United States General Accounting Office

GAO Report to Congressional Committees

April 1998 HOUSING FINANCE

FHA’s Risk-Sharing

Programs Offer

Alternatives for

Financing Affordable

Multifamily Housing

GAO/RCED-98-117

GAO United States

General Accounting Office

Washington, D.C. 20548

Resources, Community, and

Economic Development Division

B-277226 

April 23, 1998

Congressional Committees

This report responds to a mandate in the Housing and Community Development Act of 1992

(P.L. 102-550) that we evaluate the risk-sharing demonstration programs established under

section 542 of the act. More specifically, the report looks at how well the programs are meeting

their goals, identifies the benefits for participating financial institutions and HUD, and considers

opportunities for improving the programs and HUD’s administration of them. The report makes

recommendations designed to encourage greater activity in the reinsurance program and to

improve HUD’s monitoring and oversight of the federal government’s risk-sharing partners.

We are sending copies of this report to the appropriate congressional committees and to the

Secretary of HUD. Copies are available to others upon request.

If you or your staff have any questions, please call me at (202) 512-7631. Major contributors to

this report are listed in appendix X.

Sincerely yours,

Judy A. England-Joseph

Director, Housing and Community

 Development Issues
B-277226 

List of Committees

The Honorable Connie Mack

Chairman

The Honorable John Kerry

Ranking Minority Member

Subcommittee on Housing Opportunity

 and Community Development

Committee on Banking, Housing,

 and Urban Affairs

United States Senate

The Honorable Rick A. Lazio

Chairman

The Honorable Joseph P. Kennedy II

Ranking Minority Member

Subcommittee on Housing

 and Community Opportunity

Committee on Banking and Financial

 Services House of Representatives

Page 2 GAO/RCED-98-117 Housing Finance
B-277226 

Page 3 GAO/RCED-98-117 Housing Finance
Executive Summary

Purpose During the 1980s, a decline in the production of affordable housing and an

increase in the number of low-income households meant that more

low-income households were unable to obtain affordable housing.

Although the Congress wished to expand access to capital for the

production of affordable housing, it had concerns about risk after the

federal government lost over $2 billion from defaults on multifamily

mortgage loans insured through the former coinsurance program,

administered by the Department of Housing and Urban Development’s

(HUD) Federal Housing Administration (FHA). Accordingly, in the Housing

and Community Development Act of 1992, the Congress established two

new risk-sharing demonstration programs that divide the financial liability

for any defaults between the federal government and its risk-sharing

partners—state housing finance agencies or other qualified financial

institutions.

This report responds to a requirement in the act that GAO review these two

risk-sharing demonstration programs and HUD’s administration of them, as

well as identify any opportunities for improvement. More specifically, the

report looks at how well the programs are meeting their goals, identifies

their benefits for participating financial institutions and HUD, and considers

opportunities for improving the programs and their administration.

Background The two risk-sharing demonstration programs established by the 1992 act

offer incentives to financial institutions to facilitate the financing of

affordable multifamily housing. One program provides credit

enhancement1

 to state and local housing finance agencies, while the other

provides reinsurance2

 to qualified financial institutions. Both programs

rely on risk sharing to ensure sound financial management and delegation

to increase the efficiency and lower the costs of providing the credit

enhancements. The demonstration programs differ from FHA’s traditional

mortgage insurance programs in that FHA (1) assumes only a portion

(generally 50 percent), rather than all, of the risk of loss and (2) delegates,

rather than performs, loan-processing and asset management functions.

While the former coinsurance program also relied on risk sharing and

delegation, the demonstration programs establish additional requirements

1

A credit enhancement, such as mortgage insurance, transfers some of the risk of loss from the lender

to the credit enhancer. When the federal government assumes a portion of a lender’s risk under a

risk-sharing agreement, the lender may derive benefits, such as a higher bond rating, that may be

passed on to borrowers and tenants in the form of lower costs.

2

Reinsurance is a form of credit enhancement that occurs after the original financing has taken place.

Like mortgage insurance, it increases a loan’s security by committing the federal government to pay a

portion of any losses incurred through default.

Page 4 GAO/RCED-98-117 Housing Finance
Executive Summary

to protect the government’s financial interests, including more stringent

standards for participation and larger reserve requirements. The

demonstration programs are unique in requiring that FHA’s credit

enhancements be used only for properties that qualify as affordable

housing.3

Under FHA’s traditional mortgage insurance programs, insurance authority

is limited by a dollar cap, which the Congress has periodically adjusted

upward to accommodate increased demand. Under the demonstration

programs, insurance authority is restricted to a fixed number of units. To

date, the Congress has authorized 49,500 units for the credit enhancement

program and 22,500 units for the reinsurance program. HUD recently

recommended, as part of a comprehensive legislative proposal to reform

FHA’s multifamily programs, that both programs be made permanent and

subject to the same kind of insurance authority as FHA’s other mortgage

insurance programs. Bills consistent with HUD’s proposal were introduced

in both the Senate and the House in 1997 and were pending in committees

as of January 1998.

Results in Brief The credit enhancement program, together with the reinsurance program,

was established under the Housing and Community Development Act of

1992 to facilitate the financing of affordable multifamily housing and to

make that financing available in a timely manner. The credit enhancement

program is meeting these goals. As of September 1997, the 32 participating

state and local housing finance agencies had reserved4

 about 84 percent of

the risk-sharing units allocated to these agencies through March 1996.

Most of the insured loans are financing properties that serve more

low-income households than required, apparently because the credit

enhancement is being used with other subsidies, particularly low-income

housing tax credits. While it is still too soon to evaluate the financial

performance of the insured loans, the available financial indicators reflect

sound underwriting standards. Participation in the credit enhancement

program has enabled the housing finance agencies to leverage their

reserves and insure loans more quickly. According to the participating

3

That is, at least 20 percent of a property’s units must be rent restricted and occupied by households

whose incomes, adjusted for household size, do not exceed 50 percent of the local area’s median

income, or at least 40 percent (25 percent in New York City) of the property’s units must be rent

restricted and occupied by households whose adjusted incomes do not exceed 60 percent of the area’s

median income.

4

Because insurance authority is provided in risk-sharing units rather than dollars, HUD allocates a

fixed number of units to a participating financial institution, and the institution then reserves these

units for properties whose loans it decides to insure or reinsure. For each property, the number of

risk-sharing units reserved is equal to the number of dwelling units.

Page 5 GAO/RCED-98-117 Housing Finance
Executive Summary

agencies, the program would be improved if it were made permanent and

the current limits on the number of available risk-sharing units were lifted.

These changes, they said, would enable them to market the program and

manage their resources for multifamily programs more effectively.

Activity in the reinsurance program has been so limited that the program

remains largely untested. Only one institution—Fannie Mae—has

participated extensively in the program, and one lender—Banc One

Capital Funding Corporation—has originated over half of the loans that

Fannie Mae has reinsured. Banc One’s activity has demonstrated that the

risk-sharing reinsurance program can expand participation in mortgage

lending, including lending for smaller properties in rural areas—an unmet

capital need, according to HUD’s studies. However, for a variety of reasons,

HUD’s other risk-sharing partners have reserved few or none of their

risk-sharing units. Opportunities to expand participation include

reallocating unused units to Fannie Mae and allowing the use of

risk-sharing reinsurance (1) with 18-year balloon mortgages—an option

that is currently available only to Fannie Mae—and (2) with loan pools as

well as individual loans.

Participation in the demonstration programs has enabled HUD to facilitate

the financing of affordable multifamily housing while limiting its loss

exposure through risk sharing. Participation has also allowed HUD to

increase the efficiency and reduce the costs of its operations through

delegation, compared with FHA’s traditional multifamily programs. HUD has

retained responsibility for monitoring its risk-sharing partners’

performance, but its data system for monitoring the progress of credit

enhancement projects is unreliable. HUD is aware of the system’s problems

and plans to resolve them in the course of overhauling all of its

information management systems. HUD has also retained responsibility for

overseeing its risk-sharing partners’ compliance with the demonstration

programs’ requirements; however, GAO’s review identified one default that

was not reported to HUD headquarters for over a year. HUD recognizes that

effective oversight is critical, particularly if one or both of the

demonstration programs are made permanent and lenders’ activity

increases.

Page 6 GAO/RCED-98-117 Housing Finance
Executive Summary

Principal Findings

The Credit Enhancement

Program Has Facilitated

the Financing of

Affordable Multifamily

Housing

Through the credit enhancement program, housing finance agencies are

insuring loans for newly constructed and substantially rehabilitated

properties serving families and the elderly in urban, suburban, and rural

areas. All of the completed properties are meeting, and many are

exceeding, the credit enhancement program’s income-targeting

requirements. About three-quarters of the properties that are exceeding

these requirements also receive other subsidies—usually low-income

housing tax credits—that have income restrictions at least as stringent as

the credit enhancement program’s.

For most housing finance agencies, the greatest benefit of participation in

the credit enhancement program is the ability to leverage their reserves by

the percentage of risk that HUD assumes for each risk-sharing loan.

Because HUD has assumed 50 percent of the risk for loans financing about

90 percent of the risk-sharing units, the participating agencies have

generally been able to cut their reserve requirements for risk-sharing loans

in half, effectively doubling their financing capacity. Other benefits of

participation include administrative efficiencies and, in some instances,

lower interest rates or longer loan terms compared with other forms of

credit enhancement.

Housing finance agencies believe that making the credit enhancement

program permanent and removing the current limits on the number of

available risk-sharing units would assist them in marketing the program

and managing their multifamily resources. Such changes would also allow

them to keep up with the demand for risk-sharing units, which—given

their frequent use of the credit enhancement program to insure loans for

properties financed with low-income housing tax credits—is likely to

increase if pending bills proposing to raise the states’ per-capita tax credit

allocations are enacted. Finally, permanency would be consistent with the

recently enacted authority allowing the risk-sharing program to assist HUD

in its mark-to-market program.5

5

This program is designed to refinance the mortgages of subsidized multifamily properties to bring

their rents in line with market rents.

Page 7 GAO/RCED-98-117 Housing Finance
Executive Summary

The Reinsurance Program

Has Potential but Has Not

Been Tested

HUD’s current and designated partners in the reinsurance program

represent a wide range of qualified financial institutions with the potential

to expand mortgage lending at the national, regional, and local levels.

However, Fannie Mae is the only partner that has reserved all of its

allocation (7,500 units), and Banc One Capital Funding Corporation has

originated 28 of the 48 loans that Fannie Mae has agreed to reinsure.

Compared with the properties securing other loans that Fannie Mae has

agreed to reinsure, Banc One Capital Funding Corporation generally

finances smaller properties in smaller communities. Six properties had

been completed as of October 31, 1997. All six are meeting, and four are

exceeding, the program’s income-targeting requirements; five of these

properties are also partially financed with low-income housing tax credits.

Fannie Mae has been able to use its allocation because it has (1) a product

line that, like the reinsurance program, relies on delegating responsibility

and (2) flexible underwriting standards that are suitable for affordable

housing. Participation in the reinsurance program has enabled Fannie

Mae’s lenders to reduce their reserve requirements by 50 percent, thereby

doubling their financing capacity. The administrative efficiencies gained

through delegation—both from HUD to Fannie Mae and from Fannie Mae to

its lenders—have expedited the processing and reduced the transaction

costs of loans reinsured through the program.

HUD’s other current and designated risk-sharing partners have reserved a

small fraction or none of their risk-sharing units or have not signed

risk-sharing agreements with HUD for various reasons, many of them

particular to the individual institutions. For example, Freddie Mac has

reserved 538 of its 5,000 units for one property. Several factors have

limited its participation, including the fact that most of the loans it

purchases are balloon mortgages, which are not eligible for reinsurance

under its risk-sharing agreement.6

 Similarly, two loan consortia7 with

which HUD is currently negotiating risk-sharing agreements—the

Community Preservation Corporation (CPC) and the California Community

Reinvestment Corporation (CCRC)—will generally not have the loan

volumes needed to participate in the program unless their risk-sharing

agreements provide for reinsuring multiple loans (loan pools) as well as

individual loans.

6

Specifically, the risk-sharing agreement requires that all reinsured loans be fully amortizing—that is,

the entire principal is to be repaid within the term of the loan. Balloon mortgages are not fully

amortizing; at the end of the loan term, a substantial portion of the principal remains to be repaid,

usually through refinancing.

7

Associations of commercial banks and thrifts formed to finance affordable housing, particularly

multifamily housing.

Page 8 GAO/RCED-98-117 Housing Finance
Executive Summary

Given the limited activity in the reinsurance program to date,

opportunities for improvement consist primarily of providing additional

units to Fannie Mae, considering changes to existing risk-sharing

agreements that could facilitate participation, concluding risk-sharing

agreements with the loan consortia, and giving two new risk-sharing

partners—the State of New York Mortgage Agency (SONYMA) and the

Federal Home Loan Bank of New York—time to use their risk-sharing

units. HUD has said that it will reallocate 2,000 unused units to Fannie Mae,

and it is considering changes to Freddie Mac’s risk-sharing agreement. The

use of reinsurance with loan pools is authorized under the act and could

enable the loan consortia to participate.

HUD Is Assuming a

Smaller Percentage of Risk

and Lowering Its

Administrative Costs, but

Its Data System and

Oversight Have

Weaknesses

Through the risk-sharing programs, compared with the traditional

mortgage insurance programs, HUD has cut its per-loan loss exposure in

half8

 and dramatically decreased the time taken to process mortgage

insurance. According to HUD officials, they need about 80 hours to process

loans for risk-sharing projects, compared with about 880 hours for

traditional projects.

The data management system that HUD has established to track and

monitor the progress of projects in the credit enhancement program is

user unfriendly and largely unreliable. It has no edit function, cannot

generate paper printouts, and contains no definitions of required data

elements. HUD is overhauling and integrating its information management

systems and believes that personal-computer-based software applications

would be sufficient for tracking, monitoring, and reporting information for

the credit enhancement program. While HUD has established procedures

for overseeing the risk-sharing activities of participating financial

institutions, it has not always overseen compliance with these procedures.

For example, HUD headquarters was not notified that a risk-sharing loan

had been in default for over a year.

Recommendations GAO recommends that the Secretary of Housing and Urban Development

direct the Commissioner, Federal Housing Administration, to explore the

feasibility of amending HUD’s current risk-sharing agreements with

qualified financial institutions, as necessary, to allow the use of

reinsurance with 18-year balloon mortgages and loan pools. GAO also

8

To the extent that the risk-sharing programs expand the volume of multifamily loans that HUD would

not have insured otherwise, the federal government’s loss exposure is increased. However, losses are

incurred only to the extent that the premiums HUD charges for its credit enhancement or reinsurance

do not cover its costs associated with defaults.

Page 9 GAO/RCED-98-117 Housing Finance
Executive Summary

recommends that the Secretary correct current flaws in the information

management systems supporting the risk-sharing demonstration programs

and give priority to implementing a comprehensive monitoring system to

ensure compliance and timely reporting.

Agency Comments HUD agreed with GAO’s recommendations and said that it was taking or

planned to take steps to implement them.

Page 10 GAO/RCED-98-117 Housing Finance
Page 11 GAO/RCED-98-117 Housing Finance
Contents

Executive Summary 4

Chapter 1 

Introduction

16

Multifamily Production Declined While More Households Sought

Affordable Housing

16

Credit Enhancements Complement Housing Subsidies 17

Demonstration Programs Were Designed to Overcome Flaws in

FHA’s Earlier Mortgage Insurance Programs

18

Demonstration Programs Test Risk Sharing as a Means of

Providing Credit Enhancement

20

Objectives, Scope, and Methodology 26

Chapter 2 

The Risk-Sharing

Credit Enhancement

Program Is

Supporting the

Financing of

Affordable

Multifamily Housing

29

Unit Allocation and Use Vary Widely Among Housing Finance

Agencies

29

Program Is Helping to Finance Properties Serving Diverse

Markets and Income Groups

32

Housing Finance Agencies Have Derived Key Benefits From Their

Participation in the Credit Enhancement Program

36

Agencies’ Reasons for Not Participating in the Credit

Enhancement Program Varied

43

Changes to the Credit Enhancement Program Could Facilitate the

Financing of Affordable Multifamily Housing

44

Conclusions 48

Chapter 3 

The Risk-Sharing

Reinsurance Program

Is Largely Untested

Because Participation

Has Been Limited

50

Partnerships Create the Potential for Wider Lending 50

Only One Institution Has Been Active in the Risk-Sharing

Reinsurance Program

51

Fannie Mae’s Risk-Sharing Properties Vary in Size, Targeted

Income Levels, and Geographic Location

54

Other Original Participants Cited Individual Reasons for Not

Using the Program

59

More Recent Participants Have Not Had Time for Much Activity 61

Opportunities for Greater Participation Exist 62

Conclusions 66

Recommendations 67

Agency Comments 67

Page 12 GAO/RCED-98-117 Housing Finance
Contents

Chapter 4 

Risk-Sharing Limits

HUD’s Loss Exposure

and Reduces

Administrative Costs,

but Information

Systems and

Oversight Need

Improvement

69

Participation in the Risk-Sharing Demonstration Programs Limit

Government’s Exposure to Losses

69

HUD Has Derived Administrative Benefits Through Its

Participation in the Risk-Sharing Programs

72

Information Systems Are Not Reliable 73

HUD Recognizes That Programs’ Future Expansion Requires

Effective Administrative Controls

78

Conclusions 80

Recommendations 81

Agency Comments 81

Appendixes Appendix I: Allocations and Reservations of 42,000 Units by

Housing Finance Agencies With Risk-Sharing Agreements as of

September 1997

84

Appendix II: Allocation of 49,500 Units to Housing Finance

Agencies With Risk-Sharing Agreements as of October 1997

86

Appendix III: Location of Units Reserved for Completed and

Pipeline Properties as of September 1997

87

Appendix IV: Type of Construction for Units Reserved for

Completed and Pipeline Properties as of September 1997

89

Appendix V: Units in Completed Properties, by Size, as of

September 1997

91

Appendix VI: Income Levels Served by Completed Units in the

Credit Enhancement Program as of September 1997

92

Appendix VII: Profile of Selected Loan Consortia’s Multifamily

Loan Portfolios

93

Appendix VIII: Indicators of Financial Soundness of Housing

Finance Agencies

95

Appendix IX: Comments From the Department of Housing and

Urban Development

97

Appendix X: Major Contributors to This Report 100

Tables Table 2.1 Debt Service Coverage Ratio for Insured Properties as

of September 1997

41

Table 2.2: Loan-to-Value Ratio for Insured Units as of

September 1997

42

Table 2.3: Housing Finance Agencies’ Reasons for Not

Participating in the Credit Enhancement Program

43

Page 13 GAO/RCED-98-117 Housing Finance
Contents

 Table 3.1: Activity in the Risk-Sharing Reinsurance Program, as

of October 31, 1997

52

 Table 3.2: Distribution of Fannie Mae’s Risk-Sharing Units, by

Property Size

54

Table 4.1: Percentage of Risk Assumed by Housing Finance

Agencies for Insured Properties

70

Table VII.1: Characteristics of Loan Consortia’s Multifamily Loan

Portfolios

93

Table VII.2: Additional Characteristics of Loan Consortia’s

Multifamily Loan Portfolios

94

Figures Figure 2.1: Percentage of Allocations Reserved, by Number of

Agencies, as of September 1997

31

Figure 2.2: Percentage of Total Units, by Size, of Completed

Properties as of September 1997

34

Figure 3.1: Fannie Mae’s Risk-Sharing Activity, 1995 through 1997 53

Abbreviations

CCRC California Community Reinvestment Corporation

CDBG Community Development Block Grant

CPC Community Preservation Corporation

CRC Community Reinvestment Corporation

DUS Delegated Underwriting and Servicing

FHA Federal Housing Administration

FHLB Federal Home Loan Bank

GAO General Accounting Office

GGD General Government Division

Ginnie Mae Government National Mortgage Association

HUD Department of Housing and Urban Development

NCB National Cooperative Bank

OTS Office of Thrift Supervision

RCED Resources Community and Economic Development

Division

RSS Risk-Sharing Multifamily National System

SAMCO Savings Associations Mortgage Company

SONYMA State of New York Mortgage Agency

Page 14 GAO/RCED-98-117 Housing Finance
Page 15 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

During the 1980s, a decline in the production of affordable housing,

coupled with an increase in the number of low-income households,1

reduced the availability of affordable housing for low-income households.

