Securitizing low-income multifamily mortgages.
One way to increase the supply of mortgage money for low-income multifamily housing mortgages would be to create a securitized secondary market, similar to the market for mortgage-backed securities on one- to four-family houses. Admittedly, that is far easier to say than it is to achieve. Nevertheless, for the past two years, a National Task Force on Financing Affordable Housing, composed of representatives of financial institutions and trade associations, has been exploring this possibility. Its report should be available later this year.
This article, prepared in advance of the Task Force's findings, restricts its focus to a discussion of the problems with securitization of mortgages used in connection with low-income housing tax credits. It examines first, whether the low-income multifamily mortgage market is large enough to justify securitization; second, what securitization efforts are now underway; third, what means there are to provide credit enhancement for the risk on a pool of multifamily mortgages; and fourth, a possible method of structuring a securitized market based on a recommendation for partial federal support. (See sidebar.)
Where low-income housing tax credits are involved, the permanent mortgage should be a fixed-rate of interest for a term of at least 18 years (covering a 15 year minimum low-income requirement plus three years to cover probable continuation of low-income requirements and to allow time for tax auditing). Commercial banks, which have been willing to make construction or rehabilitation loans for low-income housing, are usually reluctant to tie up their funds on long-term, fixed-rate mortgages. It is clear that they will be more willing to make interim loans on this housing if there is a take-out--a long term permanent mortgage from some other type of lender.
The take-outs, or permanent mortgages, on low-income multifamily housing will be much more available if there is a securitized secondary market; yet there are extraordinary difficulties in turning these mortgages into securities with investment-grade ratings. There is no magic kiss to turn a frog into a prince. The creation of securitized market depends heavily on the roles that the federal government and Fannie Mae and Freddie Mac might play.
Before discussing those roles and credit enhancement, it is worthwhile to estimate the size of the multifamily mortgage market that accompanies low-income-housing tax credits.
Tax credit and the size of the mortgage market
We begin evaluating the size of this market by estimating the number of projects receiving the tax credits. The low-income-housing tax credit is the primary subsidy for low-income multifamily housing. A building is eligible for the tax credit if at least 20 percent of the units are occupied by low-income households with incomes under 50 percent of the area median income, or if 40 percent of the units are occupied by low-income households with incomes under 60 percent of the area median income. When one dollar of tax credit is allocated to a project, in each of the following nine years, the tax credit owner is entitled to one dollar of credit. Developers of low-income housing usually sell the 10-year stream of tax credits for an amount that will be used for acquisition, construction or rehabilitation. The amount received is discounted depending on the timing of the amounts received, and fees are deducted. A sum of five times the annual tax credit is not an unusual amount to receive for use as equity in the project, although the amount varies significantly project by project.
The equity received for the tax credit is often combined with additional subsidies in the form of grants or low-interest loans from cities, states or charitable groups. The remaining amount, after the equity and any low-interest loans, is the amount required in the first mortgages. If the first mortgage is at market interest rates, it typically covers only half or less than half of the project's costs.
In 1991, about $392 million in tax credits was allocated to about 2,500 projects containing 99,400 units. The National Council of State Housing Agencies, which collects the figures from the states, reports that the figures are subject to minor revisions and corrections.
In 1990, $213 million in tax credits was allocated to 1,764 multifamily housing projects containing 74,029 units. Tax credits allocated in 1989 were $307 million and in 1988, $210 million. President Bush and congressional leaders have stated their intention of extending the tax credits when those credits expire on June 30, 1992.
No one yet has done a study, as far as I know, on the amount of conventional (uninsured) mortgage money used to finance the housing that received tax credits. Nor do we know how many tax-credit-supported projects rent 100 percent of the units to eligible low-income tenants and how many rent a lesser amount of the units, say 20 percent, to low-income tenants. We do know that rehabilitation of existing buildings, rather than construction of new buildings, is quite common. Of course, costs vary immensely by geographical location.
