Mr. Chairman, and members of the subcommittee, my name is Michael Petrie, and I am President of P/R Mortgage and Investment Corporation in Indianapolis, Indiana.
I am appearing before you today in my capacity as chairman, of the Commercial Real Estate/Multifamily Housing Board of Governors of the Mortgage Bankers Association of America (MBA)*. MBA is grateful for the opportunity to present our views to your subcommittee today on the important issue of the FHA multifamily credit subsidy.
I have spent over 20 years in the commercial real estate finance industry. Before joining P/R Mortgage and Investment Corporation, I worked at Merchants National Corporation, where I rose to the rank of Executive Vice President and head of the Commercial Real Estate Division. My present firm, P/R Mortgage & Investment Corporation was started in 1990, has financed over $700 million in multifamily mortgages and the firm currently services $550 million in loans. Since inception, the firm has never had a 30-day delinquency on any loan.
I am also an active volunteer in affordable housing; I served eight years on the Board of the Indianapolis Neighborhood Housing Partnership and am currently on the Mayor's Indianapolis Housing Strategy Task Force. I was previously a Chairman of Near North Development Corporation Board of Directors and served on the Board of United Northwest Area CDC. I have served 16 years as President of Kenwood Place, Inc., an inner city 97-unit Section 202 housing development for the elderly, and 4 years as President of Unity Park, Inc., an inner city 60-unit Section 8 family development.
What are the FHA multifamily programs and how do they work?
The Federal Housing Administration (FHA) was created under the National Housing Act of 1934. It was developed initially to attract private and public sector credit into the housing market to meet the mortgage financing needs of low-, moderate- and middle-income Americans by insuring long-term, fully amortizing single-family and multifamily mortgages. From its beginning, a major responsibility of FHA has been to enhance the nation's multifamily housing stock. FHA facilitates the construction and maintenance of multifamily housing by providing mortgage insurance to finance the construction, purchase, rehabilitation, or the refinancing of rental housing, cooperatives, and condominiums. Over the years, FHA has been expanded to include programs for the finance of special needs groups such as the elderly and disabled. Each of the programs is referred to by the section of the National Housing Act, as amended, under which it is authorized.
FHA's multifamily mortgage insurance programs enable qualified borrowers to obtain long-term, fixed rate, non-recourse, financing for a variety of multifamily property types affordable to low- and moderate-income families. Out of the cash flow of a property approved for FHA-insured financing, the borrower pays a mortgage insurance premium (MIP) to the lender which is then passed through to FHA in return for the insurance. The MIP charged is intended to compensate FHA for its risk and the cost of doing business, including the expected cost of default.
However, despite an acute need for affordable rental housing throughout the nation, over the past four years, the FHA has insured fewer than 130,000 units in the entire country. The reason for our testimony here today is to address the program constraints in the FHA multifamily programs and to find solutions to improve and strengthen the FHA programs to provide affordable rental units.
Why is it important to raise the FHA multifamily loan limits?
First, I would like to commend Senator Corzine and Senator Carper for introducing S 1163. This bill would increase the maximum mortgage limits for the FHA multifamily programs. These limits have not been increased since 1992 and construction costs alone have risen since then, on average, by 25%. S 1163 is particularly helpful in that it not only increases the limits by 25%, but it also provides for an annual adjustment factor to the limits so that we do not face this same problem again in a few years.
The fact that the maximum mortgage limits have not been increased in almost 10 years has virtually shut down the FHA multifamily insurance programs in many high-cost markets. In most major cities in this country, and many second-tier cities, it is impossible to produce new housing using the FHA programs. In cities like Boston, where almost 20% of all working families have critical housing needs and there is only a 2.7% vacancy rate, it is vitally important to produce new housing. Yet, because of the maximum mortgage limits, no new FHA new construction or substantial rehabilitation loans were approved in Boston in 2000. Even in second-tier cities like my hometown of Indianapolis, the maximum mortgage limits have made it difficult to do FHA-insured loans.
S 1163 is key to making FHA insurance a useful tool in high-cost areas, and we fully support the bill. We suggest that the Senators consider adding a provision to their bill to allow the Secretary the discretion, on a project-by-project basis, to increase the loan limit's high-cost factor to the one currently allowed for Alaska and Hawaii. This would provide the Secretary the ability to address needs in particularly high-cost areas like Boston, New York or San Francisco where land and development expenses are particularly high.
As important as this issue is, approving higher loan limits alone will accomplish little without addressing the fundamental issue now facing the FHA program - the lack of credit subsidy. Without credit subsidy or without an accurate accounting that demonstrates when credit subsidy is needed, there will be no new construction with FHA insurance, and the increase in the loan limits would be a hollow victory.
What is credit subsidy?
While many people believe calculating the credit subsidy rates for FHA's mortgage insurance programs is merely an accounting detail, it is clear this accounting detail has shut down the FHA new production programs for months at a time for two years in a row and resulted in the loss of new affordable housing. We believe it is time these "details" are brought to light and publicly debated so an accurate accounting of these programs can be achieved.
