Good afternoon, Mr. Chairman and members of the Subcommittee. My name is Patton Roark and I serve as the Executive Vice President and Portfolio Manager for the AFL-CIO Housing Investment Trust.
On behalf of the Trust, let me first thank you for the opportunity to testify today on FHAs multifamily housing program. We applaud you for holding todays hearing on major issues facing FHAs multifamily program, which arise in the context of a national crisis of multifamily housing production. My testimony will focus on HUDs recently proposed 60% increase in the FHA 221(d) (4) mortgage insurance premium from 50 to 80 basis points and the implications of this increase for the future of this critically important multifamily loan program. We believe that the proposed increase will further depress the production of much needed rental housing and negatively affect the quality of life of working families in housing markets across the United States.
I will also comment on the credit subsidy rates for FHA multifamily mortgage insurance premiums. We question the underlying assumptions and data used to arrive at credit subsidy rates. We have utilized a version of the credit subsidy model obtained by the Mortgage Bankers Association from HUD and applied assumptions and data derived from actual transactions in the FHA 2001 pipeline. Based on this analysis, at an increased mortgage insurance premium of 80 basis points, FHA would appear to earn excess revenues at the expense of multifamily projects and, ultimately, of tenants. A significantly lower premium increase or perhaps no increase at all in the current 50 basis point premium may be necessary to achieve revenue neutrality for the 221(d) (4) program, even assuming a goal of revenue neutrality. What we are asking today is to lift the shroud of secrecy that determines the supposed cost to the Treasury of the program and require that OMB and HUD work with the industry to develop a fiscally responsible subsidy model and mortgage insurance rate.
In addition, I will comment on the need to address stagnant statutory loan limits and the stop-and-go character of the program due to insufficient credit subsidy that are further compromising FHAs effectiveness.
The AFL-CIO Housing Investment Trust recommends that Congress take a number of steps to ensure greater multifamily housing production and a stronger FHA:
Require that HUD and OMB inform Congress and the public regarding the real impact of the proposed increase in the mortgage insurance premium on housing production and rent inflation before implementing any increase.
Require a full and open public discussion of the model and assumptions used in deriving the credit subsidy rate for FHAs multifamily insurance programs.
Increase statutory loan limits by at least the 25% proposed by Secretary Martinez and provided for in legislation introduced by Senator Corzine. In addition, loan limits should be indexed to assure program effectiveness on an ongoing basis and additional flexibility should be provided in loan limits for high cost areas.
Grandfather projects currently in FHAs 2001 pipeline at the current 50-basis-point premium level.
Request that OMB immediately release $40 million in already appropriated emergency credit subsidy funds for FY2001.
Appropriate sufficient credit subsidy for FY2002 to allow the 221(d) (4) program to operate on a full-year basis at the 50 basis point premium level pending the full and open resolution of the mortgage insurance and credit subsidy issues, as we have recommended.
Background on the AFL-CIO Housing Investment Trust
The AFL-CIO Housing Investment Trust is a $2.5 billion fixed-income fund registered with the Securities and Exchange Commission under the Investment Company Act of 1940. The Trust specializes in investing in Agency-Insured Mortgage-Backed Securities for over 400 investors including both union and public employee pension plans. The Trust is one of the industrys largest investors in FHA-Insured Mortgages and currently invests up to $400 million annually through the Section 221 (d) (4) Multifamily Construction Mortgage program.
Thirty-five years ago, the AFL-CIO founded the Trusts predecessor, the AFL-CIO Mortgage Investment Trust, with the dual goals of providing a vehicle for the prudent investment of union pension assets and of using those assets to stimulate housing production that would benefit workers and their communities. Over the last 35 years, the Trust and its predecessor have financed over 65,000 units of rental housing through investments in FHA-insured mortgages, securities backed by FHA-insured mortgages, and other mortgage-backed securities. My comments are derived from the Trusts unique perspective on real estate development, capital market trading and asset management.
