CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

For those whose lives are not consumed by the comings and goings of federal housing policy, let me digress with some background. The FHFA is the regulator in charge of supervising, regulating and overseeing Fannie Mae and Freddie Mac (often lumped together as “Government Sponsored Entities” or the “GSEs”) and the Federal Home Loan Banks (“FHLBanks”).

The GSEs “guaranteed bonds backed by roughly $270 billion of the $405 billion of new home loans originated last quarter”.  They Own more than$100 billion of non-agency securities that could be impacted by the eminent domain plan. Taxpayers have spent about $170 billion to rescue them and they have paid back about $46 billion in dividends to date. Combined they own or guarantee about $5 trillion in U.S. home mortgages (about half the overall market).

The FHFA mission statement is “to promote their [the GSEs’ and FHLBanks’] safety and soundness, and support housing finance and affordable housing and support a stable and liquid mortgage market”. Given its mission statement, FHFA’s opposition seems to be both appropriate and timely.

As we have previously discussed, the plan proposed by Mortgage Resolution Partners which seeks to use eminent domain as a means of altering existing performing mortgage loan excludes debt guaranteed by the GSEs. Given that fact, what explains the strong opposition by the FHFA? In a Federal Register notice, the FHFA said that any program to use eminent domain to revise financial contracts could result in losses, which would ultimately be borne by the taxpayers.
Not to mention the possibility (actually, we already did) that such programs “could undermine and have a chilling effect on the extension of credit to borrowers seeking to become homeowners and on investors that support the housing market”, a concern shared with many others. Further, the FHFA, like many other naysayers, has raised questions about the efficacy (and more fatally, the legality) of such proposals, including, whether such proposals are constitutional, the application of federal and state consumer protection laws, the effects on holders of existing securities, the impact on millions of negotiated and performing mortgage contracts (query whether owners of homes that are underwater would realistically seek out such “protections” to improve their financial situations), the role of courts in administering and overseeing such programs, and the issues surrounding valuation.

Just a week after Edward DeMarco, acting director of the FHFA, definitively said “no” to principal reductions on loans owned or guaranteed by the GSEs, a tool that private banks and mortgage holders have used with increasing frequency, he has said that action may be taken to block the use of eminent domain to seize mortgages backing securities. In the Federal Register notice, the FHFA warns that it has determined that action may be necessary on its part, as conservator of the GSEs, to avoid a risk to safe and sound operations at its regulated entities and to avoid taxpayer expense. Interestingly, the FHFA didn’t detail what “action” is contemplated in its Federal Register notice but is seeking public comment (which I can’t wait to read!).

It isn’t difficult, however, to guess that FHFA, as conservator of Fannie and Freddie, may require that the GSEs refuse to guaranty mortgages in areas employing the eminent domain plan (a concern raised by Scott Simon of PIMCO). One cannot downplay the effect of this potential risk to homeowners and prospective borrowers in affected communities.

In the coming weeks, as the next meeting of the San Bernardino Joint Powers Authority is held, public hearings on this issue take place (at least in Chicago) and others come out publicly for and (more likely) against, the eminent domain proposals, the fate of the proposal will likely be decided. Stay tuned to CrunchedCredit for the latest developments.

By: Krystyna Blakeslee

A few weeks ago, S&P released considerations for REO to Rental securitizations. One threshold issue is whether the sponsor is structuring the securitization based only on the projected stream of future rental payments or if the proceeds from the property sales are also included in the sponsor's cash flow projections.  In either case, the properties will be transferred to the issuing entity and will be valuable collateral for bondholders. And if proceeds from the property sales are included in the cash flow projections, S&P would also consider home price forecasts and the timing of property sales. S&P also notes that while geographic diversity was always a plus in RMBS deals, the opposite may be true here, where a concentrated pool would be more efficiently managed. Keep in mind too that the core competencies and experience of the property manager and projected operating expenses for maintenance and home upkeep will be important credit considerations. In terms of the rental income, key credit considerations will be the minimum lease term and renewal provisions, an analysis of vacancy and time-to-lease scenarios and rental rate factors such as demographics, interest rates and location. 

We have blogged (here and here) about REO financing and securitization in the past. There is no doubt in my mind that this topic will dominate the residential mortgage space for many months to come. There are many investors sitting on cash who see the REO to Rental market as an attractive way to get yield. Warehouse lenders are also eager to get into this game.  The warehouse lenders may only be willing to lend up to 50 or 60% LTV on a pool of REO in the current regulatory and economic environment.  Nevertheless, there is plenty of demand from private equity shops and other investors in the process of acquiring REO who could always use some leverage to improve their yield.