The Federal Credit Reform Act changed the budgetary treatment of credit programs, effective for FY 1992. The Act requires Congress to appropriate funds for the "estimated long-term cost to the Government of a direct loan or loan guarantee." It states that "the cost of a loan guarantee shall be the net present value when a guaranteed loan is disbursed of the cash flow from (i) estimated payments by the Government to cover defaults and delinquencies, interest subsidies, and other payments, and (ii) the estimated payments to the Government including origination and other fees, penalties and recoveries."
Since 1992, the Department of Housing and Urban Development (HUD) and the Office of Management and Budget (OMB) have determined that most of the FHA insurance programs that support the new construction of multifamily housing require an annual appropriation of credit subsidy. This credit subsidy is supposed to serve as a loan loss reserve for the programs.
We believe that HUD and OMB, since the beginning of credit reform, have overestimated the long-term cost to the Government of the FHA multifamily insurance programs. This overestimation has resulted in unnecessary money being appropriated for these programs and, therefore, "wasted."
Since the arrival of Secretary Martinez and Dr. Weicher at HUD, both HUD and OMB have been very generous in sharing information about the calculation of the credit subsidy rates for the FHA multifamily programs. Greater access to the formula, as well as detailed explanations of the assumptions used, has been provided to MBA. We appreciate their openness and their willingness to share their data. It is invaluable in our ability to evaluate the performance of these programs and how we proceed in the future to continue to provide greater access to affordable rental housing in the most efficient method possible.
What is the current credit subsidy crisis and how did it get to this point?
It appears from our analysis of the data provided to us that there are two key drivers of the calculation. The first is the cumulative claims rate which, put simply, is the percentage of loans originated each year that are expected to default and result in a claim on the insurance fund during the life of those loans. The second is when in the life of those loans the claims are expected to occur.
For the cumulative claims rate, HUD and OMB are currently using 28%. This is based on the entire experience of the Section 220 and 221(d)(4) programs, beginning in 1956. As you can imagine, those rates vary widely - from 0% for loans originated in 1995 and 1999 to 64.8% for loans originated in 1983. The highest claims rates are, not surprisingly, for loans originated in years affected by major tax changes: the early 1970s and the early 1980s. By removing those years from the calculation or by reducing their weight in the calculation, the credit subsidy rate would drop dramatically. Another way to approach the cumulative claims rate would be to focus more on the most recent experience of the programs. Since HUD made significant underwriting changes in 1991, their default and claims experience has improved dramatically. From the data HUD has provided to MBA, the cumulative claims rate has been less than 4% for every year from 1992 through 2000.
In my experience as a lender at a bank, when we created loan loss reserves, we looked at the experience of loans similar to loans we were currently underwriting. No one expects that we will ever experience again the devastation in real estate markets that was the result of the tax changes that began with accelerated depreciation in 1981 and ended with the Tax Reform Act of 1986 which eliminated, retroactively, various tax incentives. If we did expect such a downturn in the real estate market, no one would be investing in real estate today. HUD's assumptions for credit subsidy should eliminate the experiences of that unusual period and should more heavily weight the recent experience, which reflects how financial institutions are underwriting loans today.
As I mentioned, the other key driver in the credit subsidy calculation is the point at which any of these loans will result in a claim. HUD and OMB have heavily front-end-loaded the claims. Their calculations assume that 9.3% of the loans will result in a claim in the first three years of the mortgage and 14.3% will result in a claim in the first five years of the loan. This approach has an immense impact on the credit subsidy rate.
The impact of HUD's assumptions are evident from the numbers called "re-estimates" that appear in the HUD budget. Until recently, the federal budget included "re-estimates" of the credit subsidy needed for each origination year since 1992, the year credit reform was implemented. The re-estimates reflect the history of the loans originated in those years and clearly demonstrate that the original calculations were excessively high. For example, loans originated in 1992 had an original credit subsidy rate of 1.51% and a re-estimated rate in the FY 2000 budget of -2.29%. For 1993 loans, the rate dropped from 12.41% to 3.70%. Similar reductions were evident in subsequent years until HUD and OMB stopped re-estimating the rates for loans originated in 1997 and beyond. We believe that HUD and OMB need to review their assumptions, and base their default predictions on more recent experience with loans underwritten since 1991.
What has happened with the annual appropriation for credit subsidy?
By our estimates, Congress has appropriated over $1.4 billion since 1992 for credit subsidy for the FHA multifamily programs. None of these funds have been expended. In fact, based on the re-estimates in the budget, HUD and OMB do not expect a large portion of these funds ever to be needed for these programs. Perhaps there is a way to recapture and reuse some of this excess credit subsidy. At the very least, we need to recognize that credit subsidy should not be continually appropriated and never used.
Why does MBA oppose the increase in the mortgage insurance premium?
