Housing Finance: FHA's Risk-Sharing Programs Offer Alternatives for
Financing Affordable Multifamily Housing (Chapter Report, 04/23/98,
GAO/RCED-98-117).
Pursuant to a legislative mandate, GAO reviewed the risk-sharing
demonstration programs established under section 542 of the Housing and
Community Development Act of 1992, focusing on: (1) how well the
programs' goals are being met; (2) the benefits for participating
financial institutions and the Department of Housing and Urban
Development (HUD); and (3) opportunities for improving the programs and
HUD's administration of them.
GAO noted that: (1) the credit enhancement program, together with the
reinsurance program, was established under the Housing and Community
Development Act of 1992 to facilitate the financing of affordable
multifamily housing and to make that financing available in a timely
manner; (2) the credit enhancement program is meeting these goals; (3)
as of September 1997, 32 participating state and local housing finance
agencies had reserved about 84 percent of the risk-sharing units
allocated to these agencies through March 1996; (4) most of the insured
loans are financing properties that serve more low-income households
than required, apparently because the credit enhancement is being used
with other subsidies, particularly low-income housing tax credits; (5)
while it is still too soon to evaluate the financial performance of the
insured loans, the available financial indicators reflect sound
underwriting standards; (6) activity in the reinsurance program has been
so limited that the program remains largely untested; (7) only one
institution--Fannie Mae--has participated extensively in the program,
and one lender--Banc One Capital Funding Corporation--has originated
over half of the loans that Fannie Mae has reinsured; (8) Banc One's
activity has demonstrated that the risk-sharing reinsurance program can
expand participation in mortgage lending, including lending for smaller
properties in rural areas--an unmet capital need, according to HUD's
studies; (9) participation in the demonstration programs has enabled HUD
to facilitate the financing of affordable multifamily housing while
limiting its loss exposure through risk sharing; (10) participation has
also allowed HUD to increase the efficiency and reduce the costs of its
operations through delegation, compared with the Federal Housing
Administration's traditional multifamily program; (11) HUD has retained
responsibility for monitoring its risk-sharing partners' performance,
but its data system for monitoring the progress of credit enhancement
projects is unreliable; (12) HUD is aware of the system's problems and
plans to resolve them in the course of overhauling all of its
information management systems; (13) HUD has also retained
responsibility for overseeing its risk-sharing partners' compliance with
the demonstration programs' requirements; however, GAO's review
identified one default that was not reported to HUD headquarters for
over a year; and (14) HUD recognizes that effective oversight is
critical, particularly if one or both of the demonstration programs are
made permanent and lenders' activity increases.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: RCED-98-117
TITLE: Housing Finance: FHA's Risk-Sharing Programs Offer
Alternatives for Financing Affordable Multifamily Housing
DATE: 04/23/98
SUBJECT: Mortgage programs
Housing programs
Mortgage loans
Low income housing
Program management
Federal aid for housing
Financial institutions
Tax credit
Management information systems
Cost control
IDENTIFIER: Community Development Block Grant
HUD Risk-Sharing Multifamily National System
HUD Low Income Housing Tax Credit Program
HUD 2020 Management Reform Plan
General Insurance Fund
Special Risk Insurance Fund
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Cover
================================================================ COVER
Report to Congressional Committees
April 1998
HOUSING FINANCE - FHA'S
RISK-SHARING PROGRAMS OFFER
ALTERNATIVES FOR FINANCING
AFFORDABLE MULTIFAMILY HOUSING
GAO/RCED-98-117
Housing Finance
(385670)
Abbreviations
=============================================================== ABBREV
CCRC - California Community Reinvestment Corporation
CDBG - Community Development Block Grant
CPC - Community Preservation Corporation
CRC - Community Reinvestment Corporation
DUS - Delegated Underwriting and Servicing
FHA - Federal Housing Administration
FHLB - Federal Home Loan Bank
GAO - General Accounting Office
GGD - General Government Division
GinnieMae - Government National Mortgage Association
HUD - Department of Housing and Urban Development
NCB - National Cooperative Bank
OTS - Office of Thrift Supervision
RCED - Resources Community and Economic Development Division
RSS - Risk-Sharing Multifamily National System
SAMCO - Savings Associations Mortgage Company
SONYMA - State of New York Mortgage Agency
Letter
=============================================================== LETTER
B-277226
April 23, 1998
Congressional Committees
This report responds to a mandate in the Housing and Community
Development Act of 1992 (P.L. 102-550) that we evaluate the
risk-sharing demonstration programs established under section 542 of
the act. More specifically, the report looks at how well the
programs are meeting their goals, identifies the benefits for
participating financial institutions and HUD, and considers
opportunities for improving the programs and HUD's administration of
them. The report makes recommendations designed to encourage greater
activity in the reinsurance program and to improve HUD's monitoring
and oversight of the federal government's risk-sharing partners.
We are sending copies of this report to the appropriate congressional
committees and to the Secretary of HUD. Copies are available to
others upon request.
If you or your staff have any questions, please call me at (202)
512-7631. Major contributors to this report are listed in appendix
X.
Sincerely yours,
Judy A. England-Joseph
Director, Housing and Community
Development Issues
List of Committees
The Honorable Connie Mack
Chairman
The Honorable John Kerry
Ranking Minority Member
Subcommittee on Housing Opportunity
and Community Development
Committee on Banking, Housing,
and Urban Affairs
United States Senate
The Honorable Rick A. Lazio
Chairman
The Honorable Joseph P. Kennedy II
Ranking Minority Member
Subcommittee on Housing
and Community Opportunity
Committee on Banking and Financial
Services House of Representatives
EXECUTIVE SUMMARY
============================================================ Chapter 0
PURPOSE
---------------------------------------------------------- Chapter 0:1
During the 1980s, a decline in the production of affordable housing
and an increase in the number of low-income households meant that
more low-income households were unable to obtain affordable housing.
Although the Congress wished to expand access to capital for the
production of affordable housing, it had concerns about risk after
the federal government lost over $2 billion from defaults on
multifamily mortgage loans insured through the former coinsurance
program, administered by the Department of Housing and Urban
Development's (HUD) Federal Housing Administration (FHA).
Accordingly, in the Housing and Community Development Act of 1992,
the Congress established two new risk-sharing demonstration programs
that divide the financial liability for any defaults between the
federal government and its risk-sharing partners--state housing
finance agencies or other qualified financial institutions.
This report responds to a requirement in the act that GAO review
these two risk-sharing demonstration programs and HUD's
administration of them, as well as identify any opportunities for
improvement. More specifically, the report looks at how well the
programs are meeting their goals, identifies their benefits for
participating financial institutions and HUD, and considers
opportunities for improving the programs and their administration.
BACKGROUND
---------------------------------------------------------- Chapter 0:2
The two risk-sharing demonstration programs established by the 1992
act offer incentives to financial institutions to facilitate the
financing of affordable multifamily housing. One program provides
credit enhancement\1 to state and local housing finance agencies,
while the other provides reinsurance\2 to qualified financial
institutions. Both programs rely on risk sharing to ensure sound
financial management and delegation to increase the efficiency and
lower the costs of providing the credit enhancements. The
demonstration programs differ from FHA's traditional mortgage
insurance programs in that FHA (1) assumes only a portion (generally
50 percent), rather than all, of the risk of loss and (2) delegates,
rather than performs, loan-processing and asset management functions.
While the former coinsurance program also relied on risk sharing and
delegation, the demonstration programs establish additional
requirements to protect the government's financial interests,
including more stringent standards for participation and larger
reserve requirements. The demonstration programs are unique in
requiring that FHA's credit enhancements be used only for properties
that qualify as affordable housing.\3
Under FHA's traditional mortgage insurance programs, insurance
authority is limited by a dollar cap, which the Congress has
periodically adjusted upward to accommodate increased demand. Under
the demonstration programs, insurance authority is restricted to a
fixed number of units. To date, the Congress has authorized 49,500
units for the credit enhancement program and 22,500 units for the
reinsurance program. HUD recently recommended, as part of a
comprehensive legislative proposal to reform FHA's multifamily
programs, that both programs be made permanent and subject to the
same kind of insurance authority as FHA's other mortgage insurance
programs. Bills consistent with HUD's proposal were introduced in
both the Senate and the House in 1997 and were pending in committees
as of January 1998.
--------------------
\1 A credit enhancement, such as mortgage insurance, transfers some
of the risk of loss from the lender to the credit enhancer. When the
federal government assumes a portion of a lender's risk under a
risk-sharing agreement, the lender may derive benefits, such as a
higher bond rating, that may be passed on to borrowers and tenants in
the form of lower costs.
\2 Reinsurance is a form of credit enhancement that occurs after the
original financing has taken place. Like mortgage insurance, it
increases a loan's security by committing the federal government to
pay a portion of any losses incurred through default.
\3 That is, at least 20 percent of a property's units must be rent
restricted and occupied by households whose incomes, adjusted for
household size, do not exceed 50 percent of the local area's median
income, or at least 40 percent (25 percent in New York City) of the
property's units must be rent restricted and occupied by households
whose adjusted incomes do not exceed 60 percent of the area's median
income.
RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3
The credit enhancement program, together with the reinsurance
program, was established under the Housing and Community Development
Act of 1992 to facilitate the financing of affordable multifamily
housing and to make that financing available in a timely manner. The
credit enhancement program is meeting these goals. As of September
1997, the 32 participating state and local housing finance agencies
had reserved\4 about 84 percent of the risk-sharing units allocated
to these agencies through March 1996. Most of the insured loans are
financing properties that serve more low-income households than
required, apparently because the credit enhancement is being used
with other subsidies, particularly low-income housing tax credits.
While it is still too soon to evaluate the financial performance of
the insured loans, the available financial indicators reflect sound
underwriting standards. Participation in the credit enhancement
program has enabled the housing finance agencies to leverage their
reserves and insure loans more quickly. According to the
participating agencies, the program would be improved if it were made
permanent and the current limits on the number of available
risk-sharing units were lifted. These changes, they said, would
enable them to market the program and manage their resources for
multifamily programs more effectively.
Activity in the reinsurance program has been so limited that the
program remains largely untested. Only one institution--Fannie
Mae--has participated extensively in the program, and one
lender--Banc One Capital Funding Corporation--has originated over
half of the loans that Fannie Mae has reinsured. Banc One's activity
has demonstrated that the risk-sharing reinsurance program can expand
participation in mortgage lending, including lending for smaller
properties in rural areas--an unmet capital need, according to HUD's
studies. However, for a variety of reasons, HUD's other risk-sharing
partners have reserved few or none of their risk-sharing units.
Opportunities to expand participation include reallocating unused
units to Fannie Mae and allowing the use of risk-sharing reinsurance
(1) with 18-year balloon mortgages--an option that is currently
available only to Fannie Mae--and (2) with loan pools as well as
individual loans.
Participation in the demonstration programs has enabled HUD to
facilitate the financing of affordable multifamily housing while
limiting its loss exposure through risk sharing. Participation has
also allowed HUD to increase the efficiency and reduce the costs of
its operations through delegation, compared with FHA's traditional
multifamily programs. HUD has retained responsibility for monitoring
its risk-sharing partners' performance, but its data system for
monitoring the progress of credit enhancement projects is unreliable.
HUD is aware of the system's problems and plans to resolve them in
the course of overhauling all of its information management systems.
HUD has also retained responsibility for overseeing its risk-sharing
partners' compliance with the demonstration programs' requirements;
however, GAO's review identified one default that was not reported to
HUD headquarters for over a year. HUD recognizes that effective
oversight is critical, particularly if one or both of the
demonstration programs are made permanent and lenders' activity
increases.
--------------------
\4 Because insurance authority is provided in risk-sharing units
rather than dollars, HUD allocates a fixed number of units to a
participating financial institution, and the institution then
reserves these units for properties whose loans it decides to insure
or reinsure. For each property, the number of risk-sharing units
reserved is equal to the number of dwelling units.
PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:4
THE CREDIT ENHANCEMENT
PROGRAM HAS FACILITATED THE
FINANCING OF AFFORDABLE
MULTIFAMILY HOUSING
-------------------------------------------------------- Chapter 0:4.1
Through the credit enhancement program, housing finance agencies are
insuring loans for newly constructed and substantially rehabilitated
properties serving families and the elderly in urban, suburban, and
rural areas. All of the completed properties are meeting, and many
are exceeding, the credit enhancement program's income-targeting
requirements. About three-quarters of the properties that are
exceeding these requirements also receive other subsidies--usually
low-income housing tax credits--that have income restrictions at
least as stringent as the credit enhancement program's.
For most housing finance agencies, the greatest benefit of
participation in the credit enhancement program is the ability to
leverage their reserves by the percentage of risk that HUD assumes
for each risk-sharing loan. Because HUD has assumed 50 percent of
the risk for loans financing about 90 percent of the risk-sharing
units, the participating agencies have generally been able to cut
their reserve requirements for risk-sharing loans in half,
effectively doubling their financing capacity. Other benefits of
participation include administrative efficiencies and, in some
instances, lower interest rates or longer loan terms compared with
other forms of credit enhancement.
Housing finance agencies believe that making the credit enhancement
program permanent and removing the current limits on the number of
available risk-sharing units would assist them in marketing the
program and managing their multifamily resources. Such changes would
also allow them to keep up with the demand for risk-sharing units,
which--given their frequent use of the credit enhancement program to
insure loans for properties financed with low-income housing tax
credits--is likely to increase if pending bills proposing to raise
the states' per-capita tax credit allocations are enacted. Finally,
permanency would be consistent with the recently enacted authority
allowing the risk-sharing program to assist HUD in its mark-to-market
program.\5
--------------------
\5 This program is designed to refinance the mortgages of subsidized
multifamily properties to bring their rents in line with market
rents.
THE REINSURANCE PROGRAM HAS
POTENTIAL BUT HAS NOT BEEN
TESTED
-------------------------------------------------------- Chapter 0:4.2
HUD's current and designated partners in the reinsurance program
represent a wide range of qualified financial institutions with the
potential to expand mortgage lending at the national, regional, and
local levels. However, Fannie Mae is the only partner that has
reserved all of its allocation (7,500 units), and Banc One Capital
Funding Corporation has originated 28 of the 48 loans that Fannie Mae
has agreed to reinsure. Compared with the properties securing other
loans that Fannie Mae has agreed to reinsure, Banc One Capital
Funding Corporation generally finances smaller properties in smaller
communities. Six properties had been completed as of October 31,
1997. All six are meeting, and four are exceeding, the program's
income-targeting requirements; five of these properties are also
partially financed with low-income housing tax credits. Fannie Mae
has been able to use its allocation because it has (1) a product line
that, like the reinsurance program, relies on delegating
responsibility and (2) flexible underwriting standards that are
suitable for affordable housing. Participation in the reinsurance
program has enabled Fannie Mae's lenders to reduce their reserve
requirements by 50 percent, thereby doubling their financing
capacity. The administrative efficiencies gained through
delegation--both from HUD to Fannie Mae and from Fannie Mae to its
lenders--have expedited the processing and reduced the transaction
costs of loans reinsured through the program.
HUD's other current and designated risk-sharing partners have
reserved a small fraction or none of their risk-sharing units or have
not signed risk-sharing agreements with HUD for various reasons, many
of them particular to the individual institutions. For example,
Freddie Mac has reserved 538 of its 5,000 units for one property.
Several factors have limited its participation, including the fact
that most of the loans it purchases are balloon mortgages, which are
not eligible for reinsurance under its risk-sharing agreement.\6
Similarly, two loan consortia\7 with which HUD is currently
negotiating risk-sharing agreements--the Community Preservation
Corporation (CPC) and the California Community Reinvestment
Corporation (CCRC)--will generally not have the loan volumes needed
to participate in the program unless their risk-sharing agreements
provide for reinsuring multiple loans (loan pools) as well as
individual loans.
Given the limited activity in the reinsurance program to date,
opportunities for improvement consist primarily of providing
additional units to Fannie Mae, considering changes to existing
risk-sharing agreements that could facilitate participation,
concluding risk-sharing agreements with the loan consortia, and
giving two new risk-sharing partners--the State of New York Mortgage
Agency (SONYMA) and the Federal Home Loan Bank of New York--time to
use their risk-sharing units. HUD has said that it will reallocate
2,000 unused units to Fannie Mae, and it is considering changes to
Freddie Mac's risk-sharing agreement. The use of reinsurance with
loan pools is authorized under the act and could enable the loan
consortia to participate.
--------------------
\6 Specifically, the risk-sharing agreement requires that all
reinsured loans be fully amortizing--that is, the entire principal is
to be repaid within the term of the loan. Balloon mortgages are not
fully amortizing; at the end of the loan term, a substantial portion
of the principal remains to be repaid, usually through refinancing.
\7 Associations of commercial banks and thrifts formed to finance
affordable housing, particularly multifamily housing.
HUD IS ASSUMING A SMALLER
PERCENTAGE OF RISK AND
LOWERING ITS ADMINISTRATIVE
COSTS, BUT ITS DATA SYSTEM
AND OVERSIGHT HAVE
WEAKNESSES
-------------------------------------------------------- Chapter 0:4.3
Through the risk-sharing programs, compared with the traditional
mortgage insurance programs, HUD has cut its per-loan loss exposure
in half\8 and dramatically decreased the time taken to process
mortgage insurance. According to HUD officials, they need about 80
hours to process loans for risk-sharing projects, compared with about
880 hours for traditional projects.
The data management system that HUD has established to track and
monitor the progress of projects in the credit enhancement program is
user unfriendly and largely unreliable. It has no edit function,
cannot generate paper printouts, and contains no definitions of
required data elements. HUD is overhauling and integrating its
information management systems and believes that
personal-computer-based software applications would be sufficient for
tracking, monitoring, and reporting information for the credit
enhancement program. While HUD has established procedures for
overseeing the risk-sharing activities of participating financial
institutions, it has not always overseen compliance with these
procedures. For example, HUD headquarters was not notified that a
risk-sharing loan had been in default for over a year.
--------------------
\8 To the extent that the risk-sharing programs expand the volume of
multifamily loans that HUD would not have insured otherwise, the
federal government's loss exposure is increased. However, losses are
incurred only to the extent that the premiums HUD charges for its
credit enhancement or reinsurance do not cover its costs associated
with defaults.
RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:5
GAO recommends that the Secretary of Housing and Urban Development
direct the Commissioner, Federal Housing Administration, to explore
the feasibility of amending HUD's current risk-sharing agreements
with qualified financial institutions, as necessary, to allow the use
of reinsurance with 18-year balloon mortgages and loan pools. GAO
also recommends that the Secretary correct current flaws in the
information management systems supporting the risk-sharing
demonstration programs and give priority to implementing a
comprehensive monitoring system to ensure compliance and timely
reporting.
AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:6
HUD agreed with GAO's recommendations and said that it was taking or
planned to take steps to implement them.
INTRODUCTION
============================================================ Chapter 1
During the 1980s, a decline in the production of affordable housing,
coupled with an increase in the number of low-income households,\1
reduced the availability of affordable housing for low-income
households. Although the federal government wished to expand the
availability of affordable housing, particularly multifamily housing,
reductions in federal spending precluded increases in housing
subsidies--the federal government's primary means of making rental
housing affordable to low-income households. In addition, federal
credit enhancements, such as mortgage insurance or reinsurance, came
under increased public scrutiny after the federal government lost
nearly $2.4 billion by 1992 from defaults on multifamily mortgage
loans insured through its former coinsurance program--a program
delegating federal loan-processing and asset management functions to
approved lenders that HUD implemented in 1983 to meet the market's
demands for multifamily mortgage insurance.
To stimulate the production of affordable multifamily housing and to
gain the administrative efficiencies but avoid the risks of the
coinsurance program, the Congress, in the Housing and Community
Development Act of 1992, authorized two new risk-sharing
demonstration programs. These programs (1) provide credit
enhancements to encourage the financing of affordable multifamily
housing and (2) divide the financial liability for any default
between the federal government and the financial institutions and
agencies selected to become its risk-sharing partners.
This report responds to a requirement in the 1992 legislation that we
review these two risk-sharing demonstration programs as well as
identify any opportunities for improvement. More specifically, the
report looks at how well the programs are meeting their goals,
identifies their benefits for participating financial institutions
and the Department of Housing and Urban Development (HUD), and
considers opportunities for improving the programs and HUD's
administration of them.
--------------------
\1 Households with incomes at or below 80 percent of the local area's
median income.
MULTIFAMILY PRODUCTION DECLINED
WHILE MORE HOUSEHOLDS SOUGHT
AFFORDABLE HOUSING
---------------------------------------------------------- Chapter 1:1
In establishing the risk-sharing demonstration programs, the Congress
recognized that the production of multifamily housing had been
declining steadily since the mid-1980s. According to Senate Report
102-332\2 and studies of the multifamily mortgage markets conducted
in the early 1990s, several key factors were responsible for this
decline. Among the more important were (1) changes in government
policies and regulations on taxation, banking, and housing subsidies;
(2) a sharp decline in multifamily mortgage credit enhancement by the
Federal Housing Administration (FHA); and (3) the withdrawal from the
multifamily secondary market\3
by Freddie Mac (formerly the Federal Home Loan Mortgage Corporation).
As we reported in 1993,\4 more households were seeking affordable
multifamily housing at the same time as the production of such
housing declined. Studies issued since 1993 have identified the
types of multifamily properties that are needed and the areas where
multifamily housing is needed. According to a 1995 HUD analysis,\5
unmet capital needs include smaller properties, larger rehabilitation
projects, and housing for the elderly. Affordable new construction
is also needed in high-growth markets. Inner-city neighborhoods and
rural areas are commonly identified as "underserved housing markets"
that often require smaller properties, both subsidized and
unsubsidized. However, because these smaller properties have
proportionally high transaction costs and low fees, they are less
attractive to lenders than larger properties when interest rates are
equivalent. The complexity often associated with the multiple
subsidies needed to finance affordable housing also acts as a
deterrent. According to HUD's 1995 analysis, the secondary market
has generally not been active in purchasing rehabilitation loans.