The Multifamily Housing Production Crisis
The issues being reviewed by the Subcommittee today arise in the context of a national crisis in rental housing production. The United States is barely producing enough new rental housing to compensate for losses from the inventory due to age, condominium conversion, and other causes. The number of all rental units in the United States increased by just 2.3% during the 1990s. Over the same period, population increased by 13.2 % and the number of households increased by 14.7%. The result is a predictable imbalance of housing supply and demand. In major markets across the country, increases in rents have far outstripped inflation and growth in incomes. Thats why, according to the Joint Center for Housing Studies at Harvard, after a decade of unprecedented economic growth in the United States, 14 million American households thats one in eight now pay over half their income for housing or live in substandard apartments. Rising rents are pricing working families out of the rental housing market. We are simply not producing enough rental housing.
The Need for an Effective FHA
Historically, FHA has played a critical role in assuring the production of an adequate supply of new multifamily housing, whether in responding to the crisis of the Great Depression or the need for housing following World War II. During the 1970s and the 1980s, FHA was a major force in the market for financing of rental housing and the country achieved high levels of rental housing production. In 1980, FHA insured 42% of the dollar volume of all multifamily loans. During the decade of the 1980s, the country achieved a multifamily production level of over 4.5 million units.
During the decade of 1990s, FHA stepped back from its leadership role in multifamily housing production. By 1997, FHAs multifamily loan market share had dropped to just over 10%. During the 1990s, only 2.5 million new rental housing units were produced, just over half of production levels during the 1980s, contributing directly to the crisis in rental housing supply and escalating rents.
FHA plays a unique role in the multifamily housing industry. Its stated mission includes maintaining rental housing opportunities, contributing to the building of healthy neighborhoods and communities, and stabilizing credit markets in times of economic disruption.
Through the 221(d) (4) program, FHA provides insurance for multifamily loans, which allows institutional investors, like the AFL-CIO Housing Investment Trust, to buy securities backed by these loans. The resulting capital market efficiencies lower the cost of capital for projects resulting in lower rents and more projects that are economically feasible.
FHAs insurance program offers significant advantages that are unique in the industry:
Mortgage insurance covering both construction and permanent loans. Alternative sources of mortgage loan insurance or guarantees do not cover loans during the construction period. As a result, such alternative sources tend to be used more to refinance existing, stabilized projects than to the create new housing units. Allowing institutional investment in construction loans drives down construction loan interest rates, reduced project costs, lower rent requirements in underwriting, and increasing affordability.
Fixed, rather than floating, construction and permanent loan rates. This provides predictability to developers, who are otherwise exposed to significant interest rate risk during the development period. Risk reduction translates into lower returns required by equity investors, reducing project costs, and lowering required rents.
A 40-year loan amortization period, which reduces loan payments and rent levels needed to meet debt service. Alternative sources of credit enhancement in the market have amortization periods of 30 years or less.
A 90% maximum loan-to-value ratio for insured loans. This results in an equity requirement of only 10% of total project costs. Alternative sources of multifamily financing require equity levels of 20% to 35%. Generally, capital markets expect equity rates of return to be at least double mortgage interest rates because of the increased risk of holding equity rather than debt. Why is this relevant to affordability? When the portion of project costs covered by equity is increased, it increases the overall cost of funds. When the cost of funds is increased, it increases the rents necessary to make the project feasible, given prudent underwriting. When required rents are increased, either tenants must pay the difference, or the project is not built. Either way, the result is that fewer American families can afford a place to live.
In summary, each of these components of the FHA multifamily program increases the willingness of developers to build and investors to invest in harder to serve areas. Each component reduces the cost of financing for multifamily projects, thus enabling the development of apartments with rents that are affordable to working families.
Obstacles to FHAs Effectiveness
Despite the importance of the unique financing tools that FHA offers, FHAs multifamily loan production has declined over the past decade due to a number of factors:
The time required to process FHA transactions has been substantially longer than that required for private transactions. For developers, time is money. To address this, HUD introduced the Multifamily Accelerated Processing (MAP) Program, effective this year. Early reports on this program are encouraging.
