Money from bond investors around the world is flowing into affordable housing, thanks in part to securitization programs.
“What we do is provide liquidity—securitization is a way that we do that,” says David Leopold, vice president of Targeted Affordable Sales and Investments for Freddie Mac.
Several growing securitization programs help sell loans from affordable housing properties to bond investors. Lenders then can use this money to make more loans to finance additional affordable housing properties, including both new construction and renovations of older properties such as public housing. The capital raised through securitization has helped lower interest rates and finance more deals—especially using tax-exempt bond mortgages.
“By marketing tax-exempt bonds on the public bond markets, Freddie Mac and Fannie Mae were able to broaden the pool of potential investors,” says Evan Williams, senior vice president of Capital One's Multifamily Finance Group.
That’s made the process of financing affordable housing with tax-exempt bonds much more dependable, which is becoming increasingly important as state officials and developers plan to build more affordable housing projects with tax-exempt bonds.
“Borrowers are going to be concerned with the viability and competitiveness of these solutions,” says Ila Afsharipour, a managing director in KeyBanc Capital Markets’ Public Finance Group. “They are probably beginning to develop pretty deep pipelines of projects—they want to make sure that these programs are going to be here.”
In cities and towns across the country, there is a huge shortage of affordable housing, according to experts like the Joint Center for Housing Studies at Harvard University.
To help fill that need, housing officials in many states are expanding their tax-exempt bond programs to build more multifamily affordable housing. “We are seeing a lot more new construction,” says John Sokolovic, co-founder of the Red Stone Cos. “A few of the states are prioritizing new construction.” For example, states like Colorado, Texas, and Washington are using much of their tax-exempt bond cap to finance multifamily affordable housing, he says.
Interest rates are low and falling lower
Tax-exempt mortgages are providing affordable housing borrowers relatively low interest rates at relatively high leverage levels—thanks in part to securitization programs.
“With securitized loans being able to offer more aggressive pricing and higher leverage, it enables the borrower to close the gap in the capital stack needed to offset rising construction costs and reduced equity pricing,” says Heather Olson, vice president of real estate finance for Walker & Dunlop.
Borrowers who closed tax-exempt bond loans in July locked in interest rates fixed in the mid- to low 4% range, according to Red Stone. That interest rate is 50 to 75 basis points lower than the rates borrowers could get for tax-exempt loans just six months prior. “I would say rates are at an all-time low,” says Sokolovic. “The last securitization we did was seven to eight times oversubscribed by tax-exempt bond investors.”
Afsharipour agrees. “The appetite to buy tax-exempt bonds is at a historic level.”
The eagerness of tax-exempt bond investors is helping finance development in markets that would be hard to serve with more conventional financing programs. That includes “areas that would traditionally be considered riskier markets, such as inner-city communities going through a revitalization,” says Marsha Goff, executive vice president of originations at Merchants Capital.
“Securitized loans can really benefit developments that need high leverage,” she says. By “high leverage,” Goff means financings with an anticipated loan-to-value ratio of more than 90% or a debt-service coverage ratio as low as 1.15x.
Securitization programs have helped keep interest rates low for tax-exempt loans, even after reform of the federal tax code lessened the benefits of tax-advantaged investments for many banks. “If it were not for securitization programs, interest rates would be much higher,” says Red Stone’s Sokolovic.
Earlier in the recovery from the global financial crisis, many banks made tax-exempt loans to affordable housing developments and bought the tax-exempt bonds associated with these loans directly, says Sokolovic. “Before securitization became common, finance companies would buy and hold tax-exempt bonds on their balance sheets,” he says.
Back then, the corporate tax rate was still 35%, so many banks had a substantial need for tax-advantaged investments like the tax-exempt bonds associated with these affordable housing properties. That need lessened when Congress lowered the federal corporate tax rate from a top rate of 35% to 21%.
“The appetite for banks to hold tax-exempt debt has diminished significantly,” says Keybanc’s Afsharipour. “Banks took it on the chin with their direct-purchase programs.”
However, there are still investors across the U.S. eager to buy tax-advantaged investments like tax-exempt bonds—that’s because they still pay a high, individual tax rate of 39%.
Securitization programs help bring money from these bond investors to affordable housing properties. “The industry was able to bring the benefits of securitization to the tax-exempt bond market with the Freddie Mac Tax Exempt Loan (TEL) program in 2014 and the Fannie Mae M.TEB (mortgage-backed securities as tax-exempt bond collateral) program in 2015,” says Capital One's Williams. Both of these programs use mortgage-backed securities to collateralize a publicly issued tax-exempt bond.
Under both programs, the government-sponsored enterprises provide credit enhancement to the tax-exempt loans that they securitize. Freddie Mac’s ML and M programs provide credit enhancement to pools of tax-exempt bonds for its TEL program. “By securitizing tax-exempt bonds in pools, Freddie Mac can share risk with private investors, deliver a consistent servicing standard, and provide the credit strength of cross-collateralization and Freddie Mac guarantee,” says Williams.
Fannie Mae’s M.TEB program also provides credit enhancement to individual loans that are securitized to bond investors in single-asset securitizations.
“Securitizing a pool of loans is different, but not more difficult, as compared to single-asset securitization,” says Merchant Capital’s Goff. Pool securitizations are completed after the individual loans are closed, unlike single-asset securitizations, which typically start when the interest rate is locked for the transaction and is completed approximately one month from transaction closing.
“While, the securitization process (steps) may be different, fundamentally both securitizations provide the same benefits: strong credit, strong performance, call protection, transparency and consistency, and post-securitization asset management and servicing standards,” says Goff.
“Being able to transfer risk, through a diverse pool of assets or single-asset mortgage-backed security, means access to the global capital markets,” says Paul McPeake, vice president for CBRE. “That means access to a lower-cost capital and availability of capital in certain geographies that may not be achievable otherwise.”