Like the Universe, the Short-term Bond Opportunity Continues to Expand

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1 National Association of Local Housing Finance Agencies 2014 Annual Educational Conference Atlanta, Georgia April 2-5, 2015 Like the Universe, the Short-term Bond Opportunity Continues to Expand Presented by: R. WADE NORRIS, ESQ. (202) EICHNER NORRIS & NEUMANN PLLC th Street, N.W., Suite 750 Washington, D.C Fax: (202) Website: Eichner Norris & Neumann PLLC

2 Since the worldwide financial crisis in the 2008, interest rates on certain types of taxable debt, especially debt explicitly or implicitly backed by the US government, such as debt issued or guaranteed by GNMA, and now Freddie Mac and Fannie Mae, have actually fallen below the rates on AA+ or Aaa rated tax-exempt municipal bonds backed by the same credits. We rolled out the short-term cash backed bond structure in early For the first 4 ½ years the program was used almost exclusively with FHA insured loans and RD loans, because of the extremely low rates achievable in taxable GNMA sales and the critical elimination of devastating construction period negative arbitrage which the program achieves on most Section 221(d)(4) new construction/sub rehab loans. 2

3 Long Term Rate Comparison: 30-Year MMD (Tax Exempt) Versus 10-Year Constant Maturity Treasury (Taxable) 9.00% 8.00% 7.00% Early 2008 Taxable US Government Securities Rates Fall Below Tax Exempt Municipal Rates 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 30-Yr MMD 10-Yr US Treasury 3

4 Long Term Rate Comparison: 30-Year MMD (Tax Exempt) Versus 10-Year Constant Maturity Treasury (Taxable) January 1, Present 6.00% 5.00% 4.00% 400 BPS 3.00% 120 BPS 2.00% 1.00% Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan Year MMD 10-Year US Treasury 4

5 The big bang in the short-term bond universe occurred last summer. An article in the October 30, 2013 Wall Street Journal describes the dramatic improvement in yields on taxable GSE Fannie/ Freddie risk share securities in 3 months since Chairman Bernanke s threat to pull $85 billion per month stimulus in June. The price on M-2 Class of Freddie Mac Structured Agency Credit Risk Notes (a hybrid GSE/ private credit) soared from $105 to about $118 and yield fell almost a third - from 7.3% in July to 4.67% in late October. 5

6 Markets in 100% GSE backed securities (like the ones we use) are less volatile. But these yields also fell relative to long-term credits. Why? What happened? 1. The market believes that the tapering of Fed MBS purchases suggests economic and housing recovery is real strengthens Fannie and Freddie 2. Both GSE s are now quite profitable have fully reimbursed the $188 billion of federal bailout funds; federal government needs money; perhaps a better political future in Congress??? 6

7 3. We now have a new head of Fannie and Freddie s regulator, the Federal Housing Finance Administration, Mel Watt, who is dramatically more friendly to the mission of affordable housing than his predecessor, Edward DeMarco. 4. Most important, regrowth in private capital for housing since private securitization markets largely destroyed in Fall of 2008 has been painfully slow. Two GSE s plus FHA still provide 90% of funding for U.S. housing loans (single family and multifamily) versus about 60% before financial crisis. Federal Government s (FHA/Fannie/Freddie) Role in US Mortgage Originations Wall Street Journal September 6,

8 Federal Government (FHA/Fannie/Freddie) v. Private Credit in US Mortgage Markets Wall Street Journal August 6, 2013 Regrowth in private mortgage credit in the US since the securitization markets were virtually destroyed in the 2008 financial crisis has been anemic at best. 8

9 Notice two things about the orange bars atop the green bars for in the chart above: (i) They are teenie weanie, and (ii) They are hardly growing. Implies Fannie Mae and Freddie Mac may be restructured, but government credit will play huge role in U.S. mortgage markets until private capital can be enticed back in. This would significantly raise mortgage interest rates, which presents a major policy dilemma for the US government. All of the above suggests that the markets are coming to view Fannie Mae and Freddie Mac as much better long-term credits than previously thought. Much like Ginnie Mae and the U.S. Government and perhaps better than any long-term private credits. 9