Although the federal government wished to expand the availability of

affordable housing, particularly multifamily housing, reductions in federal

spending precluded increases in housing subsidies—the federal

government’s primary means of making rental housing affordable to

low-income households. In addition, federal credit enhancements, such as

mortgage insurance or reinsurance, came under increased public scrutiny

after the federal government lost nearly $2.4 billion by 1992 from defaults

on multifamily mortgage loans insured through its former coinsurance

program—a program delegating federal loan-processing and asset

management functions to approved lenders that HUD implemented in 1983

to meet the market’s demands for multifamily mortgage insurance.

To stimulate the production of affordable multifamily housing and to gain

the administrative efficiencies but avoid the risks of the coinsurance

program, the Congress, in the Housing and Community Development Act

of 1992, authorized two new risk-sharing demonstration programs. These

programs (1) provide credit enhancements to encourage the financing of

affordable multifamily housing and (2) divide the financial liability for any

default between the federal government and the financial institutions and

agencies selected to become its risk-sharing partners.

This report responds to a requirement in the 1992 legislation that we

review these two risk-sharing demonstration programs as well as identify

any opportunities for improvement. More specifically, the report looks at

how well the programs are meeting their goals, identifies their benefits for

participating financial institutions and the Department of Housing and

Urban Development (HUD), and considers opportunities for improving the

programs and HUD’s administration of them.

Multifamily

Production Declined

While More

Households Sought

Affordable Housing

In establishing the risk-sharing demonstration programs, the Congress

recognized that the production of multifamily housing had been declining

steadily since the mid-1980s. According to Senate Report 102-3322

 and

studies of the multifamily mortgage markets conducted in the early 1990s,

several key factors were responsible for this decline. Among the more

important were (1) changes in government policies and regulations on

taxation, banking, and housing subsidies; (2) a sharp decline in multifamily

1

Households with incomes at or below 80 percent of the local area’s median income.

2

Senate Report 102-332 is part of the legislative history for the Housing and Community Development

Act of 1992.

Page 16 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

mortgage credit enhancement by the Federal Housing Administration

(FHA); and (3) the withdrawal from the multifamily secondary market3

 by

Freddie Mac (formerly the Federal Home Loan Mortgage Corporation).

As we reported in 1993,4

 more households were seeking affordable

multifamily housing at the same time as the production of such housing

declined. Studies issued since 1993 have identified the types of multifamily

properties that are needed and the areas where multifamily housing is

needed. According to a 1995 HUD analysis,5

 unmet capital needs include

smaller properties, larger rehabilitation projects, and housing for the

elderly. Affordable new construction is also needed in high-growth

markets. Inner-city neighborhoods and rural areas are commonly

identified as “underserved housing markets” that often require smaller

properties, both subsidized and unsubsidized. However, because these

smaller properties have proportionally high transaction costs and low fees,

they are less attractive to lenders than larger properties when interest

rates are equivalent. The complexity often associated with the multiple

subsidies needed to finance affordable housing also acts as a deterrent.

According to HUD’s 1995 analysis, the secondary market has generally not

been active in purchasing rehabilitation loans. Such loans are needed in

inner-city neighborhoods to preserve low-cost housing units, stabilize

neighborhoods, and improve housing conditions for low-income residents.

The study concludes that without rehabilitation loans, many properties in

inner-city neighborhoods will be demolished or abandoned.

Credit Enhancements

Complement Housing

Subsidies

Governments have several tools, apart from public housing, that they can

use to make multifamily housing more affordable—(1) rental subsidies to

make up the shortfall between the rents that tenants can afford and the

rents that landlords must charge to cover their costs and earn a profit,

(2) grants and favorable tax treatment to lower the costs of building or

operating housing, and (3) credit enhancements, such as mortgage

insurance, to facilitate the financing of affordable housing. While subsidies

are the government’s primary means of making multifamily housing

affordable for low-income households, credit enhancements can

3

In what is called the secondary market, investors, such as pension funds, purchase securities backed

by long-term, fixed-rate mortgage loans as investments, thereby creating liquidity for primary lenders

and allowing them to make additional loans or otherwise reinvest the funds.

4

Housing Finance: Expanding Capital for Affordable Multifamily Housing (GAO/RCED-94-3, Oct. 27,

1993).

5

Economic Analysis, Office of Policy Development and Research, HUD (Nov. 1, 1995).

Page 17 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

complement subsidies by increasing the financing available for such

housing.

Credit enhancements transfer some of the risk of loss from the lender to

the credit enhancer, making loans more secure and encouraging both

mortgage lending and investment in mortgage loans. Specifically, credit

enhancements encourage primary lenders, such as commercial banks, to

make long-term, fixed-rate mortgage loans that they otherwise might not

make, and investors, such as pension funds, to buy these loans in the

secondary market. The sale of individual loans, or of securities backed by

pools of loans, returns funds to primary lenders, creating liquidity and

allowing the lenders to make additional loans or otherwise reinvest the

funds.

Credit enhancement can occur when a loan is originated or when it is sold

in the secondary market. If it occurs at the time of origination, such as

when a housing finance agency sells bonds to raise capital to lend to

developers of affordable multifamily housing, it can affect the terms of the

loan. Because the enhancement provides additional support—usually

through mortgage insurance—it improves the housing finance agency’s

bond rating. The housing finance agency can then obtain a lower interest

rate and/or a longer-term loan, the benefits of which it can pass along to

the affordable multifamily housing developer. In turn, the developer can

convey these benefits to tenants in the form of lower monthly rents. If the

credit enhancement occurs when the loan is sold in the secondary market,

it transfers the credit risk from the investor purchasing the loan to the

credit enhancer. At the same time as this transfer reduces the purchaser’s

credit risk, it reduces the seller’s reserve requirements, freeing capital for

further investment. The credit enhancement that occurs when a loan is

sold in the secondary market is called reinsurance.

Demonstration

Programs Were

Designed to

Overcome Flaws in

FHA’s Earlier

Mortgage Insurance

Programs

Under the traditional mortgage insurance programs, FHA is involved in all

aspects of lending—loan underwriting, loan servicing, asset management,

and property disposition. These tasks are time consuming and resource

intensive. As a result, FHA has traditionally been slow to approve loans

through these programs, and it incurs substantial staff costs.

In 1983, FHA implemented the coinsurance program to expedite loan

processing and gain administrative efficiencies by delegating many of its

mortgage underwriting, processing, monitoring, and foreclosure functions

to approved lenders. The coinsurance program achieved these objectives,

Page 18 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

but it also resulted in substantial losses to the federal government. Even

though the lenders assumed a portion of the credit risk for the loans they

approved, this portion was not supported by sufficient reserves to ensure

sound underwriting. In addition, the program’s fee structure created

incentives for the lenders to focus on the volume rather than the quality of

the loans they made. Furthermore, the lenders’ losses were insured by the

Government National Mortgage Administration (Ginnie Mae), a

government-sponsored enterprise. Thus, when defaults occurred and the

lenders’ reserves were not adequate to cover them, Ginnie Mae paid the

remaining balance and the federal government was ultimately responsible

for the losses.

Like the coinsurance program, the risk-sharing demonstration programs

are designed to expedite loan processing and gain administrative

efficiencies by delegating many of FHA’s traditional loan-processing and

asset management responsibilities to other entities. The demonstration

programs also resemble the coinsurance program in that they are designed

to share the risk of loss from default. However, the demonstration

programs differ from the coinsurance program in important ways,

reflecting lessons learned about flaws in the design of the coinsurance

program.

First, the demonstration programs establish higher standards for

participation than the coinsurance program. Entry into the demonstration

programs is limited to qualified financial institutions, such as

government-sponsored enterprises and state and local housing finance

agencies with strong track records in multifamily lending. The housing

finance agencies must meet standards of financial soundness and capable

management established by a nationally recognized credit rating agency or

have a dedicated reserve account with sufficient capital to meet the

agency’s outstanding obligations under the programs. The participating

institutions are either publicly chartered or are regulated by a state or

federal agency. In addition, their mission, like FHA’s, includes supporting

affordable housing. Thus, they are held accountable to public entities

other than FHA for ensuring that they have the financial capacity and

integrity to implement the risk-sharing programs. In contrast, FHA’s

partners in the coinsurance program were mortgage bankers

unaccountable to a third party.

Second, the risk-sharing partners generally bear a larger share of the risk

under the demonstration programs than under the coinsurance program.

In most instances, the risk is divided equally under the demonstration

Page 19 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

programs, whereas, under the coinsurance program, the lenders assumed

the first 5 percent of the losses on loans and shared any remaining losses

with FHA on a 15-percent/85-percent basis. The more equal division of risk

for most loans currently insured under the demonstration programs

creates stronger incentives for FHA’s risk-sharing partners to use sound

underwriting terms and service their loans diligently.

Third, the demonstration programs provide for FHA’s oversight of

compliance with their requirements for maintaining a high credit rating or

sufficient reserves. While the coinsurance program established reserve

requirements for lenders, these requirements were not adequate, and

neither FHA nor any other HUD authority monitored the lenders’ reserves.

Fourth, the demonstration programs explicitly preclude the use of Ginnie

Mae’s insurance with risk-sharing loans.

Demonstration

Programs Test Risk

Sharing as a Means of

Providing Credit

Enhancement

Section 542 of the Housing and Community Development Act of 1992

directs HUD, through FHA, to test the use of risk sharing as a means of

providing federal credit enhancements for multifamily loans. Through two

demonstration programs, HUD is to evaluate the effectiveness and

efficiency of entering into partnerships or other contractual arrangements,

including risk-sharing agreements, with qualified financial institutions

(subsection b) and with state and local housing finance agencies

(subsection c).

The key statutory objectives of the risk-sharing partnerships with qualified

financial institutions are to

• ensure that the qualified participating entities bear a share of the risk that

is sufficient to create strong, market-oriented incentives to maintain sound

underwriting and loan management practices;

• use the resources of FHA to assist in increasing multifamily lending as

needed;

• provide a more adequate supply of mortgage credit for sound multifamily

rental housing projects in underserved urban and rural markets;

• encourage major financial institutions to expand their participation in

mortgage lending;

• increase the efficiency, and lower the costs to the federal government, of

processing and servicing multifamily housing mortgage loans insured by

FHA; and

Page 20 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

• improve the quality and expertise of FHA staff and other resources, as

required for the sound management of reinsurance and other

market-oriented forms of credit enhancement.

The act does not explicitly apply these objectives to the risk-sharing

partnerships with state and local housing finance agencies. However, HUD

has explicitly incorporated two of these objectives—using the resources of

FHA to assist in increasing multifamily lending and increasing the efficiency

of processing and servicing multifamily mortgage loans—into its

regulations for implementing the demonstration program with state and

local housing finance agencies. Moreover, according to FHA’s

Commissioner, all six goals are reflected in the design and implementation

of the program with state and local housing finance agencies. In this

report, we refer to the subsection (b) program as the reinsurance program

and the subsection (c) program as the credit enhancement program.

While both demonstration programs transfer a percentage of the risk of

default to HUD’s risk-sharing partners, it is important to note that, to the

extent the programs promote the development of affordable multifamily

housing that HUD otherwise would not have insured, the federal

government’s loss exposure is increased. However, losses are incurred

only to the extent that the premium HUD charges for its credit

enhancement or reinsurance does not cover its costs associated with

defaults.

Risk-Sharing Reinsurance

Agreements Are Designed

to Expand Access to

Capital

The act authorizes HUD to enter into risk-sharing reinsurance agreements

with qualified financial institutions, three of which are named in the

legislation—Fannie Mae (formerly the Federal National Mortgage

Association), Freddie Mac, and the Federal Housing Finance Board, which

implicitly includes its 12-member Federal Home Loan banks. Qualified

housing finance agencies may also participate in the program. Fannie Mae

and Freddie Mac are both government-sponsored enterprises that function

as intermediaries in the secondary market, purchasing individual and

pooled mortgage loans from primary lenders for sale as mortgage-backed

securities to investors, such as pension funds and life insurance

companies. Although Fannie Mae and Freddie Mac are private

corporations and operate without explicit federal guarantees, they enjoy a

special relationship with the federal government because they are

federally chartered and, in the view of the investment community, have

implicit federal guarantees. The Federal Home Loan banks are not

technically secondary market intermediaries, but they perform a similar

Page 21 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

function by selling combined obligation bonds in the capital markets to

finance mortgage loans originated and held by their member institutions.

These member institutions include over 6,500 financial institutions,

primarily commercial banks and thrifts, and are located in every state.

Under the risk-sharing reinsurance program, the qualified financial

institutions are responsible for originating, underwriting, and servicing

loans; managing assets; and disposing of properties in accordance with the

terms of their risk-sharing agreements. The institutions may delegate these

responsibilities to approved lenders. Any proposed changes to the terms of

the risk-sharing agreements require HUD’s approval.

Each risk-sharing reinsurance agreement commits HUD to paying

50 percent of any loss arising from a borrower’s default. HUD’s risk-sharing

partner is responsible for paying the other 50 percent. If a borrower does

default, the risk-sharing partner will manage and dispose of the property

and pay all of the costs associated with the loan’s disposition. HUD will

then reimburse its partner for 50 percent of any eligible loss on the loan

specified in the risk-sharing agreement. The partner pays HUD an annual

risk sharing/reinsurance premium in an amount equal to 25 basis points 6

(0.25 percent) times the average unpaid principal balance on each

mortgage loan reinsured under the program.

Under the program, reinsurance may be provided for loans financing the

construction, substantial rehabilitation, refinancing, or acquisition of

affordable multifamily housing properties. To qualify as affordable, the

housing must satisfy the requirements of the Low-Income Housing Tax

Credit program.7

 In addition, the property must continue to qualify as

affordable for at least 15 years. When reinsurance is provided for

acquisition or refinancing loans, the properties must remain affordable for

at least 10 years beyond the terms specified in any existing commitments.

Not all loans for affordable multifamily housing projects are eligible for

reinsurance under the program. Specifically, loans for properties housing

transients or serving as hotels, for nursing homes, and for intermediate

care facilities are ineligible. In addition, HUD will not reinsure construction

loans or refinancing loans when the qualifying financial entity is the

6

Each basis point equals one-hundredth of a percent.

7

These requirements are that at least 20 percent of the units in a property must be rent restricted and

occupied by households with incomes no greater than 50 percent of the area’s median income, as

adjusted for each household’s size, or at least 40 percent of the units (25 percent in New York City)

must be rent restricted and occupied by households with incomes no greater than 60 percent of the

area’s median income, as adjusted for each household’s size.

Page 22 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

mortgagee or guarantor of the original loan. Moreover, HUD will not

provide reinsurance until a project is completed and at least 50-percent

occupied, although the risk-sharing partner may insure or purchase the

loan at any point. Finally, the risk-sharing partner assumes the initial costs

of originating the loan and any risk associated with a construction loan.

Although HUD delegates most of its traditional loan management

responsibilities to its risk-sharing reinsurance partners, it retains

monitoring and oversight functions. HUD headquarters monitors and

oversees the reinsurance program and maintains centralized data on the

credit enhancement program, while HUD field offices generally monitor and

oversee the credit enhancement program.

Risk-Sharing Credit

Enhancement Agreements

Are Designed to Encourage

Mortgage Lending

The act authorizes HUD to enter into risk-sharing agreements with state or

local housing finance agencies that are HUD-approved mortgagees in good

standing and have received HUD’s approval to participate. To receive such

approval, an agency must demonstrate its financial and administrative

strength by

• carrying a “top tier” designation from Standard and Poor’s or any other

nationally recognized rating agency; receiving an “A” rating on its general

obligation bonds; or otherwise demonstrating its capacity on the basis of

factors such as its experience in financing multifamily housing, fund

balances, administrative capabilities, investment policies, internal

controls, financial management, portfolio quality, and state or local

support;

• having at least 5 years’ experience in multifamily underwriting; and

• certifying that it does not have any outstanding civil rights violations

unless it is conforming to a court order or implementing a HUD-approved

compliance plan to correct the violation.

Under the risk-sharing credit enhancement program, loans for new

construction, substantial rehabilitation, and certain acquisitions and

refinancings are eligible for full mortgage insurance. Once a housing

finance agency presents HUD with the appropriate certification on a loan,

HUD will endorse 8 the loan. Housing finance agencies are responsible for

the full range of loan-processing and asset management activities.

Properties under the program are generally financed through bonds issued

by the housing finance agencies and secured by the mortgages on the

financed properties.

8

That is, make a formal commitment to insure a loan.

Page 23 GAO/RCED-98-117 Housing Finance
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Introduction

Through a risk-sharing agreement, a housing finance agency contracts

with HUD to assume from 10 to 90 percent of the risk of loss on each loan

that the agency underwrites. HUD, in turn, is responsible for assuming the

balance of the risk. The agency pays HUD an annual risk-sharing/credit

enhancement premium equal to 50 basis points times the percentage of

risk FHA has assumed, times the average unpaid principal balance on each

mortgage loan insured under the program.

If a foreclosure occurs, HUD is responsible for advancing 100 percent of the

outstanding principal balance to the agency so that the agency can repay

the investors. The agency is then responsible for disposing of the property,

determining the loss (if any), and repaying HUD as necessary to cover its

share of the loss as specified in the risk-sharing agreement.

