Refi Returns: Refinancing Under HUD’s FHA Section 223(f) Program Gains New Popularity
- Sep 06, 2011
By Keat Foong, Executive Editor
The Federal Housing Administration’s (FHA) Section 221(d)(4) program gained kudos as being practically the only source of construction financing available to multi-housing developers during the 2008-2010 financial crisis. Nevertheless, the 221(d)(4) was not the only FHA-insured financing that saw a dramatic spike in volume. A surge of interest from developers was also directed at FHA’s refinancing program—the 223(f).
The fact is that capital pullback in the past few years may have similarly driven borrowers to the Section 223(f) FHA-insured financing. On the one hand, it is true that life companies and banks are now back in the market. And Fannie Mae and Freddie Mac are reliable sources of capital as well. However, a major player-—CMBS—is much less competitive today, and the multifamily financing market is nowhere as aggressive as it used to be in the mid-2000s.
“The lack of alternative financing has left many borrowers seeking FHA loans that previously never needed the leverage,” says Tyler Griffin, senior underwriter and assistant vice president at Beech Street Capital. “At the same time, interest rates have reached a historical low, attracting new borrowers to FHA.”
Griffin says that FHA borrowers traditionally tended to be non-profits, low-income housing, affordable housing and some market-rate borrowers. However, the more subdued capital markets may have drawn some Fannie Mae and Freddie Mac borrowers to the FHA-insured refinancing program. These could be cash-rich borrowers who traditionally preferred the speed of the GSEs over the higher proceeds and
rate savings of the FHA-insured product.
Additionally, HUD’s tightening of underwriting standards may also have contributed to a rush of applications last year as borrowers attempted to beat the deadline. Under the new rules that came into effect last September, the maximum LTV allowed under the 223(f) refinance/acquisition program was lowered from 85 percent to 83.3 percent for market-rate properties. (Maximum LTV was increased from 85 percent to 87 percent for properties with 90 percent or greater of rental assistance, and there was no change in LTV requirements for affordable transactions.) The minimum DSC was increased to 1.20 from 1.176 for market-rate projects insured under Section 223(f).
The capital markets pullback, as well as a rush to apply before the new rules came into effect, may have contributed to the record volume seen in the Section 223(f) program last year. The Department of Housing and Urban Development (HUD) closed a record 473 Section 223(f) loans, totaling $4.49 billion in FY 2010. This dollar amount of Section 223(f) financing completed in FY 2010 is almost quadruple the volume of loans closed the year before, in FY 2009, when HUD insured mortgages for 229 projects, totaling $1.29 billion. (See table.)
At least with regard to the level of closings, as opposed to applications, this year HUD expects to keep up with, or even exceed, the financing volume that was achieved in the last fiscal year. “FY 2010 was the peak, but the 2011 pacing is just as high,” says Brian Sullivan, spokesperson at HUD’s Office of Public Affairs. “We are on the path to surpassing even that, with 318 Section 223(f) loans totaling $2.5 billion so far in FY 2011 (as of 7/20/11).”
Karl Reinlein, executive vice president, head of production at Berkadia, a top FHA lender, surmises the increased volume in Section 223(f) refinancing will dip as even more capital comes into the multifamily market. However, he expects applications for the program to remain robust. “There is a greater need than ever before for the Section 223(f) program for refinancing, because the capital markets have not completely returned with the same vitality as in 2005, 2006 and 2007,” says Reinlein.
That mid-2000s period witnessed the CMBS boom, when HUD financing was at a much lower level as borrowers had aggressive CMBS financing available to them, and GSE, CMBS and life company lenders were vigorously vying for business, he suggests. That kind of environment is not present today.
At least this year, the Section 223(f) business continues to grow. The number of applications received by HUD seems to have increased since October 2010. From February to June, the number of applications has not dipped below 46, whereas they were in the 30-40 range from October to January.
The popularity of FHA financing also has to do with the benefits of the financing itself. The FHA refinancing program provides “long-term, fully amortizing, fixed-rate financing that is not available through any other sources,” points out Reinlein. Reinlein adds that the long-term nature of the financing is, in part, responsible for the low default rates of the 223(f) program.
Under Section 223(f)-insured financing, borrowers can fix their interest rates for a term of up to 35 years. To be eligible for Section 223(f), the property must have been completed or substantially rehabilitated at least three years before the application for the loan. Non-critical repairs, involving the replacement of not more than one major system, are allowed, but not substantial rehabilitation.