Nearly 20 percent of the tax credits are used with Farmers Home Administration 1 percent mortgages. Simply applying that percentage to 1991's volume would leave 80 percent of the 99,400 units, 79,520 financed with conventional mortgages. If we assume, for the sake of a rough calculation, that the average mortgage per unit was $15,000, then the total mortgage amount in 1991 was nearly $1.2 billion. Half of this amount or more would be sufficient to sustain an ongoing securitized secondary market.
Current financing programs for low-income multifamily housing
There are existing financing programs for low-income multifamily housing. Fannie Mae, which has pledged $10 billion in affordable housing mortgages over three years, is beginning a major program to issue forward commitments, for up to two years, to buy or securitize $300 million of permanent financing made to developers or owners by Fannie Mae-approved multifamily lenders. This program is targeted to families that meet the low-income housing tax credit eligibility requirements. Fannie Mae will commit to purchase the mortgage, either with or without a rate lock. To lock in a rate two years hence can be initially quite expensive, but it may prove to be wise in these times of relatively low interest rates.
Another way to finance the forward commitment is for an investor, such as a pension fund, to commit to purchase Fannie Mae's triple-A-rated securities in the amount of the mortgage loan. (One part of the Fannie Mae program covers the swap of securities for tax-exempt or taxable bonds issued by public housing finance agencies, but that it is outside the scope of this article.)
Fannie Mae's permanent, low-income, multifamily mortgage will be for a minimum term of 18 amortized over 25 years, with a yield maintenance provision for 10 years. The minimum mortgage is $1 million and the maximum, unless the maximum is waived, is $10 million. When the permanent mortgage purchase is made, the minimum occupancy must be 90 percent for each of the three consecutive months immediately preceding loan deliver, with the minimum rental achievement specified in the commitment.
Fannie Mae has made a good number of forward commitments for multifamily mortgages in the past three years. It also continues a $120 million low-income multifamily housing commitment in conjunction with the Mortgage Bankers Association of America in six cities. One reason for the relatively slow pace of these commitments has apparently been due to the difficulties in originating apartment loans with available subsidies.
Freddie Mac entered into an agreement with the Local Initiatives Managed Assets Corporation (LIMAC) to purchase up to $100 million of low-income multifamily housing mortgages from LIMAC, which in turn would purchase those mortgages from Freddie Mac-approved seller-servicers. LIMAC receives Freddie Mac triple-A-rated securities that it places with institutional investors. LIMAC agrees to take the top 20 percent of the risk on the pool sold to Freddie Mac, although part of that risk is borne by the originators of the loans. This program has been going slowly.
There are primary lenders that have been active in the low-income housing market in addition to the secondary market agencies, notably the AFL-CIO Housing Trust, as well as many banks.
The Resolution Trust Corporation (RTC) has a financial program for the multifamily housing projects it sells under its affordable housing disposition program. Nonprofit housing organizations and public agencies may finance 95 percent of the purchase price in the form of RTC seller-financing provided they agree to retain the properties purchased for low-income families (defined in a different way than definition used for the low-income housing tax credits) for [period of between 40 and 50 years. The seller financing is for 15 years amortized over 30 years and can be at a below-market interest rate depending on the purchase price. For-profit entities purchasing apartments for low-income families can obtain 85 percent financing, but it is generally to their advantage in bidding to seek not more than 75 percent financing. The RTC will also offer a second mortgage on its affordable housing properties to nonprofits and public agencies if an institutional lender is offering a first mortgage.
Experience with multifamily mortgage securitization
Although a securitized secondary market for low-income multifamily housing mortgages has not been created, the industry has years of experience with the securitization of multifamily mortgages. In 1986, CIGNA took nine, large multifamily mortgages and divided them into first liens and second liens. The first liens were the basis for securities that it sold. Connecticut General Life, part of CIGNA, retained the second liens.
