Fannie Mae and Freddie Mac have made preservation deals a top priority for 2011.

But the dramatic rise of the benchmark 10-year Treasury, combined with climbing investor spreads, sent all-in rates for preservation deals soaring in the fourth quarter.

The yield on the 10-year Treasury was at 2.6 percent Nov. 8, and borrowers were still locking rates in the mid-4 percent range. But by early January, the benchmark was hovering around 3.3 percent, and investor spreads climbed about 25 basis points (bps) since November. That's a 95-bp rise in just a month or two.

Suddenly, 10-year deals were quoting in the mid-5 percent range, with seven-year loans around 5.15 percent and five-year money at around 4.5 percent, in early January.

That mid-5 percent range is an important milestone. Fannie Mae uses an underwriting floor of 5.5 percent when sizing a 10-year loan, and that hadn't been an issue for most of the second half of the year. But with all-in rates at around 5.5 percent in January, proceeds were starting to be affected.

“When your immediate rates are higher than the floor, you're going to have loan proceeds impacted,” says C. Lamar Seats, senior vice president at Columbia, Md.-based Enterprise Community Investment, a Fannie Mae lender. “And it impacts the net cash flow of the borrower after the debt service is paid."

Often, the government-sponsored enterprises (GSEs) will lower their spreads to keep all-in rates manageable when the benchmark rapidly rises.

But the possibility and timing of such a move was unclear at press time. “If Treasuries just go through the ceiling, there may be some spread compression," says Seats. “I just haven't seen any willingness yet."

Enterprise had a big year in 2010, originating about double the Fannie Mae loan volume it had budgeted at the beginning of 2010. And the company is expanding its debt platform significantly in 2011.

Enterprise will enter Freddie Mac's Targeted Affordable Housing network in the first quarter, giving the company all three agency licenses. “The integration of the Freddie program will become our focus and challenge [in 2011,]” says Seats. The company is looking to hire three more originators in 2011, one each in New York, Los Angeles, and Chicago.

Most agency lenders don't expect to see any big changes in the way the GSEs underwrite deals in 2011. Fannie Mae is hoping that improving fundamentals will allow it to pare down its crowded pre-review list. When a market's on pre-review, credit terms are tougher and lenders must get a deal approved by Fannie Mae headquarters, which slows down the process.

“I suspect that as some markets improve, there probably will be some room to take some markets off of pre-review,” says Manny Menendez, a vice president at Washington, D.C.-based Fannie Mae. “We're trying to calibrate the waivers and see if there are situations where we can provide more delegation back to the lenders."

New Issue Bond Program

While Fannie Mae remains very competitive on preservation deals, bond deals are a different story. The New Issue Bond Program (NIBP) continued to fuel much activity in the fourth quarter, but much of the business was going to Freddie Mac.

One of Freddie's advantages is that it routinely offers 35-year amortizations on bond credit enhancements, while Fannie stops at 30 years. And Freddie Mac still offers variable-rate executions, something Fannie hasn't offered in years.

“Originally, Freddie was very aggressive about getting NIBP business,"

says Paige Warren, a managing director who oversees affordable housing lending at Newark, N.J.-based Prudential Mortgage Capital. “And with Fannie out of the variable-rate bond business, more bond business was being done with Freddie the last few years.

So there was already a lot of bond momentum at Freddie."

Prudential's historic strength is in the bond sector, and the NIBP has sent a lot of business its way. The company closed about 11 deals in the span of just two weeks in December, some with interest rates below 4 percent.

The NIBP has been a breath of fresh air for the affordable housing world, and its extension into 2011 was applauded by the community. But many state allocations of NIBP volume are expected to run out by mid-year.

“It's been tremendously helpful at preserving existing deals. The NIBP ended up filling the gap in places where tax credit pricing had not come back,” says Warren. “But at this point, we figure that the states will run out of money early [this] year, and it will be the end of a good thing."

Outside of the NIBP, Freddie's variable- rate execution is well poised to win a majority of bond deals in 2011.

When the 10-year Treasury was sinking like a stone in the second half of 2010, fixed-rate executions were suddenly on par with variable-rate, giving Fannie Mae an opportunity. But if the run-up in Treasuries continues in the first quarter, that window of opportunity may be closing for Fannie.

9 percent forwards

The GSEs continue to price themselves out of the market on forward commitments for 9 percent lowincome housing tax credit deals.

Many Community Reinvestment Act-driven banks have been able to offer comparable execution at around 7 percent, while the GSEs are at least 150 to 225 bps higher than that. Agency lenders don't expect any relief in sight, though the GSEs continue to say they're working on it.

“We're certainly studying whether there are ways we can lower the forward spread in the future,” says Kim Griffith, vice president of multifamily affordable sales and investment at McLean, Va.-based Freddie Mac. “The forward curve is quite volatile, and the last several years have taught us how volatile it is. Now, we're looking through that volatility in a clearer way and just being, in our pricing, transparent to that volatility."

The future of the GSEs

The Obama administration was slated to unveil its proposal for the future of the GSEs in the first quarter. But the Republican gains made during the mid-term elections will have a big impact on the content, and timing, of any GSE-related legislation. While a divided Congress may be able to forge a middle path, history suggests it may also result in more gridlock.

“You're going to need some bipartisanship to deal with this,” says Michael Berman, chairman-elect of the Washington, D.C.-based Mortgage Bankers Association and president and CEO of Needham, Mass.-based lender CWCapital. “And if you can't create that consensus, then this issue isn't going to move until after the next presidential election."

There are some points of consensus between each party, but there are far more disagreements. Everyone agrees that the federal government's role has to shrink, that the next generation of housing finance entities need to be privately capitalized so that taxpayers would be fully protected.

But some of the most critical decisions— such as the creation of an explicit federal government guarantee— lack clear consensus.

“It's so enormous and so complicated, and the path to a vibrant private- sector participation is so uncertain, that everybody just has to take a step back, take a deep breath, and consider that we're in this for the long haul,” says Doug Bibby, president of the Washington, D.C.-based National Multi Housing Council. “This is a multi-year proposition—some people are saying seven to 10 years, some are more optimistic and saying five to seven years."