• New growth in lending for affordable housing
  • DSC ratios for affordable housing increased
  • Watching the market when it comes to underwriting

Like many financial institutions, Fannie Mae was expecting 2002 to be a year of transition and uncertainty. As the boom years of strong economic growth and low interest rates appeared to be ending, Fannie Mae said it was still committed to finding ways to finance affordable housing.
As 2001 drew to a close and a recession appeared to be starting, the giant secondary market organization was carefully considering how to reach its affordable housing goals in 2002. “Sept. 11 really gave us additional challenges [when making] assumptions for next year,” said Wendell Johns, vice president of multifamily affordable housing for Fannie Mae.

The main thing the market should understand, Johns stressed, is that Fannie Mae will continue to develop products targeted to low- and moderate-income households in spite of what may happen in the economy. “If interest rates do go up, we’re still going to be there, just like in the low-interest rate environment,” he said.

With lending for affordable housing running at a very strong pace in 2001, Johns said Fannie was on track to meet its 10-year $175 billion goal for affordable housing within its American Dream Commitment. “We are on track, which means many more families of lower incomes will be able to benefit from our purchases and mortgage revenue bonds, our equity and debt financing of tax credit properties, and the refinancing we’re working on for properties that have expiring Sec. 8 contracts.”

In 2002, there are some areas of uncertainty. Project operating costs are expected to rise. Then there is the weakening of demand of apartments as unemployment increases. Finally, many economic analysts and lenders expect interest rates to rise substantially in a year or so. And one cost likely to go up quickly is insurance, Johns said, based on the insurance claims made after Sept. 11. Higher rates could impact future affordable housing deals. And one unanticipated piece of good news? “Utilities remained stable, even after we thought it was [going to be one of those costs] that would go through the roof,” Johns said.

New growth in lending for affordable housing

Lending for affordable housing is one of the biggest growth areas for Fannie Mae Delegated Underwriting and Servicing (DUS) lenders. In 2001, most, if not all, of the 26 DUS lenders were making or planning to make loans under Fannie’s Targeted Affordable Housing programs.

For the first six months of 2001, Fannie Mae posted a record $8.4 billion through its DUS product line for apartments. Lending for targeted affordable housing through June 2001 was in excess of $900 million. This record production nearly matched total DUS production for 2000. “Together, with our DUS lenders, we have made great progress since last year,” said Kenneth Bacon, Fannie’s senior vice president for multifamily lending and investment. According to Bacon, this has been accomplished through a record number of DUS committees and task forces aimed at more actively engaging DUS lenders early in the new product development process.

In 2000, Fannie Mae participated in financing $13.5 billion in multifamily, up from $12.4 billion in 1999.

In 1999, Fannie Mae reported that it financed $12.4 billion of multifamily housing. Fannie did more than $1.6 billion in multifamily affordable housing production. Other totals include $7.2 billion in deliveries through its DUS lenders, $1.3 billion in tax-exempt credit enhancements and $340 million in seniors housing transactions.

DSC ratios for affordable housing increased

Fannie Mae recognized the growing concern about the soundness of tax credit projects in 2001 when it increased debt service coverage requirements for such projects.

In a letter to DUS lenders, the firm said it was increasing minimum underwritten debt service coverage of 9% tax credit transactions from 1.10x to 1.15x and for 4% deals from 1.15x to 1.20x. The change takes effect for all transactions for which applications are made after March 15, 2001.

The move came after an analysis of the firm’s watch list prompted by the recently enacted 40% increase in tax credit authority. Fannie Mae has financed a large proportion of the tax credit projects built since the program was created in 1986, and is concerned that an influx of new projects in coming years coupled with a weakening economy may undermine project feasibility.

In the letter, Fannie Mae officials said that their analysis “indicates that the properties which exhibit sustainability and that maintain good or better physical condition are those with higher than minimum debt service coverage (DSC).”

The move is “probably judicious” said Lynn Coovert, senior vice present and chief underwriter of The Midland Cos. She also chairs the multifamily affordable housing committee of the DUS Lenders Advisory Council.

Previously, lenders had to try to estimate what market rents would be for a property and if the actual rents were expected to be 10% less than market rents, they could use DSC ratios of 1.10x or 1.15x.

The change eliminates the need to calculate the differential from market rents and subjects all projects to the same DSC requirements regardless of how their rents compare to market rents. This reflects the fact that tax credit projects frequently are competing with other tax credit projects for tenants, Coovert said.

However, she added, Fannie Mae will consider allowing a project to use the lower DSC ratios if it is located in an underserved area or if it has rents substantially below the market.

How much will the change affect loan proceeds? Not much in today’s rate environment, said Coovert. With interest rates at relative lows, most loans are limited by loan-to-value ratios, not debt service coverage.

Another Fannie Mae DUS lender took a slightly different view. He said the change in DSC requirements may result in reduced loan amounts for bond-financed projects. With bond deals, a project’s value can be increased to reflect the value of tax-exempt financing, which means that DSC, not loan-to-value limits, may come into play.

The relatively low interest rates that prevailed in 2001 offset the impact of the underwriting changes, but still, developers have been forced to seek more sources of subordinate financing and to defer more of their fees. It didn’t help that the change coincided with a reduction in equity prices for tax credits.

Watching the market when it comes to underwriting

Lenders acknowledged they had changed their underwriting in response to riskier market conditions, lower tax credit equity prices and increasing operating costs, particularly for insurance.

“We have revised our underwriting procedures to account for potential increases in utility costs and insurance premiums. The increase in operating expenses may result in lower loan proceeds and, thus, a need to obtain subordinate financing,” said Chris Tawa of Lend Lease.

Lenders had mixed views on how affordable housing would do during a recession. In theory, it should not suffer declines in occupancy since rising unemployment will force many tenants from market-rate housing into the subsidized housing market.

But with tax credit volume increasing again in 2002, some lenders were concerned that some markets might see an oversupply of tax credit projects. To be safe, lenders are likely to treat Fannie Mae debt service requirements as a minimum, and to focus more on the financial strength and operating experience of the sponsor and the tax credit investor.