A s affordable housing developers get set to ramp up dormant projects, Fannie Mae's high rates on forward commitments are forcing many to look elsewhere for debt.

Fannie Mae's rates on immediate fundings are competitive, in the low- to mid-6 percent range, and the government- sponsored enterprise (GSE) is seeing a lot of refinancing business on tax credit and Sec. 8 deals.

But new construction deals are another story: Rates on forward commitments have been climbing higher each month this year.

For funded forward commitments, Fannie Mae offers a rate of around 9 percent, and unfunded forward commitments are closer to the 9.5 percent range, as of late August. That's up from around 7.75 percent and 8.25 percent in early March.

Freddie Mac's rates on forward commitments were well inside of Fannie's for most of the year, at times by as much as 100 basis points (bps). But Freddie is getting costly too, pricing in the 8.75 percent range on forwards. This has frustrated many GSE lenders this year, especially given that Fannie and Freddie have managed rates on the market-rate side very effectively.

As a result, many banks are poised to steal market share from the GSEs, fighting amongst themselves to fulfill Community Reinvestment Act (CRA) requirements in a market that features few new deals. Many banks offer “miniperm” loans, or construction loans with a permanent term extended through the compliance period.

“The [GSE] pricing is ridiculous,” says Thomas Booher, executive vice president at PNC MultiFamily Capital. “There are CRA-motivated banks in strategic markets that are 150 bps lower on a forward. They're able to undercut the agency pricing pretty significantly.”

The costs associated with a GSE forward commitment—including an origination fee, a standby fee, site inspections, and survey requirements— are another consideration. If a borrower used a construction lender and a separate GSE lender, they would have to pay many costs twice.

So, why are the GSEs so uncompetitive? The steep yield curve is one reason. But the GSEs' current business models may also be to blame. The companies are under a congressional mandate to reduce their portfolio holdings, and forward commitments have traditionally been held on their balance sheets. The companies are pricing the executions based on investor interest with an eye on getting these loans off their books.

“The agencies are pricing forwards today as if they had to sell it immediately,” says Tim Leonhard, who heads up the affordable housing debt platform for St. Paul, Minn.-based Oak Grove Capital. “The market for this paper is very limited, and the people that are buying are commanding a premium. I think that's the reason you've seen such a signifi- cant rise in spreads the past 18 months.”

While Freddie Mac is offering lower rates on forwards, another big advantage is the company's willingness to do 35-year amortizations. Fannie Mae offers 35-year amortizations in only a handful of markets. But Freddie Mac will programmatically offer 35-year amortizations, and if a borrower chooses a 30-year amortization, Freddie offers a modest reduction, maybe 5 bps, on the interest rate.

Borrowers are also increasingly turning to the Federal Housing Administration (FHA) to fund new low-income housing tax credit (LIHTC) developments. The FHA made some big changes last year in how tax credits can work with its Sec. 221(d)(4) program, making it much easier to execute. Plus, Sec. 221(d)(4) deals are being priced about 200 bps below Fannie and Freddie, and the FHA will go up to 90 percent loan-to-cost and down to a 1.11x debt-service coverage ratio (DSCR).

Preservation business

While Fannie Mae is still seeing much preservation business, its underwriting requirements are forcing many borrowers to look elsewhere. Freddie Mac is taking its usual targeted approach as opposed to Fannie Mae's blanket approach.

For instance, the entire state of Florida is on Fannie Mae's “pre-review” list. So a borrower looking to refinance a tax credit or Sec. 8 deal can only hope for, at best, a 65 percent loan-to-value (LTV) and a 1.35x DSCR in those markets. Freddie Mac, though, will offer market rates and terms to deals in certain Florida markets, according to Frank Baldasare, the Southeast regional loan manager for Boston-based CWCapital. And then there's the FHA, whose Sec. 223(f) program will go up to 85 percent LTV.

The FHA's rates on a refinancing for a Sec. 8 or tax credit property are about 40 bps better than what the GSEs are offering, with a better DSCR (1.18x) and LTV ratio (85 percent). Still, if time is of the essence, most borrowers will go with the GSEs, since a refican be done inside of 60 days, compared to a four- or five-month timeline with the FHA.

Fannie Mae also continues to tighten up its underwriting, taking a much closer look at collections trends on affordable properties. The company is projecting income based on the lowest of the trailing 12, six, three, or most recent month. If there's a downward trend, Fannie Mae underwriters are automatically adding a minimum 2 percent additional vacancy to the lowest figure as an underwriting cushion.

A flurry of activity

Developers are now in a holding pattern, waiting for the Tax Credit Assistance Program and tax credit exchange to be finalized. Once the Internal Revenue Service releases all of the corresponding regulations and the state housing finance agencies wrap up their plans and procedures, watch out. “We're going to start to see a flurry of activity toward the end of the third quarter and into the fourth quarter and first quarter of 2010,” says Leonhard.

The GSEs will soon adopt underwriting policies around those programs. But the absence of a LIHTC investor will likely cause the agencies and their lenders to be more conservative, perhaps underwriting at a 1.20x coverage instead of 1.15x.

“We will definitely treat those transactions a little more conservatively if we don't have a syndicator there to ultimately provide some financial support and some management and compliance oversight,” says Booher.

And the GSEs are expected to revamp their forward commitment programs to prepare for the coming wave of business. “I think they'll react as quickly and aggressively as possible to capture as much of that market share as they can,” says Leonhard. “But right now, it's hard to offer a product to a market that hasn't set itself yet.”