Beginning in 1987, 20 or more savings and loan associations began using the senior-subordinated structure to sell securities backed by multifamily housing mortgages. The mortgages would be divided into classes, such as 80 percent or 85 percent for the senior class, and 20 percent or 15 percent for the junior class. The subordinate class would cover risk of loss on the senior class. Many of the senior-class certificates were given ratings, usually single-A, and primarily by the credit rating firm of Duff & Phelps. The savings institution would usually retain the junior portion.
One of the reasons for the demise of the senior-subordinated, multifamily mortgage-security sales was the imposition, after the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), of rules that required the savings institution, as holder of the subordinated class, to retain capital as though the institution still held the entire pool of mortgages. Because a primary reason for the sale of mortgages was to reduce capital requirements, the regulatory agency rules were a major factor in ending this type of securitization for depository institutions.
For several years, Fannie Mae has swapped its securities for multifamily mortgages in pools, either fixed-rate or adjustable-rate mortgages, with a minimum pool size of $20 million. Freddie Mac, even though it has been out of the multifamily housing origination market, has also been willing to swap securities for mortgage pools. When it was in the origination market, Freddie Mac would sell participation certificates backed by multifamily loans.
The major seller of multifamily housing securities today is the RTC. The securities are backed by performing multifamily mortgages underwritten by savings institutions taken over by the RTC. The RTC has created a class of securities that is double-A rated by each of the credit rating agencies, but in order to obtain that rating, it had to provide a reserve fund consisting of government or other highly rated obligations. In the first multifamily issue, in August 1991, a reserve fund of 35 percent of the principal was created. In the following two offerings, a reserve fund of 27 percent was set up and, in addition, a senior-subordinated structure was used to provide that 12 percent of the principal amount that was in subordinate securities.
The extensive reserve funds that the RTC found necessary to create indicates the difficulty in obtaining a high investment-grade rating, such as double-A, for multifamily housing mortgages. Securities based on a pool of multifamily mortgages without credit enhancement will not be purchased.
There are a variety of means to provide that credit support: a reserve fund that may be drawn upon if funds are inadequate to meet specified payments a senior-subordinated structure, overcollateralization, obtaining a third-party letter of credit or surety bond, mortgage insurance or a combination of these techniques.
A reserve fund provides the primary support for RTC commercial and multifamily. Only the federal government can afford such a large reserve fund to provide security for low-income multifamily housing mortgages.
The senior-subordinated structure provides security for the senior class of securities without the additional cost of credit enchancement from a reserve fund or third party. If, for example, low-income, multifamily mortgages in a pool consist only of 50 percent loan-to-value loans and three is an 80/20 senior subordinate split, this means that the loan-to-value is reduced to 80 percent of the 50 percent, (or 40 percent) and the debt-service-coverage ratio for the senior securities is increased. However, loan-to-value ratios may not be reliable for safety reasons, particularly because it is difficult to determine value in areas where only subsidized rentals are feasible and rental payments may not be increased as operating costs increase. Today, a senior-subordinated structure can help provide security, but it is not enough by itself to justify a high investment-grade rating.
Overcollateralization--for example, doubling the number of mortgages backing the securities--is not as satisfactory to investors as a reserve fund. One reason is that losses on the additional collateral tend to come at the same time and for the same reason as the remaining collateral for securities. Overcollateralization has seldom been used.
Letters of credit, private insurance and surety bonds are generally not available for low-income, multifamily housing mortgages. One company offering bond insurance is Guaranty Risk Services in New York, which has provided credit enhancement for larger conventional multifamily housing finance agency bonds.
Foreign banks used to be frequent providers of letters of credit for commercial mortgage securities, but they have not recently been in the market for that kind of obligation.
Finally, the Federal Housing Administration (FHA) insures multifamily housing and securities based on insured mortgages sold with a GNMA guarantee. The FHA coinsurance program, no longer in operation because of severe losses, was a program whereby approved coinsurers could originate mortgages on which they would take the top portion of the risk and share an additional portion of the risk with the federal government which, however, would take the ultimate risk after the coinsurer had paid its share.