Such loans are needed in inner-city neighborhoods to preserve
low-cost housing units, stabilize neighborhoods, and improve housing
conditions for low-income residents. The study concludes that
without rehabilitation loans, many properties in inner-city
neighborhoods will be demolished or abandoned.
--------------------
\2 Senate Report 102-332 is part of the legislative history for the
Housing and Community Development Act of 1992.
\3 In what is called the secondary market, investors, such as pension
funds, purchase securities backed by long-term, fixed-rate mortgage
loans as investments, thereby creating liquidity for primary lenders
and allowing them to make additional loans or otherwise reinvest the
funds.
\4 Housing Finance: Expanding Capital for Affordable Multifamily
Housing (GAO/RCED-94-3, Oct. 27, 1993).
\5 Economic Analysis, Office of Policy Development and Research, HUD
(Nov. 1, 1995).
CREDIT ENHANCEMENTS COMPLEMENT
HOUSING SUBSIDIES
---------------------------------------------------------- Chapter 1:2
Governments have several tools, apart from public housing, that they
can use to make multifamily housing more affordable--(1) rental
subsidies to make up the shortfall between the rents that tenants can
afford and the rents that landlords must charge to cover their costs
and earn a profit, (2) grants and favorable tax treatment to lower
the costs of building or operating housing, and (3) credit
enhancements, such as mortgage insurance, to facilitate the financing
of affordable housing. While subsidies are the government's primary
means of making multifamily housing affordable for low-income
households, credit enhancements can complement subsidies by
increasing the financing available for such housing.
Credit enhancements transfer some of the risk of loss from the lender
to the credit enhancer, making loans more secure and encouraging both
mortgage lending and investment in mortgage loans. Specifically,
credit enhancements encourage primary lenders, such as commercial
banks, to make long-term, fixed-rate mortgage loans that they
otherwise might not make, and investors, such as pension funds, to
buy these loans in the secondary market. The sale of individual
loans, or of securities backed by pools of loans, returns funds to
primary lenders, creating liquidity and allowing the lenders to make
additional loans or otherwise reinvest the funds.
Credit enhancement can occur when a loan is originated or when it is
sold in the secondary market. If it occurs at the time of
origination, such as when a housing finance agency sells bonds to
raise capital to lend to developers of affordable multifamily
housing, it can affect the terms of the loan. Because the
enhancement provides additional support--usually through mortgage
insurance--it improves the housing finance agency's bond rating. The
housing finance agency can then obtain a lower interest rate and/or a
longer-term loan, the benefits of which it can pass along to the
affordable multifamily housing developer. In turn, the developer can
convey these benefits to tenants in the form of lower monthly rents.
If the credit enhancement occurs when the loan is sold in the
secondary market, it transfers the credit risk from the investor
purchasing the loan to the credit enhancer. At the same time as this
transfer reduces the purchaser's credit risk, it reduces the seller's
reserve requirements, freeing capital for further investment. The
credit enhancement that occurs when a loan is sold in the secondary
market is called reinsurance.
DEMONSTRATION PROGRAMS WERE
DESIGNED TO OVERCOME FLAWS IN
FHA'S EARLIER MORTGAGE
INSURANCE PROGRAMS
---------------------------------------------------------- Chapter 1:3
Under the traditional mortgage insurance programs, FHA is involved in
all aspects of lending--loan underwriting, loan servicing, asset
management, and property disposition. These tasks are time consuming
and resource intensive. As a result, FHA has traditionally been slow
to approve loans through these programs, and it incurs substantial
staff costs.
In 1983, FHA implemented the coinsurance program to expedite loan
processing and gain administrative efficiencies by delegating many of
its mortgage underwriting, processing, monitoring, and foreclosure
functions to approved lenders. The coinsurance program achieved
these objectives, but it also resulted in substantial losses to the
federal government. Even though the lenders assumed a portion of the
credit risk for the loans they approved, this portion was not
supported by sufficient reserves to ensure sound underwriting. In
addition, the program's fee structure created incentives for the
lenders to focus on the volume rather than the quality of the loans
they made. Furthermore, the lenders' losses were insured by the
Government National Mortgage Administration (Ginnie Mae), a
government-sponsored enterprise. Thus, when defaults occurred and
the lenders' reserves were not adequate to cover them, Ginnie Mae
paid the remaining balance and the federal government was ultimately
responsible for the losses.
Like the coinsurance program, the risk-sharing demonstration programs
are designed to expedite loan processing and gain administrative
efficiencies by delegating many of FHA's traditional loan-processing
and asset management responsibilities to other entities. The
demonstration programs also resemble the coinsurance program in that
they are designed to share the risk of loss from default. However,
the demonstration programs differ from the coinsurance program in
important ways, reflecting lessons learned about flaws in the design
of the coinsurance program.
First, the demonstration programs establish higher standards for
participation than the coinsurance program. Entry into the
demonstration programs is limited to qualified financial
institutions, such as government-sponsored enterprises and state and
local housing finance agencies with strong track records in
multifamily lending. The housing finance agencies must meet
standards of financial soundness and capable management established
by a nationally recognized credit rating agency or have a dedicated
reserve account with sufficient capital to meet the agency's
outstanding obligations under the programs. The participating
institutions are either publicly chartered or are regulated by a
state or federal agency. In addition, their mission, like FHA's,
includes supporting affordable housing. Thus, they are held
accountable to public entities other than FHA for ensuring that they
have the financial capacity and integrity to implement the
risk-sharing programs. In contrast, FHA's partners in the
coinsurance program were mortgage bankers unaccountable to a third
party.
Second, the risk-sharing partners generally bear a larger share of
the risk under the demonstration programs than under the coinsurance
program. In most instances, the risk is divided equally under the
demonstration programs, whereas, under the coinsurance program, the
lenders assumed the first 5 percent of the losses on loans and shared
any remaining losses with FHA on a 15-percent/85-percent basis. The
more equal division of risk for most loans currently insured under
the demonstration programs creates stronger incentives for FHA's
risk-sharing partners to use sound underwriting terms and service
their loans diligently.
Third, the demonstration programs provide for FHA's oversight of
compliance with their requirements for maintaining a high credit
rating or sufficient reserves. While the coinsurance program
established reserve requirements for lenders, these requirements were
not adequate, and neither FHA nor any other HUD authority monitored
the lenders' reserves.
Fourth, the demonstration programs explicitly preclude the use of
Ginnie Mae's insurance with risk-sharing loans.
DEMONSTRATION PROGRAMS TEST
RISK SHARING AS A MEANS OF
PROVIDING CREDIT ENHANCEMENT
---------------------------------------------------------- Chapter 1:4
Section 542 of the Housing and Community Development Act of 1992
directs HUD, through FHA, to test the use of risk sharing as a means
of providing federal credit enhancements for multifamily loans.
Through two demonstration programs, HUD is to evaluate the
effectiveness and efficiency of entering into partnerships or other
contractual arrangements, including risk-sharing agreements, with
qualified financial institutions (subsection b) and with state and
local housing finance agencies (subsection c).
The key statutory objectives of the risk-sharing partnerships with
qualified financial institutions are to
-- ensure that the qualified participating entities bear a share of
the risk that is sufficient to create strong, market-oriented
incentives to maintain sound underwriting and loan management
practices;
-- use the resources of FHA to assist in increasing multifamily
lending as needed;
-- provide a more adequate supply of mortgage credit for sound
multifamily rental housing projects in underserved urban and
rural markets;
-- encourage major financial institutions to expand their
participation in mortgage lending;
-- increase the efficiency, and lower the costs to the federal
government, of processing and servicing multifamily housing
mortgage loans insured by FHA; and
-- improve the quality and expertise of FHA staff and other
resources, as required for the sound management of reinsurance
and other market-oriented forms of credit enhancement.
The act does not explicitly apply these objectives to the
risk-sharing partnerships with state and local housing finance
agencies. However, HUD has explicitly incorporated two of these
objectives--using the resources of FHA to assist in increasing
multifamily lending and increasing the efficiency of processing and
servicing multifamily mortgage loans--into its regulations for
implementing the demonstration program with state and local housing
finance agencies. Moreover, according to FHA's Commissioner, all six
goals are reflected in the design and implementation of the program
with state and local housing finance agencies. In this report, we
refer to the subsection (b) program as the reinsurance program and
the subsection (c) program as the credit enhancement program.
While both demonstration programs transfer a percentage of the risk
of default to HUD's risk-sharing partners, it is important to note
that, to the extent the programs promote the development of
affordable multifamily housing that HUD otherwise would not have
insured, the federal government's loss exposure is increased.
However, losses are incurred only to the extent that the premium HUD
charges for its credit enhancement or reinsurance does not cover its
costs associated with defaults.
RISK-SHARING REINSURANCE
AGREEMENTS ARE DESIGNED TO
EXPAND ACCESS TO CAPITAL
-------------------------------------------------------- Chapter 1:4.1
The act authorizes HUD to enter into risk-sharing reinsurance
agreements with qualified financial institutions, three of which are
named in the legislation--Fannie Mae (formerly the Federal National
Mortgage Association), Freddie Mac, and the Federal Housing Finance
Board, which implicitly includes its 12-member Federal Home Loan
banks. Qualified housing finance agencies may also participate in
the program. Fannie Mae and Freddie Mac are both
government-sponsored enterprises that function as intermediaries in
the secondary market, purchasing individual and pooled mortgage loans
from primary lenders for sale as mortgage-backed securities to
investors, such as pension funds and life insurance companies.
Although Fannie Mae and Freddie Mac are private corporations and
operate without explicit federal guarantees, they enjoy a special
relationship with the federal government because they are federally
chartered and, in the view of the investment community, have implicit
federal guarantees. The Federal Home Loan banks are not technically
secondary market intermediaries, but they perform a similar function
by selling combined obligation bonds in the capital markets to
finance mortgage loans originated and held by their member
institutions. These member institutions include over 6,500 financial
institutions, primarily commercial banks and thrifts, and are located
in every state.
Under the risk-sharing reinsurance program, the qualified financial
institutions are responsible for originating, underwriting, and
servicing loans; managing assets; and disposing of properties in
accordance with the terms of their risk-sharing agreements. The
institutions may delegate these responsibilities to approved lenders.
Any proposed changes to the terms of the risk-sharing agreements
require HUD's approval.
Each risk-sharing reinsurance agreement commits HUD to paying 50
percent of any loss arising from a borrower's default. HUD's
risk-sharing partner is responsible for paying the other 50 percent.
If a borrower does default, the risk-sharing partner will manage and
dispose of the property and pay all of the costs associated with the
loan's disposition. HUD will then reimburse its partner for 50
percent of any eligible loss on the loan specified in the
risk-sharing agreement. The partner pays HUD an annual risk
sharing/reinsurance premium in an amount equal to 25 basis points \6
(0.25 percent) times the average unpaid principal balance on each
mortgage loan reinsured under the program.
Under the program, reinsurance may be provided for loans financing
the construction, substantial rehabilitation, refinancing, or
acquisition of affordable multifamily housing properties. To qualify
as affordable, the housing must satisfy the requirements of the
Low-Income Housing Tax Credit program.\7 In addition, the property
must continue to qualify as affordable for at least 15 years. When
reinsurance is provided for acquisition or refinancing loans, the
properties must remain affordable for at least 10 years beyond the
terms specified in any existing commitments.
Not all loans for affordable multifamily housing projects are
eligible for reinsurance under the program. Specifically, loans for
properties housing transients or serving as hotels, for nursing
homes, and for intermediate care facilities are ineligible. In
addition, HUD will not reinsure construction loans or refinancing
loans when the qualifying financial entity is the mortgagee or
guarantor of the original loan. Moreover, HUD will not provide
reinsurance until a project is completed and at least 50-percent
occupied, although the risk-sharing partner may insure or purchase
the loan at any point. Finally, the risk-sharing partner assumes the
initial costs of originating the loan and any risk associated with a
construction loan.
Although HUD delegates most of its traditional loan management
responsibilities to its risk-sharing reinsurance partners, it retains
monitoring and oversight functions. HUD headquarters monitors and
oversees the reinsurance program and maintains centralized data on
the credit enhancement program, while HUD field offices generally
monitor and oversee the credit enhancement program.
--------------------
\6 Each basis point equals one-hundredth of a percent.
\7 These requirements are that at least 20 percent of the units in a
property must be rent restricted and occupied by households with
incomes no greater than 50 percent of the area's median income, as
adjusted for each household's size, or at least 40 percent of the
units (25 percent in New York City) must be rent restricted and
occupied by households with incomes no greater than 60 percent of the
area's median income, as adjusted for each household's size.
RISK-SHARING CREDIT
ENHANCEMENT AGREEMENTS ARE
DESIGNED TO ENCOURAGE
MORTGAGE LENDING
-------------------------------------------------------- Chapter 1:4.2
The act authorizes HUD to enter into risk-sharing agreements with
state or local housing finance agencies that are HUD-approved
mortgagees in good standing and have received HUD's approval to
participate. To receive such approval, an agency must demonstrate
its financial and administrative strength by
-- carrying a "top tier" designation from Standard and Poor's or
any other nationally recognized rating agency; receiving an "A"
rating on its general obligation bonds; or otherwise
demonstrating its capacity on the basis of factors such as its
experience in financing multifamily housing, fund balances,
administrative capabilities, investment policies, internal
controls, financial management, portfolio quality, and state or
local support;
-- having at least 5 years' experience in multifamily underwriting;
and
-- certifying that it does not have any outstanding civil rights
violations unless it is conforming to a court order or
implementing a HUD-approved compliance plan to correct the
violation.
Under the risk-sharing credit enhancement program, loans for new
construction, substantial rehabilitation, and certain acquisitions
and refinancings are eligible for full mortgage insurance. Once a
housing finance agency presents HUD with the appropriate
certification on a loan, HUD will endorse \8 the loan. Housing
finance agencies are responsible for the full range of
loan-processing and asset management activities. Properties under
the program are generally financed through bonds issued by the
housing finance agencies and secured by the mortgages on the financed
properties.
Through a risk-sharing agreement, a housing finance agency contracts
with HUD to assume from 10 to 90 percent of the risk of loss on each
loan that the agency underwrites. HUD, in turn, is responsible for
assuming the balance of the risk. The agency pays HUD an annual
risk-sharing/credit enhancement premium equal to 50 basis points
times the percentage of risk FHA has assumed, times the average
unpaid principal balance on each mortgage loan insured under the
program.
If a foreclosure occurs, HUD is responsible for advancing 100 percent
of the outstanding principal balance to the agency so that the agency
can repay the investors. The agency is then responsible for
disposing of the property, determining the loss (if any), and
repaying HUD as necessary to cover its share of the loss as specified
in the risk-sharing agreement.
Housing finance agencies that assume 50 to 90 percent of the risk on
loans are given level I approval and may use their own underwriting
standards and loan terms and conditions without further approval from
HUD. HUD allows these agencies to use their own standards because it
believes that they will exercise due diligence to protect both their
interests and HUD's. Agencies that assume less than 50 percent of
the risk are given level II approval and must have their underwriting
standards and loan terms and conditions approved by HUD.\9
The actual percentage of risk that an agency assumes may vary from
one loan to another but must be documented for each loan.
To ensure that participating housing finance agencies have the
resources to cover potential losses, HUD has established certain
financial reserve requirements for them. Agencies with a top-tier
designation or an overall credit rating of "A" are not required to
have additional reserves to meet their obligations under the program
so long as they maintain that designation or rating. Agencies that
do not meet either of these criteria must establish a liquid asset
reserve of at least $500,000, which must be augmented with additional
amounts at each loan closing. \10
Properties must meet the same requirements for tenants' incomes and
rents as they would if they were being processed through the
risk-sharing reinsurance program. HUD's regulations specify that the
housing must be maintained as "affordable" for as long as the
mortgage is insured under the program. Furthermore, any projects
financed with federal low-income housing tax credits must remain
affordable for at least 15 years to comply with the Low-Income
Housing Tax Credit program's requirements.
--------------------
\8 That is, make a formal commitment to insure a loan.
\9 When the loan-to-replacement cost ratio for a new or substantially
rehabilitated property or the loan-to-value ratio for an existing
property is greater than or equal to 75 percent, the housing finance
agency assumes 25 percent of the loss. When these ratios are less
than 75 percent, the agency can choose to assume 10 percent or 25
percent of the loss.
\10 In addition to the $500,000, a housing finance agency must, at
each loan closing, deposit 1 percent of the mortgage amount for any
amount up to $50 million, plus 75 basis points for any amount between
$50 million and $150 million, plus 50 basis points for any amount
over $150 million.
PROPOSED LEGISLATION WOULD
MAKE DEMONSTRATION PROGRAMS
PERMANENT
-------------------------------------------------------- Chapter 1:4.3
To date, the Congress has authorized 49,500 units under the
risk-sharing credit enhancement program and 22,500 units under the
risk-sharing reinsurance program. HUD has allocated the units
authorized under the credit enhancement program to 32 housing finance
agencies and the units authorized under the reinsurance program to 8
financial institutions. These agencies and institutions have, in
turn, reserved\11 their allocated units for multifamily properties,
which have either been completed or are in the agencies' pipelines.
Most recently, a bill, H.R. 2406, proposed authorizing 15,000
additional units for each program.
In 1997, HUD proposed, as part of a comprehensive legislative
proposal to reform FHA's multifamily programs, to make both
demonstration programs permanent. Conceptually, the programs are
consistent with the transformation of the Department envisioned in
its 2020 Management Reform Plan.\12 In this plan, HUD proposes to
convert FHA's traditional multifamily insurance programs from retail
to essentially wholesale operations, under which FHA would rely
primarily on mortgagees or contractors to underwrite loans, manage
assets, and dispose of properties. According to HUD, permanency
would allow the demonstration programs to operate under the same
rules as HUD's other insurance programs.
In response to HUD's proposal, H.R. 1433, introduced in April 1997,
and S. 853, introduced in June 1997, included the proposal to make
both demonstration programs permanent. As of March 1998, the bills
had been referred to the House Committee on Banking and Financial
Services and the Senate Committee on Banking, Housing and Urban
Affairs, respectively. No further action has been taken on the bills
to date.
--------------------
\11 Throughout this report, the term "reserved" means that housing
finance agencies and/or financial institutions have set aside a
portion of their allocated units for projects that are being
developed (in the pipeline) or are completed and have been insured by
FHA.
\12 This plan proposes a fundamental overhaul of HUD's management and
delivery of services to ensure the Department's effectiveness into
the 21st century.
OBJECTIVES, SCOPE, AND
METHODOLOGY
---------------------------------------------------------- Chapter 1:5
As required by the Housing and Community Development Act of 1992,
this report assesses HUD's implementation of the risk-sharing
demonstration programs by evaluating how each (1) has been used to
achieve its statutory and/or regulatory goals, (2) has been
administered, and (3) could be improved to serve as a more effective
source of housing finance.
To examine how the demonstration programs have been used to achieve
their statutory and regulatory goals, we reviewed their legislative
history, as well as key studies that documented problems in the
capital market for affordable multifamily housing and the
congressional purpose in creating the programs to address these
problems. We also reviewed nationwide data on the units authorized
and allocated under the programs as of September 1997. These data
identify all participants and nonparticipants in the demonstration
programs, the units allocated to the participants, and the types of
properties supported by the programs.
To gain a firsthand perspective on the use and results of the credit
enhancement program, we visited seven housing finance agencies, which
accounted for over 65 percent of the units allocated to date. We
also conducted structured telephone interviews and focus groups with
all less active and nonparticipating housing finance agencies. In
addition, we visited and conducted structured telephone interviews
with institutions that have risk-sharing reinsurance agreements with
HUD. Our purpose was primarily to identify impediments to the
program's greater use and the benefits these institutions had
achieved to date. Finally, we (1) compared the policies and
procedures of the demonstration programs with those of FHA's
traditional multifamily insurance programs to identify benefits
unique to the demonstration programs and (2) reviewed and analyzed
data on the characteristics and financial condition of the properties
completed and insured under the demonstration programs to further
assess the programs' support of affordable multifamily housing.
To review the demonstration programs' administration, we assessed
HUD's (1) general administration of the programs and (2) monitoring
of approved projects and enforcement of the program's requirements.
As part of this assessment, we reviewed the credit enhancement
program's regulations and the risk-sharing agreements between HUD and
selected participating housing finance agencies and other qualified
financial institutions. We also interviewed officials from HUD
headquarters and field offices, as well as senior officials from the
participating housing finance agencies and other qualified financial
institutions. Additionally, we held discussions with representatives
of all nonparticipating housing finance agencies and other key
financial institutions to identify administrative impediments to
their participation.
To identify any opportunities for improving either the credit
enhancement or the reinsurance program, we held two separate focus
groups with commercial banks and loan consortia--entities created and
funded by banks and/or thrifts to provide financing for affordable
housing developments, particularly multifamily rental properties. We
asked both groups structured questions about their interest in
participating in either of the risk-sharing programs, whether
indirectly through existing participants or directly as participants
in the reinsurance program.\13 We also asked them to identify the
benefits they would expect to derive from participating in these
programs. In addition, we conducted a structured telephone survey of
participants in these focus groups to gain an understanding of their
experiences with affordable multifamily lending.
