How low can it go?

That was the question on everybody's mind throughout 2011, as the limbo stick of interest rates plunged to new lows and borrowers happily danced in droves.

There was never a better time to lock in some long-term debt than 2011. The yield on the benchmark 10-year Treasury just kept dropping and bottomed out at an all-time low of 1.72 percent Sept. 22, hovering between there and 2.3 percent through the beginning of November.

Yet, for every step forward there was another step back. While the benchmark dropped, investor spreads on agency debt rose as the fragile economy stumbled through the summer, highlighted by Standard & Poor's downgrade of America's credit rating, which included Fannie Mae, Freddie Mac, and Ginnie Mae.

That stark contrast between low U.S. bond yields and equally low U.S. economic prospects will continue to be the central tension throughout 2012. Interest rates will continue to stay low, and the agencies will keep liquidity flowing—but those tailwinds could meet with headwinds.

Nearly every affordable housing lender recorded their largest volumes in years in 2011, and low rates were one part of the puzzle. The continued proliferation of New Issue Bond Program (NIBP) deals was also a huge shot in the arm, providing rates under 2 percent, allowing more deals in high-cost areas to pencil out. And the increased sales volume of stabilized affordable communities signified renewed investor gusto.

But in the affordable housing debt industry, all roads lead back to equity. And the recovery of low-income housing tax credit (LIHTCs) pricing spoke of an industry where optimism has once again put a bounce in everyone's step.

To some industry stakeholders, there's no stopping this train once it gets going— this head of steam is giddily rushing us into 2012. But slow down folks. The NIBP will disappear come the new year (After press time, the Treasury Department announced that it would extend the NIBP through 2012. See "NIBP Extended Through 2012.").

And though the troubled national economy necessitates more affordable housing production, it doesn't necessarily encourage it.

“Next year you may see it slow down dramatically—it may be an off year for affordable housing debt,” says Tim Leonhard, managing director of affordable housing debt production for Oak Grove Capital. “NIBP is likely going away, and various forms of soft money won't be available as states suspend or reduce their subordinate loan programs. This industry is certainly not immune to the effects of the bad economy."


Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA) kept the spigot turned on this year, with Fannie doing about $1.75 billion, Freddie processing about $1.1 billion, and the FHA slowly digesting more than those two combined, at $3.3 billion in affordable housing debt, according to a preliminary estimate by Leonhard.

Yet, the total market for agency affordable housing debt may shrink from $6.15 billion this year to $5 billion next year due to the end of NIBP, a 10 percent reduction in new LIHTC transactions due to lack of subsidy, and the FHA's ongoing bottleneck blues, Leonhard says.

Each government-sponsored enterprise (GSE) had a different strategic focus this year, mostly out of necessity. Freddie decided to focus on NIBP deals when the program began at the end of 2009. And by virtue of an aggressive approach, and its ability to provide a variable-rate credit enhancement, it became a clear winner for bond deals.

Fannie became more competitive on bond deals in 2011, though its lack of a variablerate credit enhancement product was a big handicap. So Fannie instead chose to focus its business model on a longer-term horizon— on preservation deals, a smart move given how much of that business is expected to come over the next five years.

Fannie outpaced Freddie on preservation deals in two key ways. Fannie had a faster process, turning deals around faster than Freddie by about three weeks, according to agency lenders. Freddie's prior approval model has a tendency to slow things down.

“Unlike Freddie's program, the Fannie program is a delegated process, and we're turning deals around as quickly as 45 days, sometimes as quickly as 30,” says Jay Blasberg, executive vice president for Fannie Mae lender Alliant Capital. “That's the difference with Fannie lenders— if we like a deal and we know we need to rush it, we can, and we do."

But the second advantage was simply that Fannie Mae offered a more flexible product. Both of the GSEs securitize their loans, but the way they do it is very different. Fannie Mae's immediate fundings run through its Mortgage Backed Securities (MBS) program, which are individual securities sold to investors.

And this was the first full year that Freddie Mac began offering immediate fundings through its Capital Markets Execution (CME) program, which at first blush seemed like a great idea. Rates were a bit lower than what Freddie could offer through its on-book portfolio execution.

But the CME program is a pool of mortgages sold to investors—dozens of loans packaged together. Why is that important to a borrower? Because the way your mortgages are bought on the back end affects the rates and terms you get on the front end.

If investors are buying securities backed by a whole bunch of mortgages, as opposed to just one, they have to understand them all. And investors have been slow to warm to, and fully grasp, the complexities inherent in an affordable housing deal, as compared with a market-rate mortgage.

The CME program had some growing pains in 2011 on the affordable side.

“There are some inherent challenges to an affordable deal going CME,” says Leonard. “If you want to customize yield maintenance or go to a lower debt-service coverage, CME has limitations that Fannie doesn't have to deal with via an individual MBS issuance. I'm confident Freddie will adjust, but there's some work to be done."

Fannie's focus on preservation inspired some creativity, too. In May, Fannie and the FHA launched the Green Refinance Plus program, which provides very favorable terms for energy- and water-efficient upgrades and other renovations. The program offers debt-service coverage ratios as low as 1.15x and loan-to-value ratios of up to 85 percent.

For its own part, the FHA continues to undercut the GSEs in pricing, featuring rates as low as 4 percent on long-term deals, compared with the GSEs being around 4.75 percent as of late September. But of course with the FHA, the concern is not about their rates or terms, which are clearly unbeatable. It all has to do with timing— the FHA can take about six months to turn around a Sec. 223(f) loan.

“If you can wade through the process, you are rewarded at the end. It's just a matter of their bulbous pipeline and the ability to move the food through the belly of the snake,” says Blasberg. “But in all fairness, FHA is looking to see what it can do to improve, and I'm expecting in 2012 and 2013 improvements to their MO."


All three agencies will continue to focus on preservation deals in 2012, but Fannie as of the fourth quarter seems to have a clear edge in execution and underwriting flexibility.

In all, 2011 was the continuation of a comeback year for the affordable housing industry. All-in interest rates are bound to go up some in 2012, maybe by as much as 50 basis points, but that's a minor concern when you're starting from the lowest rates in history.

We're entering an election year, so get ready to hear some sound and fury coming out of Capitol Hill about the agencies. But don't expect the noise to translate into immediate action—the enormity of housing finance reform is going to take some time. Meanwhile, the agencies remain focused on their missions.

“Despite all the noise concerning the agencies, I think it's going to be business as usual,” says Blasberg. “Rates will stay low, and we're probably at the narrowest point regarding credit restriction—I don't see it getting much narrower. I'm expecting 2012 to be a very good year."