As the subprime mortgage meltdown sends chills through the world’s credit markets, the agency best suited to bring stability is itself caught up in turbulence.
The Federal Housing Administration (FHA), which invented the modern single-family mortgage market, could sustain the multifamily industry as other sources of capital face new constraints, thanks to its ability to back loans with the full faith and credit of the U.S. government.
But the agency has fallen on difficult times. Its production volume continues to dwindle as slow deal cycle times, inconsistent field offices, and archaic requirements scare off developers.
These problems strain the FHA’s ability to spur multifamily development or be a steadying force, leaving many to wonder just what’s ahead for the agency.
FHA products, such as the Sec. 232 program for nursing homes, are very competitive, and some, like the 221(d)(4) program for new construction or substantial rehabilitation, with its 40-year, non-recourse terms, are described as the best in the industry by developers and lenders alike.
The FHA also promotes development in areas underserved by the capital markets, such as healthcare and skilledcare facilities for seniors. As a government agency, it has the resources to innovate, and isn’t as susceptible to the whims of the market as private enterprise.
It was the first to come out with products specifically for retirement centers, for instance. “Without FHA, there would be a lot less elderly housing, and assisted-living and skilledcare facilities,” said Thom Cooley, a 13-year veteran of the FHA who most recently led FHA production for ARCS Commercial Mortgage. What’s more, the FHA serves rural areas in secondary and tertiary markets, “and a lot of lenders won’t even go to those little towns.”
The FHA’s business often runs counter to the industry at large. When capital is readily available on the market, the FHA’s volume shrinks: When underwriting tightens up and capital dries up—as it has now—many flock to the FHA’s programs.
The agency’s volume suffered over the last three years as many capital sources, especially conduit lenders, fought to place money in multifamily assets. “Your ability to borrow in a CMBS (commercial mortgage-backed securities) program [was] as cheap as what you might be able to borrow under the FHA programs,” said Brian Pollard, president of Lancaster Pollard.
But as lenders tighten underwriting, sending the cost of capital higher, developers will again look to the FHA. For instance, one of the Sec. 221(d)(4) program’s greatest benefits is its ability to lock in a permanent rate at commencement of construction, a feature rarely seen in competing programs.
“That’s going to become much more important to developers as we get into a less stable interest-rate environment,” said Pollard. “A perception of rising long-term interest rates will make the FHA more palatable, because of that ability to lock rates.”
However, the value of those products is offset by the hassle of engaging with the agency.
Stop breaking down
The FHA’s deal turnaround times lag behind the rest of the mortgage industry. A developer can get a bank loan in 90 days, but may have to wait as long as a year for the FHA to turn a deal around. “It isn’t that they really should be the lender of last resort, but frequently they are, solely because the projects take so long to get through the pipeline,” Cooley said.
The FHA’s requirements are archaic. A credit-worthy borrower can go to a bank with plan specs, financial information, and a resume in hand, and 90 days later, commence construction. As long as the borrower provides enough information on which to make an underwriting decision, the bank is happy. But the FHA requires a higher barrier of entry: Borrowers must have construction-ready documents and a contractor’s price that’s written in stone.
The FHA’s programs often are too narrowly written. Because the FHA’s programs are divided into tightly defined categories, a single continuumof- care seniors facility featuring independent living, assisted living, and skilled nursing would be processed under separate mortgages using different underwriting criteria.
The FHA’s multifamily mortgage limits are out of touch with high-cost areas like San Francisco or New York, making it nearly impossible to do an FHA deal in such areas. For example, the basic high-cost-area loan limit for a two-bedroom unit in a building with an elevator under the Sec. 221(d)(4) program is $172,411. Such a unit could easily cost twice that in San Francisco.
Legislation under consideration in Congress would increase the maximum FHA multifamily mortgage limits from 140 percent to 170 percent of the basic loan limit. The bill, the Expanding American Homeownership Act of 2007, also would give the Department of Housing and Urban Development (HUD) secretary authority to increase that limit to 215 percent on a projectby- project basis (for more on the Act, see sidebar, page 32).