Housing finance agencies that assume 50 to 90 percent of the risk on loans

are given level I approval and may use their own underwriting standards

and loan terms and conditions without further approval from HUD. HUD

allows these agencies to use their own standards because it believes that

they will exercise due diligence to protect both their interests and HUD’s.

Agencies that assume less than 50 percent of the risk are given level II

approval and must have their underwriting standards and loan terms and

conditions approved by HUD.

9

 The actual percentage of risk that an agency

assumes may vary from one loan to another but must be documented for

each loan.

To ensure that participating housing finance agencies have the resources

to cover potential losses, HUD has established certain financial reserve

requirements for them. Agencies with a top-tier designation or an overall

credit rating of “A” are not required to have additional reserves to meet

their obligations under the program so long as they maintain that

designation or rating. Agencies that do not meet either of these criteria

must establish a liquid asset reserve of at least $500,000, which must be

augmented with additional amounts at each loan closing. 10

Properties must meet the same requirements for tenants’ incomes and

rents as they would if they were being processed through the risk-sharing

9

When the loan-to-replacement cost ratio for a new or substantially rehabilitated property or the

loan-to-value ratio for an existing property is greater than or equal to 75 percent, the housing finance

agency assumes 25 percent of the loss. When these ratios are less than 75 percent, the agency can

choose to assume 10 percent or 25 percent of the loss.

10In addition to the $500,000, a housing finance agency must, at each loan closing, deposit 1 percent of

the mortgage amount for any amount up to $50 million, plus 75 basis points for any amount between

$50 million and $150 million, plus 50 basis points for any amount over $150 million.

Page 24 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

reinsurance program. HUD’s regulations specify that the housing must be

maintained as “affordable” for as long as the mortgage is insured under the

program. Furthermore, any projects financed with federal low-income

housing tax credits must remain affordable for at least 15 years to comply

with the Low-Income Housing Tax Credit program’s requirements.

Proposed Legislation

Would Make

Demonstration Programs

Permanent

To date, the Congress has authorized 49,500 units under the risk-sharing

credit enhancement program and 22,500 units under the risk-sharing

reinsurance program. HUD has allocated the units authorized under the

credit enhancement program to 32 housing finance agencies and the units

authorized under the reinsurance program to 8 financial institutions.

These agencies and institutions have, in turn, reserved11 their allocated

units for multifamily properties, which have either been completed or are

in the agencies’ pipelines. Most recently, a bill, H.R. 2406, proposed

authorizing 15,000 additional units for each program.

In 1997, HUD proposed, as part of a comprehensive legislative proposal to

reform FHA’s multifamily programs, to make both demonstration programs

permanent. Conceptually, the programs are consistent with the

transformation of the Department envisioned in its 2020 Management

Reform Plan.12 In this plan, HUD proposes to convert FHA’s traditional

multifamily insurance programs from retail to essentially wholesale

operations, under which FHA would rely primarily on mortgagees or

contractors to underwrite loans, manage assets, and dispose of properties.

According to HUD, permanency would allow the demonstration programs

to operate under the same rules as HUD’s other insurance programs.

In response to HUD’s proposal, H.R. 1433, introduced in April 1997, and S.

853, introduced in June 1997, included the proposal to make both

demonstration programs permanent. As of March 1998, the bills had been

referred to the House Committee on Banking and Financial Services and

the Senate Committee on Banking, Housing and Urban Affairs,

respectively. No further action has been taken on the bills to date.

11Throughout this report, the term “reserved” means that housing finance agencies and/or financial

institutions have set aside a portion of their allocated units for projects that are being developed (in

the pipeline) or are completed and have been insured by FHA.

12This plan proposes a fundamental overhaul of HUD’s management and delivery of services to ensure

the Department’s effectiveness into the 21st century.

Page 25 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

Objectives, Scope,

and Methodology

As required by the Housing and Community Development Act of 1992, this

report assesses HUD’s implementation of the risk-sharing demonstration

programs by evaluating how each (1) has been used to achieve its

statutory and/or regulatory goals, (2) has been administered, and (3) could

be improved to serve as a more effective source of housing finance.

To examine how the demonstration programs have been used to achieve

their statutory and regulatory goals, we reviewed their legislative history,

as well as key studies that documented problems in the capital market for

affordable multifamily housing and the congressional purpose in creating

the programs to address these problems. We also reviewed nationwide

data on the units authorized and allocated under the programs as of

September 1997. These data identify all participants and nonparticipants in

the demonstration programs, the units allocated to the participants, and

the types of properties supported by the programs.

To gain a firsthand perspective on the use and results of the credit

enhancement program, we visited seven housing finance agencies, which

accounted for over 65 percent of the units allocated to date. We also

conducted structured telephone interviews and focus groups with all less

active and nonparticipating housing finance agencies. In addition, we

visited and conducted structured telephone interviews with institutions

that have risk-sharing reinsurance agreements with HUD. Our purpose was

primarily to identify impediments to the program’s greater use and the

benefits these institutions had achieved to date. Finally, we (1) compared

the policies and procedures of the demonstration programs with those of

FHA’s traditional multifamily insurance programs to identify benefits

unique to the demonstration programs and (2) reviewed and analyzed data

on the characteristics and financial condition of the properties completed

and insured under the demonstration programs to further assess the

programs’ support of affordable multifamily housing.

To review the demonstration programs’ administration, we assessed HUD’s

(1) general administration of the programs and (2) monitoring of approved

projects and enforcement of the program’s requirements. As part of this

assessment, we reviewed the credit enhancement program’s regulations

and the risk-sharing agreements between HUD and selected participating

housing finance agencies and other qualified financial institutions. We also

interviewed officials from HUD headquarters and field offices, as well as

senior officials from the participating housing finance agencies and other

qualified financial institutions. Additionally, we held discussions with

representatives of all nonparticipating housing finance agencies and other

Page 26 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

key financial institutions to identify administrative impediments to their

participation.

To identify any opportunities for improving either the credit enhancement

or the reinsurance program, we held two separate focus groups with

commercial banks and loan consortia—entities created and funded by

banks and/or thrifts to provide financing for affordable housing

developments, particularly multifamily rental properties. We asked both

groups structured questions about their interest in participating in either

of the risk-sharing programs, whether indirectly through existing

participants or directly as participants in the reinsurance program.13 We

also asked them to identify the benefits they would expect to derive from

participating in these programs. In addition, we conducted a structured

telephone survey of participants in these focus groups to gain an

understanding of their experiences with affordable multifamily lending.

We conducted our work at HUD headquarters and selected field offices

throughout the country; the offices of the seven housing finance agencies

that accounted for over 65 percent of the units allocated under the credit

enhancement program (California; Colorado; Florida; Montgomery

County, Maryland; Massachusetts; New Jersey; and New York State); the

offices of five of the eight institutions that have received or are scheduled

to receive units under the reinsurance program (Fannie Mae, Freddie Mac,

the National Cooperative Bank, the Federal Home Loan Bank of New

York, and the State of New York Mortgage Agency); and the offices of the

Federal Housing Finance Board. To obtain additional perspectives on the

demonstration programs, we spoke with representatives of the 4 housing

finance agencies that, as of September 1997, had signed risk-sharing

agreements but had not reserved any units and of the 24 state housing

finance agencies that, as of that date, had not participated in the program.

We also either conducted structured phone interviews or held panel

discussions with representatives of the 23 remaining housing finance

agencies that had signed agreements and had participated to some degree

in the program. Finally, we spoke with representatives of the remaining

qualified financial institutions that either had signed agreements to

participate in the reinsurance program or had units allocated to them by

HUD but had not yet signed agreements as of February 1998.

We provided copies of a draft of this report to HUD for its review and

comment. The Department’s comments appear in appendix IX and are

13Because they were not housing finance agencies, they were not eligible to participate in the credit

enhancement program.

Page 27 GAO/RCED-98-117 Housing Finance
Chapter 1 

Introduction

discussed at the end of chapters 3 and 4. We also provided a copy of a

draft of this report to the National Council of State Housing Agencies and

copies of relevant portions of the draft of this report to Fannie Mae,

Freddie Mac, the Federal Housing Finance Board, the National

Cooperative Bank, the Federal Home Loan Bank of New York, the Federal

Home Loan Bank of Seattle, the State of New York Mortgage Agency, and

Banc One Capital Funding Corporation. These groups offered a number of

technical suggestions and clarifications, which we incorporated as

appropriate.

We conducted our review from April 1997 through March 1998 in

accordance with generally accepted government auditing standards. We

relied on data obtained from housing finance agencies and other qualified

financial institutions through the use of structured data collection

instruments. We determined that the data were generally reliable and

usable for our purposes.

Page 28 GAO/RCED-98-117 Housing Finance
Chapter 2 

The Risk-Sharing Credit Enhancement

Program Is Supporting the Financing of

Affordable Multifamily Housing

In the 32 states and localities with participating housing finance agencies,

the credit enhancement program is increasing access to capital markets

and thereby supporting the production of affordable multifamily housing.

Overall, about 84 percent of the 42,000 units allocated to these agencies

through 1996 have been reserved for properties that either have been

completed or are in the agencies’ pipelines. The properties include new

construction, rehabilitation, and refinancing in urban, suburban, and rural

areas. Most of the properties are serving more low-income households

than required because the credit enhancement is being combined with

other subsidies, especially low-income housing tax credits.

Participation in the credit enhancement program has enabled housing

finance agencies to increase their lending capacity, extend their loan

terms, lower their interest rates, and process loans more quickly than they

are able to do in their traditional multifamily insurance programs. As a

result, the agencies have been able to finance affordable housing more

efficiently, over longer periods of time. While it is still too early to evaluate

the financial performance of the properties insured through the program,

the available financial indicators appear to reflect sound underwriting

criteria. Agencies that have not participated in the program identified

several barriers to participation, some of which are beyond their control

and others of which could be eliminated through training, wider

marketing, or making the program permanent.

Participating agencies believe that they would derive even greater benefits

if the program were made permanent and the limits on the number of

authorized credit enhancement units were lifted. Agencies believe that

demand for the program will increase with anticipated increases in the

states’ tax credit allocations1

 and with HUD’s implementation of a

mark-to-market initiative, under which HUD will refinance subsidized rental

properties to bring their rents in line with local market rents.

Unit Allocation and

Use Vary Widely

Among Housing

Finance Agencies

To date, the Congress has authorized 49,500 units under the credit

enhancement program. These units were made available through three

separate authorizations. The first 30,000 units were authorized in October

1992 under the original statute establishing the program, the next 12,000

units were authorized in March 1996, and the last 7,500 units were

authorized in June 1997. As of September 1997, 28 state housing finance

1

The Low-Income Housing Tax Credit program is currently the largest federal program to fund the

development and rehabilitation of multifamily housing for low-income families. Each year, states are

allocated tax credits in an amount equal to $1.25 per resident. Legislation is being proposed to increase

this amount to $1.75.

Page 29 GAO/RCED-98-117 Housing Finance
Chapter 2 

The Risk-Sharing Credit Enhancement

Program Is Supporting the Financing of

Affordable Multifamily Housing

agencies and 4 local housing finance agencies2 had entered into

risk-sharing agreements with HUD and had received allocations.

According to HUD officials, HUD allocated the first 30,000 units on the basis

of the population of the states that had signed risk-sharing agreements

with HUD. It allocated the two subsequent authorizations on the basis of

usage. HUD’s application of these criteria has resulted in wide variation

among the states in the number of units allocated. Five states—California,

Colorado, Florida, Massachusetts, and New York—and one local

agency—Montgomery County, Maryland—have received approximately

65 percent of the 42,000 units authorized as of March 1996. California and

Florida alone have received over 15,000 units.

In total, as of September 1997, the housing finance agencies had reserved

35,116 units, or about 84 percent of the 42,000 units authorized as of

March 1996, for either completed properties (12,851 units) or properties in

their pipelines (22,265 units). From state to state, however, this percentage

varies widely. Specifically, 19 of the 32 housing finance agencies have

reserved more than 75 percent of their allocations for either completed

properties or properties in their pipelines. Nine agencies have reserved

between 24 and 75 percent of their allocations, and the four remaining

agencies have not reserved any of their allocations. Figure 2.1 shows the

extent to which the participating agencies have reserved their allocations.

(See apps. I and II for detailed information on the uses that the 32 housing

finance agencies had made of their allocations as of October 1997.)

2

The four local agencies are Montgomery County, Maryland; Philadelphia, Pennsylvania; Fairfax

County, Virginia; and New York City, New York.

Page 30 GAO/RCED-98-117 Housing Finance
Chapter 2 

The Risk-Sharing Credit Enhancement

Program Is Supporting the Financing of

Affordable Multifamily Housing

Figure 2.1: Percentage of Allocations

Reserved, by Number of Agencies, as

of September 1997

Number of Agencies

0

2

4

6

8

10

12

14

100%

79%-98%

51%-71%

24%-44%

0%

Percentage of Allocated Units Reserved

Source: GAO’s analysis of data provided by housing finance agencies.

Several factors are associated with the extent to which housing finance

agencies have used their allocations. Those that have reserved over

75 percent of their units generally have active multifamily programs, have

a significant demand for multifamily housing within their state, and/or do

not have a comparable credit enhancement mechanism available. From

the start, many of these agencies appear to have recognized the potential

benefits of participation. In contrast, agencies that have reserved fewer

than 50 percent of their units generally have less demand for multifamily

housing, are not as experienced in operating a multifamily housing finance

program, or have an alternative credit enhancement mechanism available.

As of September 1997, four housing finance agencies had not reserved any

of their allocations. The Alaska Housing Finance Corporation had not used

its 50-unit allocation because it believed that the program’s benefits were

marginal relative to the cost of the credit enhancement. The New York

City Housing Finance Agency had not used its 300-unit allocation because,

after allocating most of its revenue bond authority to raise capital for

Page 31 GAO/RCED-98-117 Housing Finance
Chapter 2 

The Risk-Sharing Credit Enhancement

Program Is Supporting the Financing of

Affordable Multifamily Housing

financing single-family housing, it did not have sufficient authority to

finance multifamily housing. HUD recaptured these agencies’ units and

reallocated them to other agencies. In Indiana and Louisiana, the housing

finance agencies were slow to use their allocations—300 units and 280

units, respectively—because they did not join the risk-sharing program

until a year and a half after other agencies had joined and other priorities

delayed the start of their risk-sharing programs. HUD has not sought to

recapture their units.

Program Is Helping to

Finance Properties

Serving Diverse

Markets and Income

Groups

Housing finance agencies are insuring properties in urban, suburban, and

rural markets. These properties, most of which are newly constructed or

substantially rehabilitated, vary in size and serve various populations and

income levels. Overall, the percentage of low-income households served

through the credit enhancement program is higher than required by

statute.

Agencies Are Serving

Different Housing Markets

Data from the housing finance agencies show that 110 completed

properties had been insured through the risk-sharing program as of

September 1997. Overall, approximately 47 percent of the units in these

completed properties are in urban areas, 44 percent in suburban areas, and

9 percent in rural areas. The distribution of units reserved for properties in

the agencies’ pipelines is somewhat different: 57 percent are in urban

areas, 36 percent in suburban areas, and 7 percent in rural areas. Appendix

III shows, for each of the 32 housing finance agencies, the significant

variation in the distribution of units for properties that have been

completed and are in their pipelines.

Program Is Being Used

Primarily to Finance New

Construction

Agencies are generally using the credit enhancement program to help

finance new properties. Nationwide, 48 percent of the units in the 110

completed properties were in new construction, 32 percent in substantial

rehabilitation, 14 percent in refinancing, and 6 percent in acquisition. Units

reserved by agencies for properties in their pipelines are concentrated

even more heavily in new construction. Specifically, 66 percent of these

units are reserved for new construction, 29 percent for rehabilitation, and

Page 32 GAO/RCED-98-117 Housing Finance
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The Risk-Sharing Credit Enhancement

Program Is Supporting the Financing of

Affordable Multifamily Housing

5 percent for refinancing.3 Appendix IV shows the variation in how the

housing finance agencies have used their allocations to finance different

types of construction for properties that have been completed or are in

their pipelines.

Properties Vary in Size The average number of units for the 110 completed properties is 117;

however, some of these properties have as few as 8 units, while 1 property

has 500 units. Overall, as figure 2.2 shows, the program has primarily

supported the financing of larger properties. About half of the units are in

properties with more than 200 units, and only about 6 percent of the units

are in properties with fewer than 50 units. For properties in the agencies’

pipelines, the proportion of smaller properties has increased—about

15 percent have been reserved for properties with 50 or fewer units. As

noted in chapter 1, HUD has identified smaller properties as an unmet

capital need.

3

According to housing finance agency officials, the current limits on the number of available units can

create a bias in favor of new construction because new construction generally costs more per unit

than rehabilitation. Therefore, agencies that use the credit enhancement program to finance new

construction may obtain a higher value for their units than agencies that use the program to finance

rehabilitation. However, according to HUD, rehabilitation projects are an unmet capital need,

especially in inner-city neighborhoods.

Page 33 GAO/RCED-98-117 Housing Finance
Chapter 2 

The Risk-Sharing Credit Enhancement

Program Is Supporting the Financing of

Affordable Multifamily Housing

Figure 2.2: Percentage of Total Units,

by Size, of Completed Properties as of

September 1997

• 4%

400 or more units

43% • 200-399 units

29%•

100-199 units

•19%

50-99 units

•

6%

Under 50 units

Source: GAO’s analysis of data provided by housing finance agencies.

Such variation in size is even greater from one housing finance agency to

another, reflecting different market conditions and local housing needs.

Appendix V shows how, for completed properties, the housing finance

agencies used their units to help finance properties of varying sizes.

Despite the variation in the size of the properties financed through the

credit enhancement program, most housing finance agencies have not

used the program to support properties of fewer than 50 units. According

to housing finance agency officials, such properties do not afford the

economies of scale that allow them to underwrite and provide long-term

permanent financing for affordable housing. The officials also said that

they rely on other programs to develop smaller properties. Florida, for

example, relies on the HOME4

 program and state funding sources, while

4

The HOME Investment Partnerships program was established in November 1990 by the HOME

Investment Partnerships Act to provide funds to expand the supply of affordable housing for persons

with very low and low incomes.

Page 34 GAO/RCED-98-117 Housing Finance
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The Risk-Sharing Credit Enhancement

Program Is Supporting the Financing of

Affordable Multifamily Housing

Colorado assists smaller properties by cross-subsidizing some of the costs

through fees charged to larger properties. Finally, housing finance agency

officials said, smaller properties are generally perceived as riskier than

larger ones because they are more prone to management deficiencies and

more likely to be located in distressed areas.

Household Types and

Income Levels Vary Widely

Nationally, for completed properties, housing finance agencies have used

about 74 percent of their risk-sharing units for properties serving families,

25 percent for properties serving the elderly, and 1 percent for properties

serving people with special needs, such as those who are homeless or

disabled. However, these percentages vary considerably from one housing

finance agency to another. For instance, the Massachusetts agency has

used almost half of its risk-sharing units for facilities serving the elderly,

while the Florida agency has used 100 percent of its units for properties

serving families. Many of the units in the Florida properties have multiple

bedrooms to meet the needs of large low-income families.