10 As a result of these developments, the pricing on these Freddie Mac and Fannie Mae credits has recently improved versus other credits, including long-term municipal bonds. A developer can now achieve a lower all-in borrowing rate by selling a Freddie or Fannie mod rehab loan in the taxable market, rather than putting the same Freddie or Fannie credit backed 18-year fixed rate municipal bonds. On a Freddie Mac mod rehab loan, the Freddie Mac Lender will fully fund the affordable housing loan at closing (except for certain rehab escrows). Freddie Mac will then simply purchase the loan from the Freddie Mac Lender two to three weeks post-closing. In the case of a Fannie Mae moderate rehabilitation affordable housing loan, the Fannie Mae Lender can wrap the taxable loan with a Fannie Mae Mortgage Backed Security ( MBS ), which the Fannie Mae Lender can simply sell in the taxable marketplace for MBS securities. 10

11 In today s markets, such loans may be sold at interest rates producing an all-in borrowing cost of about 5.5% to 5.60% versus 6.00% for an 18-year Freddie/Fannie backed municipal bond financed loan. Moreover, due to certain regulatory priorities at Freddie Mac vis-à-vis the Federal Housing Finance Administration, as its GSE regulator, if a project has roughly 50% or more of its tenants at income levels of 50% of AMI or lower (due to Section 8 subsidy or other factors), at least for the time being, Freddie Mac will purchase the taxable loan at rates as low as 5.0% to 5.25%. 11

12 Estimated All-In Borrowing Rates from Alternative Executions FHA Insured Short-Term Cash Backed Tax-Exempt Bond + Taxable Loan Sale Long-term (18, 35 or 40-year) Tax- Exempt Bonds Backed by FHA/GNMA, Freddie Mac or Fannie Mae Estimated Approximate Savings in Rate Section 223(f) (Acq/ Mod Rehab) 4.50% v. 5.40% 0.90% Section 221(d)(4) (New Cons/ Sub Rehab) 5.00% v. 5.45% 0.45% Plus: Long-term Bonds. Dramatic Reduction in Construction Period Negative Arbitrage; 1%-1.5% v. 8-10% for Freddie Mac or Fannie Mae Moderate Rehab Loans 60% affordability) 5.50% 5.75% v. 6.00% 0.25% to 0.50% Freddie Mac (>50% of units at <50% of AMI) 5.0% to 5.25% v. 6.00% 0.75% to 1.00% 12

13 TAXABLE FREDDIE MAC OR FANNIE MAE SALE WITH TAX EXEMPT BONDS AND 4% LIHTC 1 2 Yr Bonds Trustee 9 Bond Payoff (after Project is placed in service) Bond Purchaser Borrower 3 6 Bond Proceeds 2 Cash Paper / Securities Project Fund Borrower s Submits Full Loan Draw Request at Closing Bond Proceeds Disbursement to Borrower to cover project costs at Closing 5 Collateral Fund Tax Exempt Bond Proceeds Bond Proceeds equal to Collateral Fund Deposit (to Lender Released or Borrower to Lender/ Borrower at Closing) Freddie Mac or Fannie Mae Lender Lender delivers full Loan to Freddie or Fannie MBS to MBS Purchaser (after Closing 2 3 weeks) Benefits: Qualifies for 4% LIHTC; 0.5% to 1.0% Reduction in Mortgage Rate 4 8 Lender Funds Full Loan Advance from its funds into Collateral Fund at Closing 7 Freddie Mac or Fannie Mae MBS Purchaser Freddie Mac or Fannie Mae MBS Purchaser delivers Loan purchase price to Lender 13

