SPECIAL FOCUS: FEDERAL HOUSING ADMINISTRATION
APARTMENT FINANCE TODAY • SEPTEMBER 2007
Losing Ground
How can the FHA regain competitiveness and reshape itself
into a 21st century agency?
By Jerry Ascierto
As the subprime mortgage
meltdown sends chills
through the world’s credit
markets, the agency best
suited to bring stability is
itself caught up in turbulence.
The Federal Housing Administration (FHA), which
invented the modern single-family mortgage market, could
sustain the multifamily industry as other sources of capital
face new constraints, thanks to its ability to back loans with
the full faith and credit of the U.S. government.
But the agency has fallen on difficult times. Its production
volume continues to dwindle as slow deal cycle times, inconsistent
field offices, and archaic requirements scare off
developers.
These problems strain the FHA’s ability to spur multifamily
development or be a steadying force, leaving many to
wonder just what’s ahead for the agency.
FHA products, such as the Sec. 232 program for nursing
homes, are very competitive, and some, like the 221(d)(4)
program for new construction or substantial rehabilitation,
with its 40-year, non-recourse terms, are described as the
best in the industry by developers and lenders alike.
The FHA also promotes development in areas underserved
by the capital markets, such as healthcare and skilledcare
facilities for seniors. As a government agency, it has the
resources to innovate, and isn’t as susceptible to the whims
of the market as private enterprise.
It was the first to come out with products specifically for
retirement centers, for instance. “Without FHA, there would
be a lot less elderly housing, and assisted-living and skilledcare
facilities,” said Thom Cooley, a 13-year veteran of the
FHA who most recently led FHA production for ARCS
Commercial Mortgage. What’s more, the FHA serves rural
areas in secondary and tertiary markets, “and a lot of lenders
won’t even go to those little towns.”
The FHA’s business often runs
counter to the industry at large. When
capital is readily available on the market,
the FHA’s volume shrinks: When
underwriting tightens up and capital
dries up—as it has now—many flock to
the FHA’s programs.
The agency’s volume suffered over
the last three years as many capital
sources, especially conduit lenders,
fought to place money in multifamily
assets. “Your ability to borrow in a
CMBS (commercial mortgage-backed
securities) program [was] as cheap as
what you might be able to borrow
under the FHA programs,” said Brian
Pollard, president of Lancaster
Pollard.
But as lenders tighten underwriting,
sending the cost of capital higher,
developers will again look to the FHA.
For instance, one of the Sec. 221(d)(4)
program’s greatest benefits is its ability
to lock in a permanent rate at commencement
of construction, a feature
rarely seen in competing programs.
“That’s going to become much more
important to developers as we get into
a less stable interest-rate environment,”
said Pollard. “A perception of rising
long-term interest rates will make the
FHA more palatable, because of that
ability to lock rates.”
However, the value of those products
is offset by the hassle of engaging
with the agency.
Stop breaking down
The FHA’s deal turnaround times lag
behind the rest of the mortgage industry.
A developer can get a bank loan in
90 days, but may have to wait as long as
a year for the FHA to turn a deal
around. “It isn’t that they really should
be the lender of last resort, but frequently
they are, solely because the
projects take so long to get through the
pipeline,” Cooley said.
The FHA’s requirements are archaic.
A credit-worthy borrower can go to a
bank with plan specs, financial information,
and a resume in hand, and 90
days later, commence construction. As
long as the borrower provides enough
information on which to make an
underwriting decision, the bank is
happy. But the FHA requires a higher
barrier of entry: Borrowers must have
construction-ready documents and a
contractor’s price that’s written in
stone.
The FHA’s programs often are too
narrowly written. Because the FHA’s
programs are divided into tightly
defined categories, a single continuumof-
care seniors facility featuring independent
living, assisted living, and
skilled nursing would be processed
under separate mortgages using different
underwriting criteria.
The FHA’s multifamily mortgage
limits are out of touch with high-cost
areas like San Francisco or New York,
making it nearly impossible to do an
FHA deal in such areas. For example,
the basic high-cost-area loan limit for a
two-bedroom unit in a building with an
elevator under the Sec. 221(d)(4) program
is $172,411. Such a unit could easily
cost twice that in San Francisco.