We conducted our work at HUD headquarters and selected field offices
throughout the country; the offices of the seven housing finance
agencies that accounted for over 65 percent of the units allocated
under the credit enhancement program (California; Colorado; Florida;
Montgomery County, Maryland; Massachusetts; New Jersey; and New York
State); the offices of five of the eight institutions that have
received or are scheduled to receive units under the reinsurance
program (Fannie Mae, Freddie Mac, the National Cooperative Bank, the
Federal Home Loan Bank of New York, and the State of New York
Mortgage Agency); and the offices of the Federal Housing Finance
Board. To obtain additional perspectives on the demonstration
programs, we spoke with representatives of the 4 housing finance
agencies that, as of September 1997, had signed risk-sharing
agreements but had not reserved any units and of the 24 state housing
finance agencies that, as of that date, had not participated in the
program. We also either conducted structured phone interviews or
held panel discussions with representatives of the 23 remaining
housing finance agencies that had signed agreements and had
participated to some degree in the program. Finally, we spoke with
representatives of the remaining qualified financial institutions
that either had signed agreements to participate in the reinsurance
program or had units allocated to them by HUD but had not yet signed
agreements as of February 1998.
We provided copies of a draft of this report to HUD for its review
and comment. The Department's comments appear in appendix IX and are
discussed at the end of chapters 3 and 4. We also provided a copy of
a draft of this report to the National Council of State Housing
Agencies and copies of relevant portions of the draft of this report
to Fannie Mae, Freddie Mac, the Federal Housing Finance Board, the
National Cooperative Bank, the Federal Home Loan Bank of New York,
the Federal Home Loan Bank of Seattle, the State of New York Mortgage
Agency, and Banc One Capital Funding Corporation. These groups
offered a number of technical suggestions and clarifications, which
we incorporated as appropriate.
We conducted our review from April 1997 through March 1998 in
accordance with generally accepted government auditing standards. We
relied on data obtained from housing finance agencies and other
qualified financial institutions through the use of structured data
collection instruments. We determined that the data were generally
reliable and usable for our purposes.
--------------------
\13 Because they were not housing finance agencies, they were not
eligible to participate in the credit enhancement program.
THE RISK-SHARING CREDIT
ENHANCEMENT PROGRAM IS SUPPORTING
THE FINANCING OF AFFORDABLE
MULTIFAMILY HOUSING
============================================================ Chapter 2
In the 32 states and localities with participating housing finance
agencies, the credit enhancement program is increasing access to
capital markets and thereby supporting the production of affordable
multifamily housing. Overall, about 84 percent of the 42,000 units
allocated to these agencies through 1996 have been reserved for
properties that either have been completed or are in the agencies'
pipelines. The properties include new construction, rehabilitation,
and refinancing in urban, suburban, and rural areas. Most of the
properties are serving more low-income households than required
because the credit enhancement is being combined with other
subsidies, especially low-income housing tax credits.
Participation in the credit enhancement program has enabled housing
finance agencies to increase their lending capacity, extend their
loan terms, lower their interest rates, and process loans more
quickly than they are able to do in their traditional multifamily
insurance programs. As a result, the agencies have been able to
finance affordable housing more efficiently, over longer periods of
time. While it is still too early to evaluate the financial
performance of the properties insured through the program, the
available financial indicators appear to reflect sound underwriting
criteria. Agencies that have not participated in the program
identified several barriers to participation, some of which are
beyond their control and others of which could be eliminated through
training, wider marketing, or making the program permanent.
Participating agencies believe that they would derive even greater
benefits if the program were made permanent and the limits on the
number of authorized credit enhancement units were lifted. Agencies
believe that demand for the program will increase with anticipated
increases in the states' tax credit allocations\1 and with HUD's
implementation of a mark-to-market initiative, under which HUD will
refinance subsidized rental properties to bring their rents in line
with local market rents.
--------------------
\1 The Low-Income Housing Tax Credit program is currently the largest
federal program to fund the development and rehabilitation of
multifamily housing for low-income families. Each year, states are
allocated tax credits in an amount equal to $1.25 per resident.
Legislation is being proposed to increase this amount to $1.75.
UNIT ALLOCATION AND USE VARY
WIDELY AMONG HOUSING FINANCE
AGENCIES
---------------------------------------------------------- Chapter 2:1
To date, the Congress has authorized 49,500 units under the credit
enhancement program. These units were made available through three
separate authorizations. The first 30,000 units were authorized in
October 1992 under the original statute establishing the program, the
next 12,000 units were authorized in March 1996, and the last 7,500
units were authorized in June 1997. As of September 1997, 28 state
housing finance agencies and 4 local housing finance agencies\2 had
entered into risk-sharing agreements with HUD and had received
allocations.
According to HUD officials, HUD allocated the first 30,000 units on
the basis of the population of the states that had signed
risk-sharing agreements with HUD. It allocated the two subsequent
authorizations on the basis of usage. HUD's application of these
criteria has resulted in wide variation among the states in the
number of units allocated. Five states--California, Colorado,
Florida, Massachusetts, and New York--and one local
agency--Montgomery County, Maryland--have received approximately 65
percent of the 42,000 units authorized as of March 1996. California
and Florida alone have received over 15,000 units.
In total, as of September 1997, the housing finance agencies had
reserved 35,116 units, or about 84 percent of the 42,000 units
authorized as of March 1996, for either completed properties (12,851
units) or properties in their pipelines (22,265 units). From state
to state, however, this percentage varies widely. Specifically, 19
of the 32 housing finance agencies have reserved more than 75 percent
of their allocations for either completed properties or properties in
their pipelines. Nine agencies have reserved between 24 and 75
percent of their allocations, and the four remaining agencies have
not reserved any of their allocations. Figure 2.1 shows the extent
to which the participating agencies have reserved their allocations.
(See apps. I and II for detailed information on the uses that the 32
housing finance agencies had made of their allocations as of October
1997.)
Figure 2.1: Percentage of
Allocations Reserved, by Number
of Agencies, as of September
1997
(See figure in printed
edition.)
Source: GAO's analysis of data provided by housing finance agencies.
Several factors are associated with the extent to which housing
finance agencies have used their allocations. Those that have
reserved over 75 percent of their units generally have active
multifamily programs, have a significant demand for multifamily
housing within their state, and/or do not have a comparable credit
enhancement mechanism available. From the start, many of these
agencies appear to have recognized the potential benefits of
participation. In contrast, agencies that have reserved fewer than
50 percent of their units generally have less demand for multifamily
housing, are not as experienced in operating a multifamily housing
finance program, or have an alternative credit enhancement mechanism
available.
As of September 1997, four housing finance agencies had not reserved
any of their allocations. The Alaska Housing Finance Corporation had
not used its 50-unit allocation because it believed that the
program's benefits were marginal relative to the cost of the credit
enhancement. The New York City Housing Finance Agency had not used
its 300-unit allocation because, after allocating most of its revenue
bond authority to raise capital for financing single-family housing,
it did not have sufficient authority to finance multifamily housing.
HUD recaptured these agencies' units and reallocated them to other
agencies. In Indiana and Louisiana, the housing finance agencies
were slow to use their allocations--300 units and 280 units,
respectively--because they did not join the risk-sharing program
until a year and a half after other agencies had joined and other
priorities delayed the start of their risk-sharing programs. HUD has
not sought to recapture their units.
--------------------
\2 The four local agencies are Montgomery County, Maryland;
Philadelphia, Pennsylvania; Fairfax County, Virginia; and New York
City, New York.
PROGRAM IS HELPING TO FINANCE
PROPERTIES SERVING DIVERSE
MARKETS AND INCOME GROUPS
---------------------------------------------------------- Chapter 2:2
Housing finance agencies are insuring properties in urban, suburban,
and rural markets. These properties, most of which are newly
constructed or substantially rehabilitated, vary in size and serve
various populations and income levels. Overall, the percentage of
low-income households served through the credit enhancement program
is higher than required by statute.
AGENCIES ARE SERVING
DIFFERENT HOUSING MARKETS
-------------------------------------------------------- Chapter 2:2.1
Data from the housing finance agencies show that 110 completed
properties had been insured through the risk-sharing program as of
September 1997. Overall, approximately 47 percent of the units in
these completed properties are in urban areas, 44 percent in suburban
areas, and 9 percent in rural areas. The distribution of units
reserved for properties in the agencies' pipelines is somewhat
different: 57 percent are in urban areas, 36 percent in suburban
areas, and 7 percent in rural areas. Appendix III shows, for each of
the 32 housing finance agencies, the significant variation in the
distribution of units for properties that have been completed and are
in their pipelines.
PROGRAM IS BEING USED
PRIMARILY TO FINANCE NEW
CONSTRUCTION
-------------------------------------------------------- Chapter 2:2.2
Agencies are generally using the credit enhancement program to help
finance new properties. Nationwide, 48 percent of the units in the
110 completed properties were in new construction, 32 percent in
substantial rehabilitation, 14 percent in refinancing, and 6 percent
in acquisition. Units reserved by agencies for properties in their
pipelines are concentrated even more heavily in new construction.
Specifically, 66 percent of these units are reserved for new
construction, 29 percent for rehabilitation, and 5 percent for
refinancing.\3 Appendix IV shows the variation in how the housing
finance agencies have used their allocations to finance different
types of construction for properties that have been completed or are
in their pipelines.
--------------------
\3 According to housing finance agency officials, the current limits
on the number of available units can create a bias in favor of new
construction because new construction generally costs more per unit
than rehabilitation. Therefore, agencies that use the credit
enhancement program to finance new construction may obtain a higher
value for their units than agencies that use the program to finance
rehabilitation. However, according to HUD, rehabilitation projects
are an unmet capital need, especially in inner-city neighborhoods.
PROPERTIES VARY IN SIZE
-------------------------------------------------------- Chapter 2:2.3
The average number of units for the 110 completed properties is 117;
however, some of these properties have as few as 8 units, while 1
property has 500 units. Overall, as figure 2.2 shows, the program
has primarily supported the financing of larger properties. About
half of the units are in properties with more than 200 units, and
only about 6 percent of the units are in properties with fewer than
50 units. For properties in the agencies' pipelines, the proportion
of smaller properties has increased--about 15 percent have been
reserved for properties with 50 or fewer units. As noted in chapter
1, HUD has identified smaller properties as an unmet capital need.
Figure 2.2: Percentage of
Total Units, by Size, of
Completed Properties as of
September 1997
(See figure in printed
edition.)
Source: GAO's analysis of data provided by housing finance agencies.
Such variation in size is even greater from one housing finance
agency to another, reflecting different market conditions and local
housing needs. Appendix V shows how, for completed properties, the
housing finance agencies used their units to help finance properties
of varying sizes.
Despite the variation in the size of the properties financed through
the credit enhancement program, most housing finance agencies have
not used the program to support properties of fewer than 50 units.
According to housing finance agency officials, such properties do not
afford the economies of scale that allow them to underwrite and
provide long-term permanent financing for affordable housing. The
officials also said that they rely on other programs to develop
smaller properties. Florida, for example, relies on the HOME\4
program and state funding sources, while Colorado assists smaller
properties by cross-subsidizing some of the costs through fees
charged to larger properties. Finally, housing finance agency
officials said, smaller properties are generally perceived as riskier
than larger ones because they are more prone to management
deficiencies and more likely to be located in distressed areas.
--------------------
\4 The HOME Investment Partnerships program was established in
November 1990 by the HOME Investment Partnerships Act to provide
funds to expand the supply of affordable housing for persons with
very low and low incomes.
HOUSEHOLD TYPES AND INCOME
LEVELS VARY WIDELY
-------------------------------------------------------- Chapter 2:2.4
Nationally, for completed properties, housing finance agencies have
used about 74 percent of their risk-sharing units for properties
serving families, 25 percent for properties serving the elderly, and
1 percent for properties serving people with special needs, such as
those who are homeless or disabled. However, these percentages vary
considerably from one housing finance agency to another. For
instance, the Massachusetts agency has used almost half of its
risk-sharing units for facilities serving the elderly, while the
Florida agency has used 100 percent of its units for properties
serving families. Many of the units in the Florida properties have
multiple bedrooms to meet the needs of large low-income families.
Besides targeting different types of households, housing finance
agencies are using the credit enhancement program to serve households
at different income levels. All of the agencies are meeting the
program's income eligibility criteria. In addition, the agencies as
a group are financing properties that serve more low-income
households than the program requires.\5 Specifically, of the 12,851
risk-sharing units in completed properties as of September 1997,
8,400, or about 65 percent, are reserved for households with incomes
at or below 60 percent of the local area's median income. This
percentage varies from one state to another. In five states and two
localities,\6 the housing finance agencies have reported using all of
their risk-sharing units for properties that serve only low-income
households.
Most of the properties that are exceeding the credit enhancement
program's income-targeting requirements are also being financed by
other subsidies. Specifically, about 74 percent of these properties
also receive other subsidies that have income restrictions at least
as stringent as the risk-sharing program's. For example, 61
properties, containing 7,376 units, were subsidized through the
Low-Income Housing Tax Credit program. In our March 1997 report on
this program,\7 we estimated that about three-fourths of the
households in tax-credit-supported units had incomes in 1996 that
were at or below 50 percent of the local area's median income.
Appendix VI shows the income levels being served by the 21 housing
finance agencies that had completed properties with risk-sharing
units as of September 1997.
--------------------
\5 At a minimum, to be eligible for insurance under the risk-sharing
program, a property must set aside either 20 percent of its units for
households with incomes at or below 50 percent of the area's median
income or 40 percent of its units for households with incomes at or
below 60 percent of the area's median income. Therefore, the
remaining units may be rented at market rates, or they may be subject
to rent restrictions if additional restrictions are required to
receive or take advantage of other housing subsidies. For example,
the Low-Income Housing Tax Credit program establishes the same rent
restrictions as the credit enhancement program, but tax credits are
available only for rent-restricted units. Thus, in many properties
financed with tax credits, all of the units are rent restricted.
\6 The states are Kentucky, Maryland, Montana, Oregon, and Rhode
Island. The localities are Philadelphia, Pennsylvania; and Fairfax
County, Virginia.
\7 Tax Credits: Opportunities to Improve Oversight of the Low-Income
Housing Program (GAO/GGD/RCED-97-55, Mar. 28, 1997).
HOUSING FINANCE AGENCIES HAVE
DERIVED KEY BENEFITS FROM THEIR
PARTICIPATION IN THE CREDIT
ENHANCEMENT PROGRAM
---------------------------------------------------------- Chapter 2:3
Two key objectives of the credit enhancement program are to (1)
increase the production of affordable multifamily housing and (2)
make affordable housing available to eligible families and
individuals in a timely manner. Another objective is to ensure the
financial soundness of the affordable multifamily housing properties
insured under the program.\8 Our work shows that housing finance
agencies and HUD have essentially met these objectives: First, the
program has allowed housing finance agencies to finance affordable
housing by leveraging their reserves, lowering their interest rates,
and extending their loan terms. Additionally, the program has
assisted some housing finance agencies in establishing viable
affordable multifamily housing programs. Second, by delegating the
underwriting and processing of affordable multifamily housing loans
to housing finance agencies, the program has enabled borrowers to
obtain loans in a more timely manner. Finally, by creating
risk-sharing arrangements predicated upon a sharing of losses, the
program has established appropriate incentives for financing
economically sound properties.
--------------------
\8 As noted in ch. 1, a statutory objective of the reinsurance
program is to ensure the maintenance, through risk sharing, of "sound
underwriting and loan management practices."
AFFORDABLE HOUSING IS BEING
DEVELOPED
-------------------------------------------------------- Chapter 2:3.1
The credit enhancement program has facilitated the production of
affordable multifamily housing, primarily by allowing housing finance
agencies to leverage their reserves and by lowering borrowing costs
and extending mortgage terms. In addition, the credit enhancement
program has helped three housing finance agencies establish
affordable multifamily housing programs.
LEVERAGING RESERVES
------------------------------------------------------ Chapter 2:3.1.1
In our judgment, the single greatest benefit that housing finance
agencies have derived from their participation in the credit
enhancement program is the ability to leverage their reserves. To
raise capital to finance affordable multifamily housing, these
agencies sell bonds to investors. To pay the lowest possible
interest rate on the bonds, an agency provides a credit enhancement
(i.e., funded reserves) or purchases a credit enhancement (i.e.,
risk-sharing insurance) to improve its bond rating.\9 If the agency
provides a credit enhancement, it is usually required to fund a
dedicated reserve account equal to a fixed percentage of its
outstanding mortgages, as required by a national rating agency such
as Standard and Poor's or Moody's. Consequently, the ability of the
agency to finance affordable multifamily housing is limited by its
available reserves. The agency can leverage its reserves by
participating in the credit enhancement program: When it uses the
program to enhance the credit of the loans it offers as collateral
for the bonds it sells, it reduces its reserve requirement in direct
proportion to the percentage of risk assumed by HUD. For example,
when HUD assumes 50 percent of the risk, the agency reduces its
reserve requirement by 50 percent, meaning that it can double its
financing capacity without increasing its reserves. As of September
1997, about 90 percent of the units were in properties financed by
loans for which HUD has assumed at least 50 percent of the risk. All
of the participating housing finance agencies with insured loans have
derived this leveraging benefit.
The importance of leveraging varies not only with the percentage of
risk assumed by HUD but also with the level of reserves maintained by
the agency and the agency's demand for financing. The benefit is
much greater for an agency that does not have sufficient reserves to
meet the current and/or anticipated demand than for an agency that
has larger reserves and/or lower demand. The California Housing
Finance Agency, which was allocated more risk-sharing units than any
other housing finance agency, was one of the agencies that derived
substantial benefits from leveraging. When the agency entered into a
50/50 risk-sharing agreement with HUD in 1994, the demand for
affordable multifamily housing was very high because, according to
agency officials, the savings and loans crisis in the late 1980s and
an economic recession that continued in many regions of the state
until 1995 had limited the agency to financing about $25 million a
year, on average, in affordable multifamily housing. After entering
the credit enhancement program, the agency increased its financing to
about $200 million per year. According to agency officials, about
half of this activity is attributable to the leveraging benefit they
derive from their 50/50 risk-sharing partnership with HUD.
--------------------
\9 The rating of the bonds is critical to a viable bond issue. The
higher the rating, the less the perceived risk to the investor and,
thus, the more marketable the bonds. The reduced risk associated
with the bonds encourages investors to accept a lower bond yield.
The lower the bond yield, potentially the lower the effective
mortgage interest rate paid by the developer of the affordable
multifamily property. As defined by Moody's, bonds rated "A" possess
many favorable investment attributes and are to be considered as
upper-medium-grade obligations. A medium-grade obligation indicates
that as long as there is no significant economic decline, the bond
will be able to meet payments when due.
LOWERING BORROWING COSTS
------------------------------------------------------ Chapter 2:3.1.2
Another benefit of the credit enhancement program--lowering borrowing
costs--has helped to increase the production of affordable
multifamily housing to the extent that such housing would not have
been economically feasible at higher interest rates. Because the
credit enhancement program generally enhances the credit rating on
bonds issued by housing finance agencies, investors are willing to
accept a lower yield (interest rate). If this lower rate is passed
on to developers, it makes the development of affordable multifamily
housing more feasible. The actual reduction in interest rates
attributable to the risk-sharing program varies with the credit
ratings of individual housing finance agencies, as well as with
market interest rates at given times. Because most housing finance
agencies participating in the risk-sharing program generally have at
least an "A" credit rating and because market interest rates have
been low over the past few years, the risk-sharing program has
generally contributed to only a marginal reduction in interest rates
(15 to 30 basis points). However, housing finance agencies reported
to us that even marginal reductions in interest rates can affect the
financial feasibility of affordable multifamily properties.
In at least one instance, participation in the credit enhancement
program contributed to a significant reduction in interest rates.
The Montgomery County housing finance agency used the program to
refinance a 311-unit property. The original mortgage was financed by
two bond issues with a combined interest rate of about 8 percent.
After the refinanced mortgage was insured through the credit
enhancement program--when market interest rates were lower than they
had been at the time the property was originally financed--the
interest rate dropped to about 6 percent. This 2-percent reduction,
together with a write-off of part of the original debt, allowed the
housing finance agency to maintain the property as affordable
housing.
EXTENDING MORTGAGE TERMS
------------------------------------------------------ Chapter 2:3.1.3
Finally, several housing finance agencies have used the credit
enhancement program to extend the mortgage repayment period to 40
years. A longer repayment period can make an affordable multifamily
property more financially feasible because less operating revenue is
required to meet the monthly mortgage payments. For example, the New
York State Housing Finance Agency used the program to provide a
40-year mortgage for an 83-room property with 142 beds designed to
serve elderly residents, including those who are mentally ill,
handicapped, and/or homeless. Because these residents have very
limited incomes, the 40-year mortgage was necessary to make the
property financially feasible for the residents. State agency
officials said that without the credit enhancement program, the term
of the mortgage would have been 30 years because the agency would
have had to rely on a state mortgage insurance program that limits
mortgages to 30 years or less. Had the agency been required to use
this state program, the officials said, additional subsidies would
have been needed to reduce the amount of the mortgage loan to make
the property financially feasible.
