FHA Business - Current Considerations
MIDWEST LENDERS CONFERENCE
June 18th 2013
Future FHA Business Prospects
ED TELLINGS
RED Mortgage Capital
MBA Update
Eileen Gray
Mortgage Bankers Association
Capital Markets Update
Karen Cady
Credit Suisse
1
Future FHA Business Prospects
2
From The Girl Next Door to Belle of the Ball: the emergence of FHA / HUD as a
force in Multifamily Finance
FHA Fills the Credit Void
Why HUD/FHA Multifamily Loan Programs are Likely to Thrive in the Future
5 Reasons for Optimism
Some Challenges to Consider
3
$9,739
Endorsements
$12,000
$11,000
Averave Loan
Balance
$10,000
$12,000
$10,000
$9,000
$8,000
$8,000
$6,000
$7,000
$6,000
$4,000
Thousands
$14,000
Average Loan Size
Total Initial Endorsements
Millions
FHA FILLS THE CREDIT VOID DURING FINANCIAL CRISIS
$5,000
$13,051
$12,505
$11,289
$5,437
$3,733
$4,191
$5,127
$5,550
$7,540
$7,359
$6,481
$4,791
$0
$4,190
$2,000
$4,000
$3,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
FISCAL YEAR
Form 2007 to 2011, loans endorsed expanded more than 300% and average loan size increased 111%.
Source: HUD.gov HUB initial endorsement data base.
Excludes OAHP 223a7s and OHP health care loans
4
MULTIFAMILY CREDIT MARKET SHARE 2007 - 2012
ORIGINATION VOLUME IN
BILLIONS / MARKET SHARE AS %
2007
EST.
OTHER,
$85.3,
54%
FHA,
$4.8,
3%
EST.
OTHER,
$25.4,
24%
FHA,
$13.1,
13%
2012
FANNIE,
$45.3,
29%
FREDDIE,
$21.6,
14%
FREDDIE,
$30.9,
30%
FANNIE,
$33.8,
33%
Sources: HUD, MBA , FRB and RED CAPITAL Research.
5
WILL IT LAST, OR EVEN GROW
FIVE REASONS FOR OPTIMISM
Programmatic Advantages
Competitor Challenges
Rental Housing Demand
Need for Affordable Housing
Recent FHA Converts
6
REASONS FOR OPTIMISM #1: PROGRAMMATIC
ADVANTAGES
Long-term, Fixed-rate Assumable Financing
Competitive LTV and DSCR Levels
Fixed-rate, Non-recourse Construction Credit
Competitive, Fixed Interest Rates
Residential Healthcare Financing
7
PROGRAMMATIC ADVANTAGES: TERM
FHA Loans offer long, fully-amortizing terms. Competing lenders, with limited
exceptions, offer only balloon structures. In a low interest rate environment,
borrowers seek to lock-in attractive rates.
Lender
FHA 223f Refi / Purchase
Fannie / Freddie Fixed-rate Balloon
Term (months)
420
60 – 120 (360)
Bank & Thrift
60 – 180
Life Company
60 – 240
CMBS
60 – 120
8
PROGRAMMATIC ADVANTAGES: DSCR
Low Debt-service Coverage Ratio: FHA loans generally bear a Debt-service to NOI
Coverage Ratio of 1.20%. Competing products apply 1.25X ratios on even the
highest quality loans, and higher ratios on lesser credits.
Lender
FHA 223f Refi / Purchase
MIN DSCR
1.20X
Fannie / Freddie Fixed-rate Balloon
1.25X +
Bank & Thrift
1.25X +
Life Company
1.30X +
CMBS
1.25X +
9
PROGRAMMATIC ADVANTAGES: LTV
Loan-to-Value Ratio Advantages: FHA loans may be funded up to 80% of value,
and in some cases slightly more. Competing lenders are generally less aggressive
except with respect to the highest quality credits generating exceptional cash flows.
Lender
MAX LTV
FHA 223f Refi / Purchase
80% / 83%
Fannie / Freddie Fixed-rate Balloon
65% - 80%
Bank & Thrift
55% - 75%
Life Company
55% - 70%
CMBS
55% - 75%
10
PROGRAMMATIC ADVANTAGES: CONSTRUCTION
FINANCING
HUD offer the most attractive construction financing in the market: fixed-rate, nonrecourse financing with structured permanent mortgage take-out. Construction
financing available in the private market consists of Libor-based floaters with full or
partial recourse to the sponsor characterized by greater lease-up, revenue and
permanent take-out risks.