Statutory loan limits are too low. These limits have not been adjusted since 1992. This has made the 221(d) (4) program unworkable in high cost markets, precisely where the need is greatest. For this reason, last year there were no FHA loans issued in markets such as New York, Boston, Providence, San Francisco, San Jose, Syracuse, Cincinnati, Birmingham and many more. Secretary Martinez has proposed to address this problem and legislation has been introduced by Senator Corzine that would increase statutory loan limits by 25%. We strongly support an increase by at least 25%. We also support indexing the increase in statutory loan limits to assure continued program effectiveness and recommend that additional flexibility be provided for high cost areas.
The stop-and-go character of the program, due to disputes over credit subsidy, frustrates developers who have played by the rules and relied on the availability of FHA loans. In fiscal year 2000, the 221(d) (4) program was effectively shut down in June. In this fiscal year 2001, the program was shut down in April. The Trust is currently working with developers of projects totaling approximately $100 million, representing over 600 badly needed rental units, who are preparing to walk away from existing FHA loan commitments that cannot be acted on. Their future interest in FHAs programs will depend on assurances that the programs can be relied upon.
The Impact of an Increased Mortgage Insurance Premium
Now HUD is proposing a 60% increase in the cost of FHA mortgage insurance. This increase will add further costs to the development of multifamily housing and directly contribute to decreased housing affordability in markets FHA now serves.
According to the 2002 Budget, HUD forecasts that $3 billion in FHA-insured 221(d) (4) mortgage commitments will be issued in fiscal year 2002. The proposed 30 basis point increase in the mortgage insurance premium would effectively be a tax of approximately $105 million (present value of the increase over 40 years) on new multifamily projects. For these development projects to remain viable, this $105 million must be absorbed by tenants through rent increases further escalating the affordability crisis facing working families.
The premium increase could also result in a long-term process of adverse selection that reduces the integrity of the FHAs existing portfolio. Developers who choose to finance through FHA and who have strong, financially viable projects in the most stable markets, may subsequently choose to prepay and refinance out of the FHA program at the first opportunity, leaving only the weaker projects in the FHA portfolio. This tendency to prepay high-premium FHA loans may also be reflected in the capital markets pricing of the securities requiring a higher yield because of the increase in prepayment risk.
An increase in the mortgage insurance premium is not justified by high default rates in the insured portfolio. The AFL-CIO Housing Investment Trust has invested over $1.25 billion in FHA-insured multifamily loans over the past 10 years. The Trust, one of the industrys largest investors in such loans, has experienced cumulative defaults of slightly over one percent of that total. HUDs statistics back up our experience. Since 1990, the default rate for all loans under the full 221(d) (4) program has averaged about one percent annually. For loans originated after 1990, the annual default rate is even lower just over half that. Why then is HUD proposing to increase mortgage insurance premiums now?
It is important also to be cognizant of current economic conditions. Federal Reserve Chairman Alan Greenspan testified to Congress last week that the economy remains depressed, notwithstanding an unprecedented seven reductions in the federal funds rate and the prospect of fiscal stimulus through the tax reduction package enacted by Congress and the President. FHA has long been seen as providing a stimulus to the economy by promoting housing construction and thereby creating jobs in construction and related industries. The multiplier effect associated with these jobs is felt throughout the economy. If, as suggested, increasing the mortgage insurance premium by 60% risks reducing the production of rental housing at a time when it is sorely needed, a question that this subcommittee must ask and answer is whether now is the time to risk elimination of these construction and related jobs.
The Need for Independent Critical Evaluation of the Proposed Premium Increase and Credit Subsidy Model
In proposing a substantial increase in the mortgage insurance premium through an interim rule that changes the premium during a fiscal year, HUD is acting precipitously. Department staff do not appear to have adequately consulted with developers, bankers, investors, tenants, housing advocates or others knowledgeable in the industry or impacted by the decision. HUD is acting without independently verified information regarding the potential near-term and long-term impact of this change on rental housing production or on rent levels.