ESTABLISHING AFFORDABLE
MULTIFAMILY LENDING
PROGRAMS
------------------------------------------------------ Chapter 2:3.1.4
The credit enhancement program has helped three housing finance
agencies--in Florida, Kentucky, and New Mexico--establish viable
affordable multifamily lending programs. In Florida, the program
gave the agency access to a continuous and reasonably priced source
of credit enhancement, which it needed as security for its bonds so
that it could finance affordable multifamily housing. Similarly, in
Kentucky and New Mexico, the program gave the agencies access to an
affordable source of credit enhancement that enabled them to compete
with other sources of financing available to developers of
multifamily housing. In Kentucky, the credit enhancement enabled the
housing finance agency to provide financing for developers of smaller
properties (24 to 30 units) in rural areas--an important benefit,
given recent reductions in funding for the Rural Housing Service's
section 515 program. In New Mexico, the credit enhancement also
enabled the agency to finance properties with fewer than 100 units,
as well as properties for persons with special needs. Such housing
was not being developed through other sources.
AFFORDABLE MULTIFAMILY
HOUSING IS BEING FINANCED IN
A TIMELY WAY
-------------------------------------------------------- Chapter 2:3.2
The credit enhancement program is achieving its second key objective
--making affordable housing available in a timely manner. Because
the program delegates to housing finance agencies much of the loan
underwriting and processing authority that HUD retains under FHA's
traditional insurance programs, it delivers FHA insurance more
efficiently than the traditional programs (see ch. 4).
The efficiencies in loan processing gained through the program
provide two direct benefits to developers of affordable housing--(1)
an earlier determination of a property's financial feasibility and
(2) the savings associated with being able to initiate construction
sooner rather than later. Because the development of affordable
housing frequently requires multiple subsidies and a property's
financial feasibility generally depends on bringing all of these
subsidies and any related debt financing together by a specific time,
any delay in approving the financing can jeopardize the property's
feasibility. The Florida Housing Finance Agency has taken advantage
of the program's efficiencies to bring together the financing for
both construction loans and permanent mortgage loans in a timely way.
This agency issues bonds to finance both types of loans for its
affordable multifamily properties. While it uses a private bond
insurer to provide a credit enhancement for the construction
financing, it uses the risk-sharing program to provide a credit
enhancement for the permanent financing. Because the private insurer
requires assurance that the permanent financing will be available
before it agrees to provide the credit enhancement for the
construction financing, the agency needs to obtain the credit
enhancement for the permanent loan expeditiously. The program
provides the credit enhancement expeditiously, whereas delays could
occur in HUD's traditional multifamily insurance programs. Such
delays could, in the opinion of agency officials, postpone the
development of certain properties long enough to increase their costs
to the point that the properties would no longer be financially
feasible.
An associated benefit of more prompt approval of a property's
permanent financing is reflected in the adage that "time is money."
According to officials at various housing finance agencies, by
reducing the time required for processing loans, the program has
reduced the costs of developing properties. In addition, by
shortening the time required for approving permanent mortgages, some
of these officials noted, the program has provided developers with
better assurance that proposed properties will be financially
feasible. The faster approval time avoids potential increases in
interest rates that could be high enough to prevent some properties
from being built.
PARTNERSHIPS PROMOTE THE
FINANCIAL VIABILITY OF
INSURED PROPERTIES
-------------------------------------------------------- Chapter 2:3.3
As previously discussed, the credit enhancement program establishes
economic incentives for HUD and its risk-sharing partners to perform
their respective functions properly and makes them financially
accountable if they do not. Although little information is currently
available for evaluating the financial performance of housing finance
agencies as risk-sharing partners, the available indicators suggest
that the agencies are generally using the program responsibly.
It is still too early to project the financial performance of the 110
properties insured under the credit enhancement program through
September 1997; however, our limited analysis indicates that
reasonable underwriting standards were applied. We reviewed two key
financial indicators, the debt service coverage ratio\10 and the
loan-to-value ratio,\11 and found that the participating housing
finance agencies have used generally accepted underwriting criteria
for the loans they have insured under the program.
The debt service coverage ratio is used in underwriting to evaluate
the potential for a property's income to cover the property's
mortgage debt. The higher the ratio, the less the property is likely
to face financial difficulties that could lead to default. The
benchmark generally used in the housing industry for unsubsidized
properties is about 1.20. However, for subsidized properties, this
benchmark can range from 1.05 to 1.15. A lower debt service coverage
ratio can allow rents to be lower, making a property more affordable
to low-income households. Our analysis of data provided by the 21
housing finance agencies showed that, for the 110 properties
completed as of September 1997, the median debt service coverage
ratio was 1.11. Moreover, as table 2.1 indicates, about 33 percent
of the insured units were in properties with a debt service coverage
ratio of more than 1.15, and over 95 percent of the units were in
properties with a debt service coverage ratio of at least 1.05.
Table 2.1 Debt Service Coverage Ratio
for Insured Properties as of September
1997
Number of Number of Percentage
Debt service coverage ratio properties units of units
---------------------------- ------------ ------------ ------------
Above 1.15 33 4,278 33.3
1.10 to 1.15 60 6,545 50.9
1.05 to 1.09 13 1,421 11.1
Below 1.05 3 523 4.0
Not reported 1 84 0.7
======================================================================
Total 110 12,851 100.0
----------------------------------------------------------------------
Source: GAO's analysis of questionnaire data provided by housing
finance agencies.
The loan-to-value ratio is used to determine whether a property's
cash value will be sufficient to cover the mortgage debt in the event
of foreclosure. The lower the ratio, the more the property's value
is likely to be sufficient to pay off the outstanding mortgage
obligation. Among private lenders, the benchmark used to finance
unsubsidized properties is about 80 percent, and under FHA's
traditional multifamily insurance program for profit-making
developers it is 90 percent. Under FHA's traditional multifamily
insurance program for nonprofit sponsors, the loan-to-value ratio can
be as high as 100 percent. The median loan-to-value ratio for
insured units under the risk-sharing program is 80 percent. Table
2.2 presents the loan-to-value ratios for units in properties insured
as of September 1997. As the table indicates, most of the units are
in properties with loan-to-value ratios ranging from 70 to 90
percent.
Table 2.2
Loan-to-Value Ratio for Insured Units as
of September 1997
Percentage of
Loan-to-value ratio Number of units units
------------------------------ ------------------ ------------------
Equal to 100 percent 394 3.1
90-99 percent 1,130 8.8
70-90 percent 7,796 60.6
Below 70 percent 3,287 25.6
Not reported 244 1.9
======================================================================
Total 12,851 100.0
----------------------------------------------------------------------
Source: GAO's analysis of questionnaire data provided by housing
finance agencies.
It is too early to project the future performance of loans insured
through the credit enhancement program. However, data reported by
agencies participating in the program generally indicate that their
entire portfolios are performing well. According to these data, the
agencies' existing multifamily portfolios show less than 1.28 percent
of their total loan dollars in default and less than 0.34 percent in
foreclosure. However, one loan, originated by the California Housing
Finance Agency under the credit enhancement program, went into
default shortly before it received final endorsement from HUD. This
loan was one of the three loans with an original debt service
coverage ratio below 1.05 (see table 2.1). Although the California
Housing Finance Agency should have notified HUD headquarters of this
default, it notified the responsible HUD field office instead. The
field office did not forward the information to HUD headquarters.
Therefore, headquarters officials were not aware of the default until
we brought it to their attention. As noted in chapter 4, California
is withdrawing this loan from the risk-sharing program.
--------------------
\10 The debt service coverage ratio is a property's net operating
income divided by the required mortgage payments.
\11 The loan-to-value ratio is the outstanding mortgage on a property
divided by its market value.
AGENCIES' REASONS FOR NOT
PARTICIPATING IN THE CREDIT
ENHANCEMENT PROGRAM VARIED
---------------------------------------------------------- Chapter 2:4
We contacted the 24 state housing finance agencies that have not
participated in the credit enhancement program to understand why they
have not done so. Their responses are summarized in table 2.3.
Table 2.3
Housing Finance Agencies' Reasons for
Not Participating in the Credit
Enhancement Program
Percenta
Number ge of
of total
Reasons for not participating agencies response
-------------------------------------------------- -------- --------
State's multifamily program was limited or 13 55
nonexistent and/or agency could not meet
program's reserve requirements
State policies and legislative processes prevented 5 21
participation
Staff lacked sufficient knowledge and skills to 2 8
operate program
Agency believes it is ineligible for program 1 4
Agency relies on other options to finance 2 8
multifamily housing
Agency provided no reason 1 4
======================================================================
Total 24 100
----------------------------------------------------------------------
Source: GAO's analysis of data from structured telephone interviews
with nonparticipating housing finance agencies.
Some of the reasons cited for not participating, such as not having a
multifamily program or being subject to state policies that prevent
participation, appear to be outside the agencies' control. Eighteen,
or about 76 percent, of the agencies identified these reasons as
barriers to their participation. Other reasons for not
participating, such as not having sufficient knowledge of the
program's benefits or staff skills, could be eliminated through
training, hiring contractors, and/or marketing the program and its
benefits more effectively. The Florida Housing Finance Agency, for
example, hires contractors to underwrite its loans because it has not
hired in-house staff to perform this function. Two of the agencies
identified these reasons as barriers to their participation.
Finally, two of the agencies reported relying on other options to
finance their multifamily mortgages. One of the agencies said that
it works with banks to finance its multifamily housing, while the
other indicated that it has a high enough credit rating to finance
its properties without the program. However, 42 percent of these
agencies indicated that if circumstances changed, they would consider
using the credit enhancement program.
CHANGES TO THE CREDIT
ENHANCEMENT PROGRAM COULD
FACILITATE THE FINANCING OF
AFFORDABLE MULTIFAMILY HOUSING
---------------------------------------------------------- Chapter 2:5
According to the participating housing finance agencies, several
changes would improve the financing and administration of the credit
enhancement program. Options for improving the program's
administration are discussed in chapter 4. Options for improving the
program's financing are discussed in the remainder of this chapter.
Housing finance agencies believe that making the credit enhancement
demonstration program permanent and removing the legislative limits
on the number of authorized units would assist them in planning for
and financing additional affordable multifamily housing. According
to the agencies, both the program's demonstration status and the
limits on the number of available units are hampering their marketing
of the program and management of their multifamily resources. Some
agencies have used all or nearly all of their credit enhancement
units to meet the current demand, and if bills proposing to increase
the states' per-capita tax credit allocations are enacted, they are
likely to see an even greater demand for credit enhancement units.
Finally, the credit enhancement program may be used to insure
mortgages refinanced under the Multifamily Assisted Housing Reform
and Affordability Act of 1997, commonly known as "portfolio
reengineering" or "mark-to-market." Although the Congress has
provided statutory authority to meet any increased demand for
risk-sharing units attributable to this program, making the credit
enhancement program permanent would logically complement this
authority.
LACK OF PERMANENCY IMPEDES
EFFICIENT MANAGEMENT
-------------------------------------------------------- Chapter 2:5.1
Because the credit enhancement program was established as a
demonstration program, HUD must seek congressional authorization to
(1) extend its duration and (2) obtain additional units. If the
program is made permanent, its insurance authority will, presumably,
be limited by a dollar amount, which can be adjusted with demand,
rather than by a unit allocation. FHA's traditional mortgage
insurance programs operate under a dollar cap, which the Congress has
increased as necessary to provide for greater activity.
According to the housing finance agencies, the program's lack of
permanency and limits on the number of available units impede their
marketing of the program to lenders, management of multifamily
resources, and financing of affordable multifamily properties. For
example, the New Mexico Housing Finance Agency noted that the program
is difficult to market to affordable multifamily housing developers
when the agency is unsure how long the program will continue and
whether the agency will have enough units to meet the potential
demand. Similarly, officials from the California Housing Finance
Agency told us that because it can take 3 to 4 years to structure the
financing for and develop an affordable multifamily property, they
need an ongoing stream of units or dollars available over a long
period of time. Officials from several other agencies confirmed that
the uncertainty surrounding the program's future and level of
activity hinders their marketing of the program and creates problems
for them in planning the financing of additional affordable
multifamily properties.
As shown in appendix I, many housing finance agencies have reserved
all or nearly all of their allocated units, and some agencies do not
have enough additional units to meet the current demand.
Specifically, 12 of the 32 participating housing finance agencies had
reserved all of their allocated units by September 1997, and another
6 agencies had reserved between 89 and 98 percent of their units.
According to officials at several of these agencies, they have other
properties in their pipelines that are candidates for the credit
enhancement program, but they are waiting to receive additional units
before they formally agree to use the program to help finance these
properties' development. According to officials at the Florida
Housing Finance Agency, the agency has reserved all but 605 of the
7,002 units in its allocation. It has properties with a total of 605
units in its pipeline and estimates that it could use another 1,600
units per year. However, until it receives an additional allocation,
it cannot satisfy this demand through the credit enhancement program.
Officials at the Maine Housing Finance Agency told us that they had
reserved 140 of the 150 units in the agency's original allocation and
may not reserve the 10 remaining units unless they receive an
additional allocation.
DEMAND FOR CREDIT
ENHANCEMENT UNITS IS LIKELY
TO INCREASE WITH AN INCREASE
IN THE STATES' TAX CREDIT
ALLOCATIONS
-------------------------------------------------------- Chapter 2:5.2
Housing finance agencies have frequently used the credit enhancement
program in conjunction with the Low-Income Housing Tax Credit
program. As previously noted, 61 of the 110 completed properties
that were financed through the credit enhancement program were also
financed through the Low-Income Housing Tax Credit program. Using
the two programs together is logical, given that both have the same
income eligibility criteria.
As we reported in March 1997,\12 the Low-Income Housing Tax Credit
program is currently the largest federal program to fund the
development and rehabilitation of housing for low-income households.
Since the program's inception in 1986, the Internal Revenue Service
has allocated tax credits to each state in an amount equal to $1.25
per resident to be used to help finance affordable multifamily
housing properties. During the 3-year period (1992-94) covered by
our study, this allocation supported the development of about 4,100
low-income housing properties containing about 172,000 units.
Currently, according to a general consensus in the housing industry,
the demand for low-income housing tax credits is exceeding the supply
by about three or four to one. Accordingly, S. 1252 and H.R. 2990,
introduced in 1997, propose to increase each state's tax credit
allocation to $1.75 per resident and to index, or adjust, this amount
annually for inflation. Should these bills become law, the
production of affordable housing could be expected to increase.
Given the past association between the tax credit and the
risk-sharing programs, the demand for risk-sharing units would also
be likely to increase.
--------------------
\12 Tax Credits: Opportunities to Improve Oversight of the
Low-Income Housing Program (GAO/GGD/RCED-97-55, Mar. 28, 1997).
CREDIT ENHANCEMENT PROGRAM
HAS BEEN AUTHORIZED TO
SUPPORT HUD'S MARK-TO-MARKET
DEMONSTRATION PROGRAM
-------------------------------------------------------- Chapter 2:5.3
About 8,600 privately owned multifamily properties with FHA-insured
mortgages totaling $17.8 billion receive federal rental subsidies for
some or all of their apartments under HUD's section 8 project-based
assistance program. These properties contain about 859,000 units.
For subsidized units, HUD pays the difference between the rent and 30
percent of the household's income. The rents at many properties
exceed market levels, resulting in high subsidies. To reduce the
costs of these subsidies and address other problems, HUD proposed
adjusting the rents to market levels and writing down the mortgages
as needed to allow the properties to operate at market rents.
The Congress generally adopted HUD's proposal when it enacted the
Multifamily Assisted Housing Reform and Affordability Act of 1997,
which authorized the mark-to-market program. The act encourages
owners of eligible multifamily housing properties to restructure
their FHA-insured mortgages and project-based assistance contracts
before the contracts expire. The purposes of this act are to ensure
the continued economic and physical viability of the properties,
protect FHA's General Insurance Fund from excessive defaults, reduce
the long-term costs of these insured properties, and guard against
the possible displacement of families.
To restructure these mortgages, the act requires HUD to enter into
portfolio restructuring agreements with participating administrative
entities that (1) have demonstrated experience in working with
low-income residents, (2) have demonstrated the capacity to
restructure the financing of eligible multifamily properties, and (3)
have a history of financial stability. The act gives preference to
housing finance agencies to serve as the participating administrative
entities under these agreements. The act also encourages housing
finance agencies to use several tools, including the risk-sharing
program, to help them restructure the mortgages of eligible
multifamily properties. In addition, the act specifies that the
number of units used to refinance eligible multifamily housing
properties under the mark-to-market legislation will not reduce the
number of units available for mortgage insurance under section 542.
Moreover, any credit subsidy costs of providing mortgage insurance
are to be paid from the Liquidating Accounts of the General Insurance
Fund or the Special Risk Insurance Fund.
As of May 1997, HUD had designated 30 state housing finance agencies,
with three-quarters of the properties eligible for the mark-to-market
initiative within their jurisdiction, to serve as entities under the
mark-to-market demonstration program.\13
HUD's guidelines and instructions for implementing the demonstration
program require each designated entity to develop a management plan
for implementing the program and receive an approved contract from
HUD to restructure mortgages. As of the end of January 1998, 17
state and local housing finance agencies, all with risk-sharing
agreements, had obtained HUD's approval of their management plans,
and 6 agencies had also obtained approved contracts. As of this
date, however, none of these agencies had restructured any mortgages.
Housing finance agency officials identified two key impediments to
using the credit enhancement program for restructuring mortgages.
First, while the mark-to-market legislation authorizes the use of the
credit enhancement program as a restructuring tool and thus assumes
the program's continuation, the officials have no assurance that the
program will continue. Housing finance agency officials told us that
before they plan to use the program in restructuring loans, they need
to be assured that the program will be available when the
restructuring occurs.
Second, housing finance agency officials were reluctant to use the
credit enhancement program to insure these refinanced loans because
they would then be exposed to risk if HUD did not renew the
properties' section 8 rental assistance contracts. If HUD did not
renew the contracts, the properties might not generate enough income
to repay the refinanced loans, and the properties' financial solvency
might be jeopardized. These housing finance agency officials told us
that because the decision to renew the contracts would rest with HUD,
they would not want to insure these properties through the credit
enhancement program unless FHA assumed total responsibility for any
losses resulting from a decision by HUD not to renew the section 8
contracts. We discussed this issue with the senior HUD official
responsible for administering the mark-to-market demonstration
program. According to him, only 1 of the 17 agencies had expressed
an interest in providing the funding for any restructured mortgages.
The other agencies had only expressed an interest in facilitating the
restructuring of the mortgages and had suggested that the capital for
the refinancing should come from a source outside the refinancing
agency. According to this official, if HUD were to assume total
liability in the event that it chose not to renew section 8
contracts, more housing financing agencies would likely be interested
in refinancing restructured mortgages.
A bill (H.R. 2447) was introduced in September 1997 to provide for
HUD to "assume an appropriate share of the risk of a loan for
affordable multifamily housing in a manner that mitigates
uncertainties regarding actions of the Federal Government (including
the possible failure to renew short-term subsidy contracts)." This
bill has been referred to the House Committee on Banking and
Financial Services.
--------------------
\13 Before the enactment of the 1997 act, HUD operated a
mark-to-market demonstration program.
CONCLUSIONS
---------------------------------------------------------- Chapter 2:6
The credit enhancement demonstration program is meeting several key
objectives, including facilitating the financing of affordable
multifamily housing and making affordable multifamily housing
available in a timely manner. Making the program permanent and
lifting the limits on the number of available units could have
several benefits. Specifically, housing finance agencies currently
participating in the program could be expected to increase their
activity to meet both current and anticipated demand, and
nonparticipating agencies could be expected to give more
consideration to entering the program knowing that its benefits would
be available in the future. Agencies might also be encouraged to
expand their financing for smaller properties and for rehabilitation
projects, particularly in underserved rural and inner-city markets.
In addition, permanency would support the program's continued use in
financing tax-credit-supported properties and would complement
anticipated increases in states' tax credit allocations. Finally,
permanency would support the use of the credit enhancement program
with the "mark to market" program. However, until a decision has
been reached on whether FHA will assume the entire risk of default if
HUD does not renew short-term section 8 subsidy contracts on
properties with restructured mortgages, housing finance agencies will
be unlikely to finance these restructured mortgages. And unless an
agency does finance these mortgages, it will not need to use the
credit enhancement program to support the mark-to-market initiative.
Finally, permanency implies that HUD will exercise appropriate
administrative controls over housing finance agencies to ensure that
they are meeting their responsibilities under the program, that the
government's interests are being protected, and that the program's
results can be evaluated. Problems with these administrative
controls and HUD's plans to address them are discussed in chapter 4.
THE RISK-SHARING REINSURANCE
PROGRAM IS LARGELY UNTESTED
BECAUSE PARTICIPATION HAS BEEN
LIMITED
============================================================ Chapter 3
Today, more than 5 years after the reinsurance program was
authorized, the program remains largely untested. Although HUD's
risk-sharing partners have the potential to expand the participation
of major financial institutions in mortgage lending, as envisioned in
the risk-sharing statute, only one of the four institutions that was
allocated units authorized in 1992--Fannie Mae--has participated
extensively in the program, and one lender--Banc One Capital Funding
Corporation--has originated over half of the loans that Fannie Mae
has reinsured. Banc One Capital's experience has demonstrated that
the reinsurance program can expand participation in mortgage lending,
including lending for smaller properties in rural areas. Resolving
questions about the use of reinsurance with balloon mortgages and
loan pools and building on recent initiatives of two Federal Home
Loan banks, assuming these initiatives are successful, could expand
participation in the program.
PARTNERSHIPS CREATE THE
POTENTIAL FOR WIDER LENDING
---------------------------------------------------------- Chapter 3:1
HUD's current and designated risk-sharing reinsurance partners
represent a range of financial institutions that operate nationally
and at the state and city levels. All of these institutions have
affordable housing goals and, with the exception of the two loan
consortia,\1 have strong credit ratings. As a group, they have the
potential to expand the participation of major financial institutions
in affordable multifamily lending.