Legislation under consideration in
Congress would increase the maximum
FHA multifamily mortgage limits from
140 percent to 170 percent of the basic
loan limit. The bill, the Expanding
American Homeownership Act of 2007,
also would give the Department of
Housing and Urban Development
(HUD) secretary authority to increase
that limit to 215 percent on a projectby-
project basis (for more on the Act,
see sidebar, page 32).
Another problem is the FHA’s susceptibility
to the whims of politics.
Because it’s a steady revenue producer,
the executive branch is often tempted
to use the agency as a cash cow by
increasing the mortgage insurance premiums
(MIPs) it charges, for instance,
which drives business away from the
agency (for more on MIPs, see sidebar
page 25).
Many wonder if volumes will continue
to drop to the point that the agency
becomes nothing more than an afterthought
in the multifamily industry. “I
don’t think they’ve hit bottom yet;
sometime in the next five years they’ll
hit bottom,” said Cooley. “[Borrowers]
are likely to continue to withdraw simply
because the processes, which are
well-grounded historically, no longer fit
the system today. The methods they use
are simply too onerous for today’s borrowers.”
Mapping it out
The FHA insured about a third of all
multifamily mortgages in the early
1980s, but that figure fell to 16 percent
in the mid-1980s, and down to less than
5 percent by the late 1990s, according to
HUD’s Survey of Mortgage Lending
Activity.
So in 2000, the agency unveiled its
Multifamily Accelerated Processing
(MAP) system to lure borrowers back.
Initially, MAP slashed turnaround time
on the agency’s mortgage insurance
programs by allowing commercial
lenders to perform much of the processing
and underwriting that had previously
been done at HUD. “Review,
don’t redo” was the program’s mantra.
Its initial success was staggering.
Endorsements of multifamily loans
steadily grew from $3.7 billion in 2000
up to a high of $7.5 billion in 2004. But
the program lost its way. In 2005, MAP
volume slipped 26 percent, to $5.55 billion,
and last year, fell another 7.5 percent,
to $5.13 billion. This year looks no
better. From October 2006 to July 24,
2007, the FHA endorsed 689 loans for
$3.17 billion, a 22.7 percent decline from
the $4.1 billion it helped finance in the
year-earlier period.
The problems that MAP was meant
to address, such as inconsistency
between field offices and slow processing,
have returned, many say.
Before MAP, the FHA field offices,
also known as hubs, each seemed to
have their own way of doing things.
The MAP Guide sought to instill consistency
on the way deals were
processed, spelling out policies and
procedures that, for the first few years
of the program, achieved uniformity.
That efficiency didn’t last. “They
don’t seem to be meeting their timeframes,
and [swift deal processing] just
depends on which hub you’re doing
business in at times,” said Marie Head,
president of MAP lender Prudential
Huntoon Paige. Before joining
Prudential, Head led the FHA’s multifamily
production for 20 years.
Although the MAP guide standardizes
much of the process, every deal has
its own nuances that make it unique
and require some degree of human
interaction.
Underwriting multifamily loans
“will always be somewhat of an art, so
you have to have the human capital to
run it,” said David Cardwell, vice president
of capital markets at the National
Multi Housing Council. “The lenders
that are most successful with FHA will
tell you that they have great success
with certain offices and won’t even produce
with others, and you can’t operate
that way.”
Under MAP, the FHA pledged to
process a pre-application for its Sec.
221(d)(4) program in 45 days, and issue
the firm commitment in another 45
days. For a refinance or acquisition, the
FHA would have an answer for the
developer in 60 days, at least twice as
fast as before.
How can developers navigate the
system? It’s important to use a banker
or lender with strong ties to the FHA to
help smooth any delays that emerge.
And having some industry heavyweights
on staff helps too. One development
company’s CEO can get HUD
headquarters staff on the phone quicker
than even most field offices, based on
long-standing relationships that CEO
has forged with key HUD staff. “We’ll
say to the field office contact, do you
mind if we call headquarters, and
they’ll say, ‘No, you’ll probably have better
luck than us,’” said an executive at a
developer that uses FHA, who requested
anonymity.
Forest for the trees
Many lenders and industry groups
have called for a reorganization of the
FHA’s multifamily program to bring it
more in line with the practices of private
enterprise.