Moreover, HUD is proposing a fundamental rule change in the middle of the game. This has created serious uncertainty and a lack of confidence in capital markets and among developers. It will layer new costs on pending projects not only because of higher premiums but also due to the need for re-underwriting and new financial feasibility studies.
To restore investor and borrower confidence in the FHA program as well as address the need to increase rental housing production, HUD should immediately contract for an independent critical evaluation of the proposed premium increase and its likely impact on rental housing production and rent inflation. The methodology as well as the results of the study should be made available to Congress and the public within 90 days. A decision to increase the mortgage insurance premium should not be made without a disciplined and open process that examines the likely impacts of such a decision.
In addition, Congress should request that the Office of Management and Budget make public the model and the assumptions and data used to determine credit subsidy levels for the FHA multifamily insurance program. We applied data and assumptions derived from current projects in FHAs 2001 pipeline to the FHA Multifamily Budgetary Cash Flow Model obtained by the Mortgage Bankers Association from HUD. Our results are substantially different from those apparently arrived at by FHA and OMB. Our preliminary analysis strongly suggests that a premium of 80 basis points may not be required to offset the actual default risks insured by the program. Our understanding is that certain defaulted projects from the 1970s and 1980s underwritten under programs and using standards no longer in use today are skewing the default ratio derived in the model. Such projects do not reflect current risks.
If FHA and OMB fairly evaluate the current default risk of the multifamily portfolio using data from the past 10 years, they will likely conclude that a 60% increase in insurance premiums is not necessary to create a revenue neutral program, even assuming a goal of revenue neutrality. Without an open examination of the model and the assumptions and data that went into it, these conclusions remain preliminary. What we can say definitively is that public policy matters as important as the future of FHA and the availability of housing at affordable rents should not be determined behind a shroud of secrecy.
Allow Projects Now Stuck in FHAs Pipeline to Go Forward and Assure Future Program Continuity
We recommend that Congress request that OMB immediately release the $40 million in emergency credit subsidy which has already been appropriated for FY 2001 to allow projects now stuck in FHAs production pipeline to go forward.
Moreover, FHA should allow projects, for which it has invited firm commitments, to be provided financing at the current 50 basis point premium. Developers have relied on the availability of FHA financing at substantial expense. FHA has completed preliminary underwriting and expressed a desire to provide financing. It is a waste of both project and taxpayer resources to mandate that such projects be restructured by developers and then re-underwritten by FHA. By allowing these projects to be financed, the credibility of the FHA insurance program will be enhanced as a reliable financing option and thousands of badly needed rental units will be able to start construction immediately.
To avoid program disruptions next year, sufficient credit subsidy must be appropriated for FY2002 to assure that the 221(d) (4) program can remain operational through the entire fiscal year at the 50-basis-point premium level, pending a full and open resolution of the issues of credit subsidy and appropriate insurance premium level, as we are recommending.
Multifamily housing production in the United States is lagging far behind population growth and household formation the usual indicators of housing demand. The result is a crisis of housing affordability that is hurting working families in major housing markets across the country. The crisis is predictable, but not inevitable.
To reverse the decline in national rental housing production, FHA must be allowed to do more, not less. FHA programs have played a critical role in rental housing production in the past and with a renewed commitment and appropriate changes, these programs can help lead the country out of its current housing production crisis. Unfortunately, the current HUD proposal to increase mortgage insurance premiums is a step in the wrong direction. It will increase the cost of rental housing production and reduce developer and investor confidence in FHA programs, hastening the erosion of FHAs role in multifamily lending. This is not a desirable outcome and certainly not one that we should back into without full and open discussion and debate.
Mr. Chairman, we appreciate the opportunity to testify before this subcommittee. I would also like at this point to submit a letter from President John Sweeney of the AFL-CIO, on behalf of the 40 million Americans who live in labor households. President Sweeney and many state and local labor leaders hear every day about the impact that the housing crisis is having on working men and women and their families, across the nation. He joins us in urging that FHA resume its historic leadership position in supporting the production of multifamily housing.
Mr. Chairman, I would be pleased to answer any questions and to brief the subcommittee staff at any time. Thank you.
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