The FHA has become the most prolific and popular construction debt source since the advent of the credit crunch. But the agency dropped a bombshell at the recent MBA/CREF Conference when it unveiled proposed changes to its Sec. 221(d)(4) and Sec. 223(f) programs that could make it much harder for developers to gain access to those programs.

As Carol Galante, HUD’s deputy assistant secretary of multifamily housing, outlined the proposed changes to some key FHA programs, a packed room of FHA lenders expressed disapproval in a contentious session with Galante.

The proposed changes, which will be published on the Federal Register in the next 60 days, could have huge ramifications on the multifamily industry. Most notably, the FHA wants to raise the debt service coverage ratio (DSCR) for the popular Sec. 221(d)(4) program, which has become the only game in town for construction capital throughout the recession.

The 221(d)(4) program has always offered some of the most generous terms in the industry, terms that have never changed throughout the programs history. The loan’s 1.11x DSCR is a key feature of the program.

But under the proposed changes, market-rate deals seeking 221(d)(4) loans would be underwritten to a minimum 1.20x DSCR. Projects with subsidy levels of 95 percent or greater will still enjoy a 1.11x DSCR, but low-income tax credit deals would be bumped up to a minimum 1.15x.

And that’s not all. Another proposed change would increase the minimum required amount of working capital funds. In the past, developers had to put up 2 percent of the total loan amount in a working capital fund, but that figure will be 4 percent under the proposed rules. That’s a big change: On a $10 million dollar loan, a developer will have to come up with another $200,000. Another proposed change involves increasing the program’s required operating deficit reserves, from three months of debt service to four months.

More modest changes were proposed to the FHA’s Sec. 223(f) program for refinancings or acquisitions. That program, which has also been a key source of liquidity for the multifamily industry, will see a tougher DSCR requirement as well. Tax-credit deals and HAP-contract deals will stay at the program’s current level of 1.1765x DSCR, but market-rate deals will be bumped up to 1.20x.

Several lenders wondered why the FHA would fundamentally change the program’s terms, rather than a more incremental change, like increasing the Mortgage Insurance Premium. Other lenders pointed out that HUD shouldn’t try to time the market with programmatic changes.

But Galante said that HUD was concerned with the weaknesses seen in its existing portfolio of 221(d)(4) loans, with a large amount of losses expected in 2010 through that program alone. The broader issues of overbuilding and market weaknesses also bolster the case for changes to be made. The fear is that the agency is setting itself up for more losses over the next 24 months, since the FHA has become the predominant lender of new construction throughout the past year or so.

But the irony is, a good portion of those troubled loans may have been made when the FHA was still a “lender of last resort” to smaller developers for smaller properties. Since the credit crisis began, the FHA has become a lender of choice to some of the industry’s biggest and most well capitalized firms. Some lenders now argue that those premier developers, many of whom are using the FHA for the first time, will now be penalized for the sins of a less well-heeled borrower base.

One of the lending community’s main concerns was the grandfathering issue, and Galante made it a point of saying that FHA is sensitive to the potential impact of deals already in process.

The changes will be open for public comment once they are published on the Federal Register. And judging by the initial reaction of FHA lenders, there will be quite a debate between industry lobbying groups and the agency. The Mortgage Bankers Association is still studying the impact of the changes and gathering additional information on the rationale behind them, before it takes an official position.

Translation: Stay tuned.