Legislation has authorized a total of 22,500 units for the
reinsurance program--15,000 in 1992 and 7,500 in 1996. In 1994, HUD
signed risk-sharing agreements with four qualified financial
institutions and allocated the first 15,000 units among them. Three
of these institutions--Fannie Mae, Freddie Mac, and the National
Cooperative Bank--operate nationally, and the fourth--the Federal
Home Loan Bank of Seattle--operates regionally but is affiliated with
the national Federal Home Loan Bank System. The 12 affiliates of
this system are regulated by the Federal Housing Finance Board and
have 6,504 member banks that operate in all 50 states.
HUD earmarked the 7,500 units authorized in 1996 to four new
institutions--the State of New York Mortgage Agency (SONYMA), the
Federal Home Loan Bank of New York, the Community Preservation
Corporation (CPC), and the California Community Reinvestment
Corporation (CCRC). SONYMA is a state agency whose activity is
restricted to New York State. CCRC and CPC are loan consortia; CCRC
operates at the state level, while CPC operates at the city and
metropolitan-area level. To date, HUD has signed risk-sharing
agreements with SONYMA (in April 1997) and the Federal Home Loan Bank
of New York (in January 1998) and is negotiating agreements with CPC
and CCRC. All of the risk-sharing agreements provide 50-percent FHA
reinsurance for loans purchased under the program.
--------------------
\1 Loan consortia were created and funded by banks and/or thrifts to
provide financing for affordable housing developments, particularly
multifamily rental properties.
ONLY ONE INSTITUTION HAS BEEN
ACTIVE IN THE RISK-SHARING
REINSURANCE PROGRAM
---------------------------------------------------------- Chapter 3:2
Fannie Mae is the only recipient of units authorized in 1992 that has
participated extensively in the reinsurance program. Fannie Mae has
reserved all of its 7,500 units for 48 properties. As of October 31,
1997, six of these properties, with 956 units, have received final
endorsement from HUD, and the remaining 42 properties, with 6,544
reserved units, are in various stages of development. Freddie Mac,
the only other original participant with any activity, had reserved
538, or about 11 percent, of its 5,000 allocated units for one
property as of October 31, 1997. The National Cooperative Bank and
the Federal Home Loan Bank of Seattle did not reserve any of their
allocated units. Thus, as of October 31, 1997, 8,038, or about 54
percent, of the 15,000 units authorized in 1992 had been reserved.
Recently, the National Cooperative Bank and the Federal Home Loan
Bank of Seattle agreed to return their units to HUD. According to
HUD, it will reallocate 2,000 units to Fannie Mae and hold the
remaining 500 units in reserve.
No loans have received final endorsement for the 7,500 units
authorized in 1996. As of October 31, 1997, SONYMA had reserved 306,
or about 13 percent, of its 2,400 allocated units for two properties.
Table 3.1 indicates how, as of October 31, 1997, the six
participating and two designated financial institutions had used the
program's 22,500 authorized units.
Table 3.1
Activity in the Risk-Sharing Reinsurance
Program, as of October 31, 1997
Status of allocated units
----------------------------------------------------
Qualified
financial Number of Number endorsed Number not yet
institution allocated units by HUD Number reserved reserved
----------------- ---------------- ---------------- ---------------- ----------------
Designated in 1992, with a risk-sharing agreement signed in 1994
-----------------------------------------------------------------------------------------
Fannie Mae 7,500 956 6,544 0
Freddie Mac 5,000 0 538 4,462
National 2,000\a 0 0 2,000
Cooperative Bank
Federal Home Loan 500\a 0 0 500
Bank of Seattle
Designated in 1996, with a risk-sharing agreement signed in 1997 or 1998
-----------------------------------------------------------------------------------------
SONYMA 2,400 0 306 2,094
Federal Home Loan 2,000 0 0 2,000
Bank of New York
Negotiating a risk-sharing agreement with HUD
-----------------------------------------------------------------------------------------
CPC 2,000 0 0 2,000
CCRC 1,100 0 0 1,100
=========================================================================================
Total 22,500 956 7,388 13,154
-----------------------------------------------------------------------------------------
\a In February 1998, these units were returned to HUD for
reallocation.
Source: GAO's analysis of data provided by HUD and participating
financial institutions.
ONE PRODUCT LINE AND ONE
LENDER ACCOUNT FOR MOST OF
FANNIE MAE'S REINSURANCE
ACTIVITY
-------------------------------------------------------- Chapter 3:2.1
Fannie Mae has reserved or purchased all but 1\2 of its 48
risk-sharing loans through its Delegated Underwriting and Servicing
(DUS) product line. This product line is compatible with the
reinsurance program because, like the program, it delegates
responsibilities and shares risks. Under DUS, Fannie Mae delegates
its authority to underwrite and determine the creditworthiness of a
loan to the originating lender and agrees to purchase the loan
without prior review. In return for this autonomy, the DUS lender
assumes a percentage of the risk of default on the loan.
Specifically, the lender is responsible for the first 5 percent of
any loss on the loan and shares with Fannie Mae in the next 15
percent of any loss. Both the benefits of autonomy and the risk of
loss create incentives for the DUS lender to underwrite the loan
prudently and service\3 it diligently. Currently, Fannie Mae does
business with about 28 DUS lenders, most of which Fannie Mae
considers to be experienced, well-capitalized mortgage bankers.
Since the DUS product line's inception in 1987, the loss rate (to
lenders) on DUS loans has been less than 1 percent. It is still too
early to determine or predict any loss rates under the reinsurance
program.
One DUS lender is responsible for more than half of Fannie Mae's
reserved loans in the reinsurance program. Banc One Capital Funding
Corporation, an affiliate of a large bank holding company, originated
the loans for 28 of Fannie Mae's 48 properties. These 28 properties
account for 3,175, or about 42 percent, of Fannie Mae's 7,500
reserved units. Eight other DUS lenders had participated in the
risk-sharing program as of October 31, 1997, and account for the
balance of the properties and units.
--------------------
\2 The single non-DUS loan was approved under Prior Approval
authority. When using this authority, Fannie Mae underwrites and
approves each loan before purchasing it and assumes all of the credit
risk. The approved risk-sharing loan of $40 million was secured by a
property with 1,175 units. None of the properties securing
DUS/risk-sharing loans exceeded 450 units.
\3 For a multifamily mortgage loan, loan servicing involves regular
reviews of the property's financial statements and loan payments and
physical inspections of the property to ensure its proper
maintenance.
FANNIE MAE'S ACTIVITY HAS
INCREASED OVER TIME
-------------------------------------------------------- Chapter 3:2.2
Fannie Mae's activity in the risk-sharing reinsurance program has
grown steadily, peaking in 1997. Figure 3.1 tracks Fannie Mae's
activity in the program from 1995 through 1997.
Figure 3.1: Fannie Mae's
Risk-Sharing Activity, 1995
through 1997
(See figure in printed
edition.)
Source: GAO's analysis of data provided by Fannie Mae.
Fannie Mae reserved the last of its risk-sharing units in October
1997. It has asked HUD for additional units, and, as noted, HUD has
said that it will reallocate to Fannie Mae 2,000 of the units its
expects to be returned. As of February 1998, HUD had not reallocated
the units.
FANNIE MAE'S RISK-SHARING
PROPERTIES VARY IN SIZE,
TARGETED INCOME LEVELS, AND
GEOGRAPHIC LOCATION
---------------------------------------------------------- Chapter 3:3
Fannie Mae's 48 risk-sharing properties vary in size, and their units
are reserved for households of varying income levels. The properties
are located in both urban and rural markets, most of which are
concentrated in a few states.
PROPERTIES WITH RISK-SHARING
UNITS VARY IN SIZE, BUT
UNITS ARE CONCENTRATED IN
LARGER PROPERTIES
-------------------------------------------------------- Chapter 3:3.1
Fannie Mae's risk-sharing properties range in size from 31 to 1,175
units, according to Fannie Mae's data. On average, these properties
have 156 units. About half of the properties have fewer than 100
units, and about half have more. However, the larger properties
account for about 80 percent of Fannie Mae's total reservation.
Table 3.2 shows the distribution of units according to property size.
Table 3.2
Distribution of Fannie Mae's Risk-
Sharing Units, by Property Size
Number of
units in
category as
a percentage
Number of Number of of the total
Category of property, by properties units in number of
number of units in category category units
---------------------------- ------------ ------------ ------------
Under 50 units 4 158 2
50-99 units 19 1,369 18
100-199 units 12 1,606 21
200-399 units 11 2,742 37
400 or more units 2 1,625 22
======================================================================
Total 48 7,500 100
----------------------------------------------------------------------
Source: GAO's analysis of data provided by Fannie Mae.
PERCENTAGE OF LOWER-INCOME
HOUSEHOLDS SERVED IS
GENERALLY HIGHER THAN
REQUIRED
-------------------------------------------------------- Chapter 3:3.2
All six of the properties that had received final endorsement from
HUD as of October 31, 1997, meet, and four exceed, the reinsurance
program's income-targeting requirements.\4 The four that exceed the
requirements have reserved all of their units for households with
incomes at or below either 50 or 60 percent of the area's median
income. The other two properties meet the program's minimum
targeting standards: One has reserved 20 percent of its units for
households with incomes at or below 50 percent of the area's median
income while the other has reserved 40 percent of its units for
households with incomes at or below 60 percent of the area's median
income.
All four of the properties that exceed, and one of the properties
that meet, the program's income-targeting requirements are able to do
so because they are partially financed with low-income housing tax
credits. The Low-Income Housing Tax Credit program encourages the
production of affordable units by making the tax credit subsidy
available only to such units.
--------------------
\4 To be eligible for insurance under the risk-sharing program,
properties must be rent restricted and have reserved at least (1) 20
percent of their units for households with incomes at or below 50
percent of the area's median income or (2) 40 percent of their units
for households with incomes at or below 60 percent of the area's
median income.
RISK SHARING UNITS ARE
CONCENTRATED IN THREE STATES
-------------------------------------------------------- Chapter 3:3.3
Fannie Mae has reserved units in properties serving both urban and
rural markets. Although these properties are located in 11 states,
most are concentrated in 3--California, Texas and Ohio. These three
states account for 29 properties and about 52 percent of Fannie Mae's
7,500 allocated units. In Ohio, Banc One Capital Funding Corporation
has funded 14 properties with 1,068 units. Banc One Capital's
headquarters and many of its commercial banks are located in Ohio.
Because many of these banks are located in rural areas, most of the
properties they have financed through the reinsurance program are
located in smaller communities. The loans for these properties are,
on average, much smaller than the risk-sharing loans financed by
Fannie Mae's other DUS lenders. HUD has identified a nationwide need
for smaller multifamily rental properties in rural areas.
SEVERAL FACTORS HAVE
FACILITATED FANNIE MAE'S USE
OF RISK-SHARING UNITS
-------------------------------------------------------- Chapter 3:3.4
Several factors help to explain why Fannie Mae has used its
risk-sharing units more extensively than HUD's other risk-sharing
partners. These factors include the previously noted parallels
between the DUS product line and the reinsurance program, Banc One
Capital's unique affiliation with local lenders that have an
incentive to finance affordable housing, and Fannie Mae's efforts to
both clarify and expand the program's benefits for lenders.
When Fannie Mae signed its risk-sharing agreement with HUD in 1994,
it had a product line in place that was uniquely compatible with the
reinsurance program. As noted, both the DUS product line and the
reinsurance program delegate responsibilities to other parties, and
both secure their investment through risk sharing. Because Fannie
Mae had been operating the DUS product line since 1988, it and its
lenders had experience with delegation and risk sharing when the
reinsurance program started. The other original participants in the
reinsurance program did not have such experience.
Modifications to the DUS product line created additional incentives
for DUS lenders to participate in the reinsurance program. First, in
1994, Fannie Mae introduced the Targeted Affordable Housing product
line, which allows DUS lenders to use more flexible underwriting
standards than are required for the traditional DUS program.\5 At the
same time, Fannie Mae reduced its total loan guarantee fee to DUS
lenders.\6 These changes made it easier for lenders to finance
affordable multifamily housing. Second, in 1996, Fannie Mae
introduced the modified risk supplement, an incentive that allows a
DUS lender to terminate its credit risk entirely within 3 years if a
loan is performing according to prescribed criteria for payments,
cash flow, and rent rates.\7 By comparison, the traditional DUS
program does not provide for terminating a lender's credit risk at
any time during the term of the loan. Termination frees the lender's
cash reserves for redirection to new projects. In addition,
termination relieves banks, thrifts, and their mortgage banking
subsidiaries of the risk-based capital requirements established for
them by their respective federal regulatory agencies.\8 According to
Fannie Mae, these requirements have deterred multifamily lenders from
participating in the DUS product line.
Banc One Capital Funding Corporation's affiliation with a number of
local banks has also facilitated Fannie Mae's participation in the
reinsurance program. As a subsidiary of a multibank holding company,
it has organizational ties to federally insured banks located in
several states with multiple branch locations. This affiliation,
which is unique among Fannie Mae's DUS/risk-sharing lenders, has
provided Banc One Capital with a reliable network of local lenders
seeking permanent financing for multifamily affordable housing
projects. These lenders have an incentive to finance such projects
because they are required, under the Community Reinvestment Act of
1977, to serve the credit needs of their entire community, including
low- and moderate-income neighborhoods. Providing these lenders with
easy access to the secondary market also allows them to remain
short-term lenders and avoid both long-term credit risk liability and
risk-based capital requirements.
According to Fannie Mae, its efforts to familiarize the DUS lenders
with the reinsurance program have increased their participation.
Fannie Mae has provided information about the program through a
separate chapter on risk sharing in a guide that it publishes for DUS
lenders, as well as through special training on risk sharing. In
addition, according to Fannie Mae, the willingness of HUD staff to
work with Fannie Mae to resolve programmatic issues, such as the
restriction on purchasing fully amortizing loans (discussed later in
this ch.), has encouraged participation.
--------------------
\5 Specifically, Fannie Mae (1) reduced the minimum debt service
coverage ratio required for purchasing loans to 1.1 for properties
whose units are reserved exclusively for low-income households, (2)
reduced the guarantee fee for loans with a 1.15 debt service coverage
ratio, and (3) increased the maximum loan-to-value ratio on the first
mortgage from 80 or 85 percent to 90 percent.
\6 By passing along the savings associated with the lower guarantee
fee that FHA charges when it insures 50 percent of the risk of
default, Fannie Mae was able to reduce its total loan guarantee fee
by 10 to 20 basis points.
\7 After the originating lender's credit risk is terminated, Fannie
Mae and HUD each assume 50 percent of any future losses on a
risk-sharing loan.
\8 Under these requirements for banks, a loan with even a small
amount of partial recourse (i.e., first loss position) must be
treated as if the entire loan is at risk. Since most multifamily
loans fall into this category, multifamily lenders must generally
maintain the maximum equity capital required for these loans--8
percent of the loans' total value. Thus, if the first 5 percent of a
$1 million loan ($50,000) is in the first loss position but the
entire loan is posted on the bank's books as a liability, the bank
will have to maintain equity capital equal to 8 percent of the loan's
value ($80,000), even though the bank can lose no more than $50,000.
While thrifts operate under similar standards, their federal
regulator, the Office of Thrift Supervision (OTS), takes into account
the percentage of top loss risk in determining how much of the loan
is at risk.
RISK SHARING BENEFITS
PARTICIPANTS BY ENCOURAGING
PRODUCTION AND EFFICIENCY
-------------------------------------------------------- Chapter 3:3.5
When used with the DUS product line, the reinsurance program offers
different but interrelated benefits to Fannie Mae, DUS lenders, and
borrowers. All three groups have benefited because participation has
encouraged the production of affordable multifamily properties.
Fannie Mae has done more business through its Targeted Affordable
Housing product line--including more business that counts toward
meeting the federal affordable housing goals for government-sponsored
enterprises.\9 DUS lenders have increased their lending capacity, and
borrowers have produced more multifamily housing. Production has
increased because participation decreases both the lenders' and
Fannie Mae's loss exposure by 50 percent and reduces the lenders'
reserve requirements by 50 percent, allowing the lenders to finance
more properties. Additionally, under Fannie Mae's modified risk
supplement, the lenders' loss exposure and reserve requirements are
eliminated entirely after 3 years if their loans are performing
satisfactorily. While the modified risk supplement largely benefits
the participating lenders by further increasing their lending
capacity, we believe it also benefits Fannie Mae because, as a
performance-based incentive, it strengthens the lenders' motivation
to prudently underwrite and diligently service their risk-sharing
loans.
Fannie Mae, DUS lenders, and borrowers have benefited from the
combination of the DUS product line and the reinsurance program.
Because HUD delegates its underwriting responsibility to Fannie Mae
and Fannie Mae, in turn, delegates its underwriting responsibility to
the DUS lenders, thereby eliminating the need for re-underwriting,
loans are processed more quickly and their transaction costs are
lowered. Efficient processing is particularly important for
affordable housing loans because the costs of delays can make such
loans financially infeasible.\10 The Targeted Affordable Housing
product line's lower loan guarantee fee also benefits borrowers by
further reducing their transaction costs; at the same time, the lower
fee benefits Fannie Mae by making its loans more competitive.
Finally, to the extent that the reinsurance program's incentives make
lenders more willing to originate loans for affordable multifamily
properties, borrowers benefit from the availability of a wider
network of DUS lenders, thereby increasing the supply of long-term
mortgage financing for these projects.
--------------------
\9 The Housing and Community Development Act of 1992 (P.L. 102-550)
established three separate goals for the enterprises' purchases of
mortgages. The purpose of these goals is to provide housing
financing for (1) low-and moderate-income families; (2)
very-low-income families; and (3) families living in central cities,
rural areas, and other underserved areas.
\10 Since affordable multifamily housing projects often rely on
multiple sources of financing, each of which generally operates on a
tight schedule, a delay in financing the permanent loan can result in
the loss of one or more critical sources of financing.
OTHER ORIGINAL PARTICIPANTS
CITED INDIVIDUAL REASONS FOR
NOT USING THE PROGRAM
---------------------------------------------------------- Chapter 3:4
For reasons particular to each, Freddie Mac has made little use of
the reinsurance program, and the National Cooperative Bank and the
Federal Home Loan Bank of Seattle chose not to use any of their
units. Freddie Mac and HUD have been working to overcome some of the
barriers to Freddie Mac's use of the program; the National
Cooperative Bank did not reach agreement with HUD on when a project
becomes a cooperative; and the members of the Federal Home Loan Bank
of Seattle showed no interest in the program.
SEVERAL FACTORS HAVE LIMITED
FREDDIE MAC'S PARTICIPATION
IN THE REINSURANCE PROGRAM
-------------------------------------------------------- Chapter 3:4.1
One factor limiting Freddie Mac's activity in the reinsurance
program, according to Freddie Mac, is its risk-sharing agreement's
requirement that all risk-sharing loans be fully amortizing--that is,
that the terms of the loans coincide with their amortization periods.
This requirement excludes balloon mortgages from the reinsurance
program because the amortization periods for balloon mortgages exceed
the principal repayment periods of the loans. Most of the loans that
Freddie Mac purchases have balloon mortgages,\11 according to Freddie
Mac; therefore, most of its loans are ineligible for the risk-sharing
program. On August 21, 1997, Freddie Mac asked HUD to amend its
risk-sharing agreement to allow the purchase of balloon mortgages of
10 years or more. Although HUD, in November 1997, approved a request
from Fannie Mae to allow the purchase of 18-year balloon
mortgages--commonly used in financing properties with low-income
housing tax credits--it considers 10-year balloon mortgages less
common in financing affordable housing and believes that they may
present a greater refinancing risk to the borrower.\12 HUD is
therefore waiting for Freddie Mac to demonstrate that this added risk
is worth the potential benefit to Freddie Mac.
Another impediment to Freddie Mac's participation in the reinsurance
program is uncertainty over the applicability of the term
"refinancing loan," which appears in Freddie Mac's risk-sharing
agreement. Freddie Mac has asked HUD to resolve this uncertainty.
According to a senior Freddie Mac official, the term's usage
currently appears to require a 10-year extension of any existing
affordability requirements when a borrower with a first mortgage on a
multifamily property refinances that mortgage--even when the
refinancing occurs shortly after the property's construction. The
possibility that affordability requirements may be extended deters
lenders because it appears to reduce the property's long-term
income-producing potential. HUD is planning to resolve this
uncertainty as Freddie Mac has requested.
A third factor that may have limited Freddie Mac's participation in
the reinsurance program is its underwriting standards, which are set
at a level that excludes many affordable multifamily mortgage loans.
Program Plus, the multifamily product line that Freddie Mac
introduced in 1994, requires a minimum debt service coverage ratio of
1.2 and a maximum loan-to-value ratio of 80 to 85 percent. In
contrast, Fannie Mae's Targeted Affordable Housing product line
allows a debt service coverage ratio as low as 1.1 and a
loan-to-value ratio as high as 90 percent (or higher if a subordinate
mortgage is part of a property's financing). This comparison is not
intended to suggest that Freddie Mac should modify its underwriting
standards to better accommodate the risk-sharing program, but to
indicate that fewer affordable multifamily mortgages are eligible for
purchase under Freddie Mac's reinsurance program than under Fannie
Mae's.
--------------------
\11 Freddie Mac said that (1) 86 percent of the multifamily loans
that it purchased from January 1995 through October 1997 were balloon
mortgages and (2) most of the multifamily loans that it purchased had
10-year balloons and 20- to 25-year amortization periods.
\12 Specifically, because 10-year balloon mortgages require
refinancing virtually all of the loan principal after 10 years, HUD
is concerned that income-restricted properties may not be able to
generate the cash flow needed to repay the refinanced mortgages if
interest rates rise substantially during the 10 years between the
dates of originating the first mortgage and the refinanced mortgage.