Besides targeting different types of households, housing finance agencies

are using the credit enhancement program to serve households at different

income levels. All of the agencies are meeting the program’s income

eligibility criteria. In addition, the agencies as a group are financing

properties that serve more low-income households than the program

requires.5

 Specifically, of the 12,851 risk-sharing units in completed

properties as of September 1997, 8,400, or about 65 percent, are reserved

for households with incomes at or below 60 percent of the local area’s

median income. This percentage varies from one state to another. In five

states and two localities,6

 the housing finance agencies have reported

using all of their risk-sharing units for properties that serve only

low-income households.

Most of the properties that are exceeding the credit enhancement

program’s income-targeting requirements are also being financed by other

subsidies. Specifically, about 74 percent of these properties also receive

5

At a minimum, to be eligible for insurance under the risk-sharing program, a property must set aside

either 20 percent of its units for households with incomes at or below 50 percent of the area’s median

income or 40 percent of its units for households with incomes at or below 60 percent of the area’s

median income. Therefore, the remaining units may be rented at market rates, or they may be subject

to rent restrictions if additional restrictions are required to receive or take advantage of other housing

subsidies. For example, the Low-Income Housing Tax Credit program establishes the same rent

restrictions as the credit enhancement program, but tax credits are available only for rent-restricted

units. Thus, in many properties financed with tax credits, all of the units are rent restricted.

6

The states are Kentucky, Maryland, Montana, Oregon, and Rhode Island. The localities are

Philadelphia, Pennsylvania; and Fairfax County, Virginia.

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other subsidies that have income restrictions at least as stringent as the

risk-sharing program’s. For example, 61 properties, containing 7,376 units,

were subsidized through the Low-Income Housing Tax Credit program. In

our March 1997 report on this program,7

 we estimated that about

three-fourths of the households in tax-credit-supported units had incomes

in 1996 that were at or below 50 percent of the local area’s median income.

Appendix VI shows the income levels being served by the 21 housing

finance agencies that had completed properties with risk-sharing units as

of September 1997.

Housing Finance

Agencies Have

Derived Key Benefits

From Their

Participation in the

Credit Enhancement

Program

Two key objectives of the credit enhancement program are to (1) increase

the production of affordable multifamily housing and (2) make affordable

housing available to eligible families and individuals in a timely manner.

Another objective is to ensure the financial soundness of the affordable

multifamily housing properties insured under the program.8

 Our work

shows that housing finance agencies and HUD have essentially met these

objectives: First, the program has allowed housing finance agencies to

finance affordable housing by leveraging their reserves, lowering their

interest rates, and extending their loan terms. Additionally, the program

has assisted some housing finance agencies in establishing viable

affordable multifamily housing programs. Second, by delegating the

underwriting and processing of affordable multifamily housing loans to

housing finance agencies, the program has enabled borrowers to obtain

loans in a more timely manner. Finally, by creating risk-sharing

arrangements predicated upon a sharing of losses, the program has

established appropriate incentives for financing economically sound

properties.

Affordable Housing Is

Being Developed

The credit enhancement program has facilitated the production of

affordable multifamily housing, primarily by allowing housing finance

agencies to leverage their reserves and by lowering borrowing costs and

extending mortgage terms. In addition, the credit enhancement program

has helped three housing finance agencies establish affordable multifamily

housing programs.

7

Tax Credits: Opportunities to Improve Oversight of the Low-Income Housing Program

(GAO/GGD/RCED-97-55, Mar. 28, 1997).

8

As noted in ch. 1, a statutory objective of the reinsurance program is to ensure the maintenance,

through risk sharing, of “sound underwriting and loan management practices.”

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Leveraging Reserves In our judgment, the single greatest benefit that housing finance agencies

have derived from their participation in the credit enhancement program

is the ability to leverage their reserves. To raise capital to finance

affordable multifamily housing, these agencies sell bonds to investors. To

pay the lowest possible interest rate on the bonds, an agency provides a

credit enhancement (i.e., funded reserves) or purchases a credit

enhancement (i.e., risk-sharing insurance) to improve its bond rating.9

 If

the agency provides a credit enhancement, it is usually required to fund a

dedicated reserve account equal to a fixed percentage of its outstanding

mortgages, as required by a national rating agency such as Standard and

Poor’s or Moody’s. Consequently, the ability of the agency to finance

affordable multifamily housing is limited by its available reserves. The

agency can leverage its reserves by participating in the credit

enhancement program: When it uses the program to enhance the credit of

the loans it offers as collateral for the bonds it sells, it reduces its reserve

requirement in direct proportion to the percentage of risk assumed by HUD.

For example, when HUD assumes 50 percent of the risk, the agency reduces

its reserve requirement by 50 percent, meaning that it can double its

financing capacity without increasing its reserves. As of September 1997,

about 90 percent of the units were in properties financed by loans for

which HUD has assumed at least 50 percent of the risk. All of the

participating housing finance agencies with insured loans have derived

this leveraging benefit.

The importance of leveraging varies not only with the percentage of risk

assumed by HUD but also with the level of reserves maintained by the

agency and the agency’s demand for financing. The benefit is much greater

for an agency that does not have sufficient reserves to meet the current

and/or anticipated demand than for an agency that has larger reserves

and/or lower demand. The California Housing Finance Agency, which was

allocated more risk-sharing units than any other housing finance agency,

was one of the agencies that derived substantial benefits from leveraging.

When the agency entered into a 50/50 risk-sharing agreement with HUD in

1994, the demand for affordable multifamily housing was very high

because, according to agency officials, the savings and loans crisis in the

late 1980s and an economic recession that continued in many regions of

the state until 1995 had limited the agency to financing about $25 million a

9

The rating of the bonds is critical to a viable bond issue. The higher the rating, the less the perceived

risk to the investor and, thus, the more marketable the bonds. The reduced risk associated with the

bonds encourages investors to accept a lower bond yield. The lower the bond yield, potentially the

lower the effective mortgage interest rate paid by the developer of the affordable multifamily property.

As defined by Moody’s, bonds rated “A” possess many favorable investment attributes and are to be

considered as upper-medium-grade obligations. A medium-grade obligation indicates that as long as

there is no significant economic decline, the bond will be able to meet payments when due.

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year, on average, in affordable multifamily housing. After entering the

credit enhancement program, the agency increased its financing to about

$200 million per year. According to agency officials, about half of this

activity is attributable to the leveraging benefit they derive from their 50/50

risk-sharing partnership with HUD.

Lowering Borrowing Costs Another benefit of the credit enhancement program—lowering borrowing

costs—has helped to increase the production of affordable multifamily

housing to the extent that such housing would not have been economically

feasible at higher interest rates. Because the credit enhancement program

generally enhances the credit rating on bonds issued by housing finance

agencies, investors are willing to accept a lower yield (interest rate). If this

lower rate is passed on to developers, it makes the development of

affordable multifamily housing more feasible. The actual reduction in

interest rates attributable to the risk-sharing program varies with the

credit ratings of individual housing finance agencies, as well as with

market interest rates at given times. Because most housing finance

agencies participating in the risk-sharing program generally have at least

an “A” credit rating and because market interest rates have been low over

the past few years, the risk-sharing program has generally contributed to

only a marginal reduction in interest rates (15 to 30 basis points).

However, housing finance agencies reported to us that even marginal

reductions in interest rates can affect the financial feasibility of affordable

multifamily properties.

In at least one instance, participation in the credit enhancement program

contributed to a significant reduction in interest rates. The Montgomery

County housing finance agency used the program to refinance a 311-unit

property. The original mortgage was financed by two bond issues with a

combined interest rate of about 8 percent. After the refinanced mortgage

was insured through the credit enhancement program—when market

interest rates were lower than they had been at the time the property was

originally financed—the interest rate dropped to about 6 percent. This

2-percent reduction, together with a write-off of part of the original debt,

allowed the housing finance agency to maintain the property as affordable

housing.

Extending Mortgage Terms Finally, several housing finance agencies have used the credit

enhancement program to extend the mortgage repayment period to 40

years. A longer repayment period can make an affordable multifamily

property more financially feasible because less operating revenue is

required to meet the monthly mortgage payments. For example, the New

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York State Housing Finance Agency used the program to provide a 40-year

mortgage for an 83-room property with 142 beds designed to serve elderly

residents, including those who are mentally ill, handicapped, and/or

homeless. Because these residents have very limited incomes, the 40-year

mortgage was necessary to make the property financially feasible for the

residents. State agency officials said that without the credit enhancement

program, the term of the mortgage would have been 30 years because the

agency would have had to rely on a state mortgage insurance program that

limits mortgages to 30 years or less. Had the agency been required to use

this state program, the officials said, additional subsidies would have been

needed to reduce the amount of the mortgage loan to make the property

financially feasible.

Establishing Affordable

Multifamily Lending Programs

The credit enhancement program has helped three housing finance

agencies—in Florida, Kentucky, and New Mexico—establish viable

affordable multifamily lending programs. In Florida, the program gave the

agency access to a continuous and reasonably priced source of credit

enhancement, which it needed as security for its bonds so that it could

finance affordable multifamily housing. Similarly, in Kentucky and New

Mexico, the program gave the agencies access to an affordable source of

credit enhancement that enabled them to compete with other sources of

financing available to developers of multifamily housing. In Kentucky, the

credit enhancement enabled the housing finance agency to provide

financing for developers of smaller properties (24 to 30 units) in rural

areas—an important benefit, given recent reductions in funding for the

Rural Housing Service’s section 515 program. In New Mexico, the credit

enhancement also enabled the agency to finance properties with fewer

than 100 units, as well as properties for persons with special needs. Such

housing was not being developed through other sources.

Affordable Multifamily

Housing Is Being Financed

in a Timely Way

The credit enhancement program is achieving its second key objective

—making affordable housing available in a timely manner. Because the

program delegates to housing finance agencies much of the loan

underwriting and processing authority that HUD retains under FHA’s

traditional insurance programs, it delivers FHA insurance more efficiently

than the traditional programs (see ch. 4).

The efficiencies in loan processing gained through the program provide

two direct benefits to developers of affordable housing—(1) an earlier

determination of a property’s financial feasibility and (2) the savings

associated with being able to initiate construction sooner rather than later.

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Because the development of affordable housing frequently requires

multiple subsidies and a property’s financial feasibility generally depends

on bringing all of these subsidies and any related debt financing together

by a specific time, any delay in approving the financing can jeopardize the

property’s feasibility. The Florida Housing Finance Agency has taken

advantage of the program’s efficiencies to bring together the financing for

both construction loans and permanent mortgage loans in a timely way.

This agency issues bonds to finance both types of loans for its affordable

multifamily properties. While it uses a private bond insurer to provide a

credit enhancement for the construction financing, it uses the risk-sharing

program to provide a credit enhancement for the permanent financing.

Because the private insurer requires assurance that the permanent

financing will be available before it agrees to provide the credit

enhancement for the construction financing, the agency needs to obtain

the credit enhancement for the permanent loan expeditiously. The

program provides the credit enhancement expeditiously, whereas delays

could occur in HUD’s traditional multifamily insurance programs. Such

delays could, in the opinion of agency officials, postpone the development

of certain properties long enough to increase their costs to the point that

the properties would no longer be financially feasible.

An associated benefit of more prompt approval of a property’s permanent

financing is reflected in the adage that “time is money.” According to

officials at various housing finance agencies, by reducing the time required

for processing loans, the program has reduced the costs of developing

properties. In addition, by shortening the time required for approving

permanent mortgages, some of these officials noted, the program has

provided developers with better assurance that proposed properties will

be financially feasible. The faster approval time avoids potential increases

in interest rates that could be high enough to prevent some properties

from being built.

Partnerships Promote the

Financial Viability of

Insured Properties

As previously discussed, the credit enhancement program establishes

economic incentives for HUD and its risk-sharing partners to perform their

respective functions properly and makes them financially accountable if

they do not. Although little information is currently available for

evaluating the financial performance of housing finance agencies as

risk-sharing partners, the available indicators suggest that the agencies are

generally using the program responsibly.

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It is still too early to project the financial performance of the 110

properties insured under the credit enhancement program through

September 1997; however, our limited analysis indicates that reasonable

underwriting standards were applied. We reviewed two key financial

indicators, the debt service coverage ratio10 and the loan-to-value ratio,11

and found that the participating housing finance agencies have used

generally accepted underwriting criteria for the loans they have insured

under the program.

The debt service coverage ratio is used in underwriting to evaluate the

potential for a property’s income to cover the property’s mortgage debt.

The higher the ratio, the less the property is likely to face financial

difficulties that could lead to default. The benchmark generally used in the

housing industry for unsubsidized properties is about 1.20. However, for

subsidized properties, this benchmark can range from 1.05 to 1.15. A lower

debt service coverage ratio can allow rents to be lower, making a property

more affordable to low-income households. Our analysis of data provided

by the 21 housing finance agencies showed that, for the 110 properties

completed as of September 1997, the median debt service coverage ratio

was 1.11. Moreover, as table 2.1 indicates, about 33 percent of the insured

units were in properties with a debt service coverage ratio of more than

1.15, and over 95 percent of the units were in properties with a debt

service coverage ratio of at least 1.05.

Table 2.1 Debt Service Coverage Ratio

for Insured Properties as of

September 1997

Debt service coverage

ratio

Number of

properties Number of units

Percentage of

units

Above 1.15 33 4,278 33.3

1.10 to 1.15 60 6,545 50.9

1.05 to 1.09 13 1,421 11.1

Below 1.05 3 523 4.0

Not reported 1 84 0.7

Total 110 12,851 100.0

Source: GAO’s analysis of questionnaire data provided by housing finance agencies.

The loan-to-value ratio is used to determine whether a property’s cash

value will be sufficient to cover the mortgage debt in the event of

foreclosure. The lower the ratio, the more the property’s value is likely to

10The debt service coverage ratio is a property’s net operating income divided by the required

mortgage payments.

11The loan-to-value ratio is the outstanding mortgage on a property divided by its market value.

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be sufficient to pay off the outstanding mortgage obligation. Among

private lenders, the benchmark used to finance unsubsidized properties is

about 80 percent, and under FHA’s traditional multifamily insurance

program for profit-making developers it is 90 percent. Under FHA’s

traditional multifamily insurance program for nonprofit sponsors, the

loan-to-value ratio can be as high as 100 percent. The median loan-to-value

ratio for insured units under the risk-sharing program is 80 percent. Table

2.2 presents the loan-to-value ratios for units in properties insured as of

September 1997. As the table indicates, most of the units are in properties

with loan-to-value ratios ranging from 70 to 90 percent.

Table 2.2: Loan-To-Value Ratio for

Insured Units as of September 1997 Loan-to-value ratio Number of units Percentage of units

Equal to 100 percent 394 3.1

90-99 percent 1,130 8.8

70-90 percent 7,796 60.6

Below 70 percent 3,287 25.6

Not reported 244 1.9

Total 12,851 100.0

Source: GAO’s analysis of questionnaire data provided by housing finance agencies.

It is too early to project the future performance of loans insured through

the credit enhancement program. However, data reported by agencies

participating in the program generally indicate that their entire portfolios

are performing well. According to these data, the agencies’ existing

multifamily portfolios show less than 1.28 percent of their total loan

dollars in default and less than 0.34 percent in foreclosure. However, one

loan, originated by the California Housing Finance Agency under the credit

enhancement program, went into default shortly before it received final

endorsement from HUD. This loan was one of the three loans with an

original debt service coverage ratio below 1.05 (see table 2.1). Although

the California Housing Finance Agency should have notified HUD

headquarters of this default, it notified the responsible HUD field office

instead. The field office did not forward the information to HUD

headquarters. Therefore, headquarters officials were not aware of the

default until we brought it to their attention. As noted in chapter 4,

California is withdrawing this loan from the risk-sharing program.

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Agencies’ Reasons for

Not Participating in

the Credit

Enhancement

Program Varied

We contacted the 24 state housing finance agencies that have not

participated in the credit enhancement program to understand why they

have not done so. Their responses are summarized in table 2.3.

Table 2.3: Housing Finance Agencies’

Reasons for Not Participating in the

Credit Enhancement Program

Reasons for not participating

Number of

agencies

Percentage

of total

response

State’s multifamily program was limited or nonexistent

and/or agency could not meet program’s reserve

requirements 13 55

State policies and legislative processes prevented

participation 5 21

Staff lacked sufficient knowledge and skills to operate

program 2 8

Agency believes it is ineligible for program 1 4

Agency relies on other options to finance multifamily

housing 2 8

Agency provided no reason 1 4

Total 24 100

Source: GAO’s analysis of data from structured telephone interviews with nonparticipating

housing finance agencies.

Some of the reasons cited for not participating, such as not having a

multifamily program or being subject to state policies that prevent

participation, appear to be outside the agencies’ control. Eighteen, or

about 76 percent, of the agencies identified these reasons as barriers to

their participation. Other reasons for not participating, such as not having

sufficient knowledge of the program’s benefits or staff skills, could be

eliminated through training, hiring contractors, and/or marketing the

program and its benefits more effectively. The Florida Housing Finance

Agency, for example, hires contractors to underwrite its loans because it

has not hired in-house staff to perform this function. Two of the agencies

identified these reasons as barriers to their participation. Finally, two of

the agencies reported relying on other options to finance their multifamily

mortgages. One of the agencies said that it works with banks to finance its

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multifamily housing, while the other indicated that it has a high enough

credit rating to finance its properties without the program. However,

42 percent of these agencies indicated that if circumstances changed, they

would consider using the credit enhancement program.

Changes to the Credit

Enhancement

Program Could

Facilitate the

Financing of

Affordable

Multifamily Housing

According to the participating housing finance agencies, several changes

would improve the financing and administration of the credit

enhancement program. Options for improving the program’s

administration are discussed in chapter 4. Options for improving the

program’s financing are discussed in the remainder of this chapter.

Housing finance agencies believe that making the credit enhancement

demonstration program permanent and removing the legislative limits on

the number of authorized units would assist them in planning for and

financing additional affordable multifamily housing. According to the

agencies, both the program’s demonstration status and the limits on the

number of available units are hampering their marketing of the program

and management of their multifamily resources. Some agencies have used

all or nearly all of their credit enhancement units to meet the current

demand, and if bills proposing to increase the states’ per-capita tax credit

allocations are enacted, they are likely to see an even greater demand for

credit enhancement units. Finally, the credit enhancement program may

be used to insure mortgages refinanced under the Multifamily Assisted

Housing Reform and Affordability Act of 1997, commonly known as

“portfolio reengineering” or “mark-to-market.” Although the Congress has

provided statutory authority to meet any increased demand for

risk-sharing units attributable to this program, making the credit

enhancement program permanent would logically complement this

authority.