We’ve also discussed at length (here and here) the recent offering by Fannie Mae of pools of REO (with requirements that the purchaser rent out the homes for at least three years before selling) and the key considerations for bidders interested in acquiring one or more of those pools. With respect to the Fannie offering, note that in recent testimony before the House, Meg Burns from the FHFA made it very clear that this initial offering is just a pilot and should not be construed as an indication that Fannie will abandon its reliance on existing retail sales strategies as the primary vehicle for liquidating its REO inventory. It seems like the government was shocked by how much interest there was in the offering and wanted to reset industry expectations concerning the pace of future government sales. In any event, the genie is out of the bottle. 

Am I excited about all of this activity surrounding investments in REO? Yes. Do I think this offering by Fannie Mae will influence how banks dispose of their own portfolios of REO? Yes. Do I think there is a larger problem looming behind the headlines surrounding REO to Rental? Yes.

That problem is how to slow the rate of delinquencies and mortgage foreclosures. Offering pools to encourage the REO to Rental strategy is a great initiative and the industry should continue to pursue it. It’s a smart way to reduce the oversupply of housing in distressed markets and meet the demand of families who are no longer able to qualify for purchase money mortgage financing. Nevertheless, we can’t lose sight of the mountain of delinquent mortgage loans that have not yet been converted into REO. The question is how do we accomplish “delinquent mortgage loan to Rental” and thereby prevent the next wave of REO from hitting the balance sheets of the GSEs and the private banks. There may be 500,000 REO on the books of Fannie, Freddie and private banks but there is a shadow inventory in the pipeline of 3 million borrowers who have not made a payment in over a year. The continuing high default rate that has persisted throughout the credit crisis is the disease that needs to be cured. This high default rate is made more problematic by the fact that it often takes well over a year to foreclose on a defaulted mortgage loan. While this delay may benefit the individual borrower for some period of months, the ultimate burden falls on the GSEs and the private banking system whose collateral deteriorates in condition and value in the meantime, further compounding losses. Before we can see a meaningful bottom to housing prices and truly see prices stabilize, we need wage increases, more credit and more employment opportunities across the board. This problem is too large to solve with targeted programs. We need to grow our way out of it by changing our overall economic and fiscal policies.

But in the meantime, there are deals to be done and many opportunities for us lawyers to get involved...

By: Ralph Mazzeo

Over the past few months, an inter-disciplinary group of Dechert finance, real estate, regulatory, banking, securitization and financial services attorneys have had several conversations with clients discussing how these deals will work.  This week, I co-authored a brief article together with my partners Patrick Dolan, Mac Dorris, Bob Ledig, Ralph Mazzeo, Tom Vartanian, Jay Zagoren and Gordon Miller that highlights an innovative program initiated by the FHFA, designed to convert thousands of single family REO to rental properties.  This article focuses primarily on the issues faced by investors, and provides a detailed explanation of the FHFA’s plan and recent events related to the initiative.

Now if only we could convince this year’s crop of college graduates to rent an apartment instead of returning home … 

Click here to access the full Dechert OnPoint.

By:  Matthew Clark

We need to get on with it.  There are already lots of good ideas in circulation.  We’re not going to get any smarter.  We do not need more symposia. Official leadership just needs to get out of the “I’ll think about this some day” box and into the “do today” box.  When your pants are on fire, stop worrying about the tailoring!

A few things seem obvious to me.  First, there will be a private securitization market again.  That market, when not crushed by a giant securitizer with zero cost of funds and no need to make a profit, will re-flate.  Simply and syllogistically, the need for credit will be met by supply.

Second, the government is going to continue to fill the role of guarantor of last resort.  Okay, some countries, many with much larger governmental sectors than ours, seem to have done pretty well without a government role in housing, but that train has left the station.  There’s a notion that government needs to remain a final bastion of defense against the next housing apocalypse.  That is received wisdom and will be part of Housing Finance 2.0.

Third, we have two great organizations full of bright and hard-working people who can and should be part of the solution.

So let’s stop kicking this can down the road.  The outlines of the solution are apparent.  Freddie and Fannie need to be re-launched using some variant of a good bank/bad bank structure.  A private tranche of guaranty capital must be developed with some ultimate governmental backstop bought and paid for.  Paying a premium for a federal backstop, at least on some type of mortgages, will even-out the playing field and open the tap for private money and conventional securitization.  We need that.  Otherwise, housing will continue to be starved for capital and, simultaneously, suffering as a political football.  I personally think some sort of co-op structure, such as can be found today in the federal home loan bank system, seems appealing.