A possible course of action
A securitized secondary market for low-income, multifamily housing mortgages would depend on the federal government, Freddie Mac and Fannie Mae. This is the case because the senior subordinated structure will not normally provide sufficient security; support from private third parties is not available in any needed degree.
It is uncertain at present whether Fannie Mae or Freddie Mac will undertake a more expansive role to encourage a secondary market in low-income multifamily mortgages. In any event, each should be involved in establishing underwriting requirements and providing standard documentation for whatever secondary market might emerge.
It would be useful, I believe, to explore possible alternatives that would supplement the programs of Fannie Mae and Freddie Mac. In particular, it may be necessary to develop procedures for pooling small mortgages (for example, those averaging $500,000) because a large number of existing apartment buildings available for low-income housing have less than 35 units.
A convincing argument can be made that the federal government should be the ultimate guarantor of the securitized, low-income, multifamily mortgage market. It is considered to be the ultimate guarantor of Fannie Mae and Freddie Mac. It has provided FHA insurance to multifamily housing that meets certain requirements. Rather than create another FHA coinsurance program, the federal government might pattern its support for the secondary market after Farmer Mac I.
In Farmer Mac I (to distinguish it from later Farmer Mac programs), pools of income-producing mortgages in rural areas can be assembled by what are called Certified Facilities that purchase those mortgages from originating banks, thrifts or mortgage bankers. The Certified Facility takes the initial losses in the pool up to 10 percent of the pool principal. If there is a loss beyond that, Farmer Mac guarantees timely payment of principal and interest. To support that guarantee, Farmer Mac has a $1.5 billion line of credit from the U.S. Treasury. The guarantee has only been used once because agricultural lenders have found that retaining the loans is profitable. Farmer Mac I's guarantee has been used only once, when, in December 1991, it guaranteed mortgage-backed securities issued against a pool of $112 million in agricultural mortgages formed by John Hancock Mutual Life Insurance Company.
In the federal government, through a line of credit, is willing to take the risk after a 10 percent loss on pools of agricultural real estate, the argument can easily be made that it should take a contingent risk for excessive losses in low-income multifamily housing mortgages, perhaps from an existing line of credit.
If the federal government would, for example, take any loss beyond 15 percent of a pool's value, it would mean that 30 percent of the mortgages could lose 50 percent of their value before federal funds would be needed. This is not likely with properly underwritten low-income projects because there is always a market for low rents. Moreover, the mortgages would have, at least initially, a low loan-to-value ratio and a debt service coverage of perhaps 1.2 or more. Careful management and reserves for repairs are essential to prevent losses on long-term mortgages.
To cover the top 15 percent of any loss, two steps might be taken. First, the owners or developers of low-income housing might contribute in an amount equal to 5 percent of the mortgage to a reserve fund. The reserve fund would be the first to be drawn upon in case of loss and the contributions would be pooled. Any amount remaining in the reserve fund, plus interest earned, would be returned after 15 years.
Many people believe that there should be recourse for losses on the mortgage to the originating institution. This recourse might be limited to a one-time fee, perhaps replenishing the 5 percent contribution if the sold mortgage went into default and the loss was greater than 5 percent.
Second, the remaining 10 percent of the risk could be covered by subordinating securities. The main problem is whether any institution will purchase these subordinated securities, despite their relatively high interest rate. Just as the possible role of the federal government needs exploration, so a determination must be made as to whether or not there would be purchasers for such a subordinate class of securities protected only by a 5 percent reserve.
It is also unclear whether or not the need to provide credit enhancement would make the mortgage so expensive to the borrower that the project could not be built. Much depends on the spread of mortgage rates over double-A-rated, long-term securities and the steepness of the yield curve if the securities are to be divided into short-term, medium-term and long-term obligations.