NATIONAL COOPERATIVE BANK
AND FHLB OF SEATTLE RETURNED
THEIR UNITS TO HUD
-------------------------------------------------------- Chapter 3:4.2
The National Cooperative Bank (NCB) signed a risk-sharing agreement
with HUD in September 1994, but no risk-sharing loans were ever
approved because, according to a senior HUD official, HUD and the NCB
have been unable to agree upon when a project legally becomes a
cooperative under the terms of the risk-sharing agreement. The
risk-sharing agreement prohibited the approval of any cooperative
housing loans until the parties concurred on this point and amended
the agreement accordingly. Because the bank's primary mission is to
originate loans to cooperatives, including low-income housing
cooperatives, this prohibition prevented the bank from using the
reinsurance program. The NCB has verbally agreed to return its 2,000
units to HUD.
The Federal Home Loan Bank (FHLB) of Seattle did not participate in
the reinsurance program because its member financial institutions
(thrifts, commercial and savings banks and credit unions) did not
express an interest in doing so. The FHLB of Seattle agreed to
participate in the summer of 1994, after the acting director of its
regulator, the Federal Housing Finance Board, encouraged the FHLBs to
participate in the reinsurance program. The FHLB of Seattle agreed,
knowing that customers in rural communities were having difficulty
originating mortgages for affordable rental housing, primarily
because there was no effective, efficient secondary market for loans
of less than $2 million. But the FHLB did not survey its members to
assess their interest in the program before signing a risk-sharing
agreement with HUD in September 1994. Instead, it spent that time
reviewing and analyzing the program's risks and resolving a legal
uncertainty. When it subsequently surveyed its members, it found
that they (1) perceived little need for risk-sharing insurance, since
they considered their own underwriting standards adequate to ensure
little or no loss; (2) wished to avoid involvement with FHA, whose
programs they regarded as time-consuming and bureaucratic; and (3)
recognized that the program's fees would increase their financing
costs, making their loans less competitive. When none of its members
expressed an interest in the reinsurance program, the FHLB took no
further action until January 1998. At that time, it returned its 500
units to HUD for reallocation.
MORE RECENT PARTICIPANTS HAVE
NOT HAD TIME FOR MUCH ACTIVITY
---------------------------------------------------------- Chapter 3:5
It is generally too soon to determine how the second set of financial
institutions--SONYMA, the FHLB of New York, and the two loan
consortia--will use their risk-sharing units and how extensively they
will participate in the reinsurance program. The program offers
these institutions certain benefits that may encourage their
participation.
SONYMA insures between 75 and 100 percent of the value of mortgage
loans secured by properties located in New York State. Its
risk-sharing agreement with HUD, signed in February 1997, provides
SONYMA with 50-percent reinsurance for individual loans that it
insures directly. This reinsurance benefits SONYMA by allowing it to
double its reserve capacity and, at the same time, double the dollar
value of the mortgage loans that it can insure for multifamily
lenders throughout the state. According to a senior SONYMA official,
the reinsurance could further benefit SONYMA by allowing it to obtain
a higher credit rating, which, in turn, would lead to lower interest
rates.
The FHLB of New York signed a risk-sharing agreement with HUD on
January 5, 1998. This agreement provides the FHLB with 50-percent
reinsurance for the portion of any eligible multifamily housing
loan--called a loan participation\13 --that it purchases from a
member financial institution. In July 1996, the Federal Housing
Finance Board approved the FHLB's purchase of both single-family and
multifamily housing loans through a pilot program known as the
Community Mortgage Asset Program. The FHLB has proposed to use the
reinsurance program to reinsure the multifamily loan participations
that it purchases through this pilot program. To the extent that the
added security provided through risk-sharing encourages the FHLB to
finance additional affordable multifamily housing properties, it
appears that the reinsurance program will (1) help increase liquidity
to lenders that do not traditionally have access to the secondary
market and (2) meet its objective of increasing multifamily lending.
As noted, CPC and CCRC are still negotiating risk-sharing agreements
with HUD. Both institutions have extensive experience in affordable
multifamily housing finance.
--------------------
\13 Instead of purchasing an entire loan originated by a member
institution, the FHLB typically expects to purchase 80 percent of the
loan while the member institution retains the balance and services
the entire loan.
OPPORTUNITIES FOR GREATER
PARTICIPATION EXIST
---------------------------------------------------------- Chapter 3:6
Through its risk-sharing agreements with several major financial
institutions, HUD has established a basis for encouraging greater
participation in mortgage lending. If the program is made permanent
or reauthorized for several years, the institutions and HUD could
take several steps to expand participation. Some of these steps
involve current participants; others involve bringing in new
risk-sharing partners and broadening the program to include pooled as
well as individual loans.
INCREASING THE PARTICIPATION
OF GOVERNMENT-SPONSORED
ENTERPRISES COULD EXPAND
MORTGAGE LENDING NATIONWIDE
-------------------------------------------------------- Chapter 3:6.1
As noted, Fannie Mae, Freddie Mac, and the Federal Home Loan Bank
System operate nationwide. Thus, increasing their participation in
the reinsurance program could increase mortgage lending for
affordable housing throughout the country.
According to Fannie Mae, it is likely to resume its participation in
the reinsurance program when it receives the 2,000 units that HUD has
agreed to reallocate to it. In addition, if the program is made
permanent or reauthorized for several years and the current limits on
the number of available units are lifted, Fannie Mae expects to be
able to use still more units. While Fannie Mae has not announced any
plans for expanding its pool of DUS lenders, other lenders may have
organizational ties to local banks that would facilitate their
participation in the reinsurance program, much as Banc One Capital
Funding Corporation's affiliation with local lenders has advanced its
risk-sharing business. Replicating Banc One Capital's experience in
other parts of the country could simultaneously increase the sale of
affordable multifamily housing loans in the secondary market and
diversify both the geographic location and the types of properties
financed through the reinsurance program. Banks and thrifts, in
particular, could increase their lending by taking advantage of the
opportunity to terminate their credit support for well-performing
loans after 3 years under Fannie Mae's modified risk supplement.
Overcoming the obstacles to Freddie Mac's participation could create
further nationwide opportunities for expanding the reinsurance
program. HUD has already said that it will consider at least two of
the issues that Freddie Mac has cited as obstacles. As noted, HUD
has agreed to assess the risks of reinsuring 10-year balloon
mortgages. While amending Freddie Mac's risk-sharing agreement to
include the purchase of 10-year balloon mortgages may make the
majority of Freddie Mac's loans eligible for reinsurance, HUD may
determine that potential increases in interest rates present an undue
risk that it is unwilling to assume. However, because HUD has
already determined that 18-year balloon mortgages do not present an
undue risk, it could offer to amend Freddie Mac's or any other
risk-sharing partner's agreement to allow for the use of reinsurance
with 18-year balloon mortgages. In addition, if it agrees that the
use of a short-term permanent loan\14
as a bridge between a construction loan and a long-term permanent
loan does not convert the permanent loan into a refinancing loan with
additional affordability requirements, it will alleviate Freddie
Mac's concerns about the possible imposition of such requirements. A
senior HUD official said that even if HUD agrees that the use of a
short-term permanent loan does not convert the permanent loan to a
refinancing loan, he believes that limits will have to be placed on
the length of such short-term loans.
The Federal Home Loan Bank System, with its 6,504 member institutions
in all 50 states, presents a major opportunity for expanding the
reinsurance program while making minimal demands on HUD's resources.
The 12 FHLBs, with close ties to their member institutions, would
select these institutions for participation and monitor their
performance. Although the Seattle FHLB's member institutions were
not interested in the reinsurance program, the FHLB of New York may
be able to demonstrate whether the program could be useful to other
FHLBs. If the New York FHLB uses reinsurance, combined with its
Community Mortgage Assistance Program, to purchase affordable
multifamily loans from many types of member institutions, including
smaller financial institutions that traditionally have not had access
to Fannie Mae's or Freddie Mac's secondary market products, other
FHLBs may decide to replicate the Community Mortgage Assistance
Program and join the reinsurance program, thus expanding the
program's geographic coverage. The Federal Housing Finance Board has
also approved a proposal by the FHLB of Atlanta to purchase
multifamily loans from a North Carolina loan consortium as a
qualified investment for its own portfolio. While this initiative
does not involve the reinsurance program, FHA's 50-percent
reinsurance could be used as an incentive to encourage other FHLBs to
purchase affordable multifamily loans from consortia operating in
their regions.
--------------------
\14 Such loans are generally referred to as "mini-perm" loans.
INVOLVING LOAN CONSORTIA
COULD INCREASE FINANCING FOR
SMALLER PROPERTIES
-------------------------------------------------------- Chapter 3:6.2
Although HUD has not yet signed risk-sharing agreements with CPC and
CCRC, these loan consortia represent another opportunity to expand
participation in the reinsurance program. They are entities created
by banks and thrifts to promote lending for affordable housing.
Since the 1970s, they have financed the development and/or
rehabilitation of affordable housing, particularly of multifamily
rental properties, at both the city and the state level. Their loans
have supported the development of smaller-size properties, most of
which have fewer than 50 units. As noted in chapter 1, HUD has
identified a nationwide need for financing for smaller properties.
Thus, involving loan consortia in the reinsurance program could help
to satisfy this need.
When HUD first established the reinsurance program, it believed that
loan consortia would become involved, not as risk-sharing partners,
but as lenders selling their loans to Fannie Mae and Freddie Mac.
Both Fannie Mae and Freddie Mac identified particular consortia in
their risk-sharing agreements as "special lenders" whose loans they
would purchase to promote the program's goals. However, neither
Fannie Mae nor Freddie Mac has purchased any risk-sharing loans from
loan consortia. Fannie Mae noted that loan consortia have gained
access to capital through other Fannie Mae sources.
Several factors make it difficult for loan consortia to sell their
loans in the secondary market. Specifically, (1) their loan volumes
are not large enough;\15 (2) their underwriting standards may not be
compatible with Fannie Mae's and Freddie Mac's conventional
standards; (3) their low net worth requires them to obtain letters of
credit or other costly credit enhancements before they can sell their
loans, and (4) their reserves are generally not adequate to meet
Fannie Mae's and Freddie Mac's requirements for long-term "credit
support" from sellers under a loan pool purchasing arrangement.\16
--------------------
\15 On average, their loans range in amount from $750,000 to $2.5
million. The total average loan volume estimated by the 10 loan
consortia surveyed by GAO during 1996 was approximately $145 million.
(CPC, the nation's largest loan consortium, was not included in the
survey). See app. VII for the characteristics of the loans and
properties financed by these 10 consortia.
\16 Loan consortia are typically capitalized by pools of funds
provided through short-term loans from their member financial
institutions. These funding pools do not maintain the long-term
reserves established by most state housing finance agencies and by
Fannie Mae and Freddie Mac. Hence, they cannot be used to provide
long-term credit support for loans sold in the secondary market.
LOAN POOL REINSURANCE COULD
FACILITATE CONSORTIA'S
ACCESS TO SECONDARY MARKETS
-------------------------------------------------------- Chapter 3:6.3
To help overcome the obstacles to their participation in the
secondary markets, CPC and CCRC have proposed using risk sharing to
reinsure pooled loans. Currently, HUD's risk-sharing reinsurance
agreements apply only to individual loans, and HUD has no experience
with loan pool insurance. However, the act authorizes loan pool
insurance, and, according to a senior HUD official, HUD is not averse
to experimenting with it as long as the credit risks are reasonable.
Loan pooling has several advantages that could facilitate the
participation of loan consortia in the secondary markets. First,
pooling aggregates loans, increasing their volume. Such aggregation
is necessary, because of the complexities and costs associated with
loan pool transactions. Second, pooling generally occurs after loans
are seasoned--that is, some years after their origination, by which
time they have acquired credit and property maintenance histories
that can alleviate concerns about underwriting terms that differ from
industry standards. Therefore, compared with newly originated loans,
seasoned loans present less uncertainty and their performance is
easier to predict. Third, losses can be more accurately projected
for a pool of loans than for individual loans.
Loan pooling alone cannot overcome all of the obstacles limiting the
participation of loan consortia in the secondary market.
Risk-sharing reinsurance could, however, make pooled loans more
attractive to purchasers. Freddie Mac, for example, decided not to
purchase a consortium's pool of balloon loans because, according to a
consortium official, (1) the consortium's net worth was too low and a
letter of credit would have been too costly to acquire and (2) the
consortium's cash reserves were not high enough to satisfy Freddie
Mac's long-term credit support requirements. Had these loans been
eligible for risk-sharing reinsurance--neither balloon mortgages nor
loan pools are eligible under Freddie Mac's risk-sharing agreement
with HUD--the reinsurance would have enhanced their credit and would
have reduced Freddie Mac's reserve requirements for the loan
consortia.
Fannie Mae has experience with pooled loans, which it purchases
through its Negotiated SWAP product line,\17 and it has proposed
using the reinsurance program to reinsure loan pools. This proposal
would appear to benefit loan consortia. However, Fannie Mae
historically has not been interested in purchasing a loan pool from
multiple lenders. Therefore, if a consortium could aggregate loans
from its member lenders, or if several consortia could combine their
loans, they would need to identify an "honest broker conduit" to sell
the pool to Fannie Mae.
Despite the difficulties they have experienced in trying to sell loan
pools in the secondary market, some loan consortia in our focus group
believed that pooling, combined with risk-sharing reinsurance, would
be an effective way for them to sell their loans. In general,
representatives of 13 consortia said that participation in the
risk-sharing program could have the following benefits (the numbers
in parentheses indicate the number of consortia identifying each
potential benefit): increase their sales of loans in the secondary
market (12), increase their loan volumes (11), increase the size of
their loans (9), and extend their loan amortization periods (8).
--------------------
\17 In the Negotiated SWAP program, rather than purchasing one loan
at a time, Fannie Mae purchases a pool of mortgage loans, and
exchanges or "swaps" the loans for a mortgage-backed security.
CONCLUSIONS
---------------------------------------------------------- Chapter 3:7
Although the reinsurance program remains largely untested, Fannie Mae
and Banc One Capital have demonstrated its potential to produce
affordable multifamily housing efficiently and, in some instances, to
produce smaller properties in rural markets, thereby helping to
satisfy an unmet capital need. If HUD can resolve the obstacles to
Freddie Mac's participation and negotiate risk-sharing agreements
with the loan consortia, these institutions may also be able to use
their risk-sharing units productively.
While HUD is considering the risks involved in Freddie Mac's request
to use reinsurance with 10-year balloon mortgages, it could offer to
amend the risk-sharing agreement of Freddie Mac--or of any other
interested risk-sharing partner--to allow the use of reinsurance with
18-year balloon mortgages, making generally available an option that
is currently limited to Fannie Mae. Because many properties with
low-income housing tax credit financing have 18-year balloon
mortgages, this action could increase the number of institutions
eligible to combine reinsurance with tax credit financing and thus
further both the reinsurance and the tax credit programs' affordable
housing goals.
Allowing the use of reinsurance with loan pools could help loan
consortia and smaller lenders offset the limitations of low net worth
and limited reserves that currently hamper their sales of loan pools
in the secondary market. Because these lenders often finance smaller
properties, facilitating their access to the secondary market could
also help to satisfy the need HUD has identified for smaller
affordable multifamily properties.
HUD's most recent risk-sharing partners may be able to demonstrate
productive new uses of the reinsurance program. SONYMA officials
appear to have a clear understanding of the program's benefits. The
efforts of the Federal Home Loan Bank of New York also bear watching,
not only because the reinsurance program, in combination with the
Community Mortgage Assistance Program, may be able to increase
liquidity to lenders that do not traditionally have access to the
secondary market, but also because the Bank, as part of the Federal
Home Loan Bank System with its over 6,500 member institutions, has an
opportunity to establish a model for producing affordable multifamily
housing that could be replicated nationwide.
Although the reinsurance program is still in the demonstration phase,
we believe that it is conceptually sound, relying on reciprocal,
market-driven risk-sharing agreements, and with more time and
experience, activity in it may increase. If it is made permanent, as
legislation has proposed, or if it is authorized for a certain number
of years, both HUD and the participating financial institutions will
have more incentive to commit resources to it.
RECOMMENDATIONS
---------------------------------------------------------- Chapter 3:8
We recommend that the Secretary of Housing and Urban Development
direct the Commissioner, Federal Housing Administration, to explore
the feasibility of amending HUD's current risk-sharing agreements to
(1) allow the use of reinsurance with 18-year balloon mortgages as is
currently permitted in an agreement with Fannie Mae and (2) authorize
the use of reinsurance with loan pools.
AGENCY COMMENTS
---------------------------------------------------------- Chapter 3:9
HUD agreed in written comments on a draft of this report (see app.
IX) to offer to amend the risk-sharing agreements of the other
participating entities to permit 18-year balloon mortgages with
30-year amortization periods. HUD also agreed, because of the
potential to reach underserved and hard-to-serve markets, to explore
the feasibility of amending current risk-sharing agreements to permit
the use of reinsurance with loan pools, assuming that the actuarial
soundness of the FHA insurance fund would be maintained.
RISK-SHARING LIMITS HUD'S LOSS
EXPOSURE AND REDUCES
ADMINISTRATIVE COSTS, BUT
INFORMATION SYSTEMS AND OVERSIGHT
NEED IMPROVEMENT
============================================================ Chapter 4
HUD has derived significant benefits through risk-sharing, primarily
by participating in the credit enhancement program. Specifically, it
has generally limited its loss exposure for insured loans to half the
outstanding loan amount and has substantially reduced the time taken
to process applications for FHA insurance, compared with the time
taken under its traditional mortgage insurance programs. The same
benefits are potentially available to HUD through the reinsurance
program, but, as discussed in chapter 3, activity in that program has
been very limited. However, problems in the data system used to
administer the credit enhancement program limit HUD's ability to
accurately monitor the program and report on its status. Weaknesses
in HUD's oversight could also jeopardize the program's benefits.
PARTICIPATION IN THE
RISK-SHARING DEMONSTRATION
PROGRAMS LIMIT GOVERNMENT'S
EXPOSURE TO LOSSES
---------------------------------------------------------- Chapter 4:1
One of the six goals of the risk-sharing programs is to ensure that
other parties bear a share of the risk, in percentage amount and in
position of exposure, that is sufficient to create strong,
market-oriented incentives for the other participating parties to
maintain sound underwriting and loan management practices. HUD has
successfully met this legislative objective. Because most of the
risk-sharing agreements require HUD's partners to share equally in
any losses arising from loan defaults, HUD has limited its loss
exposure while establishing economic incentives for its risk-sharing
partners to perform their respective functions properly. HUD has
further minimized its loss exposure by ensuring that its risk-sharing
partners have sufficient capital to meet their obligations should any
losses occur.
RISK-SHARING PARTNERS ASSUME
SIGNIFICANT RISK
-------------------------------------------------------- Chapter 4:1.1
Compared with HUD's traditional multifamily insurance programs, the
risk-sharing programs expose the federal government to substantially
less risk of loss in the event of default. HUD's traditional
programs generally hold the federal government responsible for 100
percent of any losses associated with defaults on federally insured
loans. In contrast, the risk-sharing programs are generally holding
the federal government responsible for 50 percent of any such losses.
In the reinsurance program, all of the risk-sharing agreements signed
to date divide the responsibility for any losses equally between the
federal government and its risk-sharing partners. Thus, Fannie Mae
is responsible for 50 percent of any losses for all of the 956 units
in the 6 completed properties reinsured under the reinsurance program
as of October 1997.
In the credit enhancement program, housing finance agencies can elect
to assume as little as 10 percent of the loss exposure if they use
HUD's underwriting standards,\1 but as of September 1997, 16 of the
21 agencies with closed loans had assumed 50 percent or more of the
loss exposure for 87 of the 110 loans closed by that date. These
loans accounted for about 85 percent of the 12,851 units in the 110
insured properties. Table 4.1 shows the percentage of risk assumed
by the housing finance agencies for properties insured under the
credit enhancement program through September 1997.
Table 4.1
Percentage of Risk Assumed by Housing
Finance Agencies for Insured Properties
Percentage of risk assumed Number of Number of Percentage
by agency properties units of units
---------------------------- ------------ ------------ ------------
90 4 369 3
50 83 10,869 85
25 10 524 4
10 13 1,089 8
======================================================================
Total 110 12,851 100
----------------------------------------------------------------------
Source: GAO's analysis of questionnaire data provided by housing
finance agencies.
The opportunity to use their own underwriting standards has provided
an incentive for most of the housing finance agencies to assume at
least 50 percent of the loss exposure. As of September 1997, only 4
of the 21 agencies with closed loans had elected to assume a 10- or a
25-percent loss position on all, or most, of their closed loans. The
New York Housing Finance Agency, for example, assumed only 10 percent
of the risk of loss for each of the 4 loans it processed because,
according to agency officials, the agency was already assuming the
top loss position on these loans by supporting the financing of the
insured properties through either grants or second mortgages.\2 In
the officials' view, this other financing was more than adequate to
absorb any losses if a default were to occur, and they did not
believe that the federal government was in a serious risk position.
--------------------
\1 Housing finance agencies electing to assume 50 percent or more of
the risk exposure for losses (referred to as level I agencies) use
their own underwriting standards. Agencies electing to assume less
than 50 percent of this risk (level II) are required to use HUD's
underwriting standards.
\2 These mortgages take a subordinate position to the first mortgage.
This means that if any losses occur, the first mortgage, which is
insured under the risk-sharing program, will be paid in full before
any subordinate financing is paid.
