GSE Lending Expectations for 2011

“Fannie-Freddie Tab Hits $153 Billion.” “Freddie Mac Posts $4.1 Billion Loss for Third Quarter.” These headlines make up the sort of drumbeat one hears in the general press in recent years publicizing losses at Fannie Mae and Freddie Mac, or how much the government-run Government Sponsored Entities (GSEs) will cost taxpayers. Now, the Dodd-Frank financial reform act has required proposals for GSE reform to be put forth. Lost in the din are the positive aspects of the agencies’ multifamily programs.

With government support, Fannie Mae and Freddie Mac have kept the multifamily sector comparatively well capitalized. They are said to be responsible for as much as XX percent of the multifamily permanent, acquisition and refinancing market. While this capital has certainly propped up the multifamily property market during the recession—not to mention through the darkest days of the financial crisis when no other financing was available‑it may also have provided a social good as the benefits flow ultimately to middle-income renters.

Without Fannie and Freddie since 2008, “there would have been a lot more foreclosures in the multifamily sector, and the consequence of that is tremendous negative impact on residents and tenants, as well as quality of housing stock,” comments Mitchell Kiffe, senior managing director at CB Richard Ellis (CBRE) Capital Markets. If mortgages could not be refinanced, or if mortgage capital were not available at reasonable rates, more properties would have defaulted and money may not have been reinvested in the precious multi-housing stock, contributing to their deterioration, Kiffe points out.

It is true Fannie Mae and Freddie Mac have continually had to obtain additional funds from the government. Since they were taken over in September 2008, the GSEs had cost the government $153 billion. And through the first three quarter of 2010, Fannie Mae had a net loss of $14.1 billion and Freddie Mac $13.9 billion. However, while the agencies showed these losses (which have been getting less in magnitude), their multifamily operations in particular were profitable. Although it registered losses in 2009, Fannie Mae’s multifamily business had $399 million in net-income profit through September 2010, while Freddie Mac made $752 million during the same nine months.

“Fannie and Freddie had solid earnings in 2010,” says Brian Harris, senior vice president, Banking and Finance at Moody’s Investors Service. Harris says the two agencies are “doing well” in the multifamily sector.“[Multi-housing financing] is still a profitable business for them, unlike [single-family financing].”

“Fannie Mae and Freddie Mac have remained profitable in the multifamily sector. They are the best performers in both agencies,” agrees Larry Stephenson, executive vice president, regional manager at NorthMarq Capital Inc. “Why mess up a system that is already working fine?”

“Our housing policy [should] be discussed and decisions made in a rational approach in the overall discussion of housing policy,” agrees Mark Beisler, CEO of Red Mortgage Capital LLC. “The agencies’ issues are not caused by the multifamily guarantee business because that portion of it is very sound,” he says. Beisler points out that most of the multifamily housing financed by Fannie Mae and Freddie Mac serves the middle income residents who earn 80-120 percent of area median incomes. Typical properties, he adds, as suburban infill sites, and not high rises in major metropolitan areas.

Besides showing positive income, the multifamily segment of the GSEs also has much lower default rates than the singlefamily sector. Foreclosures have riled the singlefamily market, but the story is quite different in the multifamily segment of the companies’ businesses. Fannie and Freddie’s multifamily delinquency rates both remain less than 1 percent. While they have risen in the recession, Freddie Mac’s average delinquency rate (60 days or more past due) is 0.44 percent as of the end of October. And Fannie Mae’s is 0.65 percent as of Sept 30.

“Although they are higher than three years ago, the delinquencies have not increased to the same extent as in singlefamily housing, where delinquencies have increased by whole percentage points,” comments Harris, of Moody’s. Harris attributes the lower delinquencies in the GSEs’ multifamily loans in part to stronger underwriting, and the related relative absence of an asset bubble in the multifamily sector.

By comparison, default rates were 4.67 percent in the third quarter for banks, according to Real Capital Analytics Inc. The GSEs’ multifamily delinquency rates are comparable to those for life company financing, adds Kiffe.  Default rates are in the four to five percentage points for singlefamily (over 30 percent for subprime singlefamily mortgages), Kiffe points out, while those for conduits are as high as 14 percent.

Lenders see good year

While debate continues about the GSEs, 2011 is expected to be an even stronger year for Fannie Mae and Freddie Mac multifamily financing. The GSEs are expected to remain the most viable players this year because of their government guarantees. “Fannie and Freddie will continue to be the most competitive sources of capital for good quality, stabilized properties,” says NorthMarq’s Stephenson. Because of their sound underwriting standards and implied [government] guarantee, the GSE loan pricing on the bond markets are always lower than that for CMBS.