Of course, the Section 223(f) program is also known for its relatively low interest rates. The FHA-insured mortgages are financed with Ginnie Mae (Government National Mortgage Association (GNMA) mortgage-backed securities. This ensures a flow of funds to the program from the capital markets—and relatively favorable interest rates.
Interest rates are now very low for the FHA-insured financing, says Griffin. “Interest rates this low for 35-year, fixed-rate loans have not been seen in a while,” she comments. Interest rates are now in the high-3 percent to 5 percent range. Adding the Mortgage Insurance Premium (MIP), but assuming the longer amortization, the all-in rate for FHA mortgages still compares very favorably in the financing marketplace.
Additionally, the leverage obtainable from FHA-insured refinancings is also higher, even after HUD lowered the maximum LTV last year. Maximum LTV for Fannie Mae and Freddie Mac financing is still about 80 percent, whereas that for 223(f) mortgages is 83.3 percent.
One major drawback of the dramatically increased employment of the FHA Section 223(f)-insured financing last year is that the increase in volume has caused a bottleneck of applications. The timing has now stretched from the typical two months to between four and six months—or up to 12 months—in some offices. The financing backlog at HUD offices has not yet been completely worked through, but it is improving and may be better than it was in 2010, says Reinlein. “HUD quadrupled its volume of closings, so they did a tremendous job getting through as much as they did,” Reinlein says.
HUD’s statistics show that average days from application to firm commitment in 2011 is 123 days, compared to 91 in 2010, 83 in 2009 and 88 in 2008. “Loan-processing times have lengthened due to the significant increase in volume, particularly with the spike in the number of applications in the fall of 2010,” states HUD.
At the same time that there is a higher volume of applications, HUD’s multifamily staff has been reduced by 13 percent from 2005 to 2010. In addition, there is concern about the loss of experienced staff to retirements. As much as one-third of HUD’s staff is eligible for retirement, says HUD, although it cannot project when exactly staff members will retire. Indeed, of all federal agencies, HUD has the highest share of employees eligible for retirement. “This is why we’ve had a particular focus on succession planning for years,” states Sullivan.
HUD staffing levels is one of the areas of greatest concern, agrees Reinlein. “The senior people are retiring. Those are the most experienced staff.” Reinlein says replacements are important. Griffin suggests that standardization across field offices, and transparency from the National Loan Committee, hubs and even field offices regarding what they are looking for in a deal would help improve processing times. She also recommends constant communication or e-mail blasts when HUD sees common problems arising from applications.
The recent timing issues exacerbate what is already viewed as slower processing times at HUD—a major deterrent to many multi-housing owners. “Fannie and Freddie are always a first choice in an acquisition because of speed. Even for refinances, borrowers do not know when rates are going to get away from them and would prefer a slightly lower leverage and slightly higher rate over waiting for HUD to approve the deal and risk that they
lock in no attractive rate at all,” says Griffin.
On the other hand, Griffin maintains that the recent bottlenecks are the result of borrowers trying to place the applications before the Risk Mitigation standards came into effect in September last year. Once the existing bottlenecks are worked through, “the programs should be able to run normally with the staffing available,” she says.
HUD is also implementing initiatives to improve efficiencies to ultimately improve processing times. The Multifamily Accelerated Program (MAP), introduced in the 2000s, shifted some of the underwriting, report reviews and loan preparations from HUD to lenders. The National Association of Home Builders (NAHB) reports in a newsletter that HUD is currently implementing a pilot project in the Fort Worth/Dallas field office to speed processing. Initiatives include creating a “SWAT” team to assist in screening and improving productivity of loan committees through additional staff training and improvement of forms. “We are implementing initiatives to improve efficiency which will ultimately improve processing times,” says HUD’s Sullivan.
As the government cuts back on spending, perhaps it is only inevitable that HUD staffing levels will fall. However, it seems unlikely that the FHA program will be cut as part of any federal budget cutbacks, as it is self-sustaining and funded by the MIP and returns a profit to the Treasury, says Reinlein.
“The revenues on the program, versus the losses from claims and dispositions on defaults, result in positive earnings for HUD,” says Reinlein. “So logically you would not want to pare back on something that you are making money on.” This is certainly good news for the borrowers with whom the refinancing program is finding favor.