Lender
FHA 221(d)(4) New Construction / Perm
Fannie / Freddie
MAX LTV
80% - 83% of cost
Not Available
Bank & Thrift
65% - 70% of cost
Life Company
Not Available
CMBS
Not Available
11
PROGRAMMATIC ADVANTAGE: PRICING
Basis point pricing advantage of standard FHA 223f to private lender options
Lender
Spread to FHA 223f Norms
GSE (Tier Plus)
LTV <65%
+ 140 bps
LTV>65%
+ 120 bps
Bank & Thrift
+ 150 bps and up
Life Company
+ 130 bps and up
CMBS
LTV <65%
+ 135 bps and up
LTV>65%
+ 150 bps and up
Generic Ten-year Mortgage Pricing Spreads, June 2013. FHA 223f all-in at
approximately 2.95% - 3.20% or 10-year UST + 65 – 100 bps.
12
PROGRAMMATIC ADVANTAGE: CONSTRUCTION
LOAN PRICING AND CONVERSION TO PERMANENT
FINANCING UPON COMPLETION AND COST
CERTIFICATION
FHA 221(d)(4) Spreads to Bank Floating Rates Applicable
to Construction Loans
FHA Construction – Perm
-20 bps
-70 bps
Generic Pricing Spreads, June 2013. FHA 221(d)(4) 480 month construction to
perm all-in at approximately 3.5%. Bank standard 24-month construction loan at
Libor + 300 – 350 bps, swappable to 2-year Treasury + 340 bps – 390 bps or
approximately 3.70% - 4.20%.
13
REASONS FOR OPTIMISM #2: COMPETITORS’
CHALLENGES
Government Sponsored Agencies
CMBS Conduits
Commercial Banks & Thrifts
Life Insurance Companies
14
MARKET OUTLOOK: FANNIE MAE / FREDDIE MAC
• During conservatorship period (3 – 7 years)
• Conservator seeks to limit taxpayer risk and prepare GSE to
operate without government credit subsidy
• MFH underwriting standards will tighten further
• Mortgage insurance premiums will continue to rise, diluting GSE
pricing advantage relative to CMBS/Banks
• Reform
• Uncertain outcome dictated by Congress
• GSE MFH Lines of Business may emerge as fully-private or
evolve into fully-public entities
• Implementation to last a decade or longer
• FY2013 restricted goals
15
MARKET OUTLOOK: CMBS CONDUITS
• Conduits will continue to struggle to generate sufficient deal
volume to support high fixed operating costs and overhead
• Conduits will recover market share only gradually as investor
confidence in loan underwriting improves and bond spreads
tighten
• Unlikely to be broadly competitive for class-A/B multifamily
product for the foreseeable future
• Dodd-Frank risk retention requirements problematic, making
securitization highly capital intensive and will make achieving
ROEs thresholds challenging.
16
MARKET OUTLOOK: BANKS & THRIFTS
• Local and regional banks becoming more competitive for
multifamily construction and permanent debt business
• Construction loans among their most profitable LOBs
• Underwriting terms strict, Libor spreads wide
• Personal guarantee and recourse provisions still typical
• Aggressively pursing LIHTC business for CRA purposes
• Money center and super-regional banks will be hampered by
Increased capital requirements pursuant to Basel III, less likely
to pursue large construction loan opportunities
• Local and regional banks will be less affected by Basel III and
are likely to increase as a competitive threat for smaller credits
17
MARKET OUTLOOK: LIFE COMPANIES
• Actively seeking CRE lending opportunities, especially in
class-A multifamily sector
• Highly competitive for the right deals, but remain selective.
Prefer urban infill mid-rise and high-rise properties in the major
coastal markets. Unlikely to compete actively in Heartland for
garden apartments
• Appetite for MFH debt stabilizing as absolute rate levels
bounce from early-year lows, although returns remain below
Life Co. yield hurdles.
• Likely to become a larger factor in the market when rates
return to levels typical of economic expansions.
18
REASONS FOR OPTIMISM #3: DEMAND FOR RENTAL
HOUSING
Demographic Growth
Decreasing Homeownership Rates
Construction Volumes Remain Inadequate
19
NEED FOR CONSTRUCTION FINANCING ACUTE
Demand for rental housing is growing as the rate of homeownership falls. If Americans continue to form new
households at a 1.1% annual rate over the next 10 years and the rate of homeownership falls 0.25% per year, the
U.S. will need to add nearly 700,000 rental units annually to meet demand, fueling prospective construction loan
demand.