One of the most significant variables in multifamily financing this year may be the rising interest rates. They began increasing dramatically late last year at about the time the tax cuts were extended, jumping by as much as one full percent to the 3 percent range by December. Higher price tags this year on loans could discourage prepayments and put a damper on acquisitions. However, interest rates are still in the 5 to 6 percent range, which are historically very low, notes Stephenson. And Stephenson and other lenders say although steeply rising interest rates tend to sideline borrowers, when the rates stabilize, even at higher levels, borrowers generally return to the market.

If the latest trends were any indication of increased financing this year, mortgage originations for the GSEs increased by 42 percent from the second to the third quarter last year, according to Mortgage Bankers Association (MBA). “Origination volumes for life companies and Fannie Mae and Freddie Mac were relatively strong during the third quarter,” states MBA.

Lenders expect GSE financing this year to increase somewhat as a result of greater activity on acquisitions and sales as the multifamily market recovers. Also, there will be greater amounts of refinancing, as the volume of multifamily loans maturing begins to peak. Multifamily refinancing maturities will ramp up starting in 2011, and hit peaks in 2012, 2013 and 2014, says Kiffe. “There will be a significant amount of debt that will mature. The challenge is that existing loans are too large and they are not underwritten to the new standards. We have performed a lot of cash-in refinancing this year,” he adds.

One situation that will be new this year, however, is increased activity on the part of other financing sources, such as life insurance companies and conduits. The result is that the market share of Fannie and Freddie may fall somewhat, says Kiffe. “The CMBS players are still working the kinks out, but I suspect they will begin to be competitive in the multifamily sector in 2011,” agrees Paul Cairns, senior vice president, managing director of Capital Services at NorthMarq. In addition, “in a rising interest rate environment, speed of execution is critical‑and the conduits are very effective in that area,” says Kiffe. “To the extent borrowers want a quick execution, the conduits are known to be fast.” Despite the greater financing availability in 2011, however, Red’s Beisler says Class C properties, which are traditionally outside the purview of Fannie and Freddie, will remain more difficult to finance.

All in all, Stephenson says NorthMarq is “very optimistic” about the GSE financing business for this year. He says NorthMarq is expecting a 10 to 20 percent increase in loan volume in 2011. This year, the increase in financing will be driven by loans made in early-2000s to 2005 that will be coming to maturity, Stephenson notes. Additionally, the acquisition market began to increase in the second half of last year, and will probably continue to tick up steadily in 2011, further boosting financing, he says.

GSEs not likely to be bumped?

The Fannie Mae and Freddie Mac lenders also appear to be taking possible GSE reform in stride. Although President Obama was required by law to submit reform proposals to Congress, there had been speculation that Congress may just choose the path of least resistance and take no real action on GSE reform for a while.

And lenders are expecting any “reforms”—if decided upon—will certainly not be implemented this year. “The restructuring of the U.S. financial market will take years to unfold after a decision has been made with regards to the GSEs,” says Beisler. In any case, the economy is still too fragile for Congress to make any huge changes to the GSEs this year, he says. Beisler surmises that if laws are not passed in 2011, any action may be put off until after the 2013 elections. “It is still far off, in my opinion.”

Beisler believes any complete “privatization,” as some Republicans may advocate, is inconceivable in the short- or immediate-term, and even if passed, will take a long time to bring into reality. “The idea [of privatization] was bantered around during the election, but we have heard less of it since the elections,” he notes.

“I think Fannie and Freddie are not going away,” says Stephenson. Most of the discussions on the part of Treasury officials have not mentioned removing them from the system, he says. “It is all about reform and tweaking. I have not heard anyone say, ‘get rid of them.’”

Kiffe, on the other hand, would not be surprised if the Tea Party wing of the Republican party continues to call for elimination of the GSEs. “Partisanship will very much be a part of the GSE debate,” he says. Kiffe warns of a “talent drain” from the GSEs if politicians turn up the volume in their anti-big-government rhetoric. “So far, it has been okay, but when Congress calls [the employees of the GSEs] bad citizens for what you do, it gets old,” he says.

“[The ongoing dialogue] is distracting to our friends at Fannie. Hopefully, they will be able to remain focused,” agrees Beisler. The GSEs are under greater scrutiny, he notes, with the FHFA recently calling the two agencies to cut general administrative costs in 2011.

The single-family side of Fannie and Freddie may also provide added arguments in support of keeping the role of government in the housing finance system. “Congress knows that America likes it 30-year mortgages at very low rates. If you get rid of Fannie and Freddie totally, the home mortgage rates will need to be much higher and you’ll need 80 percent LTV. Imagine the public response,” says Cairns.

Indeed, Kiffe thinks that at the end of the day, pragmatism may win over ideology in the debate over what form the nation’s housing finance system should take.