RISK-SHARING PARTNERS HAVE
FINANCIAL INTEGRITY
-------------------------------------------------------- Chapter 4:1.2
Besides requiring its risk-sharing partners to assume a significant
portion of the risk of loss on insured loans, HUD has established
criteria to ensure that its partners will be able to meet their
financial obligations. The qualified financial institutions
participating in the reinsurance program all have excellent credit
ratings or track records in multifamily lending. Fannie Mae, Freddie
Mac, and the FHLB System all have the highest ("AAA") credit rating.
SONYMA has a "AA" credit rating and the National Cooperative Bank,
which still has a risk-sharing agreement with HUD even though it has
returned its allocated units, has an "A-" credit rating, according to
the NCB's treasurer. Although two loan consortia told us that they
have not been rated, each has had a long and successful history of
multifamily lending. CCRC has made about $150 million in multifamily
loans since 1989, and CPC has originated over $800 million in
multifamily loans since 1972.
To participate in the credit enhancement program, a housing finance
agency must either meet certain minimum credit standards for
financial soundness established by a nationally recognized rating
agency, such as Standard and Poor's or Moody's Investors Service, or
have a dedicated reserve account with sufficient capital to meet the
agency's outstanding obligations under the program. The minimum
credit standards for an agency seeking acceptance into the program on
the basis of a credit agency's evaluation are either (1) a "top tier"
designation\3 or (2) an overall rating of "A" for the agency's
general obligation bonds.\4 If an agency does not meet these
criteria, HUD requires that the agency establish a dedicated reserve
account of not less than $500,000 and add to that reserve 1 percent
of the outstanding balance on all mortgages originated up to $50
million. For mortgages beyond this amount, additional but reduced
reserves are required.
Our review of the eligibility standards met by the 32 housing finance
agencies with risk-sharing agreements showed that 21 met the
program's eligibility criteria on the basis of their credit rating
from either Standard and Poor's or Moody's. The remaining 11
established dedicated reserve accounts. Appendix VIII shows the
rating criteria that the housing finance agencies met to demonstrate
their financial solvency.
--------------------
\3 A top-tier rating reflects an agency's sound assets, stable
earnings, and strong capital adequacy ratios. The rating also
implies that the agency has capable management and is able to meet
its mandate.
\4 As defined by Moody's, bonds rated "A" possess many favorable
investment attributes and are to be considered as upper-medium-grade
obligations. Factors giving security to principal and interest are
considered adequate, but elements may be present that suggest a
susceptibility to impairment sometime in the future.
HUD HAS DERIVED ADMINISTRATIVE
BENEFITS THROUGH ITS
PARTICIPATION IN THE RISK-
SHARING PROGRAMS
---------------------------------------------------------- Chapter 4:2
Another goal established for the demonstration programs is to
increase the efficiency, and lower the costs to the federal
government, of processing and servicing multifamily housing mortgage
loans insured by HUD. The programs have achieved this goal. By
delegating its loan-processing responsibilities to its risk-sharing
partners, HUD has been able to deliver multifamily insurance more
expeditiously through the risk-sharing demonstration programs than
through its traditional multifamily insurance programs. Furthermore,
because HUD has also delegated the responsibilities for monitoring
the performance of insured properties and for foreclosing on any
properties in serious default, HUD will continue to accrue
administrative benefits throughout the terms of the insured loans.
HUD has not formally assessed how much staff time it has saved
through risk sharing. However, senior management within HUD pointed
out, "it stands to reason" that the substantial reduction in HUD's
responsibilities under risk sharing should result in substantial time
savings for HUD. Estimates provided by the FHA Commissioner support
this conclusion. For example, according to the Commissioner, one
field office estimated that it takes about 480 staff hours to process
an application for a traditional mortgage loan\5 through the firm
commitment phase,\6 compared with about 80 staff hours under the
risk-sharing program. Overall, HUD estimated that processing an
application through the firm commitment stage can take as many as 540
hours under the traditional multifamily insurance programs and as few
as 12 hours under the risk-sharing program. HUD further noted that
the transfer of loan-processing and underwriting responsibilities to
its risk-sharing partners has enabled its field offices to process
projects through the firm commitment phase in 1 to 3 months, compared
with 6 to 9 months under FHA's traditional multifamily insurance
programs.
In addition, HUD estimated that under the traditional programs, its
staff put in another 400 hours per loan before it provides the final
endorsement.\7 They administer the construction loan, inspect the
property, and certify the property's costs--all responsibilities that
are delegated under the risk-sharing programs. Thus, according to
HUD's estimate, loan processing takes about 80 hours under risk
sharing, compared with about 880 hours under the traditional
programs--a 10-fold savings in staff time. While these estimates are
not scientific, they are consistent with estimates provided by HUD
staff in each of the five field offices we visited.\8
The risk-sharing programs provide HUD with additional administrative
benefits that start when an insured property becomes operational and
continue throughout the life of the mortgage loan. These savings
accrue to HUD because it delegates its asset management and property
disposition responsibilities to its risk-sharing partners. While we
did not attempt to quantify the staff time that HUD saves from
delegating these responsibilities, we did explore the management
implications of shifting them from HUD to its risk-sharing partners.
According to HUD officials, most asset managers in its field offices
are responsible for monitoring the financial and physical condition
of about 60 multifamily properties. In some offices, they may be
responsible for as many as 80 to 85 properties. In contrast,
according to the executive directors and senior program managers from
11 active housing finance agencies participating in our focus groups,
most asset managers at housing finance agencies are responsible for
25 to 30 properties. While there is no established standard for the
optimal number of properties that an asset manager should oversee,
the executive directors and risk-sharing program managers pointed out
the obvious--the smaller the number of properties that an asset
manager is responsible for overseeing, the more likely the manager
will be familiar with the properties' performance characteristics,
and the sooner the manager can identify and respond to potential
problems, the less likely the property will incur carrying costs and
physical decline.
--------------------
\5 Under section 221(d)(4). This program, used by for-profit
developers, provides multifamily mortgage insurance for new
construction and/or substantial rehabilitation.
\6 Phases in insuring a loan include the following: application
received, firm commitment issued, initial endorsement provided, and
final endorsement provided. In some instances, the application is
withdrawn or the firm commitment expires.
\7 At this stage, when HUD provides the insurance, the property has
been completed and occupied.
\8 In Boston, Denver, Jacksonville, New York, and San Francisco.
INFORMATION SYSTEMS ARE NOT
RELIABLE
---------------------------------------------------------- Chapter 4:3
The data system that HUD created to manage the credit enhancement
program--the Risk-Sharing Multifamily National System (RSS)--is
largely unreliable and user unfriendly. A comparable system does not
exist for the reinsurance program because activity in this program
has been so limited. HUD relies instead on an automated spreadsheet
to manage the reinsurance program. While recognizing the
shortcomings of RSS, HUD maintained that its primary data system,
known as F47, which it uses to monitor all insured multifamily loans,
is reliable. However, we identified errors in this system for loans
insured under both risk-sharing demonstration programs. These
problems need to be resolved if HUD is to have an accurate database
for monitoring and managing the programs.
CREDIT ENHANCEMENT PROGRAM'S
DATA SYSTEM IS FLAWED
-------------------------------------------------------- Chapter 4:3.1
HUD established RSS to monitor activity under the credit enhancement
program. This system, HUD officials said, was designed for HUD
headquarters to (1) track the number of units allocated to housing
finance agencies, (2) monitor the progress of projects through
specific phases toward completion,\9 and (3) provide program managers
with financial information on completed properties. However, the
system was not designed to be a single comprehensive point of
reference for monitoring and managing the credit enhancement program.
Rather, because HUD field offices are responsible for collecting data
from participating housing finance agencies within their
jurisdictions, HUD headquarters expected that the field offices would
create their own information systems to oversee projects applying for
and receiving insurance under the program.
RSS has met its first objective of providing HUD headquarters with
accurate data on the number of units allocated to housing finance
agencies. However, the system has generally not met the other two
objectives, even though the Director of HUD's Office of Multifamily
Housing Development emphasized the importance of reliable data in a
December 1996 memorandum to the field offices. This memorandum
stated that despite substantial progress under the credit enhancement
program, "reliable data to substantiate this achievement [remain] a
major program deficiency." In addition, the memorandum identified
significant discrepancies between the data in RSS and information
available to HUD headquarters from other sources. These sources
indicated, for example, that firm approval letters had been signed
for properties that did not appear in RSS. Such problems persist
today, even though the memorandum advised that "increased attention
be given to the availability of timely and reliable data," given the
intense interest in the new partnership between HUD and the housing
finance agencies shown by congressional, industry, and other
observers.
HUD headquarters and field officials have acknowledged that RSS was
designed quickly and, in the rush to develop and implement the
system, certain basic requirements were overlooked. Specifically,
software was provided to housing finance agencies and HUD field
offices with little, if any, training or documentation. Although a
manual was provided, the software was difficult to use. In addition,
the software did not come with a data dictionary, a basic requirement
for a data system, needed to ensure the data's reliability. Not
having a data dictionary has precluded the consistent reporting of
data from the housing finance agencies.
Officials from the seven housing finance agencies we visited and from
the eight other agencies participating in our focus group on the
credit enhancement program discussed the problems they had
encountered in using RSS. The officials were virtually unanimous in
concluding that the software for the system is user unfriendly.
Almost all of them noted, for example, that the software does not
contain an edit function. Consequently, if a user makes an error in
entering data, he or she has to start entering the data all over
again to correct the error. The officials also noted that the
software could not generate paper copies for users to verify the data
they had entered.
To work around RSS' limitations, some agencies began using
alternative software. At the time of our review, officials at the
Florida Housing Finance Agency were using spreadsheet software to
make necessary edits and to print information. They entered the same
data elements that RSS requires and sent a paper copy of their
spreadsheet to the appropriate HUD field office. The HUD field
office, in turn, reentered the data into RSS before transferring the
data to HUD headquarters for inclusion in the master RSS database.
Officials at the Massachusetts Housing Finance Agency also observed
that RSS is not user friendly because it requires the continuous,
sequential entry of all data at one time. Thus, to add or change a
data element, the person entering the data has to restart the program
and reenter the data previously entered in every data field. These
officials said they would prefer to selectively add and delete or
reenter data elements without having to reenter all of the elements
for a particular project. Officials from the New York Housing
Finance Agency identified the same problem, commenting that they
would be likely to enter new information as it became available.
To the housing finance agencies, the lack of a data dictionary posed
serious concerns about the reliability of the data entered into the
system. For instance, the Florida Housing Finance Agency developed
its own data dictionary for the required data elements. However, as
agency officials pointed out, their interpretation of data elements
might differ from other agencies' interpretations. Officials from
the Montgomery County Housing Finance Agency in Maryland were also
concerned about the difficulty of interpreting certain required data
elements without a data dictionary. For example, they showed us a
$2.4 million item for one property that they reported under the
"local grant" category when, they said, they could just as easily
have reported it under the "loans and subsidies" category. In
effect, without a data dictionary for clarification, they arbitrarily
decided where to report this item.
Finally, officials from several housing finance agencies expressed
concern because they are required to report over 50 data elements on
a property's financial and physical condition; however, they were not
aware that any use was being made of this information. Our
discussions with HUD headquarters officials confirmed that these data
have not been used to summarize the program's results or to evaluate
the program. Moreover, we found that for all loans from California
and Massachusetts, these data elements had not been entered into RSS.
HUD field office and headquarters staff told us that this problem
exists, in part, because HUD field offices have no incentive to
transfer final data on closed loans into RSS, given that similar data
are required to be reported in HUD's Multifamily Insurance System.
This system, known as F47, should contain data on all of HUD's
insured multifamily properties, including those insured under both
the credit enhancement and the reinsurance programs. HUD management
uses this system for budgeting and assessing the attainment of
production objectives.
Our visits to five HUD field offices generally confirmed the problems
noted by the housing finance agencies. In addition, one field office
noted that HUD headquarters has occasionally taken actions such as
increasing or reallocating risk-sharing units among housing finance
agencies without informing the servicing HUD field offices. Such
actions limit the field offices' ability to monitor the unit
allocations available to housing finance agencies.
Because F47 is supposed to contain financial and other data on all
FHA-insured properties, HUD headquarters officials tended to minimize
the problems associated with RSS. They noted that data on a
risk-sharing loan become part of F47's database when two events
occur--when the closing memorandum (HUD Form 290) is signed by the
authorized HUD field staff and when a check is received by HUD for
the first payment on the loan's insurance premium. Within a few days
of these two events--independent of the credit enhancement program's
administrative processes--data on the risk-sharing loan should become
part of the F47 system.
To test the reliability of the data on risk-sharing loans in the F47
system, we compared the information in the system as of November 1997
with our data on the 110 loans closed by housing finance agencies as
of September 1997 and the 6 loans closed by Fannie Mae as of October
1997. We noted errors in both cases. Specifically, the F47 system
reported 106 loans closed by the housing finance agencies and 2 loans
closed by Fannie Mae. A senior HUD headquarters official attributed
these omissions to servicing problems in HUD field offices.
According to this official, problems have occurred in documenting the
first payment of the insurance premium and in transferring the
closing memorandum to HUD headquarters. Because FHA insurance is not
recorded on a property until these two actions have been completed,
such problems have delayed the entry of data into the F47 database.
--------------------
\9 Application received, firm commitment issued, initial endorsement
provided, final endorsement provided, or application withdrawn or
firm commitment expired if appropriate.
ALTERNATIVES TO RSS ARE
AVAILABLE
-------------------------------------------------------- Chapter 4:3.2
Executive directors and risk-sharing program managers from several
housing finance agencies indicated that, in place of RSS, they would
prefer a reporting system that relied on personal-computer-based
software. Such a system with a data dictionary, they agreed, would
provide program mangers at all levels with consistent, easily
accessible data for program evaluations. In addition, they agreed
that state-of-the-art spreadsheet or database software would provide
user-friendly editing and reporting capabilities that would also
enhance the reliability of the data.
According to HUD headquarters officials, the problems associated with
RSS, a stand-alone system, should be resolved in the broader context
of ongoing efforts to overhaul and fully integrate all of HUD's
management information systems. Currently, HUD is installing a
personal-computer-based software suite departmentwide. This suite,
called HUDWARE II, includes word processing, spreadsheet, database,
and graphics/report software packages. HUD is training its staff in
the use of the new software as it is installed in headquarters and
the field. We found that HUD field offices were using the new
spreadsheet packages to partially fulfill their monitoring
requirements under the credit enhancement program. A senior HUD
headquarters program official also told us that suite software such
as HUDWARE II would provide sufficient capacity to monitor and report
on the risk-sharing program. Managers at all levels could
consistently use such software for program oversight functions.
HUD RECOGNIZES THAT PROGRAMS'
FUTURE EXPANSION REQUIRES
EFFECTIVE ADMINISTRATIVE
CONTROLS
---------------------------------------------------------- Chapter 4:4
Because the risk-sharing demonstration programs delegate virtually
all critical loan-processing and administrative functions to HUD's
risk-sharing partners, it is imperative that HUD (1) establish
procedures for ensuring that its partners are carrying out their
responsibilities in accordance with the programs' regulations and
risk-sharing agreements and (2) monitor its partners to ensure that
these procedures, regulations, and/or agreements are being followed.
HUD has established reasonable administrative controls for overseeing
the programs; however, it is somewhat premature to assess HUD's
application of these controls, given the programs' limited activity
to date. Nevertheless, we did observe some problems with HUD's
implementation of these controls. HUD is aware of these problems and
plans to address them.
HUD HAS ESTABLISHED CONTROLS
FOR OVERSIGHT
-------------------------------------------------------- Chapter 4:4.1
Procedures for implementing the credit enhancement demonstration
program are contained in a June 1995 handbook. According to these
procedures, HUD field offices have the primary responsibility for
ensuring that housing finance agencies comply with handbook's
requirements for loan underwriting, asset management, and, if
necessary, property disposition. The handbook requires the field
offices to make at least one annual on-site review of each
participating housing finance agency to assess the agency's
compliance with the handbook's requirements. This on-site visit is
to include a review of a sample of loan files to validate compliance
with agreed-upon underwriting criteria. The handbook further
requires HUD headquarters to provide "remote monitoring" of housing
finance agencies to ensure that they continue to meet the program's
eligibility criteria and maintain either an "A" credit rating or the
required dedicated reserves. The handbook also requires that housing
finance agencies submit semiannual reports to HUD headquarters that
include the status (current, delinquent, workout, or foreclosure) of
all insured loans. Finally, agencies are required to notify HUD
headquarters monthly when a mortgage is in default (30 days past due)
until it either becomes current or an application for an initial
claim payment is made.
HUD has not drafted a regulatory handbook for administering the
reinsurance program. Rather, the procedures for HUD's oversight of
the participating financial institutions are specified in each
risk-sharing agreement. According to these agreements, HUD
headquarters, rather than HUD field offices, is responsible for
monitoring the performance of participating financial institutions.
This monitoring includes receiving and reviewing semiannual reports
from the participating institutions showing the unpaid principal
balance on each risk-sharing loan and its status. While the
agreements also require the participating entity to provide HUD with
any records it deems necessary to carry out its review functions, HUD
headquarters is not required to conduct on-site reviews of the
financial institutions.
REVIEW OF OVERSIGHT
DISCLOSED SOME PROBLEMS
-------------------------------------------------------- Chapter 4:4.2
Because the demonstration programs are still evolving, and
participation by many of HUD's risk-sharing partners has been
limited, we did not conduct a comprehensive evaluation of how well
HUD field offices and headquarters are carrying out their oversight
responsibilities. However, we did discuss with officials at five HUD
field offices the procedures they are using to ensure that housing
finance agencies comply with the handbook's requirements for the
credit enhancement program. These five field offices oversee housing
finance agencies that account for about 60 percent of the units
reserved through September 1997 under the credit enhancement program.
Our review disclosed some inconsistencies in the field offices'
procedures for on-site monitoring, documentation of housing finance
agencies' performance, and communication and resolution of identified
problems with housing finance agencies.
HUD headquarters officials, with a broader perspective, confirmed
that HUD field offices have been inconsistent in reviewing housing
finance agencies to ensure that they are complying with the program's
regulations and procedures. Moreover, headquarters officials agreed
that they have not developed a systematic process for ensuring (1)
that HUD headquarters has received and reviewed the semiannual
reports required from housing finance agencies on the status of their
closed loans or (2) that housing finance agencies continue to meet
the program's eligibility criteria. We contacted the housing finance
agencies in California, Colorado, Florida, and Massachusetts, which
account for about 60 percent of the closed loans as of September
1997, to inquire whether they were complying with the semiannual
reporting requirements. Officials at the California and Florida
agencies told us that they had neglected to send in the required
reports. According to a senior official at the California Housing
Finance Agency, one of the agency's insured loans had been in default
since October 1996. Furthermore, the California Housing Finance
Agency did not notify the HUD field office of the default until
October 1, 1997, at which time the payments for loan principal,
interest, real estate taxes, and property insurance were over
$457,000 in arrears. As we pointed out in chapter 2, HUD
headquarters officials were not aware of this default until we
brought it to their attention in February 1998. However, according
to the senior California official, the agency has notified HUD that
it will hold HUD harmless on this loan because of extenuating
circumstances. The official also said that the agency is withdrawing
the loan from the risk-sharing program. We found that, for
overseeing the reinsurance program, HUD headquarters had received the
semiannual reports required from Fannie Mae.
HUD management is aware of the oversight problems as well as the
importance of ensuring that its risk-sharing partners comply with the
programs' procedures, regulations, and/or risk-sharing agreements.
According to headquarters officials, HUD plans to transfer the
responsibility for overseeing both the credit enhancement and the
reinsurance programs to a newly established quality assurance unit
that is to be created by realigning HUD field office staff. The
creation of this unit is part of HUD's ongoing initiative to
transform the way the Department administers all of its programs.
The quality assurance unit would be responsible for overseeing all
lenders participating in the risk-sharing programs and in FHA's other
insurance programs. According to headquarters officials, the unit's
responsibilities could include validating the status of housing
finance agencies' qualifications, including the agencies' financial
solvency; reviewing agencies' underwriting practices; and reviewing
the semiannual reports on the agencies' portfolios insured under the
credit enhancement program, including the original mortgage amount,
outstanding loan principal balance, and status of all loans. In
addition, headquarters officials are also considering
institutionalizing certain periodic and cyclical tasks, such as
annual reviews of housing finance agencies' financial statements and
annual requests to Moody's and Standard and Poor's for agencies'
credit ratings.
CONCLUSIONS
---------------------------------------------------------- Chapter 4:5
Whether or not the Congress permanently authorizes the risk-sharing
demonstration programs, HUD program managers will need consistent and
reliable data on the units allocated to HUD's risk-sharing partners
and on the progress of these units towards completion. Furthermore,
asset management and property disposition issues may arise over the
life of the programs that may require data on properties' financial
and physical characteristics. This broad range of information will
be needed to monitor and accurately evaluate the overall performance
of the risk-sharing programs and their individual projects. The
credit enhancement program's current data system (RSS) does not
provide reliable information, and servicing problems have led to
omissions in F47.
HUD has not yet selected the system that will support the information
and evaluation needs of the credit enhancement program's future
managers. Adequately addressing the shortcomings of the current data
system, especially the lack of a data dictionary, is, however,
imperative as designers planning the new system identify the needs of
users at all levels. HUD has indicated that it is redesigning F47.