To ensure that standard documents standard underwriting and standard policies are in place and to make sure that the originating institutions are knowledgeable in the field of low-income housing, there should be a consortium of experienced organizations to create a workable program. This consortium could serve as a conduit to acquire the right to purchase low-income multifamily mortgages when the properties are 90 percent occupied and ready to be pooled. (Conduits for income-producing mortgages are discussed in an excellent article by Joseph C. Franzetti, "Movements in Commercial Mortgage Securitization," Mortgage Banking, July 1991.) Members of the consortium might also serve as originators. The experienced organizations would probably include SAMCO in California, the Community Preservation Corporation in New York, the National Cooperative Banker (for limited equity cooperatives) and other organizations that understand the low-income-housing tax credit. Local loan consortia might be part of this national review group. A good argument can be made for having the national consortium service the loans, although the loans will be held by a real estate mortgage investment conduit trustee.
In summary, originators, such as commercial banks, thrifts and mortgage bankers, would originate the loans. Loans might be sold to Fannie Mae or to Freddie Mac. Alternatively, originators would sell to one or more conduits that would arrange for securitization when enough mortgages had been assembled. In the latter case, originators would contribute to a 5 percent reserve fund to which they would add an additional 5 percent if the loan goes into default. The originators would also take the risk of changing interest rates until the loans were actually assembled and ready to securitize. The federal government would cover losses beyond 15 percent of the pool principal.
Admittedly, a securitized secondary market might prove to be a jerry-built contraption that cannot work. On the other hand, every effort should be made to provide a continuous flow of mortgage money for low-income multifamily housing. A steady flow of these mortgages into the securities market would complement the single-family housing securities market and provide lower interest rates for borrowers. Securitization is well worth further study and innovative proposals.
Low-Income-Housing Task Force
In 1989, a technical assistance group for socially responsible investment, under the auspices of the American Council of Life Insurance, created a Low-Income Housing Task Force, which later become the National Task Force on Financing Affordable Housing. It is composed of experts from Fannie Mae and Freddie Mac, private companies, trade associations and affordable housing organizations. Gaye Beasley, president of The Patrician Financial Company, Bethesda, Maryland, represents the Mortgage Bankers Association of America and has taken an important role in drafting the final report. The task force is chaired by Wayne Hedien, chairman of Allstate Insurance Company, Northbrook, Illinois and Harry W. Albright, Jr., a New York lawyer. The effort is coordinated by Kirsten Moy, vice president of Equitable Real Estate Investment Management, Inc., New York.
Although the task force will not issue its extensive report until later this year, two of its members, Barbara Cleery, president of Affirmative Investments and Carl Eifler, managing director of The First Boston Corporation, New York, presented a statement to a hearing April 3, 1992 before the Subcommittee on Housing and Urban Affairs of the Senate Committee on Banking, Housing and Urban Affairs.
The statement indicated that the task force report would cover standardizing the key elements of financing multifamily housing, exploring new risk-sharing mechanisms, the collection of information on multifamily housing and the education of the industry on the actual risks involved, rather than the perceived risks. It would present recommendations on streamlining production at the local level and would recommend the establishment of a specialized organization to create standards to which the multifamily housing financing industry would adhere.
Among the group's specific recommendations is a universal risk-weighting system designed for multifamily housing. It asks that the feasibility of new credit enhancement roles for state and local housing agencies be investigated through mortgage insurance programs capitalized by a dedicated revenue stream or by use of federal monies or by development of risk-sharing arrangement with the federal mortgage agencies.
Another recommendation is to investigate the feasibility of national, regional and/or local private conduits to help pool, provide credit enhancement for, and possibly buy or sell smaller affordable housing mortgages. The task force recommends the creation of a new institution at a national level, called the Multifamily Institute, to address the special issues and problems associated with multifamily housing, especially affordable multifamily housing. Eric Stevenson is a Washington, D.C. lawyer.
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|Title Annotation:||Affordable Housing; includes related article on the National Task Force on Financing Affordable Housing|
|Date:||May 1, 1992|
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