14 Dramatic Growth in Short-Term Cash Backed Bonds Coupled With Freddie Mac and Fannie Mae Mod Rehab Loans We reached out to three of our clients who are active underwriters and/or purchasers of shortterm cash backed bonds on these financings and we asked them identify by taxable loan type the number and dollar bond volume of short-term cash backed bond financings they closed in the first half of 2013, and the number and dollar bond volume by loan type they closed in the second half of Analysis of 2013 Short Term Cash Backed Tax Exempt Bond Financings By Three Leading Underwriters/Purchasers First Half 2013 FHA 223 (f) FHA 221(d)(4) Freddie Mac Fannie Mae Total 1st Half 2013 Firm 1 4 $ 52,700,000 4 $ 61,250,000 0 $ 0 $ $ 113,950,000 Firm 2 4 $ 48,000,000 2 $ 10,250,000 0 $ 0 $ $ 58,250,000 Firm 3 0 $ 2 $ 16,100,000 0 $ 1 $ 4,600,000 $ 20,700,000 Total 8 $ 100,700,000 8 $ 87,600,000 0 $ 1 $ 4,600,000 $ 192,900,000 Second Half 2013 FHA 223 (f) FHA 221(d)(4) Freddie Mac Fannie Mae Total 2nd Half 2013 Firm 1 1 $ 8,900,000 3 $ 29,900,000 4 $ 78,200,000 1 $ 25,000,000 $ 142,000,000 Firm 2 0 $ 8 $ 82,700,000 0 $ 1 $ 47,000,000 $ 129,700,000 Firm 3 0 $ 0 $ 1 $ 6,900,000 4 $ 86,600,000 $ 93,500,000 Total 1 $ 8,900, $ 112,600,000 5 $ 85,100,000 6 $ 158,600,000 $ 365,200,000 Summary Second Half 2013 Freddie/ Fannie ,700,000 FHA/ GNMA ,500, % or 2/3 of Market 33.3% or 1/3 of Market 14

15 Dramatic Growth in Short-Term Cash Backed Bonds Coupled With Freddie Mac and Fannie Mae Mod Rehab Loans (Cont.) Even a quick review of the chart above shows the significant role GSE mod rehab loans now play in these financings. During the first half of 2013, according to our rough sample, only one loan out of 17 representing only about 3% of the $193 million total volume comprised a GSE loan. During the second half of the year, as the GSE executions began to work with the dramatic drop in taxable rates on those loans, total short-term cash backed volume for these purchasers increased by over 50% to $365 million. Of these 23 transactions, 11 represented Freddie Mac and Fannie Mae mod rehab loans and, since these loans tend to be larger, almost two thirds of the total dollar volume of these bond financings. 15

16 Note that under the new structure, one only has to issue tax-exempt bonds in an amount sufficient to satisfy the 50% Rule, which may be significantly less than the taxable loan amount. This can further reduce financing costs. Since the short-term tax-exempt bonds under this structure would typically bear interest at rates of 0.45% to 0.65%, actual negative arbitrage should be limited to less than 1% of the loan amount versus 2-3% or higher under the traditional long-term tax-exempt bond financing structure. We have also made certain changes in eligible investments which can give a slight boost to reinvestment yields, while still giving borrower the right to redeem bonds as soon as project placed in service. 16

17 Since its inception five years ago, the use of short-term cash backed tax-exempt bonds with taxable long-term loan sales has now been approved by almost all of the country s largest bond counsel firms. Probably well over 50 financings using this structure have now closed, and many more are now under way. The use of short-term cash backed tax-exempt bonds with taxable loan sales has now also been approved and used on financings with almost all HUD offices, as well as by Freddie Mac and Fannie Mae. The structure has become the universally accepted (get it?) new method for financing 100% affordable housing projects using FHA insurance and, more recently, for moderate rehabilitation Freddie Mac and Fannie Mae affordable housing loans. There is no limit to how much we enjoy closing deals please call us with any questions! 17