Renter Households in America
Rental Households (000)
Sources: Census Bureau and RED Research
48,000
45,000
42,000
Increase of 7 million
households over 10
years
46,315
39,583
39,000
36,000
33,000
30,000
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022
Homeownership in America declined from a historic high of 69.2% in 2004 to 65.2% in 1Q13, representing an average decrease of
about 0.48% per year. Assuming homeownership continues to decline at a rate of about 0.25% per year for the next 10 years the
number of household living in all types of rental structures (1-4, 5+, MH) will increase by about 700,000 per year.
20
DECREASE IN HOMEOWNERSHIP
The rate of homeownership in America has declined steadily since 2006, particularly among households headed
by persons under the age of 35, the group that traditionally exhibits the highest propensity to rent. Until
conventional mortgage financing with relatively low LTVs becomes readily available again, these trends are likely
to continue.
Rate of U.S. Homeownership
U.S. HOUSEHOLDS
Census Bureau
and RED ResearchAGED
ALL U.S. HOUSEHOLDS
Sources:
34 OR YOUNGER
44%
68%
42%
66%
40%
64%
38%
62%
36%
60%
34%
Title
70%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: U.S. Census Bureau
21
FORECAST CHANGE IN RENTER COHORT (AGES 16
– 29 YEARS) HOMEOWNERSHIP RATE
Rate of U.S. Homeownership
Renter
Cohort
Homeownership
Rate
Sources:
Census
Bureau and RED Research
Forecast
Renter Cohort Homeownership Rate
35%
34%
33%
32%
31%
30%
29%
28%
27%
2001
2003
2005
2007
2009
2011
2013
2015
2017
22
5+ STARTS REMAIN BELOW TREND
While American Households will demand as many 400,000 new multifamily rental units per year over the next
decade, construction starts have only recently approached the levels observed prior to the Great Recession
Units
Thousands
Annual 5+ Construction Starts
Source: U.S. Census Bureau
350
311
280
300
250
234
200
150
100
50
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
SAAR
*About one of every three renter households lives in a multifamily dwelling of 20 or more units, producing annual natural net demand for about
240,000 units. In addition, hazard and functional obsolescence removes roughly 0.2% of units in structures of 20 or more units from total
stock, producing a net need of roughly 160,000 units annual37, for a total of 400,000 units.
23
REASONS FOR OPTIMISM #4: AFFORDABLE HOUSING
Need for Affordable Housing Growing
24
CORE MISSION BUSINESS IS AS VITAL AS EVER:
AFFORDABLE HOUSING
Affordable Units Financed Made up More than 33% of all Units Financed during the
Past 10 Years
SECT. 8 /
202
10%
Tax
Exempt
Bonds
19%
SECTION
8
46%
Affordable
33%
Market Rate
67%
LIHTC
25%
Affordable housing activity by business line.
Source: RMC Portfolio as a Proxy
25
Severely Cost Burdened Households
(Millions)
NEED FOR AFFORDABLE HOUSING CONTINUED TO GROW
Households Paying More than 50% of Pre-tax Income for
Housing
22
20
9.5
18
9.0
16
14
12
7.0
6.5
10
10.5
8
6
9.0
9.0
2004
2007
7.5
4
2001
Source: Joint Center for Housing Studies, Harvard University
2010
26
REASONS FOR OPTIMISM #5: RECENT FHA
CONVERTS
Dozens of New Adopters Introduced to FHA
Positive Experience / Repeat Business
27
NEW ADOPTERS LIKELY TO REMAIN ACTIVE
CUSTOMERS
• Many experienced developers utilized Sect. 221(d)(4)
construction financing for the first time
• RED’s clients were universally satisfied
• All will consider future 221(d)(4) financings
• Some have reconfigured business models to conform to
the timing and underwriting requirements of the HUD
program
• Quality market-rate developers have become believers
and will not discontinue use of the program when
conventional construction lenders return to the market
28
PROPERTIES DEVELOPED BY NEW ADOPTERS
Properties in the Columbus HUB region developed by new adopters using FHA
construction-to-perm credit products
Hilliard Grand, Dublin, OH
Arlington Park, Hilliard, OH
Hilliard Grand, Dublin, OH
Prescott Place, Columbus, OH
Prescott Place, Columbus, OH
Arlington Park, Hilliard, OH
29
SOME CHALLENGES TO CONSIDER
Overall HUD Morale
Programmatic Changes/Enforcement
Cost of Funds
30
OVERALL HUD MORALE
• Sequestration
• Furloughs
• Reorganization
• Revised Business Model
• Lack of Resources
31
PROGRAMMATIC CHANGES/ENFORCEMENT
• LTV, DSCR, Sponsor Requirements
• Secondary Debt Limits
• Loss of Section 202 Refinancing Flexibilities
• Strengthened IOI Requirements
• Availability of Commitment Authority
• Davis-Bacon Wage Determination
32