Lack of Permanency

Impedes Efficient

Management

Because the credit enhancement program was established as a

demonstration program, HUD must seek congressional authorization to

(1) extend its duration and (2) obtain additional units. If the program is

made permanent, its insurance authority will, presumably, be limited by a

dollar amount, which can be adjusted with demand, rather than by a unit

allocation. FHA’s traditional mortgage insurance programs operate under a

dollar cap, which the Congress has increased as necessary to provide for

greater activity.

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According to the housing finance agencies, the program’s lack of

permanency and limits on the number of available units impede their

marketing of the program to lenders, management of multifamily

resources, and financing of affordable multifamily properties. For

example, the New Mexico Housing Finance Agency noted that the

program is difficult to market to affordable multifamily housing

developers when the agency is unsure how long the program will continue

and whether the agency will have enough units to meet the potential

demand. Similarly, officials from the California Housing Finance Agency

told us that because it can take 3 to 4 years to structure the financing for

and develop an affordable multifamily property, they need an ongoing

stream of units or dollars available over a long period of time. Officials

from several other agencies confirmed that the uncertainty surrounding

the program’s future and level of activity hinders their marketing of the

program and creates problems for them in planning the financing of

additional affordable multifamily properties.

As shown in appendix I, many housing finance agencies have reserved all

or nearly all of their allocated units, and some agencies do not have

enough additional units to meet the current demand. Specifically, 12 of the

32 participating housing finance agencies had reserved all of their

allocated units by September 1997, and another 6 agencies had reserved

between 89 and 98 percent of their units. According to officials at several

of these agencies, they have other properties in their pipelines that are

candidates for the credit enhancement program, but they are waiting to

receive additional units before they formally agree to use the program to

help finance these properties’ development. According to officials at the

Florida Housing Finance Agency, the agency has reserved all but 605 of

the 7,002 units in its allocation. It has properties with a total of 605 units in

its pipeline and estimates that it could use another 1,600 units per year.

However, until it receives an additional allocation, it cannot satisfy this

demand through the credit enhancement program. Officials at the Maine

Housing Finance Agency told us that they had reserved 140 of the 150

units in the agency’s original allocation and may not reserve the 10

remaining units unless they receive an additional allocation.

Demand for Credit

Enhancement Units Is

Likely to Increase With an

Increase in the States’ Tax

Credit Allocations

Housing finance agencies have frequently used the credit enhancement

program in conjunction with the Low-Income Housing Tax Credit

program. As previously noted, 61 of the 110 completed properties that

were financed through the credit enhancement program were also

financed through the Low-Income Housing Tax Credit program. Using the

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two programs together is logical, given that both have the same income

eligibility criteria.

As we reported in March 1997,12 the Low-Income Housing Tax Credit

program is currently the largest federal program to fund the development

and rehabilitation of housing for low-income households. Since the

program’s inception in 1986, the Internal Revenue Service has allocated

tax credits to each state in an amount equal to $1.25 per resident to be

used to help finance affordable multifamily housing properties. During the

3-year period (1992-94) covered by our study, this allocation supported the

development of about 4,100 low-income housing properties containing

about 172,000 units.

Currently, according to a general consensus in the housing industry, the

demand for low-income housing tax credits is exceeding the supply by

about three or four to one. Accordingly, S. 1252 and H.R. 2990, introduced

in 1997, propose to increase each state’s tax credit allocation to $1.75 per

resident and to index, or adjust, this amount annually for inflation. Should

these bills become law, the production of affordable housing could be

expected to increase. Given the past association between the tax credit

and the risk-sharing programs, the demand for risk-sharing units would

also be likely to increase.

Credit Enhancement

Program Has Been

Authorized to Support

HUD’s Mark-To-Market

Demonstration Program

About 8,600 privately owned multifamily properties with FHA-insured

mortgages totaling $17.8 billion receive federal rental subsidies for some

or all of their apartments under HUD’s section 8 project-based assistance

program. These properties contain about 859,000 units. For subsidized

units, HUD pays the difference between the rent and 30 percent of the

household’s income. The rents at many properties exceed market levels,

resulting in high subsidies. To reduce the costs of these subsidies and

address other problems, HUD proposed adjusting the rents to market levels

and writing down the mortgages as needed to allow the properties to

operate at market rents.

The Congress generally adopted HUD’s proposal when it enacted the

Multifamily Assisted Housing Reform and Affordability Act of 1997, which

authorized the mark-to-market program. The act encourages owners of

eligible multifamily housing properties to restructure their FHA-insured

mortgages and project-based assistance contracts before the contracts

12Tax Credits: Opportunities to Improve Oversight of the Low-Income Housing Program

(GAO/GGD/RCED-97-55, Mar. 28, 1997).

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expire. The purposes of this act are to ensure the continued economic and

physical viability of the properties, protect FHA’s General Insurance Fund

from excessive defaults, reduce the long-term costs of these insured

properties, and guard against the possible displacement of families.

To restructure these mortgages, the act requires HUD to enter into portfolio

restructuring agreements with participating administrative entities that

(1) have demonstrated experience in working with low-income residents,

(2) have demonstrated the capacity to restructure the financing of eligible

multifamily properties, and (3) have a history of financial stability. The act

gives preference to housing finance agencies to serve as the participating

administrative entities under these agreements. The act also encourages

housing finance agencies to use several tools, including the risk-sharing

program, to help them restructure the mortgages of eligible multifamily

properties. In addition, the act specifies that the number of units used to

refinance eligible multifamily housing properties under the

mark-to-market legislation will not reduce the number of units available

for mortgage insurance under section 542. Moreover, any credit subsidy

costs of providing mortgage insurance are to be paid from the Liquidating

Accounts of the General Insurance Fund or the Special Risk Insurance

Fund.

As of May 1997, HUD had designated 30 state housing finance agencies,

with three-quarters of the properties eligible for the mark-to-market

initiative within their jurisdiction, to serve as entities under the

mark-to-market demonstration program.13 HUD’s guidelines and

instructions for implementing the demonstration program require each

designated entity to develop a management plan for implementing the

program and receive an approved contract from HUD to restructure

mortgages. As of the end of January 1998, 17 state and local housing

finance agencies, all with risk-sharing agreements, had obtained HUD’s

approval of their management plans, and 6 agencies had also obtained

approved contracts. As of this date, however, none of these agencies had

restructured any mortgages.

Housing finance agency officials identified two key impediments to using

the credit enhancement program for restructuring mortgages. First, while

the mark-to-market legislation authorizes the use of the credit

enhancement program as a restructuring tool and thus assumes the

program’s continuation, the officials have no assurance that the program

will continue. Housing finance agency officials told us that before they

13Before the enactment of the 1997 act, HUD operated a mark-to-market demonstration program.

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plan to use the program in restructuring loans, they need to be assured

that the program will be available when the restructuring occurs.

Second, housing finance agency officials were reluctant to use the credit

enhancement program to insure these refinanced loans because they

would then be exposed to risk if HUD did not renew the properties’ section

8 rental assistance contracts. If HUD did not renew the contracts, the

properties might not generate enough income to repay the refinanced

loans, and the properties’ financial solvency might be jeopardized. These

housing finance agency officials told us that because the decision to renew

the contracts would rest with HUD, they would not want to insure these

properties through the credit enhancement program unless FHA assumed

total responsibility for any losses resulting from a decision by HUD not to

renew the section 8 contracts. We discussed this issue with the senior HUD

official responsible for administering the mark-to-market demonstration

program. According to him, only 1 of the 17 agencies had expressed an

interest in providing the funding for any restructured mortgages. The other

agencies had only expressed an interest in facilitating the restructuring of

the mortgages and had suggested that the capital for the refinancing

should come from a source outside the refinancing agency. According to

this official, if HUD were to assume total liability in the event that it chose

not to renew section 8 contracts, more housing financing agencies would

likely be interested in refinancing restructured mortgages.

A bill (H.R. 2447) was introduced in September 1997 to provide for HUD to

“assume an appropriate share of the risk of a loan for affordable

multifamily housing in a manner that mitigates uncertainties regarding

actions of the Federal Government (including the possible failure to renew

short-term subsidy contracts).” This bill has been referred to the House

Committee on Banking and Financial Services.

Conclusions The credit enhancement demonstration program is meeting several key

objectives, including facilitating the financing of affordable multifamily

housing and making affordable multifamily housing available in a timely

manner. Making the program permanent and lifting the limits on the

number of available units could have several benefits. Specifically, housing

finance agencies currently participating in the program could be expected

to increase their activity to meet both current and anticipated demand,

and nonparticipating agencies could be expected to give more

consideration to entering the program knowing that its benefits would be

available in the future. Agencies might also be encouraged to expand their

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Program Is Supporting the Financing of

Affordable Multifamily Housing

financing for smaller properties and for rehabilitation projects, particularly

in underserved rural and inner-city markets. In addition, permanency

would support the program’s continued use in financing

tax-credit-supported properties and would complement anticipated

increases in states’ tax credit allocations. Finally, permanency would

support the use of the credit enhancement program with the “mark to

market” program. However, until a decision has been reached on whether

FHA will assume the entire risk of default if HUD does not renew short-term

section 8 subsidy contracts on properties with restructured mortgages,

housing finance agencies will be unlikely to finance these restructured

mortgages. And unless an agency does finance these mortgages, it will not

need to use the credit enhancement program to support the

mark-to-market initiative.

Finally, permanency implies that HUD will exercise appropriate

administrative controls over housing finance agencies to ensure that they

are meeting their responsibilities under the program, that the

government’s interests are being protected, and that the program’s results

can be evaluated. Problems with these administrative controls and HUD’s

plans to address them are discussed in chapter 4.

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Today, more than 5 years after the reinsurance program was authorized,

the program remains largely untested. Although HUD’s risk-sharing partners

have the potential to expand the participation of major financial

institutions in mortgage lending, as envisioned in the risk-sharing statute,

only one of the four institutions that was allocated units authorized in

1992—Fannie Mae—has participated extensively in the program, and one

lender—Banc One Capital Funding Corporation—has originated over half

of the loans that Fannie Mae has reinsured. Banc One Capital’s experience

has demonstrated that the reinsurance program can expand participation

in mortgage lending, including lending for smaller properties in rural

areas. Resolving questions about the use of reinsurance with balloon

mortgages and loan pools and building on recent initiatives of two Federal

Home Loan banks, assuming these initiatives are successful, could expand

participation in the program.

Partnerships Create

the Potential for

Wider Lending

HUD’s current and designated risk-sharing reinsurance partners represent a

range of financial institutions that operate nationally and at the state and

city levels. All of these institutions have affordable housing goals and, with

the exception of the two loan consortia,1

 have strong credit ratings. As a

group, they have the potential to expand the participation of major

financial institutions in affordable multifamily lending.

Legislation has authorized a total of 22,500 units for the reinsurance

program—15,000 in 1992 and 7,500 in 1996. In 1994, HUD signed

risk-sharing agreements with four qualified financial institutions and

allocated the first 15,000 units among them. Three of these

institutions—Fannie Mae, Freddie Mac, and the National Cooperative

Bank—operate nationally, and the fourth—the Federal Home Loan Bank

of Seattle—operates regionally but is affiliated with the national Federal

Home Loan Bank System. The 12 affiliates of this system are regulated by

the Federal Housing Finance Board and have 6,504 member banks that

operate in all 50 states.

HUD earmarked the 7,500 units authorized in 1996 to four new

institutions—the State of New York Mortgage Agency (SONYMA), the

Federal Home Loan Bank of New York, the Community Preservation

Corporation (CPC), and the California Community Reinvestment

Corporation (CCRC). SONYMA is a state agency whose activity is restricted to

New York State. CCRC and CPC are loan consortia; CCRC operates at the state

1

Loan consortia were created and funded by banks and/or thrifts to provide financing for affordable

housing developments, particularly multifamily rental properties.

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level, while CPC operates at the city and metropolitan-area level. To date,

HUD has signed risk-sharing agreements with SONYMA (in April 1997) and

the Federal Home Loan Bank of New York (in January 1998) and is

negotiating agreements with CPC and CCRC. All of the risk-sharing

agreements provide 50-percent FHA reinsurance for loans purchased under

the program.

Only One Institution

Has Been Active in

the Risk-Sharing

Reinsurance Program

Fannie Mae is the only recipient of units authorized in 1992 that has

participated extensively in the reinsurance program. Fannie Mae has

reserved all of its 7,500 units for 48 properties. As of October 31, 1997, six

of these properties, with 956 units, have received final endorsement from

HUD, and the remaining 42 properties, with 6,544 reserved units, are in

various stages of development. Freddie Mac, the only other original

participant with any activity, had reserved 538, or about 11 percent, of its

5,000 allocated units for one property as of October 31, 1997. The National

Cooperative Bank and the Federal Home Loan Bank of Seattle did not

reserve any of their allocated units. Thus, as of October 31, 1997, 8,038, or

about 54 percent, of the 15,000 units authorized in 1992 had been reserved.

Recently, the National Cooperative Bank and the Federal Home Loan Bank

of Seattle agreed to return their units to HUD. According to HUD, it will

reallocate 2,000 units to Fannie Mae and hold the remaining 500 units in

reserve.

No loans have received final endorsement for the 7,500 units authorized in

1996. As of October 31, 1997, SONYMA had reserved 306, or about

13 percent, of its 2,400 allocated units for two properties. Table 3.1

indicates how, as of October 31, 1997, the six participating and two

designated financial institutions had used the program’s 22,500 authorized

units.

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Table 3.1: Activity in the Risk-Sharing Reinsurance Program, as of October 31, 1997

Status of allocated units

Qualified financial

institution

Number of allocated

units

Number endorsed by

HUD Number reserved

Number not yet

reserved

Designated in 1992, with a risk-sharing agreement signed in 1994

Fannie Mae 7,500 956 6,544 0

Freddie Mac 5,000 0 538 4,462

National Cooperative Bank 2,000a 0 0 2,000

Federal Home Loan Bank of

Seattle 500a 0 0 500

Designated in 1996, with a risk-sharing agreement signed in 1997 or 1998

SONYMA 2,400 0 306 2,094

Federal Home Loan Bank of

New York 2,000 0 0 2,000

Negotiating a risk-sharing agreement with HUD

CPC 2,000 0 0 2,000

CCRC 1,100 0 0 1,100

Total 22,500 956 7,388 13,154

aIn February 1998, these units were returned to HUD for reallocation.

Source: GAO’s analysis of data provided by HUD and participating financial institutions.

One Product Line and One

Lender Account for Most

of Fannie Mae’s

Reinsurance Activity

Fannie Mae has reserved or purchased all but 12 of its 48 risk-sharing loans

through its Delegated Underwriting and Servicing (DUS) product line. This

product line is compatible with the reinsurance program because, like the

program, it delegates responsibilities and shares risks. Under DUS, Fannie

Mae delegates its authority to underwrite and determine the

creditworthiness of a loan to the originating lender and agrees to purchase

the loan without prior review. In return for this autonomy, the DUS lender

assumes a percentage of the risk of default on the loan. Specifically, the

lender is responsible for the first 5 percent of any loss on the loan and

shares with Fannie Mae in the next 15 percent of any loss. Both the

benefits of autonomy and the risk of loss create incentives for the DUS

lender to underwrite the loan prudently and service3 it diligently.

2

The single non-DUS loan was approved under Prior Approval authority. When using this authority,

Fannie Mae underwrites and approves each loan before purchasing it and assumes all of the credit

risk. The approved risk-sharing loan of $40 million was secured by a property with 1,175 units. None of

the properties securing DUS/risk-sharing loans exceeded 450 units.

3

For a multifamily mortgage loan, loan servicing involves regular reviews of the property’s financial

statements and loan payments and physical inspections of the property to ensure its proper

maintenance.

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Currently, Fannie Mae does business with about 28 DUS lenders, most of

which Fannie Mae considers to be experienced, well-capitalized mortgage

bankers. Since the DUS product line’s inception in 1987, the loss rate (to

lenders) on DUS loans has been less than 1 percent. It is still too early to

determine or predict any loss rates under the reinsurance program.

One DUS lender is responsible for more than half of Fannie Mae’s reserved

loans in the reinsurance program. Banc One Capital Funding Corporation,

an affiliate of a large bank holding company, originated the loans for 28 of

Fannie Mae’s 48 properties. These 28 properties account for 3,175, or

about 42 percent, of Fannie Mae’s 7,500 reserved units. Eight other DUS

lenders had participated in the risk-sharing program as of October 31,

1997, and account for the balance of the properties and units.

Fannie Mae’s Activity Has

Increased Over Time

Fannie Mae’s activity in the risk-sharing reinsurance program has grown

steadily, peaking in 1997. Figure 3.1 tracks Fannie Mae’s activity in the

program from 1995 through 1997.

Figure 3.1: Fannie Mae’s Risk-Sharing

Activity, 1995 Through 1997 Number of units

0

1000

2000

3000

4000

5000

6000

1995 1996 1997

Calendar year

Source: GAO’s analysis of data provided by Fannie Mae.

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Fannie Mae reserved the last of its risk-sharing units in October 1997. It

has asked HUD for additional units, and, as noted, HUD has said that it will

reallocate to Fannie Mae 2,000 of the units its expects to be returned. As of

February 1998, HUD had not reallocated the units.

Fannie Mae’s

Risk-Sharing

Properties Vary in

Size, Targeted Income

Levels, and

Geographic Location

Fannie Mae’s 48 risk-sharing properties vary in size, and their units are

reserved for households of varying income levels. The properties are

located in both urban and rural markets, most of which are concentrated

in a few states.

Properties With

Risk-Sharing Units Vary in

Size, but Units Are

Concentrated in Larger

Properties

Fannie Mae’s risk-sharing properties range in size from 31 to 1,175 units,

according to Fannie Mae’s data. On average, these properties have 156

units. About half of the properties have fewer than 100 units, and about

half have more. However, the larger properties account for about

80 percent of Fannie Mae’s total reservation. Table 3.2 shows the

distribution of units according to property size.

Table 3.2: Distribution of Fannie Mae’s

Risk-Sharing Units, by Property Size

Category of property, by

number of units

Number of

properties in

category

Number of units

in category

Number of units

in category as a

percentage of the

total number of

units

Under 50 units 4 158 2

50-99 units 19 1,369 18

100-199 units 12 1,606 21

200-399 units 11 2,742 37

400 or more units 2 1,625 22

Total 48 7,500 100

Source: GAO’s analysis of data provided by Fannie Mae.

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Percentage of

Lower-Income Households

Served Is Generally Higher

Than Required

All six of the properties that had received final endorsement from HUD as

of October 31, 1997, meet, and four exceed, the reinsurance program’s

income-targeting requirements.4

 The four that exceed the requirements

have reserved all of their units for households with incomes at or below

either 50 or 60 percent of the area’s median income. The other two

properties meet the program’s minimum targeting standards: One has

reserved 20 percent of its units for households with incomes at or below

50 percent of the area’s median income while the other has reserved

40 percent of its units for households with incomes at or below 60 percent

of the area’s median income.

