The Federal Housing Administration (FHA) is working on some changes to the way it approaches large loans for new construction.
While nothing is set in stone yet, the FHA is getting ready to toughen up the underwriting terms on any Sec. 221(d)(4) deal of $50 million or more. The agency is concerned with the threat posed to its portfolio by such large loans, especially since the agency is on the hook all by itself. Unlike Fannie Mae’s approach, where its lenders have skin in the game of each loan, the FHA has no such risk-sharing requirements.
“We’ve definitely seen much larger loan sizes and that’s a new phenomenon for FHA,” said Carol Galante, HUD’s multifamily chief, in an interview last month. “We’ve got something like 80 projects in our pipeline that are over $50 million, and five that are over $100 million.”
The underwriting changes around large loans would be tiered, so that anything over $50 million would require a minimum 1.25x debt service coverage ratio (DSCR) and a 80 percent maximum loan to cost (LTC). For deals of $75 million or more, the DSCR would bump up to 1.35x, and the LTC ceiling would drop down to 75 percent.
The FHA would also bolster operating deficit reserve and working capital escrow requirements, and may also layer in some new liquidity requirements. The agency hopes to have a notice out to the industry some time in the next three months.
“It’s somewhat of a pushback,” says Mark Beisler, CEO of Columbus, Ohio-based FHA lender Red Mortgage Capital. “And it goes back to the issue that the lenders have no skin in the game.”
Red Mortgage Capital recently closed a $125 million Sec. 221(d)(4) loan for the 544-unit Shores, a community to be built in Marina Del Rey, Calif. The loan—the largest currently active (d)(4) in the country—had an LTC of 89.9 percent since it was submitted before the agency changed its underwriting standards in September of last year. Last September, HUD instituted LTCs of 83.3 percent, and DSCRs of 1.20x, for any market-rate (d)(4) deal, regardless of size.
These incremental changes point to the need for greater participation from the private sector. “What HUD ought to do, instead of bickering around the edges, is go into the heart of it and make lenders responsible, make them take a first-loss position like Fannie Mae does,” says David Goodman, chairman of Red Mortgage Capital. “What they need is a co-insurance program that’s got teeth in it.”
Red closed on $800 million in FHA business last year, and expects to exceed that total this year. But like all FHA lenders, it is struggling with managing borrower expectations regarding deal cycle timelines. The FHA, which has always had a slow approach, has been extremely congested of late—the agency is still trying to dig out from the avalanche of deals that came its way before those new underwriting changes went into effect last September.
“HUD is overwhelmed right now. We submitted a project in the Buffalo office in September, and its been sitting there for six months; they’ve yet to open the box,” says Ed Tellings, Red’s FHA chief underwriter. “They’re just inundated with all of those proposals submitted in response to their making the underwriting criteria more conservative in September.”