Critics Say GSEs Already Have Ample Private Capital Participation And Federal Guarantees Are Needed to Meet Rising Multifamily Demand
Plans by the federal agency overseeing mortgage giants Fannie Mae and Freddie Mac to scale back multifamily lending by about 10% this year have been met with concern and some alarm by the apartment industry.
That's little wonder, given that the two government-sponsored enterprises (GSEs) provide nearly half of all U.S. multifamily mortgage origination volume, even as they have lingered in conservatorship since being taken over by the government in 2008 at the height of the housing and financial crisis.
Edward DeMarco, acting director of the Federal Housing Finance Agency (FHFA), re-affirmed in testimony before Congress on Tuesday that he is committed to the carrying out the administration's goal of rolling back Fannie Mae and Freddie Mac multifamily mortgage volume and building a new system that creates a healthier secondary mortgage market for single-family and multifamily housing in which private capital replaces taxpayer subsidies.
Unlike the GSEs' single-family business, their multifamily lending programs weathered the financial crisis in relatively good shape and generated positive cash flow for all the agencies, DeMarco said during a meeting interrupted by vocal protesters calling for homeowner mortgage forbearence and the reduction of principal payments.
Nine state attorneys general signed a letter this week calling on Congress and the White House to fire DeMarco for refusing to allow Fannie and Freddie, which own or manage 60% of U.S. residential mortgages, to allow the mortgage modifications to help homeowners struggling with foreclosure. The agency has refused, arguing such a move could harm cost more taxpayer bailout funds and harm the housing recovery.
Fannie Mae and Freddie Mac's multifamily loans already share credit risk with loan originators and securities investors, respectively, said DeMarco, who was appointed by former President George W. Bush and retained by President Obama.
"Given that the multifamily market’s reliance on the enterprises has moved to a more normal range, to move forward with the contract goal, we are setting a target of a 10% reduction in multifamily business new acquisitions from 2012 levels," DeMarco said. "We expect that this reduction will be achieved through some combination of increased pricing, more limited product offerings and tighter overall underwriting standards."
Follow Randyl Drummer on Twitter for CRE news updates.
The prospect that government support of apartment and condo lending could be ending or sharply curtailed was met with warnings of higher capital costs over the long term by Wall Street analysts, and concerns in the apartment industry that private capital markets are not yet willing or able to take over lending from the GSEs.
The new goal first unveiled by DeMarco earlier this month as part of the FHFA's 2013 Scorecard, "lends credence to the notion that the abundant and inexpensive capital flooding the [apartment and condominium] sector is unlikely to remain indefinitely," Fitch Ratings said in a note last week.
Although multifamily REITs are not likely to be affected in the short term, a narrowed and more concentrated mortgage supply channel would likely lead to higher funding costs should the GSEs eventually exit from the apartment lending market, Fitch said.
Willy Walker, president and CEO of Walker & Dunlop Inc., which originated $9.5 billion in CRE financing in 2012 and services $35.2 billion of commercial mortgages and asset manages over 4,800 U.S. properties, called the FHFA action "misguided."
"It is very surprising that FHFA would focus on decreasing multi-family origination volumes by 10% to quote, 'bring more private capital' to the multifamily mortgage origination market," Walker told investors this month, noting that the two huge multifamily finance GSEs already have large-scale private capital participation. He noted that Fannie Mae requires private lenders to take the first-loss position on all loans originated in its DUS program and Freddie Mac only backs AAA-tranche securities with its guarantee, he said.
"Fannie and Freddie’s multifamily businesses are literally poster children for successful, public-private partnerships," Walker said. "And the fact that FHFA has decided to create a scorecard objective focused on trying to attract private capital to the multifamily finance space is misguided at best."
That said, the FHFA reduction of multifamily lending will have little impact on Walker & Dunlop’s business from a practical standpoint, Walker said.
“We have every intention of remaining one of the very largest Fannie Mae DUS lenders in the country, and moving up the rankings with both Freddie Mac and HUD in 2013."
Fannie Mae and Freddie Mac are a critical cog in the multifamily finance market, accounting for 45% of total mortgage debt outstanding as third-quarter 2012.
The elimination of a government guarantee for multifamily mortgages to be replaced by a private capital market "that has not shown itself to be ready, willing, able, disciplined or reliable would truly be a crisis of our own making," and "is not supported by the facts," said Peter Donovan of CBRE and immediate past chairman of the National Multi Housing Council (NMHC).
GSEs' market discipline, underwriting standards, origination system and alignment of interests are precisely the attributes needed for the future of multifamily lending, said Donovan, speaking on behalf of NMHC at the American Enterprise Institute (AEI).
The Fannie Mae and Freddie Mac multifamily programs, unlike those for single-family, use stringent underwriting that has resulted in a default rate of just 0.25%. Private-market sources of multifamily capital like CMBS, on the other hand, have a default rate of 15%, Donovan noted.
In addition, the enterprises ensure that capital is available for apartments in all markets at all times, not just top-tier properties in major markets, Donovan said, a presence that helps balance the bifurcated investment sales market.
The agencies backstopped the private lending market throughout the crisis as their combined multifamily loan portfolio ballooned by $85 billion, compared to a decrease of $91 billion for all other participants, according to the Mortgage Bankers Association (MBA).
Fitch and other ratings companies and equity analysts have long analyzed the impact of a growing number of longer-term risks to the multifamily sector, including the future role of the agencies.
Bolstered by the profitability of the Fannie and Freddie platforms, many market participants believed the multifamily lending programs would emerge relatively unscathed from GSE conservatorship, until recently at least.
"The recent [FHFA] goal contradicts that notion, and reaffirms that the multifamily sector could be negatively affected by the far-reaching strategic and structural changes regarding the GSEs," Fitch wrote.
While noting that management teams of the multifamily REITs Fitch tracks have made a concentrated effort to reduce their reliance on GSE and other secured debt due to the uncertainty of their future market presence, they and other multifamily owners would eventually be affected by softening capital values driven by properties and borrowers that have up until now been dependent on abundant cheap capital, a low-interest rate environment and the ability to refinance loans, Fitch said.
While the FHFA has long been clear about wanting to reduce Fannie and Freddie’s significant mortgage footprint, the focus in previous years was on gradually raising fees for loan guarantees to encourage competitive private capital to enter the market, not cutting loan volume.
The FHFA strategic plan in February 2012 asked the GSEs to evaluate how their multifamily operations would work without government guarantees.
The main action in the GSE reforms is the FHFA’s plan to create a new business entity called New Mac that Fannie Mae and Freddie Mac will own initially and will replace the companies’ legacy infrastructure. Over the next 12-18 months, the GSEs are likely to transfer some back-office functions to the new entity.
DeMarco this month laid out several other actions to accelerate the process of making the GSEs smaller, including guarantee fees, which are currently 50 basis points, double what they were in 2011.
The government would sell 5% of the GSEs’ private-label security portfolio, enter into $30 billion of credit risk sharing transactions and reduce multifamily business volumes by 10%.
Moody's said the FHFA’s goals to reduce the GSEs’ influence over the mortgage market remain modest given the Mortgage Bankers Association’s forecast of $1.4 trillion in single-family originations this year, and the GSEs’ current market share of approximately 79%.
"The FHFA’s modest goals highlight the balancing act the agency faces in attempting to shrink the GSEs without disrupting a recovering, but still fragile, housing market," Moody's Senior Vice President Brian Harris said in his report.
"In managing these conflicting goals, we expect the FHFA to err on the side of supporting the housing market. The federal goals will ramp up only when the housing rebound gains traction, and "it to take many years to wind down Fannie Mae and Freddie Mac," he said.