All four of the properties that exceed, and one of the properties that meet,

the program’s income-targeting requirements are able to do so because

they are partially financed with low-income housing tax credits. The

Low-Income Housing Tax Credit program encourages the production of

affordable units by making the tax credit subsidy available only to such

units.

Risk Sharing Units Are

Concentrated in Three

States

Fannie Mae has reserved units in properties serving both urban and rural

markets. Although these properties are located in 11 states, most are

concentrated in 3—California, Texas and Ohio. These three states account

for 29 properties and about 52 percent of Fannie Mae’s 7,500 allocated

units. In Ohio, Banc One Capital Funding Corporation has funded 14

properties with 1,068 units. Banc One Capital’s headquarters and many of

its commercial banks are located in Ohio. Because many of these banks

are located in rural areas, most of the properties they have financed

through the reinsurance program are located in smaller communities. The

loans for these properties are, on average, much smaller than the

risk-sharing loans financed by Fannie Mae’s other DUS lenders. HUD has

identified a nationwide need for smaller multifamily rental properties in

rural areas.

Several Factors Have

Facilitated Fannie Mae’s

Use of Risk-Sharing Units

Several factors help to explain why Fannie Mae has used its risk-sharing

units more extensively than HUD’s other risk-sharing partners. These

factors include the previously noted parallels between the DUS product line

and the reinsurance program, Banc One Capital’s unique affiliation with

local lenders that have an incentive to finance affordable housing, and

4

To be eligible for insurance under the risk-sharing program, properties must be rent restricted and

have reserved at least (1) 20 percent of their units for households with incomes at or below 50 percent

of the area’s median income or (2) 40 percent of their units for households with incomes at or below

60 percent of the area’s median income.

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Fannie Mae’s efforts to both clarify and expand the program’s benefits for

lenders.

When Fannie Mae signed its risk-sharing agreement with HUD in 1994, it

had a product line in place that was uniquely compatible with the

reinsurance program. As noted, both the DUS product line and the

reinsurance program delegate responsibilities to other parties, and both

secure their investment through risk sharing. Because Fannie Mae had

been operating the DUS product line since 1988, it and its lenders had

experience with delegation and risk sharing when the reinsurance

program started. The other original participants in the reinsurance

program did not have such experience.

Modifications to the DUS product line created additional incentives for DUS

lenders to participate in the reinsurance program. First, in 1994, Fannie

Mae introduced the Targeted Affordable Housing product line, which

allows DUS lenders to use more flexible underwriting standards than are

required for the traditional DUS program.5

 At the same time, Fannie Mae

reduced its total loan guarantee fee to DUS lenders.6

 These changes made it

easier for lenders to finance affordable multifamily housing. Second, in

1996, Fannie Mae introduced the modified risk supplement, an incentive

that allows a DUS lender to terminate its credit risk entirely within 3 years

if a loan is performing according to prescribed criteria for payments, cash

flow, and rent rates.7

 By comparison, the traditional DUS program does not

provide for terminating a lender’s credit risk at any time during the term of

the loan. Termination frees the lender’s cash reserves for redirection to

new projects. In addition, termination relieves banks, thrifts, and their

mortgage banking subsidiaries of the risk-based capital requirements

5

Specifically, Fannie Mae (1) reduced the minimum debt service coverage ratio required for purchasing

loans to 1.1 for properties whose units are reserved exclusively for low-income households,

(2) reduced the guarantee fee for loans with a 1.15 debt service coverage ratio, and (3) increased the

maximum loan-to-value ratio on the first mortgage from 80 or 85 percent to 90 percent.

6

By passing along the savings associated with the lower guarantee fee that FHA charges when it

insures 50 percent of the risk of default, Fannie Mae was able to reduce its total loan guarantee fee by

10 to 20 basis points.

7

After the originating lender’s credit risk is terminated, Fannie Mae and HUD each assume 50 percent

of any future losses on a risk-sharing loan.

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established for them by their respective federal regulatory agencies.8

According to Fannie Mae, these requirements have deterred multifamily

lenders from participating in the DUS product line.

Banc One Capital Funding Corporation’s affiliation with a number of local

banks has also facilitated Fannie Mae’s participation in the reinsurance

program. As a subsidiary of a multibank holding company, it has

organizational ties to federally insured banks located in several states with

multiple branch locations. This affiliation, which is unique among Fannie

Mae’s DUS/risk-sharing lenders, has provided Banc One Capital with a

reliable network of local lenders seeking permanent financing for

multifamily affordable housing projects. These lenders have an incentive

to finance such projects because they are required, under the Community

Reinvestment Act of 1977, to serve the credit needs of their entire

community, including low- and moderate-income neighborhoods.

Providing these lenders with easy access to the secondary market also

allows them to remain short-term lenders and avoid both long-term credit

risk liability and risk-based capital requirements.

According to Fannie Mae, its efforts to familiarize the DUS lenders with the

reinsurance program have increased their participation. Fannie Mae has

provided information about the program through a separate chapter on

risk sharing in a guide that it publishes for DUS lenders, as well as through

special training on risk sharing. In addition, according to Fannie Mae, the

willingness of HUD staff to work with Fannie Mae to resolve programmatic

issues, such as the restriction on purchasing fully amortizing loans

(discussed later in this ch.), has encouraged participation.

Risk Sharing Benefits

Participants by

Encouraging Production

and Efficiency

When used with the DUS product line, the reinsurance program offers

different but interrelated benefits to Fannie Mae, DUS lenders, and

borrowers. All three groups have benefited because participation has

encouraged the production of affordable multifamily properties. Fannie

Mae has done more business through its Targeted Affordable Housing

product line—including more business that counts toward meeting the

8

Under these requirements for banks, a loan with even a small amount of partial recourse (i.e., first

loss position) must be treated as if the entire loan is at risk. Since most multifamily loans fall into this

category, multifamily lenders must generally maintain the maximum equity capital required for these

loans—8 percent of the loans’ total value. Thus, if the first 5 percent of a $1 million loan ($50,000) is in

the first loss position but the entire loan is posted on the bank’s books as a liability, the bank will have

to maintain equity capital equal to 8 percent of the loan’s value ($80,000), even though the bank can

lose no more than $50,000. While thrifts operate under similar standards, their federal regulator, the

Office of Thrift Supervision (OTS), takes into account the percentage of top loss risk in determining

how much of the loan is at risk.

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federal affordable housing goals for government-sponsored enterprises.9

DUS lenders have increased their lending capacity, and borrowers have

produced more multifamily housing. Production has increased because

participation decreases both the lenders’ and Fannie Mae’s loss exposure

by 50 percent and reduces the lenders’ reserve requirements by 50 percent,

allowing the lenders to finance more properties. Additionally, under

Fannie Mae’s modified risk supplement, the lenders’ loss exposure and

reserve requirements are eliminated entirely after 3 years if their loans are

performing satisfactorily. While the modified risk supplement largely

benefits the participating lenders by further increasing their lending

capacity, we believe it also benefits Fannie Mae because, as a

performance-based incentive, it strengthens the lenders’ motivation to

prudently underwrite and diligently service their risk-sharing loans.

Fannie Mae, DUS lenders, and borrowers have benefited from the

combination of the DUS product line and the reinsurance program. Because

HUD delegates its underwriting responsibility to Fannie Mae and Fannie

Mae, in turn, delegates its underwriting responsibility to the DUS lenders,

thereby eliminating the need for re-underwriting, loans are processed

more quickly and their transaction costs are lowered. Efficient processing

is particularly important for affordable housing loans because the costs of

delays can make such loans financially infeasible.10 The Targeted

Affordable Housing product line’s lower loan guarantee fee also benefits

borrowers by further reducing their transaction costs; at the same time,

the lower fee benefits Fannie Mae by making its loans more competitive.

Finally, to the extent that the reinsurance program’s incentives make

lenders more willing to originate loans for affordable multifamily

properties, borrowers benefit from the availability of a wider network of

DUS lenders, thereby increasing the supply of long-term mortgage financing

for these projects.

9

The Housing and Community Development Act of 1992 (P.L. 102-550) established three separate goals

for the enterprises’ purchases of mortgages. The purpose of these goals is to provide housing financing

for (1) low-and moderate-income families; (2) very-low-income families; and (3) families living in

central cities, rural areas, and other underserved areas.

10Since affordable multifamily housing projects often rely on multiple sources of financing, each of

which generally operates on a tight schedule, a delay in financing the permanent loan can result in the

loss of one or more critical sources of financing.

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Other Original

Participants Cited

Individual Reasons for

Not Using the

Program

For reasons particular to each, Freddie Mac has made little use of the

reinsurance program, and the National Cooperative Bank and the Federal

Home Loan Bank of Seattle chose not to use any of their units. Freddie

Mac and HUD have been working to overcome some of the barriers to

Freddie Mac’s use of the program; the National Cooperative Bank did not

reach agreement with HUD on when a project becomes a cooperative; and

the members of the Federal Home Loan Bank of Seattle showed no

interest in the program.

Several Factors Have

Limited Freddie Mac’s

Participation in the

Reinsurance Program

One factor limiting Freddie Mac’s activity in the reinsurance program,

according to Freddie Mac, is its risk-sharing agreement’s requirement that

all risk-sharing loans be fully amortizing—that is, that the terms of the

loans coincide with their amortization periods. This requirement excludes

balloon mortgages from the reinsurance program because the amortization

periods for balloon mortgages exceed the principal repayment periods of

the loans. Most of the loans that Freddie Mac purchases have balloon

mortgages,11 according to Freddie Mac; therefore, most of its loans are

ineligible for the risk-sharing program. On August 21, 1997, Freddie Mac

asked HUD to amend its risk-sharing agreement to allow the purchase of

balloon mortgages of 10 years or more. Although HUD, in November 1997,

approved a request from Fannie Mae to allow the purchase of 18-year

balloon mortgages—commonly used in financing properties with

low-income housing tax credits—it considers 10-year balloon mortgages

less common in financing affordable housing and believes that they may

present a greater refinancing risk to the borrower.12 HUD is therefore

waiting for Freddie Mac to demonstrate that this added risk is worth the

potential benefit to Freddie Mac.

Another impediment to Freddie Mac’s participation in the reinsurance

program is uncertainty over the applicability of the term “refinancing

loan,” which appears in Freddie Mac’s risk-sharing agreement. Freddie

Mac has asked HUD to resolve this uncertainty. According to a senior

Freddie Mac official, the term’s usage currently appears to require a

10-year extension of any existing affordability requirements when a

borrower with a first mortgage on a multifamily property refinances that

11Freddie Mac said that (1) 86 percent of the multifamily loans that it purchased from January 1995

through October 1997 were balloon mortgages and (2) most of the multifamily loans that it purchased

had 10-year balloons and 20- to 25-year amortization periods.

12Specifically, because 10-year balloon mortgages require refinancing virtually all of the loan principal

after 10 years, HUD is concerned that income-restricted properties may not be able to generate the

cash flow needed to repay the refinanced mortgages if interest rates rise substantially during the 10

years between the dates of originating the first mortgage and the refinanced mortgage.

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mortgage—even when the refinancing occurs shortly after the property’s

construction. The possibility that affordability requirements may be

extended deters lenders because it appears to reduce the property’s

long-term income-producing potential. HUD is planning to resolve this

uncertainty as Freddie Mac has requested.

A third factor that may have limited Freddie Mac’s participation in the

reinsurance program is its underwriting standards, which are set at a level

that excludes many affordable multifamily mortgage loans. Program Plus,

the multifamily product line that Freddie Mac introduced in 1994, requires

a minimum debt service coverage ratio of 1.2 and a maximum

loan-to-value ratio of 80 to 85 percent. In contrast, Fannie Mae’s Targeted

Affordable Housing product line allows a debt service coverage ratio as

low as 1.1 and a loan-to-value ratio as high as 90 percent (or higher if a

subordinate mortgage is part of a property’s financing). This comparison is

not intended to suggest that Freddie Mac should modify its underwriting

standards to better accommodate the risk-sharing program, but to indicate

that fewer affordable multifamily mortgages are eligible for purchase

under Freddie Mac’s reinsurance program than under Fannie Mae’s.

National Cooperative Bank

and FHLB of Seattle

Returned Their Units to

HUD

The National Cooperative Bank (NCB) signed a risk-sharing agreement with

HUD in September 1994, but no risk-sharing loans were ever approved

because, according to a senior HUD official, HUD and the NCB have been

unable to agree upon when a project legally becomes a cooperative under

the terms of the risk-sharing agreement. The risk-sharing agreement

prohibited the approval of any cooperative housing loans until the parties

concurred on this point and amended the agreement accordingly. Because

the bank’s primary mission is to originate loans to cooperatives, including

low-income housing cooperatives, this prohibition prevented the bank

from using the reinsurance program. The NCB has verbally agreed to return

its 2,000 units to HUD.

The Federal Home Loan Bank (FHLB) of Seattle did not participate in the

reinsurance program because its member financial institutions (thrifts,

commercial and savings banks and credit unions) did not express an

interest in doing so. The FHLB of Seattle agreed to participate in the

summer of 1994, after the acting director of its regulator, the Federal

Housing Finance Board, encouraged the FHLBs to participate in the

reinsurance program. The FHLB of Seattle agreed, knowing that customers

in rural communities were having difficulty originating mortgages for

affordable rental housing, primarily because there was no effective,

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efficient secondary market for loans of less than $2 million. But the FHLB

did not survey its members to assess their interest in the program before

signing a risk-sharing agreement with HUD in September 1994. Instead, it

spent that time reviewing and analyzing the program’s risks and resolving

a legal uncertainty. When it subsequently surveyed its members, it found

that they (1) perceived little need for risk-sharing insurance, since they

considered their own underwriting standards adequate to ensure little or

no loss; (2) wished to avoid involvement with FHA, whose programs they

regarded as time-consuming and bureaucratic; and (3) recognized that the

program’s fees would increase their financing costs, making their loans

less competitive. When none of its members expressed an interest in the

reinsurance program, the FHLB took no further action until January 1998.

At that time, it returned its 500 units to HUD for reallocation.

More Recent

Participants Have Not

Had Time for Much

Activity

It is generally too soon to determine how the second set of financial

institutions—SONYMA, the FHLB of New York, and the two loan

consortia—will use their risk-sharing units and how extensively they will

participate in the reinsurance program. The program offers these

institutions certain benefits that may encourage their participation.

SONYMA insures between 75 and 100 percent of the value of mortgage loans

secured by properties located in New York State. Its risk-sharing

agreement with HUD, signed in February 1997, provides SONYMA with

50-percent reinsurance for individual loans that it insures directly. This

reinsurance benefits SONYMA by allowing it to double its reserve capacity

and, at the same time, double the dollar value of the mortgage loans that it

can insure for multifamily lenders throughout the state. According to a

senior SONYMA official, the reinsurance could further benefit SONYMA by

allowing it to obtain a higher credit rating, which, in turn, would lead to

lower interest rates.

The FHLB of New York signed a risk-sharing agreement with HUD on

January 5, 1998. This agreement provides the FHLB with 50-percent

reinsurance for the portion of any eligible multifamily housing

loan—called a loan participation13—that it purchases from a member

financial institution. In July 1996, the Federal Housing Finance Board

approved the FHLB’s purchase of both single-family and multifamily

housing loans through a pilot program known as the Community Mortgage

Asset Program. The FHLB has proposed to use the reinsurance program to

13Instead of purchasing an entire loan originated by a member institution, the FHLB typically expects

to purchase 80 percent of the loan while the member institution retains the balance and services the

entire loan.

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reinsure the multifamily loan participations that it purchases through this

pilot program. To the extent that the added security provided through

risk-sharing encourages the FHLB to finance additional affordable

multifamily housing properties, it appears that the reinsurance program

will (1) help increase liquidity to lenders that do not traditionally have

access to the secondary market and (2) meet its objective of increasing

multifamily lending.

As noted, CPC and CCRC are still negotiating risk-sharing agreements with

HUD. Both institutions have extensive experience in affordable multifamily

housing finance.

Opportunities for

Greater Participation

Exist

Through its risk-sharing agreements with several major financial

institutions, HUD has established a basis for encouraging greater

participation in mortgage lending. If the program is made permanent or

reauthorized for several years, the institutions and HUD could take several

steps to expand participation. Some of these steps involve current

participants; others involve bringing in new risk-sharing partners and

broadening the program to include pooled as well as individual loans.

Increasing the

Participation of

Government-Sponsored

Enterprises Could Expand

Mortgage Lending

Nationwide

As noted, Fannie Mae, Freddie Mac, and the Federal Home Loan Bank

System operate nationwide. Thus, increasing their participation in the

reinsurance program could increase mortgage lending for affordable

housing throughout the country.

According to Fannie Mae, it is likely to resume its participation in the

reinsurance program when it receives the 2,000 units that HUD has agreed

to reallocate to it. In addition, if the program is made permanent or

reauthorized for several years and the current limits on the number of

available units are lifted, Fannie Mae expects to be able to use still more

units. While Fannie Mae has not announced any plans for expanding its

pool of DUS lenders, other lenders may have organizational ties to local

banks that would facilitate their participation in the reinsurance program,

much as Banc One Capital Funding Corporation’s affiliation with local

lenders has advanced its risk-sharing business. Replicating Banc One

Capital’s experience in other parts of the country could simultaneously

increase the sale of affordable multifamily housing loans in the secondary

market and diversify both the geographic location and the types of

properties financed through the reinsurance program. Banks and thrifts, in

particular, could increase their lending by taking advantage of the

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opportunity to terminate their credit support for well-performing loans

after 3 years under Fannie Mae’s modified risk supplement.

Overcoming the obstacles to Freddie Mac’s participation could create

further nationwide opportunities for expanding the reinsurance program.

HUD has already said that it will consider at least two of the issues that

Freddie Mac has cited as obstacles. As noted, HUD has agreed to assess the

risks of reinsuring 10-year balloon mortgages. While amending Freddie

Mac’s risk-sharing agreement to include the purchase of 10-year balloon

mortgages may make the majority of Freddie Mac’s loans eligible for

reinsurance, HUD may determine that potential increases in interest rates

present an undue risk that it is unwilling to assume. However, because HUD

has already determined that 18-year balloon mortgages do not present an

undue risk, it could offer to amend Freddie Mac’s or any other risk-sharing

partner’s agreement to allow for the use of reinsurance with 18-year

balloon mortgages. In addition, if it agrees that the use of a short-term

permanent loan14 as a bridge between a construction loan and a long-term

permanent loan does not convert the permanent loan into a refinancing

loan with additional affordability requirements, it will alleviate Freddie

Mac’s concerns about the possible imposition of such requirements. A

senior HUD official said that even if HUD agrees that the use of a short-term

permanent loan does not convert the permanent loan to a refinancing loan,

he believes that limits will have to be placed on the length of such

short-term loans.