HUD will also need to ensure that its risk-sharing partners in both
demonstration programs are carrying out their responsibilities under
HUD's regulations and/or their risk-sharing agreements, since
activity is likely to increase if the Congress either extends the
programs or makes one or both of them permanent. Although the
programs are still relatively new, HUD has not executed some of its
oversight responsibilities. While HUD has outlined an approach for
addressing the current oversight problems and for monitoring the
performance of its risk-sharing partners in the future, it is too
early to tell whether this approach will be successful. However,
correcting the current oversight problems to ensure that the programs
are being properly administered should, in our view, be a priority
for HUD.
RECOMMENDATIONS
---------------------------------------------------------- Chapter 4:6
To ensure that the risk-sharing demonstration programs' managers have
consistent and reliable data to meet their statutory and regulatory
obligations, we recommend that the Secretary of Housing and Urban
Development take steps to correct current flaws in the information
systems supporting the programs. We recommend that, in correcting
the flaws in the data system supporting the credit enhancement
program, the Secretary direct the system's designers and the
program's managers to examine the near-term suitability of using
spreadsheets and databases commonly contained in suite software
within the context of the long-term data needs of a growing universe
of projects, giving careful consideration to the requirements of all
users of the system.
We further recommend that the Secretary give priority to implementing
a comprehensive monitoring system to ensure that the Department's
risk-sharing partners are complying with the demonstration programs'
procedures, regulations and/or risk-sharing agreements, including the
requirements for timely reporting on the status of insured loans.
AGENCY COMMENTS
---------------------------------------------------------- Chapter 4:7
HUD agreed in its written comments on a draft of this report (see
app. IX) with our concerns about the flaws in the information
systems supporting the risk-sharing demonstration programs and is
planning to implement a monitoring system to ensure that its
risk-sharing partners are complying with the programs' requirements,
including the requirements for timely reporting. More specifically,
HUD said that it is already pilot-testing a new Development
Application Process that will track mortgage insurance applications
from their submission through to endorsement. HUD said that until
data on the risk-sharing projects can be incorporated into this
system, it will develop spreadsheets to make the current systems more
user friendly and to simplify data input for its risk-sharing
partners. Also, to facilitate monitoring, compliance, and timely
reporting, HUD said that it would develop an Internet system to
provide guidance and solicit verification of its records and the
required reports from its risk-sharing partners.
ALLOCATIONS AND RESERVATIONS OF
42,000 UNITS BY HOUSING FINANCE
AGENCIES WITH RISK-SHARING
AGREEMENTS AS OF SEPTEMBER 1997
=========================================================== Appendix I
Number of
Number of units
units reserved for Percentage
Number of reserved for properties Number of of total
Housing finance units completed in unallocated allocation
agency allocated properties\a pipelines\b units reserved
------------------- ------------ ------------ ------------ ------------ ------------
District of 160 0 160 0 100
Columbia
Florida 7,002 2,511 4,491 0 100
Illinois 1,470 324 1,146 0 100
Maryland 575 212 363 0 100
Maryland- 2,217 700 1,517 0 100
Montgomery County
Michigan 950 0 950 0 100
Minnesota 810 196 614 0 100
Missouri 630 340 290 0 100
New Jersey 1,123 0 1,123 0 100
Oregon 720 113 607 0 100
Puerto Rico 250 0 250 0 100
Rhode Island 595 68 527 0 100
New Mexico 925 341 568 16 98
Kentucky 745 232 479 34 95
California 8,435 3,177 4,696 562 93
Connecticut 610 0 569 41 93
Maine 150 140 0 10 93
Virginia-Fairfax 370 330 0 40 89
County
Massachusetts 2,148 895 803 450 79
Wisconsin 1,010 194 528 288 71
New Hampshire 600 263 144 193 68
Colorado 4,310 1,885 992 1,433 67
New York State 3,015 505 1,042 1,468 51
Pennsylvania 690 0 306 384 44
South Dakota 235 0 90 145 38
Idaho 800 278 0 522 35
Pennsylvania- 400 115 0 285 29
Philadelphia
Montana 175 32 10 133 24
Alaska 0 0 0 0 0
Indiana 300 0 0 300 0
Louisiana 280 0 0 280 0
New York City 300 0 0 300 0
=========================================================================================
Total 42,000 12,851 22,265 6,884 84
-----------------------------------------------------------------------------------------
Note: Data in this table reflect activity reported by state and
local agencies as of September 1997 and include only the 42,000 units
authorized as of March 1996. Although additional units were
authorized in July 1997, we did not include these units because the
agencies had not had time to use them when we were conducting our
audit work. Appendix II includes the units authorized in July 1997.
\a "Completed properties" are those with closed loans. Insurance has
been issued for these properties, and they are occupied.
\b "Properties in the pipeline" are those for which an agency has
reserved units. They may include those for which the agency (1) has
not submitted paperwork to HUD, (2) has submitted paperwork but not
received firm approval letters from HUD, or (3) has received firm
approval letters but not yet closed the loans.
Source: GAO's analysis of data provided by HUD.
ALLOCATION OF 49,500 UNITS TO
HOUSING FINANCE AGENCIES WITH
RISK-SHARING AGREEMENTS AS OF
OCTOBER 1997
========================================================== Appendix II
Number of units Number of units Total number of
allocated as of allocated at the end units allocated as
Housing finance agency Sept. 1, 1997 of fiscal year 1997 of Oct. 6, 1997
----------------------- -------------------- -------------------- --------------------
California 8,435 1,000 9,435
Florida 7,002 2,200 9,202
Colorado 4,310 850 5,160
Massachusetts 2,148 1,222 3,370
Maryland -Montgomery 2,217 50 2,267
County
New York State 3,015 -995 2,020
New Jersey 1,123 850 1,973
Illinois 1,470 300 1,770
Oregon 720 550 1,270
New Mexico 925 250 1,175
Minnesota 810 350 1,160
Kentucky 745 280 1,025
Wisconsin 1,010 0 1,010
Michigan 950 0 950
Missouri 630 189 819
Idaho 800 0 800
Connecticut 610 150 760
Rhode Island 595 150 745
Pennsylvania 690 0 690
New Hampshire 600 75 675
Maryland 575 0 575
Virginia -Fairfax 370 175 545
County
Pennsylvania - 400 100 500
Philadelphia
Puerto Rico 250 54 304
Indiana 300 0 300
Louisiana 280 0 280
South Dakota 235 0 235
Montana 175 0 175
District of Columbia 160 0 160
Maine 150 0 150
Alaska 0 0 0
Florida -Dade County 0 0 0
New York City 300 -300 0
=========================================================================================
Total 42,000 7,500 49,500
-----------------------------------------------------------------------------------------
Source: GAO's analysis of data provided by HUD.
LOCATION OF UNITS RESERVED FOR
COMPLETED AND PIPELINE PROPERTIES
AS OF SEPTEMBER 1997
========================================================= Appendix III
Location of units Percentage of units
------------------------------ ------------------------------
Housing Total
finance number of
agency units Urban Suburban Rural Urban Suburban Rural
------------- ---------- -------- ---------- -------- -------- ---------- --------
AK 0 0 0 0 \a \a \a
CA 7,873 3,659 3,296 918 46.5 41.9 11.6
CO 2,877 1,519 663 695 52.8 23.1 24.2
CT 569 535 34 0 94.0 6.0 0.0
DC 160 160 0 0 100.0 0.0 0.0
FL 7,002 4,290 2,712 0 61.3 38.7 0.0
ID 278 278 0 0 100.0 0.0 0.0
IL 1,470 399 1,071 0 27.1 72.9 0.0
IN 0 0 0 0 \a \a \a
KY 711 315 117 279 44.3 16.4 39.3
LA 0 0 0 0 \a \a \a
MA 1,698 851 815 32 50.1 48.0 1.9
MD 575 575 0 0 100.0 0.0 0.0
MD-MC 2,217 391 1,826 0 17.6 82.4 0.0
ME 140 140 0 0 100.0 0.0 0.0
MI 950 750 66 134 78.9 6.9 14.1
MN 810 327 483 0 40.3 59.7 0.0
MO 630 630 0 0 100.0 0.0 0.0
MT 42 0 0 42 0.0 0.0 100.0
NH 407 0 407 0 0.0 100.0 0.0
NJ 1,123 719 326 79 64.0 29.0 7.0
NM 909 687 0 222 75.6 0.0 24.4
NYC 0 0 0 0 \a \a \a
NYS 1,547 599 741 207 38.7 47.9 13.4
OR 720 647 0 73 89.9 0.0 10.1
PA 306 0 275 31 0.0 90.0 10.0
PA-PH 115 115 0 0 100.0 0.0 0.0
PR 250 250 0 0 100.0 0.0 0.0
RI 595 451 144 0 75.7 24.3 0.0
SD 90 90 0 0 100.0 0.0 0.0
VA -FC 330 0 330 0 0.0 100.0 0.0
WI 722 395 285 42 54.6 39.5 5.9
=========================================================================================
Total 35,116 18,772 13,592 2,752
Percent of 100.0% 53.5% 38.7% 7.8%
total
-----------------------------------------------------------------------------------------
Note: MD-MC is Montgomery County, Maryland; PA-PH is Philadelphia,
Pennsylvania; and VA-FC is Fairfax County, Virginia.
\a Not applicable.
Source: GAO's analysis of questionnaire data provided by housing
finance agencies.
TYPE OF CONSTRUCTION FOR UNITS
RESERVED FOR COMPLETED AND
PIPELINE PROPERTIES AS OF
SEPTEMBER 1997
========================================================== Appendix IV
Percentage of units by type of
Type of construction construction
---------------------------------- ----------------------------------
Housing
finance Total Acquisit Refinanc Acquisit Refinanc
agency units ion New Rehab e ion New Rehab e
--------- ------ -------- ------ ------ -------- -------- ------ ------ --------
AK 0 0 0 0 0 \a \a \a \a
CA 8,899 0 4,960 2,913 1,026 0.0 55.7 32.7 11.5
CO 1,851 0 575 1,210 66 0.0 31.1 65.4 3.6
CT 569 0 142 427 0 0.0 25.0 75.0 0.0
DC 160 0 51 109 0 0.0 32.0 68.0 0.0
FL 7,002 0 6,501 501 0 0.0 92.8 7.2 0.0
ID 278 0 278 0 0 0.0 100.0 0.0 0.0
IL 1,470 0 922 548 0 0.0 62.7 37.3 0.0
IN 0 0 0 0 0 \a \a \a \a
KY 711 0 416 153 141 0.0 58.5 21.6 19.9
LA 0 0 0 0 0 \a \a \a \a
MA 1,698 0 667 991 40 0.0 39.3 58.4 2.4
MD 575 0 0 575 0 0.0 0.0 100.0 0.0
MD-MC 2,217 269 521 0 1,427 12.1 23.5 0.0 64.4
ME 140 140 0 0 0 100.0 0.0 0.0 0.0
MI 951 0 898 53 0 0.0 94.4 5.6 0.0
MN 810 0 0 810 0 0.0 0.0 100.0 0.0
MO 630 0 340 290 0 0.0 54.0 46.0 0.0
MT 42 0 42 0 0 0.0 100.0 0.0 0.0
NH 407 0 263 144 0 0.0 64.6 35.4 0.0
NJ 1,123 0 1,101 22 0 0.0 98.0 2.0 0.0
NM 909 211 698 0 0 23.2 76.8 0.0 0.0
NYC 0 0 0 0 0 \a \a \a \a
NYS 1,547 0 1,206 341 0 0.0 78.0 22.0 0.0
OR 720 0 477 243 0 0.0 66.3 33.7 0.0
PA 306 0 306 0 0 0.0 100.0 0.0 0.0
PA-PH 115 0 63 52 0 0.0 54.8 45.2 0.0
PR 250 0 0 250 0 0.0 0.0 100.0 0.0
RI 595 0 47 548 0 0.0 8.0 92.0 0.0
SD 90 0 90 0 0 0.0 100.0 0.0 0.0
VA-FC 330 0 120 0 210 0.0 36.4 0.0 63.6
WI 722 120 222 280 100 16.6 30.7 38.8 13.9
=========================================================================================
Total 35,117 740 20,907 10,459 3,011
Percent 100.0% 2.1% 59.5% 29.8% 8.6%
of total
-----------------------------------------------------------------------------------------
Note: MD-MC is Montgomery County, Maryland; PA-PH is Philadelphia,
Pennsylvania; and VA-FC is Fairfax County, Virginia.
\a Not applicable.
Source: GAO's analysis of questionnaire data provided by housing
finance agencies.
UNITS IN COMPLETED PROPERTIES, BY
SIZE, AS OF SEPTEMBER 1997
=========================================================== Appendix V
Number of units in size category
--------------------------------------------------------------------
Housing finance
agency 400 or more 200-399 100-199 50-99 Under 50
------------------- ------------ ------------ ------------ ------------ ------------
California 500 1,146 830 510 191
Colorado 200 986 447 252
Florida 2,511
Idaho 200 78
Illinois 227 97
Kentucky 84 148
Massachusetts 224 349 290 32
Maryland 212
Maryland - 311 236 153
Montgomery County
Maine 140
Minnesota 148 48
Missouri 244 96
Montana 32
New Hampshire 263
New Mexico 120 164 57
New York 422 83
Oregon 113
Pennsylvania - 115
Philadelphia
Rhode Island 60 8
Virginia -Fairfax 210 120
County
Wisconsin 120 58 16
=========================================================================================
Total 500 5,504 3,680 2,383 784
-----------------------------------------------------------------------------------------
Note: MD-MC is Montgomery County, Maryland; PA-PH is Philadelphia,
Pennsylvania; and VA-FC is Fairfax County, Virginia.
Source: GAO's analysis of questionnaire data provided by housing
finance agencies.
INCOME LEVELS SERVED BY COMPLETED
UNITS IN THE CREDIT ENHANCEMENT
PROGRAM AS OF SEPTEMBER 1997
========================================================== Appendix VI
Income level targeted
----------------------------------------------
Units targeted Units targeted Units targeted Percentage of
Housing Number of to over 60% of to 60% or less to 50% or less units meeting
finance units area's median of area's of area's affordability
agency reserved income median income median income requirements
----------- ------------ -------------- -------------- -------------- --------------
California 3,177 949 1,490 738 70
Colorado 1,885 915 486 484 51
Florida 2,511 1,169 1,015 327 53
Idaho 278 59 146 73 79
Illinois 324 45 240 39 86
Kentucky 232 0 190 42 100
Massachuset 895 452 5 438 50
ts
Maryland 212 0 64 148 100
Maryland - 700 94 574 32 87
Montgomery
County
Maine 140 35 77 28 75
Minnesota 196 79 78 39 60
Missouri 340 93 182 65 72
Montana 32 0 30 2 100
New 263 210 0 53 20
Hampshire
New Mexico 341 132 150 59 61
New York 505 171 219 115 66
Oregon 113 0 0 113 100
Pennsylvani 115 0 75 40 100
a -
Philadelph
ia
Rhode 68 0 66 2 100
Island
Virginia - 330 0 330 0 100
Fairfax
County
Wisconsin 194 48 40 106 75
=========================================================================================
Total 12,851 4,451 5,457 2,943 65
Percent of 100% 35% 42% 23%
total
-----------------------------------------------------------------------------------------
Source: GAO's analysis of questionnaire data provided by housing
finance agencies.
PROFILE OF SELECTED LOAN
CONSORTIA'S MULTIFAMILY LOAN
PORTFOLIOS
========================================================= Appendix VII
Table VII.1
Characteristics of Loan Consortia's
Multifamily Loan Portfolios
Increased
or
Year began Average decreased Average Number
Loan multifamily annual loan loan of
consortium finance loan volume volume size units
----------------- -------------- ------------ ------------ ------------ ------------
Chicago Community 1983 $30 million Decreased $750,000 21-50
Investment
Corporation
California 1989 $20 million Decreased $1.8 million 21-50
Community
Reinvestment
Corporation
Central Florida 1991 $5-6 million Decreased $2 million Over 100
Community
Reinvestment
Corporation
Hawaii Community 1991 $10 million Decreased $2.5 million 51-100
Reinvestment
Corporation
Nevada Community 1992 $5 million Increased $2 million 21-50
Reinvestment
Corporation
New Hampshire 1995 $5.5 million Increased $1 million 21-50
Community
Reinvestment
Corporation
Network For 1991 $10 million Same $1.25 21-50
Oregon Affordable million
Housing
Savings 1971 $35 million Decreased $2.5 million 51-100
Associations
Mortgage Company
(SAMCO)
Tampa Bay 1993 $7 million Increased $1.5 million Over 100
Community
Reinvestment
Corporation
Washington 1992 $16 million Decreased $1.5 million 21-50
Community
Reinvestment
Association
-----------------------------------------------------------------------------------------
Table VII.2
Additional Characteristics of Loan
Consortia's Multifamily Loan Portfolios
Location of Type of
Loan consortium project Type of project Financing Loan Performance
----------------- ---------------- ---------------- ---------------- ----------------
Chicago Community Urban Rehab Adjustable 1% loss on total
Investment portfolio
Corporation
California Urban, suburban, New construction Fixed Very-low default
Community rural rate
Reinvestment
Corporation
Central Florida Urban New construction Fixed No charge-offs,
Community and rehab no delinquencies
Reinvestment
Corporation
Hawaii Community Urban New construction Balloon No delinquencies
Reinvestment
Corporation
Nevada Community Urban New construction Fixed No charge-offs
Reinvestment
Corporation
New Hampshire Suburban New construction Fixed Too early to
Community determine
Reinvestment
Corporation
Network For Urban, suburban, New construction Fixed No charge-offs
Oregon Affordable rural
Housing
Savings Urban, suburban, All types Adjustable Less than 1%
Associations rural loss on
Mortgage Company delinquencies
(SAMCO)
Tampa Bay Urban Acquisition and Adjustable No charge-offs,
Community refinance no delinquencies
Reinvestment
Corporation
Washington Urban, suburban, New construction Fixed and No charge-offs
Community rural adjustable
Reinvestment
Association
-----------------------------------------------------------------------------------------
Note: The members of the loan consortia were asked to state their
average loan volume for 1994-96. They were then asked if they
expected their 1997 loan volume to be the same as the previous 3-year
average, to increase, or to decrease from that loan volume.
Source: GAO's analysis of questionnaire data provided by members of
the loan consortia.
INDICATORS OF FINANCIAL SOUNDNESS
OF HOUSING FINANCE AGENCIES
======================================================== Appendix VIII
Required reserve
Housing finance agency Risk level\a Rating agency\b account\c
----------------------- -------------------- -------------------- --------------------
Alaska I Moody's No
California I Standard and Poor's No
Colorado I Moody's No
Connecticut Both\d Standard and Poor's No
District of Columbia II Not rated Yes
Fairfax County, I Not rated Yes
Virginia
Florida I Not rated Yes
Idaho I Moody's No
Illinois Both\d Moody's No
Indiana Both\d Moody's No
Kentucky II Moody's No
Louisiana Both\d Not rated Yes
Maine Both\d Moody's and Standard No
and Poor's
Maryland Both\d Moody's Yes
Massachusetts Both\d Standard and Poor's No
Michigan I Standard and Poor's No
Minnesota I Standard and Poor's No
Missouri I Standard and Poor's No
Montana II Moody's Yes
Montgomery County, Both\d Moody's No
Maryland
New Hampshire I Moody's No
New Jersey Both\d Standard and Poor's No
New Mexico II Not rated Yes
New York City Both\d Standard and Poor's No
New York State Both\d Not rated Yes
Oregon Both\d Not rated Yes
Pennsylvania Both\d Standard and Poor's No
Philadelphia, II Not rated Yes
Pennsylvania
Puerto Rico II Not rated Yes
Rhode Island Both\d Standard and Poor's No
South Dakota Both\d Not rated Yes
Wisconsin Both\d Not rated Yes
-----------------------------------------------------------------------------------------
\a Level I: The housing finance agency assumes 50 to 90 percent of
the risk and may use its own underwriting standards and loan terms.
Level II: The housing finance agency uses underwriting standards and
loan terms and conditions approved by HUD. The agency assumes 25
percent of the risk of loss if the loan-to-value ratio is greater
that 75 percent. The agency assumes either 10 percent or 25 percent
of the risk of loss, at its option, when loan-to-value ratio is less
than 75 percent.
\b The housing finance agency (1) has received the "top tier"
designation from Standard and Poor's or another nationally recognized
rating agency, (2) has received an overall "A" rating from a
nationally recognized agency or (3) can otherwise demonstrate its
capacity to HUD by establishing a dedicated reserve account of liquid
assets of not less than $500,000.
\c The housing finance agency must maintain an account with an
initial amount of not less than $500,000. Thereafter, the agency
must deposit at each loan closing, and thereafter maintain,
additional money as specified in the regulations--essentially, 1
percent of mortgage amounts up to $50 million, plus 75 basis points
of mortgage amounts between $50 million and $150 million, plus 50
basis points for mortgage amounts over $150 million.
\d The risk-sharing partner can use level I or level II procedures to
provide FHA insurance under its risk-sharing agreement.
Source: HUD, New Products Division.
(See figure in printed edition.)Appendix IX
COMMENTS FROM THE DEPARTMENT OF
HOUSING AND URBAN DEVELOPMENT
======================================================== Appendix VIII
(See figure in printed edition.)
(See figure in printed edition.)
MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix X
RESOURCES, COMMUNITY, AND ECONOMIC
DEVELOPMENT DIVISION, WASHINGTON,
D.C.
Stanley Czerwinski, Associate Director
Dennis W. Fricke, Assistant Director
James Vitarello, Assistant Director
William F. Bley, Evaluator-in-Charge
Diane Brooks, Senior Evaluator
Patrick B. Doerning, Senior Operations Research Analyst
Elizabeth R. Eisenstadt, Communications Analyst
*** End of document. ***