Fannie Mae and Freddie Mac lenders are used to rushing to close deals at the end of the year, but December 2007 was crazier than usual.
That’s because conduit lenders, who had stolen so much market share from the government-sponsored enterprises (GSEs), became paralyzed by volatility in the capital markets mid-year. As a result, GSE lenders surged through the rest of the year.
Freddie Mac kicked off its second half by doubling its production in the span of 30 days. The company processed $1.6 billion in multifamily deals that used its early rate-lock feature in July 2007. One month later, the company processed $3.5 billion in early rate-lock deals for all of August. Fannie Mae reported a similar surge in the second half.
The proof is in the pricing. For a typical new construction deal in mid- December, conduits were quoting Treasury rates plus a spread of as much as 250 to 300 basis points, compared to Fannie Mae and Freddie Mac pricing, which was at 180 basis points over the 10-year Treasury note. That spread translated to interest rates on GSE debt of about 6 percent, with the conduits hovering closer to 7 percent and above.
Conduit lenders are expected to wait on the sidelines in early 2008 as Fannie Mae and Freddie Mac continue to process deals at a torrid pace. “Right now, the GSEs are sitting in the best spot, and they’ll continue to be in that spot for the first six months [of 2008],” said Phil Melton, senior vice president at Grandbridge Real Estate Capital. “But sooner or later, the conduits will come back.”
Challenging year ahead
Despite the availability and affordability of GSE debt, developers will face several challenges in trying to get affordable housing deals financed in 2008.
Falling low-income housing tax credit (LIHTC) prices and the Department of Housing and Urban Development’s (HUD’s) new formula for computing area median income (AMI) are two issues that stand between developers and more new construction in 2008.
According to several LIHTC industry experts, Fannie Mae and Freddie Mac’s pullback from the equity market, which began mid-year, will accelerate in 2008. Several industry experts interviewed for this article said they wouldn’t be surprised if both GSEs had absolutely no LIHTC appetite in the first half of 2008.
This reluctance from the top two LIHTC investors may cause tax credit prices—which were as low as 85 cents in some markets in mid-December—to drop even further.
“This will be a volatile year,” sad Hal Kuykendall, managing director of Citi Community Capital. “We are as bullish on affordable housing debt as we’ve ever been but concerned that if the LIHTC pricing continues to go down, there may be fewer deals that can get done.”
With less equity available to developers, the debt market may become more vital to their hopes.
The good news is that the pricing on debt for the affordable housing industry stayed fairly constant through year-end 2007, although there are signs that turbulence may be just around the corner in 2008.
One indicator of the volatility ahead is the instability of key benchmarks, such as Treasury rates, that help lenders set pricing. That volatility made it impossible for lenders to quote a price with certainty as 2007 came to a close, industry watchers said.
“We’re seeing a stable mortgage rate, but we’re seeing huge offsetting volatility in Treasuries and credit spreads,” said Tom Szydlowski, executive vice president at Wells Fargo Multifamily Capital, in early December.
As a result, the debt market was characterized by “real-time pricing” in late 2007, Szydlowski said. When borrowers request a quote, even from conventional financing sources like the GSEs, the price they get will rarely stay the same for even a week. This volatility, plus the looming threat of a recession, has pushed many lenders to re-institute the underwriting guidelines that they used before conduit lenders forced the rest of the industry to match their aggressive rates and terms.
Developing affordable housing also became more challenging in 2007 because of the way that AMI is calculated under HUD’s new methodology.
HUD now uses American Community Survey data, instead of its traditional extrapolation of census figures, to set AMIs, which drops the estimates in many communities. To ease the problem, HUD has said it would freeze its income limits at 2006 levels, but this still prevents rent increases and wreaks havoc on the ability to underwrite both existing and new affordable housing deals, since underwriting presumes annual rent increases.
“That’s going to throw a real curveball at a lot of proposed developments and a number of existing properties as well,” said Tom Booher, executive vice president at PNC MultiFamily Capital. “We’re continuing to see a number of deals involving credits where we’ve got to assume that rents are going to be totally flat for some number of years.”
Citi Community Capital heads our list of the top affordable housing lenders, a spot it should retain next year due to its acquisition of No. 3 lender Capmark’s Affordable Housing Debt group (CAHD) (for more on the acquisition, see page 32).
RBC Capital Markets came a close second with more than $1.2 billion, and Wachovia came a close fourth with more than $1.1 billion in affordable housing financing, as its 2006 acquisition of American Property Financing, Inc., continued to pay dividends. U.S. Bank was close on Wachovia’s heels at No. 5, processing more than $1 billion in construction and permanent loans for the affordable housing industry for the third straight year.
Citi’s acquisition of CAHD wasn’t the only big acquisition to close in 2007. The affordable housing lending industry continued its trend of consolidation, as large financial institutions gobbled up smaller shops in an effort to round out their product lines.
The year also saw the acquisition of ARCS Commercial Mortgage by PNC MultiFamily Capital and the sale of Collateral Real Estate to BB&T, not to mention Bank of America’s $21 billion purchase of LaSalle Bank. (For more on PNC’s acquisition of ARCS, see PNC Goes Heavyweight.)
These transactions underscore the scarcity of independent lending shops and are another sign that lenders need to offer a full spectrum of products to compete effectively.
“The industry has changed,” said Howard Levine, ARCS’ founder and CEO, at the time of the sale. “Being just a Fannie Mae lender without the banking balance sheet and the conduit capability, we were at a disadvantage compared to most Delegated Underwriting and Servicing lenders that have sold off to major financial institutions.”
The most common concern expressed by the lenders interviewed for this story was for the lack of LIHTC equity available to affordable housing developers in 2008. Developers had a difficult time when tax credits were fetching 95 cents—what will happen to affordable housing deals when one LIHTC dollar only brings in 85 cents or less?
In short, deals that were tight before will become even more difficult to pencil out in 2008, at least through the first half.
Nearly every lender surveyed for this article expects credit conditions to tighten through the second quarter of 2008, as underwriting standards continue to be reined in. This market correction was in full swing as 2007 ended, pulling the pendulum back from the high-flying days that began the year.
Still, many see the industry’s return to conservative underwriting as a return to sanity. “A lot of the crazier activity now is getting pulled back,” said Chris Tawa, a senior vice president at MMA Financial. “This is forcing the industry back to a more rational credit profile. So, the past few months will prove to be beneficial, in retrospect, from a broader lending-quality standpoint.”