (discretionary and mandatory) - 130 4,318 25 4,473 Outlays, gross (discretionary and mandatory) - 18,797 4,318 45 23,160 Actual offsetting collections (discretionary and mandatory) (-) (13,099) - - (176) (13,275) Outlays, net (discretionary and mandatory) (13,099) 18,797 4,318 (131) 9,885 Distributed offsetting receipts (-) - - - (1,070) (1,070) Agency outlays, net (discretionary and mandatory) $ (13,099) $ 18,797 $ 4,318 $ (1,201) $ 8,815 99 catastrophic Required Supplementary Information Schedule C: Comparative Combining Statement of Budgetary Resources by FHA Program for Budgetary September 30, 2016: Dollars in Millions MMI/CMHI MMI/CMHI GI/SRI Budgetary Capital Reserve Program Program Other Total Budgetary Resources: Unobligated balance brought forward, October 1 $ 15,963 $ 98 $ 6 $ 666 $ 16,733 Unobligated balance brought forward, October 1, as adjusted 15,963 98 6 666 16,733 Recoveries of prior year unpaid obligations - 11 - 230 241 Other changes in unobligated balance (+ or -) (3,514) 3,468 - (635) (681) Unobligated balance from prior year budget authority, net 12,449 3,577 6 261 16,293 Appropriations (discretionary and mandatory) - 130 3,276 25 3,431 Spending authority from offsetting collections (discretionary and mandatory) 24,771 1 - 238 25,010 Total budgetary resources $ 37,220 $ 3,708 $ 3,282 $ 524 $ 44,734 Status of Budgetary Resources: Obligations incurred - 3,629 3,282 65 6,976 Apportioned - 58 - 12 70 Unapportioned 37,220 - - 428 37,648 Unexpired unobligated balance, end of year 37,220 58 - 440 37,718 Expired unobligated balance, end of year - 21 - 19 40 Total unobligated balance, end of year 37,220 79 - 459 37,758 Total budgetary resources $ 37,220 $ 3,708 $ 3,282 $ 524 $ 44,734 Change in Obligated Balance: Unpaid obligations, brought forward, October 1 (gross) - 133 1 430 564 Uncollected customer payments from Federal sources, brought forward, October 1 (-) (14) - - (1) (15) Obligated balance, start of year (net), before adjustments (+ or -) (14) 133 1 429 549 Obligated balance, start of year (net), as adjusted (14) 133 1 429 549 Obligations incurred - 3,629 3,282 65 6,976 Outlays (gross) (-) - (3,613) (3,282) (58) (6,953) Change in uncollected customer payments from Federal sources (+ or -) (20) - - - (20) Recoveries of prior year unpaid obligations (-) - (11) - (230) (241) Unpaid obligations, end of year (gross) - 138 1 207 346 Uncollected customer payments from Federal sources, end of year (34) - - (1) (35) Obligated balance, end of year (net) $ (34) $ 138 $ 1 $ 206 $ 311 Budget Authority and Outlays, Net: Budget authority, gross (discretionary and mandatory) 24,771 131 3,276 263 28,441 Actual offsetting collections (discretionary and mandatory) (-) (24,751) - - (240) (24,991) Change in uncollected customer payments from Federal sources (discretionary and mandatory) (+ or -) (20) - - - (20) Recoveries of prior year unpaid obligations (-) - - - 1 1 Budget authority, net (discretionary and mandatory) - 131 3,276 24 3,431 Outlays, gross (discretionary and mandatory) - 3,613 3,282 58 6,953 Actual offsetting collections (discretionary and mandatory) (-) (24,751) - - (240) (24,991) Outlays, net (discretionary and mandatory) (24,751) 3,613 3,282 (182) (18,038) Distributed offsetting receipts (-) - - - (2,000) (2,000) Agency outlays, net (discretionary and mandatory) $ (24,751) $ 3,613 $ 3,282 $ (2,182) $ (20,038) 100 catastrophic Required Supplementary Information Schedule D: Comparative Combining Budgetary Resources by FHA Program for Non-Budgetary September30, 2017: Non MMI/CMHI GI/SRI Budgetary Financing Financing Other Total Budgetary Resources: Unobligated balance brought forward, October 1 $ 10,609 $ 6,012 $ (210) $ 16,411 Adjustment to unobligated balance brought forward, October 1 (+ or -) - - 234 234 Unobligated balance brought forward, October 1, as adjusted 10,609 6,012 24 16,645 Recoveries of prior year unpaid obligations 65 15 2 82 Unobligated balance from prior year budget authority, net 10,674 6,027 26 16,727 Borrowing authority (discretionary and mandatory) 6,500 812 1,064 8,376 Spending authority from offsetting collections (discretionary and mandatory) 28,972 5,661 32 34,665 Total budgetary resources $ 46,146 $ 12,499 $ 1,123 $ 59,768 Status of Budgetary Resources: Obligations incurred 30,019 3,887 1,069 34,975 Apportioned 3,568 2,664 40 6,272 Unapportioned 12,559 5,949 13 18,521 Unexpired unobligated balance, end of year 16,127 8,612 54 24,793 Total