The current process sees lenders
assemble third-party reports from
appraisers, architects, and cost analysts,
and send the package to their internal
underwriter for review before sending
it to the FHA. Each report is then
picked apart by HUD’s own appraisers,
mortgage credit analysts, architects,
and cost analysts.
HUD reviews could be done by a
chief underwriter looking at the whole
transaction, rather than by four different
specialists separately focusing on
their own specialties, according to the
Mortgage Bankers Association (MBA).
“HUD goes back over every single piece
of it,” said Cheryl Malloy, the MBA’s
senior vice president, multifamily and
governance, referring to the loan file.
“That’s how they’ve always functioned
in the past, but do they really need to
do that?”
Lenders are already held accountable
with the MAP guide’s quality control
plan and the lender quality monitoring
division within HUD, which
reviews MAP deals. “You have to have
that level of trust, and that means
accepting our underwriting packages
when they come in and doing a timely
review,” Head said.
On the trickier deals, HUD could
bring in contractors to help do an
assessment. This approach would
require the recruitment and training of
underwriters, but would streamline the
agency by eliminating the need for the
other specialists, Malloy said.
The federal government is operating
under a continuing resolution that has
effectively frozen HUD’s budget and
eliminated its ability to replace staff.
Since two-thirds of FHA senior staff is
eligible for retirement, the need for
more restructuring is obvious. “They
have to delegate more to the lenders,”
said Head. “If you can’t hire staff, then
you have to trust your partners, and
we’re their partners.”
A ranking system could be one way
to ease congestion. Lenders with low
delinquency, default, and assignment
rates could be given a more expeditious
level of review, Head argued.
Set me free
The Millennial Housing
Commission (MHC), a bipartisan study
group appointed by Congress at the end
of 2000 to analyze the nation’s housing
challenges, advocated freeing the FHA
from its restrictive structure.
The report found that the statutes
and regulations governing the FHA
“dramatically increase the time necessary
to develop and implement new
products, keeping FHA from being fully
responsive to the evolving marketplace.”
The report also said that the
FHA’s dependence on the appropriations
process, which forces it to compete
for funds within HUD, has led to
under-investment in technology, which
makes working with its industry partners
difficult.
The MHC advocated restructuring
the FHA as a wholly owned government
corporation within HUD, run by a
CEO reporting to the HUD secretary.
Such a move would let it adapt to the
marketplace much more quickly, without
relying on Congress to legislate
each change. This “could be accomplished
with no substantial budget
impact,” the report said.
“I think that day is coming,” said
Head. “You either have to run it like a
business, even if it’s government, or you
have to make it a business.”
However, the MBA and many HUD
veterans are concerned that such a
move would negatively impact HUD in
a big way, as the FHA constitutes the
bulk of real estate expertise within the
department. To separate the FHA from
HUD would gut the department and
render it less vital, they argue.
Another key MHC proposal is to
have the FHA act as a secondary market
rather than as a retail lender. One
proposal would help provide liquidity
to the small multifamily mortgage market,
serving properties between 5 and
49 units, which unlike larger developments,
lack access to efficient secondary
markets. The MHC report advocated
creating an FHA small multifamily
pool insurance program, which “would
give local lenders an outlet for small
multifamily loans at lower cost than
current FHA programs.”
The MHC also recommended to
Congress that it permit the FHA to
issue construction-only insurance.
Because it can back loans with the full
faith and credit of the federal government,
the FHA could attract secondarymarket
investors by indemnifying them
against losses from construction-only
loans.
Walkin’ blues
Two-thirds of the FHA’s senior staff
is eligible for retirement, according to
the agency. This demographic shift is a
double-edged sword: Tons of experience
will leave the organization, but if
ever an agency needed an infusion of
new blood, it’s the FHA.
“Most of what it takes to make something
work at HUD is not written
down—it’s the experience of the people
who live it every day,” said Cooley.
“HUD should bring in consultants who
can gather that intellectual capital, document
it, and systemize it before it goes
away.”
The new guard could help resuscitate
the agency over the next decade.
“The new folks, people with some
recent market experience, will revitalize
the agency,” said Cooley. “It will
reinvent itself.”
That’s crucial, because a modernized
FHA, with processes and products
more aligned with those found in private
industry, could be a boon to the
multifamily industry, especially in times
like now, when the capital markets are
on shaky ground.
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