The problem is, of course, politics.  The GSEs have been a third rail. Fixing them will take courage. Within a week, the election will be over and perhaps we’ll get down to business.  The Treasury, the GSEs and the business community should be able to sit down and sort this out.  Fundamentally, it's not that hard. And it’s hugely important.

By Rick Jones.

Which leads me to Jerry Brown filing a lawsuit against Fannie Mae and Freddie Mac last month for refusing to refi mortgages that carry liens relating to PACE bonds.  Mr. Brown, in the midst of a bid for the Governator’s seat, claims the GSEs’ actions are wrecking his State’s ability to grow a green economy and is pushing for the President to step in.  PACE bond programs give grants to homeowners for energy-efficient home improvements, for which the homeowner pays a tax-like assessment.  The economic benefits of the energy improvements – nebulous cost savings over the long term – are questionable at best. And as you’d expect, the liens associated with the assessments prime a lender’s mortgage.  This makes the bonds salable for the municipalities – but places the burden of paying for those improvements on the mortgage lender in a default scenario, causing Fannie and Freddie to balk.  So now, and without any visible sign of irony, Candidate Brown wants the Obama Administration to bully Fannie and Freddie into lowering their underwriting standards.

Now, I might suggest that there are better places to put your money than any debt issued by the State of California.  And I also might say that, at least here in the Commonwealth of Massachusetts, it’s considered rather rude to campaign against a Kennedy relative.  But let me instead end with this: the really interesting story that will develop around green improvements in coming years is the retro-fit of existing commercial real estate – most significantly, office buildings – and who will pay for it.  All industry constituents – banks, developers, government agencies and lawyers – are trying to figure out a viable way to finance energy-efficient improvements to existing buildings.  The biggest obstacle facing lenders is how to translate the cache of LEED certification, the promise of marketing “green” space to politically-conscious tenants and the possibility of reduced operating costs over the long term into cash flow that can service the lender’s debt.  Not so different than figuring out the right windows to buy, really.  One thing is for sure – the first to figure it out will make a good deal of money on the estimated $520 billion expected to be spent on green retro-fits over the next 8 years.
 

The reality is, the private markets would provide enough credit to support the housing market if they could. When and if the GSEs are scaled down, they will. Will that result in 65% of the adult population owning a house? Maybe not. But who says that’s the measure of success? Historically, it’s an anomaly.

I served on the MBA’s Committee to Enhance Liquidity, which developed a thoughtful white paper on the future of the GSEs. We will now weigh in to actually try to help our legislators and regulatory constituencies to craft a solution. On Tuesday, the Treasury, together with the Department of Housing, invited a cross section of experts and industry representatives, including the MBA, to talk about the future of the GSEs. Secretary Geithner kicked off the meeting with a speech that seems to support the notion that private capital should fundamentally fund the housing market, but that the federal government has an important ongoing role. That sort of sums up the tension at the heart of the debate. There are a lot of good ideas out there, both in the MBA and elsewhere, on what to do about these two wayward economic wards of the state, but some fundamental policy decisions need to be made before the hard work of developing an executable plan can follow.

Here’s a modest solution. Let’s do a test case and spin off the GSEs multifamily business into something new and see if it works. The multifamily businesses are small businesses in comparison to Fannie and Freddie’s single family business, but nonetheless significant. Create cooperatives for these businesses. There is a long history of cooperatives in this country and, in fact, the Federal Home Loan banks are cooperatives (OK, maybe that’s not a good example since they are mired in problems as well). But the multifamily businesses could be easily and simply spun into a cooperative in which the members are the existing GSE mortgage banking outlets as well as major depository institutions. In the cooperative structure, the members would provide capital support to the enterprise in proportion to their use of the enterprises. The co-op’s service would be as a conduit for securitization of these loans, and perhaps as a vehicle to provide warehouse financing to the members to accumulate loans on a modest scale in advance of a securitization. The co-op would not become a bloated hedge fund chock full of mortgages and thereby avoid the failed policies of the past. A government guarantee may still be necessary (though I personally wonder whether it really is), it could be bought at a fair price, and a guarantee fee would be paid to the Treasury. This would allow the business to size the value of that guarantee, engage in price discovery, and perhaps over time it could be weaned from that federal teat. There was a lot of talk on Tuesday at the Treasury / Department of Housing meeting about re-sizing the federal guaranty as some sort of backstop guaranty, with a layer of private insurance in between. The thinking being that government ultimately owns the tail risk of another complete and utter market meltdown. This may be a good idea too, and could easily be annealed to my cooperative idea, but let’s not let the perfect drive out the good. Let’s experiment with the multifamily business and see if we can begin to find a way towards a healthier and sustainable private enterprise based market place.

By Rick Jones.