The Federal Home Loan Bank System, with its 6,504 member institutions

in all 50 states, presents a major opportunity for expanding the

reinsurance program while making minimal demands on HUD’s resources.

The 12 FHLBs, with close ties to their member institutions, would select

these institutions for participation and monitor their performance.

Although the Seattle FHLB’s member institutions were not interested in the

reinsurance program, the FHLB of New York may be able to demonstrate

whether the program could be useful to other FHLBs. If the New York FHLB

uses reinsurance, combined with its Community Mortgage Assistance

Program, to purchase affordable multifamily loans from many types of

member institutions, including smaller financial institutions that

traditionally have not had access to Fannie Mae’s or Freddie Mac’s

secondary market products, other FHLBs may decide to replicate the

Community Mortgage Assistance Program and join the reinsurance

program, thus expanding the program’s geographic coverage. The Federal

Housing Finance Board has also approved a proposal by the FHLB of

14Such loans are generally referred to as “mini-perm” loans.

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Atlanta to purchase multifamily loans from a North Carolina loan

consortium as a qualified investment for its own portfolio. While this

initiative does not involve the reinsurance program, FHA’s 50-percent

reinsurance could be used as an incentive to encourage other FHLBs to

purchase affordable multifamily loans from consortia operating in their

regions.

Involving Loan Consortia

Could Increase Financing

for Smaller Properties

Although HUD has not yet signed risk-sharing agreements with CPC and

CCRC, these loan consortia represent another opportunity to expand

participation in the reinsurance program. They are entities created by

banks and thrifts to promote lending for affordable housing. Since the

1970s, they have financed the development and/or rehabilitation of

affordable housing, particularly of multifamily rental properties, at both

the city and the state level. Their loans have supported the development of

smaller-size properties, most of which have fewer than 50 units. As noted

in chapter 1, HUD has identified a nationwide need for financing for smaller

properties. Thus, involving loan consortia in the reinsurance program

could help to satisfy this need.

When HUD first established the reinsurance program, it believed that loan

consortia would become involved, not as risk-sharing partners, but as

lenders selling their loans to Fannie Mae and Freddie Mac. Both Fannie

Mae and Freddie Mac identified particular consortia in their risk-sharing

agreements as “special lenders” whose loans they would purchase to

promote the program’s goals. However, neither Fannie Mae nor Freddie

Mac has purchased any risk-sharing loans from loan consortia. Fannie Mae

noted that loan consortia have gained access to capital through other

Fannie Mae sources.

Several factors make it difficult for loan consortia to sell their loans in the

secondary market. Specifically, (1) their loan volumes are not large

enough;15 (2) their underwriting standards may not be compatible with

Fannie Mae’s and Freddie Mac’s conventional standards; (3) their low net

worth requires them to obtain letters of credit or other costly credit

enhancements before they can sell their loans, and (4) their reserves are

generally not adequate to meet Fannie Mae’s and Freddie Mac’s

15On average, their loans range in amount from $750,000 to $2.5 million. The total average loan volume

estimated by the 10 loan consortia surveyed by GAO during 1996 was approximately $145 million.

(CPC, the nation’s largest loan consortium, was not included in the survey). See app. VII for the

characteristics of the loans and properties financed by these 10 consortia.

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requirements for long-term “credit support” from sellers under a loan pool

purchasing arrangement.16

Loan Pool Reinsurance

Could Facilitate

Consortia’s Access to

Secondary Markets

To help overcome the obstacles to their participation in the secondary

markets, CPC and CCRC have proposed using risk sharing to reinsure pooled

loans. Currently, HUD’s risk-sharing reinsurance agreements apply only to

individual loans, and HUD has no experience with loan pool insurance.

However, the act authorizes loan pool insurance, and, according to a

senior HUD official, HUD is not averse to experimenting with it as long as the

credit risks are reasonable.

Loan pooling has several advantages that could facilitate the participation

of loan consortia in the secondary markets. First, pooling aggregates

loans, increasing their volume. Such aggregation is necessary, because of

the complexities and costs associated with loan pool transactions. Second,

pooling generally occurs after loans are seasoned—that is, some years

after their origination, by which time they have acquired credit and

property maintenance histories that can alleviate concerns about

underwriting terms that differ from industry standards. Therefore,

compared with newly originated loans, seasoned loans present less

uncertainty and their performance is easier to predict. Third, losses can be

more accurately projected for a pool of loans than for individual loans.

Loan pooling alone cannot overcome all of the obstacles limiting the

participation of loan consortia in the secondary market. Risk-sharing

reinsurance could, however, make pooled loans more attractive to

purchasers. Freddie Mac, for example, decided not to purchase a

consortium’s pool of balloon loans because, according to a consortium

official, (1) the consortium’s net worth was too low and a letter of credit

would have been too costly to acquire and (2) the consortium’s cash

reserves were not high enough to satisfy Freddie Mac’s long-term credit

support requirements. Had these loans been eligible for risk-sharing

reinsurance—neither balloon mortgages nor loan pools are eligible under

Freddie Mac’s risk-sharing agreement with HUD—the reinsurance would

have enhanced their credit and would have reduced Freddie Mac’s reserve

requirements for the loan consortia.

16Loan consortia are typically capitalized by pools of funds provided through short-term loans from

their member financial institutions. These funding pools do not maintain the long-term reserves

established by most state housing finance agencies and by Fannie Mae and Freddie Mac. Hence, they

cannot be used to provide long-term credit support for loans sold in the secondary market.

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Fannie Mae has experience with pooled loans, which it purchases through

its Negotiated SWAP product line,17 and it has proposed using the

reinsurance program to reinsure loan pools. This proposal would appear

to benefit loan consortia. However, Fannie Mae historically has not been

interested in purchasing a loan pool from multiple lenders. Therefore, if a

consortium could aggregate loans from its member lenders, or if several

consortia could combine their loans, they would need to identify an

“honest broker conduit” to sell the pool to Fannie Mae.

Despite the difficulties they have experienced in trying to sell loan pools in

the secondary market, some loan consortia in our focus group believed

that pooling, combined with risk-sharing reinsurance, would be an

effective way for them to sell their loans. In general, representatives of 13

consortia said that participation in the risk-sharing program could have

the following benefits (the numbers in parentheses indicate the number of

consortia identifying each potential benefit): increase their sales of loans

in the secondary market (12), increase their loan volumes (11), increase

the size of their loans (9), and extend their loan amortization periods (8).

Conclusions Although the reinsurance program remains largely untested, Fannie Mae

and Banc One Capital have demonstrated its potential to produce

affordable multifamily housing efficiently and, in some instances, to

produce smaller properties in rural markets, thereby helping to satisfy an

unmet capital need. If HUD can resolve the obstacles to Freddie Mac’s

participation and negotiate risk-sharing agreements with the loan

consortia, these institutions may also be able to use their risk-sharing units

productively.

While HUD is considering the risks involved in Freddie Mac’s request to use

reinsurance with 10-year balloon mortgages, it could offer to amend the

risk-sharing agreement of Freddie Mac—or of any other interested

risk-sharing partner—to allow the use of reinsurance with 18-year balloon

mortgages, making generally available an option that is currently limited to

Fannie Mae. Because many properties with low-income housing tax credit

financing have 18-year balloon mortgages, this action could increase the

number of institutions eligible to combine reinsurance with tax credit

financing and thus further both the reinsurance and the tax credit

programs’ affordable housing goals.

17In the Negotiated SWAP program, rather than purchasing one loan at a time, Fannie Mae purchases a

pool of mortgage loans, and exchanges or “swaps” the loans for a mortgage-backed security.

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Allowing the use of reinsurance with loan pools could help loan consortia

and smaller lenders offset the limitations of low net worth and limited

reserves that currently hamper their sales of loan pools in the secondary

market. Because these lenders often finance smaller properties, facilitating

their access to the secondary market could also help to satisfy the need

HUD has identified for smaller affordable multifamily properties.

HUD’s most recent risk-sharing partners may be able to demonstrate

productive new uses of the reinsurance program. SONYMA officials appear

to have a clear understanding of the program’s benefits. The efforts of the

Federal Home Loan Bank of New York also bear watching, not only

because the reinsurance program, in combination with the Community

Mortgage Assistance Program, may be able to increase liquidity to lenders

that do not traditionally have access to the secondary market, but also

because the Bank, as part of the Federal Home Loan Bank System with its

over 6,500 member institutions, has an opportunity to establish a model

for producing affordable multifamily housing that could be replicated

nationwide.

Although the reinsurance program is still in the demonstration phase, we

believe that it is conceptually sound, relying on reciprocal, market-driven

risk-sharing agreements, and with more time and experience, activity in it

may increase. If it is made permanent, as legislation has proposed, or if it

is authorized for a certain number of years, both HUD and the participating

financial institutions will have more incentive to commit resources to it.

Recommendations We recommend that the Secretary of Housing and Urban Development

direct the Commissioner, Federal Housing Administration, to explore the

feasibility of amending HUD’s current risk-sharing agreements to (1) allow

the use of reinsurance with 18-year balloon mortgages as is currently

permitted in an agreement with Fannie Mae and (2) authorize the use of

reinsurance with loan pools.

Agency Comments HUD agreed in written comments on a draft of this report (see app. IX) to

offer to amend the risk-sharing agreements of the other participating

entities to permit 18-year balloon mortgages with 30-year amortization

periods. HUD also agreed, because of the potential to reach underserved

and hard-to-serve markets, to explore the feasibility of amending current

risk-sharing agreements to permit the use of reinsurance with loan pools,

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assuming that the actuarial soundness of the FHA insurance fund would be

maintained.

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HUD has derived significant benefits through risk-sharing, primarily by

participating in the credit enhancement program. Specifically, it has

generally limited its loss exposure for insured loans to half the outstanding

loan amount and has substantially reduced the time taken to process

applications for FHA insurance, compared with the time taken under its

traditional mortgage insurance programs. The same benefits are

potentially available to HUD through the reinsurance program, but, as

discussed in chapter 3, activity in that program has been very limited.

However, problems in the data system used to administer the credit

enhancement program limit HUD’s ability to accurately monitor the

program and report on its status. Weaknesses in HUD’s oversight could also

jeopardize the program’s benefits.

Participation in the

Risk-Sharing

Demonstration

Programs Limit

Government’s

Exposure to Losses

One of the six goals of the risk-sharing programs is to ensure that other

parties bear a share of the risk, in percentage amount and in position of

exposure, that is sufficient to create strong, market-oriented incentives for

the other participating parties to maintain sound underwriting and loan

management practices. HUD has successfully met this legislative objective.

Because most of the risk-sharing agreements require HUD’s partners to

share equally in any losses arising from loan defaults, HUD has limited its

loss exposure while establishing economic incentives for its risk-sharing

partners to perform their respective functions properly. HUD has further

minimized its loss exposure by ensuring that its risk-sharing partners have

sufficient capital to meet their obligations should any losses occur.

Risk-Sharing Partners

Assume Significant Risk

Compared with HUD’s traditional multifamily insurance programs, the

risk-sharing programs expose the federal government to substantially less

risk of loss in the event of default. HUD’s traditional programs generally

hold the federal government responsible for 100 percent of any losses

associated with defaults on federally insured loans. In contrast, the

risk-sharing programs are generally holding the federal government

responsible for 50 percent of any such losses. In the reinsurance program,

all of the risk-sharing agreements signed to date divide the responsibility

for any losses equally between the federal government and its risk-sharing

partners. Thus, Fannie Mae is responsible for 50 percent of any losses for

all of the 956 units in the 6 completed properties reinsured under the

reinsurance program as of October 1997.

In the credit enhancement program, housing finance agencies can elect to

assume as little as 10 percent of the loss exposure if they use HUD’s

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underwriting standards,1 but as of September 1997, 16 of the 21 agencies

with closed loans had assumed 50 percent or more of the loss exposure for

87 of the 110 loans closed by that date. These loans accounted for about

85 percent of the 12,851 units in the 110 insured properties. Table 4.1

shows the percentage of risk assumed by the housing finance agencies for

properties insured under the credit enhancement program through

September 1997.

Table 4.1: Percentage of Risk

Assumed by Housing Finance

Agencies for Insured Properties

Percentage of risk

assumed by agency

Number of

properties Number of units

Percentage of

units

90 4 369 3

50 83 10,869 85

25 10 524 4

10 13 1,089 8

Total 110 12,851 100

Source: GAO’s analysis of questionnaire data provided by housing finance agencies.

The opportunity to use their own underwriting standards has provided an

incentive for most of the housing finance agencies to assume at least

50 percent of the loss exposure. As of September 1997, only 4 of the 21

agencies with closed loans had elected to assume a 10- or a 25-percent loss

position on all, or most, of their closed loans. The New York Housing

Finance Agency, for example, assumed only 10 percent of the risk of loss

for each of the 4 loans it processed because, according to agency officials,

the agency was already assuming the top loss position on these loans by

supporting the financing of the insured properties through either grants or

second mortgages.2

 In the officials’ view, this other financing was more

than adequate to absorb any losses if a default were to occur, and they did

not believe that the federal government was in a serious risk position.

Risk-Sharing Partners

Have Financial Integrity

Besides requiring its risk-sharing partners to assume a significant portion

of the risk of loss on insured loans, HUD has established criteria to ensure

that its partners will be able to meet their financial obligations. The

qualified financial institutions participating in the reinsurance program all

1

Housing finance agencies electing to assume 50 percent or more of the risk exposure for losses

(referred to as level I agencies) use their own underwriting standards. Agencies electing to assume less

than 50 percent of this risk (level II) are required to use HUD’s underwriting standards.

2

These mortgages take a subordinate position to the first mortgage. This means that if any losses

occur, the first mortgage, which is insured under the risk-sharing program, will be paid in full before

any subordinate financing is paid.

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have excellent credit ratings or track records in multifamily lending.

Fannie Mae, Freddie Mac, and the FHLB System all have the highest

(“AAA”) credit rating. SONYMA has a “AA” credit rating and the National

Cooperative Bank, which still has a risk-sharing agreement with HUD even

though it has returned its allocated units, has an “A-” credit rating,

according to the NCB’s treasurer. Although two loan consortia told us that

they have not been rated, each has had a long and successful history of

multifamily lending. CCRC has made about $150 million in multifamily loans

since 1989, and CPC has originated over $800 million in multifamily loans

since 1972.

To participate in the credit enhancement program, a housing finance

agency must either meet certain minimum credit standards for financial

soundness established by a nationally recognized rating agency, such as

Standard and Poor’s or Moody’s Investors Service, or have a dedicated

reserve account with sufficient capital to meet the agency’s outstanding

obligations under the program. The minimum credit standards for an

agency seeking acceptance into the program on the basis of a credit

agency’s evaluation are either (1) a “top tier” designation3

 or (2) an overall

rating of “A” for the agency’s general obligation bonds.4

 If an agency does

not meet these criteria, HUD requires that the agency establish a dedicated

reserve account of not less than $500,000 and add to that reserve 1 percent

of the outstanding balance on all mortgages originated up to $50 million.

For mortgages beyond this amount, additional but reduced reserves are

required.

Our review of the eligibility standards met by the 32 housing finance

agencies with risk-sharing agreements showed that 21 met the program’s

eligibility criteria on the basis of their credit rating from either Standard

and Poor’s or Moody’s. The remaining 11 established dedicated reserve

accounts. Appendix VIII shows the rating criteria that the housing finance

agencies met to demonstrate their financial solvency.

3

A top-tier rating reflects an agency’s sound assets, stable earnings, and strong capital adequacy ratios.

The rating also implies that the agency has capable management and is able to meet its mandate.

4

As defined by Moody’s, bonds rated “A” possess many favorable investment attributes and are to be

considered as upper-medium-grade obligations. Factors giving security to principal and interest are

considered adequate, but elements may be present that suggest a susceptibility to impairment

sometime in the future.

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HUD Has Derived

Administrative

Benefits Through Its

Participation in the

Risk-Sharing

Programs

Another goal established for the demonstration programs is to increase the

efficiency, and lower the costs to the federal government, of processing

and servicing multifamily housing mortgage loans insured by HUD. The

programs have achieved this goal. By delegating its loan-processing

responsibilities to its risk-sharing partners, HUD has been able to deliver

multifamily insurance more expeditiously through the risk-sharing

demonstration programs than through its traditional multifamily insurance

programs. Furthermore, because HUD has also delegated the

responsibilities for monitoring the performance of insured properties and

for foreclosing on any properties in serious default, HUD will continue to

accrue administrative benefits throughout the terms of the insured loans.

HUD has not formally assessed how much staff time it has saved through

risk sharing. However, senior management within HUD pointed out, “it

stands to reason” that the substantial reduction in HUD’s responsibilities

under risk sharing should result in substantial time savings for HUD.

Estimates provided by the FHA Commissioner support this conclusion. For

example, according to the Commissioner, one field office estimated that it

takes about 480 staff hours to process an application for a traditional

mortgage loan5

 through the firm commitment phase,6 compared with

about 80 staff hours under the risk-sharing program. Overall, HUD

estimated that processing an application through the firm commitment

stage can take as many as 540 hours under the traditional multifamily

insurance programs and as few as 12 hours under the risk-sharing

program. HUD further noted that the transfer of loan-processing and

underwriting responsibilities to its risk-sharing partners has enabled its

field offices to process projects through the firm commitment phase in 1 to

3 months, compared with 6 to 9 months under FHA’s traditional multifamily

insurance programs.

In addition, HUD estimated that under the traditional programs, its staff put

in another 400 hours per loan before it provides the final endorsement.7

They administer the construction loan, inspect the property, and certify

the property’s costs—all responsibilities that are delegated under the

risk-sharing programs. Thus, according to HUD’s estimate, loan processing

takes about 80 hours under risk sharing, compared with about 880 hours

5

Under section 221(d)(4). This program, used by for-profit developers, provides multifamily mortgage

insurance for new construction and/or substantial rehabilitation.

6

Phases in insuring a loan include the following: application received, firm commitment issued, initial

endorsement provided, and final endorsement provided. In some instances, the application is

withdrawn or the firm commitment expires.

7

At this stage, when HUD provides the insurance, the property has been completed and occupied.

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under the traditional programs—a 10-fold savings in staff time. While these

estimates are not scientific, they are consistent with estimates provided by

HUD staff in each of the five field offices we visited.8

The risk-sharing programs provide HUD with additional administrative

benefits that start when an insured property becomes operational and

continue throughout the life of the mortgage loan. These savings accrue to

HUD because it delegates its asset management and property disposition

responsibilities to its risk-sharing partners. While we did not attempt to

quantify the staff time that HUD saves from delegating these

responsibilities, we did explore the management implications of shifting

them from HUD to its risk-sharing partners. According to HUD officials, most

asset managers in its field offices are responsible for monitoring the

financial and physical condition of about 60 multifamily properties. In

some offices, they may be responsible for as many as 80 to 85 properties.