Another problem is the FHA’s susceptibility to the whims of politics. Because it’s a steady revenue producer, the executive branch is often tempted to use the agency as a cash cow by increasing the mortgage insurance premiums (MIPs) it charges, for instance, which drives business away from the agency (for more on MIPs, see sidebar page 25).
Many wonder if volumes will continue to drop to the point that the agency becomes nothing more than an afterthought in the multifamily industry. “I don’t think they’ve hit bottom yet; sometime in the next five years they’ll hit bottom,” said Cooley. “[Borrowers] are likely to continue to withdraw simply because the processes, which are well-grounded historically, no longer fit the system today. The methods they use are simply too onerous for today’s borrowers.”
Mapping it out
The FHA insured about a third of all multifamily mortgages in the early 1980s, but that figure fell to 16 percent in the mid-1980s, and down to less than 5 percent by the late 1990s, according to HUD’s Survey of Mortgage Lending Activity.
So in 2000, the agency unveiled its Multifamily Accelerated Processing (MAP) system to lure borrowers back. Initially, MAP slashed turnaround time on the agency’s mortgage insurance programs by allowing commercial lenders to perform much of the processing and underwriting that had previously been done at HUD. “Review, don’t redo” was the program’s mantra.
Its initial success was staggering. Endorsements of multifamily loans steadily grew from $3.7 billion in 2000 up to a high of $7.5 billion in 2004. But the program lost its way. In 2005, MAP volume slipped 26 percent, to $5.55 billion, and last year, fell another 7.5 percent, to $5.13 billion. This year looks no better. From October 2006 to July 24, 2007, the FHA endorsed 689 loans for $3.17 billion, a 22.7 percent decline from the $4.1 billion it helped finance in the year-earlier period.
The problems that MAP was meant to address, such as inconsistency between field offices and slow processing, have returned, many say.
Before MAP, the FHA field offices, also known as hubs, each seemed to have their own way of doing things. The MAP Guide sought to instill consistency on the way deals were processed, spelling out policies and procedures that, for the first few years of the program, achieved uniformity.
That efficiency didn’t last. “They don’t seem to be meeting their timeframes, and [swift deal processing] just depends on which hub you’re doing business in at times,” said Marie Head, president of MAP lender Prudential Huntoon Paige. Before joining Prudential, Head led the FHA’s multifamily production for 20 years.
Although the MAP guide standardizes much of the process, every deal has its own nuances that make it unique and require some degree of human interaction.
Underwriting multifamily loans “will always be somewhat of an art, so you have to have the human capital to run it,” said David Cardwell, vice president of capital markets at the National Multi Housing Council. “The lenders that are most successful with FHA will tell you that they have great success with certain offices and won’t even produce with others, and you can’t operate that way.”
Under MAP, the FHA pledged to process a pre-application for its Sec. 221(d)(4) program in 45 days, and issue the firm commitment in another 45 days. For a refinance or acquisition, the FHA would have an answer for the developer in 60 days, at least twice as fast as before.
How can developers navigate the system? It’s important to use a banker or lender with strong ties to the FHA to help smooth any delays that emerge. And having some industry heavyweights on staff helps too. One development company’s CEO can get HUD headquarters staff on the phone quicker than even most field offices, based on long-standing relationships that CEO has forged with key HUD staff. “We’ll say to the field office contact, do you mind if we call headquarters, and they’ll say, ‘No, you’ll probably have better luck than us,’” said an executive at a developer that uses FHA, who requested anonymity.
Forest for the trees
Many lenders and industry groups have called for a reorganization of the FHA’s multifamily program to bring it more in line with the practices of private enterprise.