Based on what we have seen and what we believe to be the correct credit subsidy rates for these programs, MBA thinks it is unnecessary and inappropriate for HUD to increase the mortgage insurance premiums (MIP) on many of these programs. The increase from 50 basis points to 80 basis points to be implemented by HUD is an unnecessary increase that was calculated by using the current, and we believe, flawed formula and assumptions, and HUD merely selected the MIP level that would make the programs breakeven, and, therefore, require less credit subsidy.
This premium increase will have a number of adverse affects on the production of housing. First, for those properties in markets where a rent increase is possible, rents to tenants will also increase by approximately 3.5 to 4%. Second, for properties where the market will not support a rent increase, the owner will be required to put substantially more equity into the property. If the owner does not have access to additional equity capital, the property simply will not be built. None of these outcomes is beneficial to the families that need affordable housing, nor to the communities that could benefit from the production of new housing.
Why increase the mortgage insurance premium now?
We have asked HUD to delay the implementation of the premium increase until a full review of the credit subsidy formula can be completed and an accurate rate determined. They have responded by publishing the regulation and Notice implementing the change effective August 1. We believe this was done to ensure that the $40 million they hoped to have appropriated for FY 2001 would be sufficient to fund all loans in the pipeline this year. Based on Congress' actions last week and their failure to appropriate any credit subsidy, we are asking HUD again to reconsider the MIP increase and hope that you and your subcommittee will add your voice to ours in asking for a delay in implementation of any premium increase.
Our concern today, Mr. Chairman, is accuracy, but it is also timing. The Congress cannot afford to keep appropriating millions of dollars that are not needed and never used. The developers and mortgage bankers who depend upon these programs for financing cannot operate in this unpredictable and volatile environment. The families who need affordable rental housing cannot continue to wait for it to be built.
We need more accurate credit subsidy rates calculated as soon as possible. And we need Congress to include those rates in the FY 2002 HUD/VA Appropriations bill now being considered in the House of Representatives and the Senate. Without this quick response, we will be faced with another year of unnecessary appropriations and/or an unjustified and excessive increase in the mortgage insurance premium.
How has the action last week on the Supplemental Appropriations bill exacerbated the crisis?
While I understand that it is not the primary focus of this hearing, I would be remiss if I did not mention the action by the Congress last week during consideration of the Defense Supplemental Appropriations Act. Through the hard work of you and many of your colleagues on the Banking Committee, both the Senate and House versions of the supplemental included $40 million in credit subsidy for the FHA multifamily insurance programs. This appropriation was needed to end the shutdown of the programs, which began in April when FHA fully committed the $101 million initially appropriated for the programs for this fiscal year.
In unexplained action, the conferees on the bill eliminated the $40 million from the bill, possibly to fund other priorities, even though both chambers of Congress had approved it. Clearly, the conferees did not understand the impact of their actions. Without a supplemental appropriation, the FHA new construction and substantial rehabilitation programs will be shut down until October 1. This will mean that approximately $1 billion of new construction of affordable rental housing will not get underway this year and may never be built. Forty million dollars is not much money, particularly in a $7 billion supplemental appropriation. However, since it was deleted, we will have delayed indefinitely, and perhaps lost, construction on $1 billion of housing. Housing, as you know, is an excellent economic stimulation tool. These projects could have generated more than 24,000 new jobs, more than $126 million in new local taxes and fees, and more than $255 million in new federal taxes. Unfortunately, an opportunity appears to be gone. And, certainly the rental housing is desperately needed.
There are only two ways that these programs can be restarted before the new fiscal year begins. The Administration can release the $40 million already appropriated by Congress last December as an emergency supplemental for these programs or Congress can approve a new $40 million supplemental, perhaps in the FY 2002 HUD/VA Appropriations bill, if it continues to move quickly through the Congress. We urge you, Senator Reed, to recommend to the Appropriations Committee to consider adding these supplemental funds to the FY 2002 bill. These monies have already been appropriated and they should be used to restart the program. The Senate, in its wisdom, in the Defense Supplemental Appropriations bill removed all restrictions on that original appropriation. If that same language could be included in the FY 2002 HUD/VA Appropriations bill or another appropriations vehicle that is moving quickly through Congress, we can end this shutdown and begin construction already started this year on much-needed housing.
We look forward to working with you, Mr. Chairman, your subcommittee, and other Members of Congress to reexamine the calculation process and the data used to determine the subsidy rate. Our industry stands ready to "break the logjam" so thousands of affordable rental units may be produced across the country. Thank you for the opportunity to testify here today.
* MBA is the national association representing the real estate finance industry. Headquartered in Washington, D.C., the association works to ensure the continued strength of the nationís residential and commercial real estate markets; to expand homeownership prospects through increased affordability; and to extend access to affordable housing to all Americans. MBA promotes fair and ethical lending practices and fosters excellence and technical know-how among real estate finance professionals through a wide range of educational programs and technical publications. Its membership of approximately 2,800 companies includes all elements of real estate finance; mortgage companies, mortgage brokers, commercial banks, thrifts, life insurance companies and others in the mortgage lending field. For additional information visit MBAís Web site: www.mbaa.org.
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