unobligated balance, end of year 16,127 8,612 54 24,793 Total budgetary resources $ 46,146 $ 12,499 $ 1,123 $ 59,768 Change in Obligated Balance: Unpaid obligations, brought forward, October 1 (gross) 1,985 422 243 2,650 Obligated balance, start of year (net), before adjustments (+ or -) 1,985 422 243 2,650 Obligated balance, start of year (net), as adjusted 1,985 422 243 2,650 Obligations incurred 30,019 3,887 1,069 34,975 Outlays (gross) (-) (29,597) (3,829) (755) (34,181) Recoveries of prior year unpaid obligations (-) (65) (15) (2) (82) Unpaid obligations, end of year (gross) 2,342 466 554 3,362 Obligated balance, end of year (net) $ 2,342 $ 466 $ 554 $ 3,362 Budget Authority and Outlays, Net: Budget authority, gross (discretionary and mandatory) 35,472 6,473 1,095 43,040 Actual offsetting collections (discretionary and mandatory) (-) (37,943) (6,485) (41) (44,469) Budget authority, net (discretionary and mandatory) (2,472) (12) 1,055 (1,429) Outlays, gross (discretionary and mandatory) 29,597 3,829 755 34,181 Actual offsetting collections (discretionary and mandatory) (-) (37,943) (6,485) (41) (44,469) Outlays, net (discretionary and mandatory) (8,346) (2,656) 714 (10,288) Agency outlays, net (discretionary and mandatory) $ (8,346) $ (2,656) $ 714 $ (10,288) 101 catastrophic Required Supplementary Information Schedule D: Comparative Combining Budgetary Resources by FHA Program for Non-Budgetary September 30, 2016: Non MMI/CMHI GI/SRI Budgetary Financing Financing Other Total Budgetary Resources: Unobligated balance brought forward, October 1 $ 27,597 $ 6,360 $ 29 $ 33,986 Adjustment to unobligated balance brought forward, October 1 (+ or -) - - (3) (3) Unobligated balance brought forward, October 1, as adjusted 27,597 6,360 26 33,983 Recoveries of prior year unpaid obligations 409 54 - 463 Unobligated balance from prior year budget authority, net 28,006 6,414 26 34,446 Borrowing authority (discretionary and mandatory) 11,021 1,536 520 13,077 Spending authority from offsetting collections (discretionary and mandatory) 16,405 3,381 14 19,800 Total budgetary resources $ 55,432 $ 11,331 $ 560 $ 67,323 Status of Budgetary Resources: Obligations incurred $ 44,823 $ 5,319 $ 769 $ 50,911 Apportioned 2,784 2,783 7 5,574 Unapportioned 7,825 3,229 (216) 10,838 Unexpired unobligated balance, end of year 10,609 6,012 (209) 16,412 Total unobligated balance, end of year 10,609 6,012 (209) 16,412 Total budgetary resources $ 55,432 $ 11,331 $ 560 $ 67,323 Change in Obligated Balance: Unpaid obligations, brought forward, October 1 (gross) $ 2,042 $ 440 3 $ 2,485 Obligated balance, start of year (net), before adjustments (+ or -) 2,042 440 3 2,485 Adjustment to obligated balance, start of year (net) (+ or -) - - 3 3 Obligated balance, start of year (net), as adjusted 2,042 440 6 2,488 Obligations incurred 44,823 5,319 769 50,911 Outlays (gross) (-) (44,471) (5,283) (532) (50,286) Recoveries of prior year unpaid obligations (-) (409) (54) - (463) Unpaid obligations, end of year (gross) 1,985 422 243 2,650 Obligated balance, end of year (net) $ 1,985 $ 422 $ 243 $ 2,650 Budget Authority and Outlays, Net: Budget authority, gross (discretionary and mandatory) $ 27,426 $ 4,917 $ 533 $ 32,876 Actual offsetting collections (discretionary and mandatory) (-) (23,905) (5,106) (16) (29,027) Budget authority, net (discretionary and mandatory) 3,521 (189) 517 3,849 Outlays, gross (discretionary and mandatory) 44,471 5,283 532 50,286 Actual offsetting collections (discretionary and mandatory) (-) (23,905) (5,106) (16) (29,027) Outlays, net (discretionary and mandatory) 20,566 177 516 21,259 Distributed offsetting receipts (-) - - - - Agency outlays, net (discretionary and mandatory) $ 20,566 $ 177 $ 516 $ 21,259 102 catastrophic Other Accompanying Information Summary of Financial Statement Audit and Management Assurances For FY 2017, two material weaknesses were identified by the Office of Inspector General in its audit of FHA’s Principal Financial Statements and accompanying Notes. Table 1 provides a summary of financial audit findings with regard to the audit opinion. Table 2 is a summary of FHA’s FMFIA management assurances. 103
Audit of the Federal Housing Administration's Financial Statements for Fiscal Years 2017 and 2016 (Restated)
Published by the Department of Housing and Urban Development, Office of Inspector General on 2018-02-13.
Below is a raw (and likely hideous) rendition of the original report. (PDF)