The current process sees lenders assemble third-party reports from appraisers, architects, and cost analysts, and send the package to their internal underwriter for review before sending it to the FHA. Each report is then picked apart by HUD’s own appraisers, mortgage credit analysts, architects, and cost analysts.
HUD reviews could be done by a chief underwriter looking at the whole transaction, rather than by four different specialists separately focusing on their own specialties, according to the Mortgage Bankers Association (MBA). “HUD goes back over every single piece of it,” said Cheryl Malloy, the MBA’s senior vice president, multifamily and governance, referring to the loan file. “That’s how they’ve always functioned in the past, but do they really need to do that?”
Lenders are already held accountable with the MAP guide’s quality control plan and the lender quality monitoring division within HUD, which reviews MAP deals. “You have to have that level of trust, and that means accepting our underwriting packages when they come in and doing a timely review,” Head said.
On the trickier deals, HUD could bring in contractors to help do an assessment. This approach would require the recruitment and training of underwriters, but would streamline the agency by eliminating the need for the other specialists, Malloy said.
The federal government is operating under a continuing resolution that has effectively frozen HUD’s budget and eliminated its ability to replace staff. Since two-thirds of FHA senior staff is eligible for retirement, the need for more restructuring is obvious. “They have to delegate more to the lenders,” said Head. “If you can’t hire staff, then you have to trust your partners, and we’re their partners.”
A ranking system could be one way to ease congestion. Lenders with low delinquency, default, and assignment rates could be given a more expeditious level of review, Head argued.
Set me free
The Millennial Housing Commission (MHC), a bipartisan study group appointed by Congress at the end of 2000 to analyze the nation’s housing challenges, advocated freeing the FHA from its restrictive structure.
The report found that the statutes and regulations governing the FHA “dramatically increase the time necessary to develop and implement new products, keeping FHA from being fully responsive to the evolving marketplace.” The report also said that the FHA’s dependence on the appropriations process, which forces it to compete for funds within HUD, has led to under-investment in technology, which makes working with its industry partners difficult.
The MHC advocated restructuring the FHA as a wholly owned government corporation within HUD, run by a CEO reporting to the HUD secretary. Such a move would let it adapt to the marketplace much more quickly, without relying on Congress to legislate each change. This “could be accomplished with no substantial budget impact,” the report said.
“I think that day is coming,” said Head. “You either have to run it like a business, even if it’s government, or you have to make it a business.”
However, the MBA and many HUD veterans are concerned that such a move would negatively impact HUD in a big way, as the FHA constitutes the bulk of real estate expertise within the department. To separate the FHA from HUD would gut the department and render it less vital, they argue.
Another key MHC proposal is to have the FHA act as a secondary market rather than as a retail lender. One proposal would help provide liquidity to the small multifamily mortgage market, serving properties between 5 and 49 units, which unlike larger developments, lack access to efficient secondary markets. The MHC report advocated creating an FHA small multifamily pool insurance program, which “would give local lenders an outlet for small multifamily loans at lower cost than current FHA programs.”
The MHC also recommended to Congress that it permit the FHA to issue construction-only insurance. Because it can back loans with the full faith and credit of the federal government, the FHA could attract secondarymarket investors by indemnifying them against losses from construction-only loans.
Two-thirds of the FHA’s senior staff is eligible for retirement, according to the agency. This demographic shift is a double-edged sword: Tons of experience will leave the organization, but if ever an agency needed an infusion of new blood, it’s the FHA.
“Most of what it takes to make something work at HUD is not written down—it’s the experience of the people who live it every day,” said Cooley. “HUD should bring in consultants who can gather that intellectual capital, document it, and systemize it before it goes away.”
The new guard could help resuscitate the agency over the next decade. “The new folks, people with some recent market experience, will revitalize the agency,” said Cooley. “It will reinvent itself.”
That’s crucial, because a modernized FHA, with processes and products more aligned with those found in private industry, could be a boon to the multifamily industry, especially in times like now, when the capital markets are on shaky ground.
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