In contrast, according to the executive directors and senior program

managers from 11 active housing finance agencies participating in our

focus groups, most asset managers at housing finance agencies are

responsible for 25 to 30 properties. While there is no established standard

for the optimal number of properties that an asset manager should

oversee, the executive directors and risk-sharing program managers

pointed out the obvious—the smaller the number of properties that an

asset manager is responsible for overseeing, the more likely the manager

will be familiar with the properties’ performance characteristics, and the

sooner the manager can identify and respond to potential problems, the

less likely the property will incur carrying costs and physical decline.

Information Systems

Are Not Reliable

The data system that HUD created to manage the credit enhancement

program—the Risk-Sharing Multifamily National System (RSS)—is largely

unreliable and user unfriendly. A comparable system does not exist for the

reinsurance program because activity in this program has been so limited.

HUD relies instead on an automated spreadsheet to manage the reinsurance

program. While recognizing the shortcomings of RSS, HUD maintained that

its primary data system, known as F47, which it uses to monitor all insured

multifamily loans, is reliable. However, we identified errors in this system

for loans insured under both risk-sharing demonstration programs. These

problems need to be resolved if HUD is to have an accurate database for

monitoring and managing the programs.

8

In Boston, Denver, Jacksonville, New York, and San Francisco.

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Credit Enhancement

Program’s Data System Is

Flawed

HUD established RSS to monitor activity under the credit enhancement

program. This system, HUD officials said, was designed for HUD

headquarters to (1) track the number of units allocated to housing finance

agencies, (2) monitor the progress of projects through specific phases

toward completion,9

 and (3) provide program managers with financial

information on completed properties. However, the system was not

designed to be a single comprehensive point of reference for monitoring

and managing the credit enhancement program. Rather, because HUD field

offices are responsible for collecting data from participating housing

finance agencies within their jurisdictions, HUD headquarters expected that

the field offices would create their own information systems to oversee

projects applying for and receiving insurance under the program.

RSS has met its first objective of providing HUD headquarters with accurate

data on the number of units allocated to housing finance agencies.

However, the system has generally not met the other two objectives, even

though the Director of HUD’s Office of Multifamily Housing Development

emphasized the importance of reliable data in a December 1996

memorandum to the field offices. This memorandum stated that despite

substantial progress under the credit enhancement program, “reliable data

to substantiate this achievement [remain] a major program deficiency.” In

addition, the memorandum identified significant discrepancies between

the data in RSS and information available to HUD headquarters from other

sources. These sources indicated, for example, that firm approval letters

had been signed for properties that did not appear in RSS. Such problems

persist today, even though the memorandum advised that “increased

attention be given to the availability of timely and reliable data,” given the

intense interest in the new partnership between HUD and the housing

finance agencies shown by congressional, industry, and other observers.

HUD headquarters and field officials have acknowledged that RSS was

designed quickly and, in the rush to develop and implement the system,

certain basic requirements were overlooked. Specifically, software was

provided to housing finance agencies and HUD field offices with little, if

any, training or documentation. Although a manual was provided, the

software was difficult to use. In addition, the software did not come with a

data dictionary, a basic requirement for a data system, needed to ensure

the data’s reliability. Not having a data dictionary has precluded the

consistent reporting of data from the housing finance agencies.

9

Application received, firm commitment issued, initial endorsement provided, final endorsement

provided, or application withdrawn or firm commitment expired if appropriate.

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Officials from the seven housing finance agencies we visited and from the

eight other agencies participating in our focus group on the credit

enhancement program discussed the problems they had encountered in

using RSS. The officials were virtually unanimous in concluding that the

software for the system is user unfriendly. Almost all of them noted, for

example, that the software does not contain an edit function.

Consequently, if a user makes an error in entering data, he or she has to

start entering the data all over again to correct the error. The officials also

noted that the software could not generate paper copies for users to verify

the data they had entered.

To work around RSS’ limitations, some agencies began using alternative

software. At the time of our review, officials at the Florida Housing

Finance Agency were using spreadsheet software to make necessary edits

and to print information. They entered the same data elements that RSS

requires and sent a paper copy of their spreadsheet to the appropriate HUD

field office. The HUD field office, in turn, reentered the data into RSS before

transferring the data to HUD headquarters for inclusion in the master RSS

database.

Officials at the Massachusetts Housing Finance Agency also observed that

RSS is not user friendly because it requires the continuous, sequential entry

of all data at one time. Thus, to add or change a data element, the person

entering the data has to restart the program and reenter the data

previously entered in every data field. These officials said they would

prefer to selectively add and delete or reenter data elements without

having to reenter all of the elements for a particular project. Officials from

the New York Housing Finance Agency identified the same problem,

commenting that they would be likely to enter new information as it

became available.

To the housing finance agencies, the lack of a data dictionary posed

serious concerns about the reliability of the data entered into the system.

For instance, the Florida Housing Finance Agency developed its own data

dictionary for the required data elements. However, as agency officials

pointed out, their interpretation of data elements might differ from other

agencies’ interpretations. Officials from the Montgomery County Housing

Finance Agency in Maryland were also concerned about the difficulty of

interpreting certain required data elements without a data dictionary. For

example, they showed us a $2.4 million item for one property that they

reported under the “local grant” category when, they said, they could just

as easily have reported it under the “loans and subsidies” category. In

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effect, without a data dictionary for clarification, they arbitrarily decided

where to report this item.

Finally, officials from several housing finance agencies expressed concern

because they are required to report over 50 data elements on a property’s

financial and physical condition; however, they were not aware that any

use was being made of this information. Our discussions with HUD

headquarters officials confirmed that these data have not been used to

summarize the program’s results or to evaluate the program. Moreover, we

found that for all loans from California and Massachusetts, these data

elements had not been entered into RSS. HUD field office and headquarters

staff told us that this problem exists, in part, because HUD field offices have

no incentive to transfer final data on closed loans into RSS, given that

similar data are required to be reported in HUD’s Multifamily Insurance

System. This system, known as F47, should contain data on all of HUD’s

insured multifamily properties, including those insured under both the

credit enhancement and the reinsurance programs. HUD management uses

this system for budgeting and assessing the attainment of production

objectives.

Our visits to five HUD field offices generally confirmed the problems noted

by the housing finance agencies. In addition, one field office noted that

HUD headquarters has occasionally taken actions such as increasing or

reallocating risk-sharing units among housing finance agencies without

informing the servicing HUD field offices. Such actions limit the field

offices’ ability to monitor the unit allocations available to housing finance

agencies.

Because F47 is supposed to contain financial and other data on all

FHA-insured properties, HUD headquarters officials tended to minimize the

problems associated with RSS. They noted that data on a risk-sharing loan

become part of F47’s database when two events occur—when the closing

memorandum (HUD Form 290) is signed by the authorized HUD field staff

and when a check is received by HUD for the first payment on the loan’s

insurance premium. Within a few days of these two events—independent

of the credit enhancement program’s administrative processes—data on

the risk-sharing loan should become part of the F47 system.

To test the reliability of the data on risk-sharing loans in the F47 system,

we compared the information in the system as of November 1997 with our

data on the 110 loans closed by housing finance agencies as of

September 1997 and the 6 loans closed by Fannie Mae as of October 1997.

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We noted errors in both cases. Specifically, the F47 system reported 106

loans closed by the housing finance agencies and 2 loans closed by Fannie

Mae. A senior HUD headquarters official attributed these omissions to

servicing problems in HUD field offices. According to this official, problems

have occurred in documenting the first payment of the insurance premium

and in transferring the closing memorandum to HUD headquarters. Because

FHA insurance is not recorded on a property until these two actions have

been completed, such problems have delayed the entry of data into the

F47 database.

Alternatives to RSS Are

Available

Executive directors and risk-sharing program managers from several

housing finance agencies indicated that, in place of RSS, they would prefer

a reporting system that relied on personal-computer-based software. Such

a system with a data dictionary, they agreed, would provide program

mangers at all levels with consistent, easily accessible data for program

evaluations. In addition, they agreed that state-of-the-art spreadsheet or

database software would provide user-friendly editing and reporting

capabilities that would also enhance the reliability of the data.

According to HUD headquarters officials, the problems associated with RSS,

a stand-alone system, should be resolved in the broader context of

ongoing efforts to overhaul and fully integrate all of HUD’s management

information systems. Currently, HUD is installing a

personal-computer-based software suite departmentwide. This suite,

called HUDWARE II, includes word processing, spreadsheet, database,

and graphics/report software packages. HUD is training its staff in the use

of the new software as it is installed in headquarters and the field. We

found that HUD field offices were using the new spreadsheet packages to

partially fulfill their monitoring requirements under the credit

enhancement program. A senior HUD headquarters program official also

told us that suite software such as HUDWARE II would provide sufficient

capacity to monitor and report on the risk-sharing program. Managers at

all levels could consistently use such software for program oversight

functions.

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HUD Recognizes That

Programs’ Future

Expansion Requires

Effective

Administrative

Controls

Because the risk-sharing demonstration programs delegate virtually all

critical loan-processing and administrative functions to HUD’s risk-sharing

partners, it is imperative that HUD (1) establish procedures for ensuring

that its partners are carrying out their responsibilities in accordance with

the programs’ regulations and risk-sharing agreements and (2) monitor its

partners to ensure that these procedures, regulations, and/or agreements

are being followed. HUD has established reasonable administrative controls

for overseeing the programs; however, it is somewhat premature to assess

HUD’s application of these controls, given the programs’ limited activity to

date. Nevertheless, we did observe some problems with HUD’s

implementation of these controls. HUD is aware of these problems and

plans to address them.

HUD Has Established

Controls for Oversight

Procedures for implementing the credit enhancement demonstration

program are contained in a June 1995 handbook. According to these

procedures, HUD field offices have the primary responsibility for ensuring

that housing finance agencies comply with handbook’s requirements for

loan underwriting, asset management, and, if necessary, property

disposition. The handbook requires the field offices to make at least one

annual on-site review of each participating housing finance agency to

assess the agency’s compliance with the handbook’s requirements. This

on-site visit is to include a review of a sample of loan files to validate

compliance with agreed-upon underwriting criteria. The handbook further

requires HUD headquarters to provide “remote monitoring” of housing

finance agencies to ensure that they continue to meet the program’s

eligibility criteria and maintain either an “A” credit rating or the required

dedicated reserves. The handbook also requires that housing finance

agencies submit semiannual reports to HUD headquarters that include the

status (current, delinquent, workout, or foreclosure) of all insured loans.

Finally, agencies are required to notify HUD headquarters monthly when a

mortgage is in default (30 days past due) until it either becomes current or

an application for an initial claim payment is made.

HUD has not drafted a regulatory handbook for administering the

reinsurance program. Rather, the procedures for HUD’s oversight of the

participating financial institutions are specified in each risk-sharing

agreement. According to these agreements, HUD headquarters, rather than

HUD field offices, is responsible for monitoring the performance of

participating financial institutions. This monitoring includes receiving and

reviewing semiannual reports from the participating institutions showing

the unpaid principal balance on each risk-sharing loan and its status. While

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the agreements also require the participating entity to provide HUD with

any records it deems necessary to carry out its review functions, HUD

headquarters is not required to conduct on-site reviews of the financial

institutions.

Review of Oversight

Disclosed Some Problems

Because the demonstration programs are still evolving, and participation

by many of HUD’s risk-sharing partners has been limited, we did not

conduct a comprehensive evaluation of how well HUD field offices and

headquarters are carrying out their oversight responsibilities. However, we

did discuss with officials at five HUD field offices the procedures they are

using to ensure that housing finance agencies comply with the handbook’s

requirements for the credit enhancement program. These five field offices

oversee housing finance agencies that account for about 60 percent of the

units reserved through September 1997 under the credit enhancement

program. Our review disclosed some inconsistencies in the field offices’

procedures for on-site monitoring, documentation of housing finance

agencies’ performance, and communication and resolution of identified

problems with housing finance agencies.

HUD headquarters officials, with a broader perspective, confirmed that HUD

field offices have been inconsistent in reviewing housing finance agencies

to ensure that they are complying with the program’s regulations and

procedures. Moreover, headquarters officials agreed that they have not

developed a systematic process for ensuring (1) that HUD headquarters has

received and reviewed the semiannual reports required from housing

finance agencies on the status of their closed loans or (2) that housing

finance agencies continue to meet the program’s eligibility criteria. We

contacted the housing finance agencies in California, Colorado, Florida,

and Massachusetts, which account for about 60 percent of the closed loans

as of September 1997, to inquire whether they were complying with the

semiannual reporting requirements. Officials at the California and Florida

agencies told us that they had neglected to send in the required reports.

According to a senior official at the California Housing Finance Agency,

one of the agency’s insured loans had been in default since October 1996.

Furthermore, the California Housing Finance Agency did not notify the

HUD field office of the default until October 1, 1997, at which time the

payments for loan principal, interest, real estate taxes, and property

insurance were over $457,000 in arrears. As we pointed out in chapter 2,

HUD headquarters officials were not aware of this default until we brought

it to their attention in February 1998. However, according to the senior

California official, the agency has notified HUD that it will hold HUD

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harmless on this loan because of extenuating circumstances. The official

also said that the agency is withdrawing the loan from the risk-sharing

program. We found that, for overseeing the reinsurance program, HUD

headquarters had received the semiannual reports required from Fannie

Mae.

HUD management is aware of the oversight problems as well as the

importance of ensuring that its risk-sharing partners comply with the

programs’ procedures, regulations, and/or risk-sharing agreements.

According to headquarters officials, HUD plans to transfer the

responsibility for overseeing both the credit enhancement and the

reinsurance programs to a newly established quality assurance unit that is

to be created by realigning HUD field office staff. The creation of this unit is

part of HUD’s ongoing initiative to transform the way the Department

administers all of its programs. The quality assurance unit would be

responsible for overseeing all lenders participating in the risk-sharing

programs and in FHA’s other insurance programs. According to

headquarters officials, the unit’s responsibilities could include validating

the status of housing finance agencies’ qualifications, including the

agencies’ financial solvency; reviewing agencies’ underwriting practices;

and reviewing the semiannual reports on the agencies’ portfolios insured

under the credit enhancement program, including the original mortgage

amount, outstanding loan principal balance, and status of all loans. In

addition, headquarters officials are also considering institutionalizing

certain periodic and cyclical tasks, such as annual reviews of housing

finance agencies’ financial statements and annual requests to Moody’s and

Standard and Poor’s for agencies’ credit ratings.

Conclusions Whether or not the Congress permanently authorizes the risk-sharing

demonstration programs, HUD program managers will need consistent and

reliable data on the units allocated to HUD’s risk-sharing partners and on

the progress of these units towards completion. Furthermore, asset

management and property disposition issues may arise over the life of the

programs that may require data on properties’ financial and physical

characteristics. This broad range of information will be needed to monitor

and accurately evaluate the overall performance of the risk-sharing

programs and their individual projects. The credit enhancement program’s

current data system (RSS) does not provide reliable information, and

servicing problems have led to omissions in F47.

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HUD has not yet selected the system that will support the information and

evaluation needs of the credit enhancement program’s future managers.

Adequately addressing the shortcomings of the current data system,

especially the lack of a data dictionary, is, however, imperative as

designers planning the new system identify the needs of users at all levels.

HUD has indicated that it is redesigning F47.

HUD will also need to ensure that its risk-sharing partners in both

demonstration programs are carrying out their responsibilities under HUD’s

regulations and/or their risk-sharing agreements, since activity is likely to

increase if the Congress either extends the programs or makes one or both

of them permanent. Although the programs are still relatively new, HUD has

not executed some of its oversight responsibilities. While HUD has outlined

an approach for addressing the current oversight problems and for

monitoring the performance of its risk-sharing partners in the future, it is

too early to tell whether this approach will be successful. However,

correcting the current oversight problems to ensure that the programs are

being properly administered should, in our view, be a priority for HUD.

Recommendations To ensure that the risk-sharing demonstration programs’ managers have

consistent and reliable data to meet their statutory and regulatory

obligations, we recommend that the Secretary of Housing and Urban

Development take steps to correct current flaws in the information

systems supporting the programs. We recommend that, in correcting the

flaws in the data system supporting the credit enhancement program, the

Secretary direct the system’s designers and the program’s managers to

examine the near-term suitability of using spreadsheets and databases

commonly contained in suite software within the context of the long-term

data needs of a growing universe of projects, giving careful consideration

to the requirements of all users of the system.

We further recommend that the Secretary give priority to implementing a

comprehensive monitoring system to ensure that the Department’s

risk-sharing partners are complying with the demonstration programs’

procedures, regulations and/or risk-sharing agreements, including the

requirements for timely reporting on the status of insured loans.

Agency Comments HUD agreed in its written comments on a draft of this report (see app. IX)

with our concerns about the flaws in the information systems supporting

the risk-sharing demonstration programs and is planning to implement a

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monitoring system to ensure that its risk-sharing partners are complying

with the programs’ requirements, including the requirements for timely

reporting. More specifically, HUD said that it is already pilot-testing a new

Development Application Process that will track mortgage insurance

applications from their submission through to endorsement. HUD said that

until data on the risk-sharing projects can be incorporated into this

system, it will develop spreadsheets to make the current systems more

user friendly and to simplify data input for its risk-sharing partners. Also,

to facilitate monitoring, compliance, and timely reporting, HUD said that it

would develop an Internet system to provide guidance and solicit

verification of its records and the required reports from its risk-sharing

partners.

Page 82 GAO/RCED-98-117 Housing Finance
Page 83 GAO/RCED-98-117 Housing Finance
Appendix I 

Allocations and Reservations of 42,000 Units

by Housing Finance Agencies With

Risk-Sharing Agreements as of September

1997

Housing finance agency

Number of units

allocated

Number of units

reserved for

completed

propertiesa

Number of units

reserved for

properties in

pipelinesb

Number of

unallocated units

Percentage of

total allocation

reserved

District of Columbia 160 0 160 0 100

Florida 7,002 2,511 4,491 0 100

Illinois 1,470 324 1,146 0 100

Maryland 575 212 363 0 100

Maryland-Montgomery County 2,217 700 1,517 0 100

Michigan 950 0 950 0 100

Minnesota 810 196 614 0 100

Missouri 630 340 290 0 100

New Jersey 1,123 0 1,123 0 100

Oregon 720 113 607 0 100

Puerto Rico 250 0 250 0 100

Rhode Island 595 68 527 0 100

New Mexico 925 341 568 16 98

Kentucky 745 232 479 34 95

California 8,435 3,177 4,696 562 93

Connecticut 610 0 569 41 93

Maine 150 140 0 10 93

Virginia-Fairfax County 370 330 0 40 89

Massachusetts 2,148 895 803 450 79

Wisconsin 1,010 194 528 288 71

New Hampshire 600 263 144 193 68

Colorado 4,310 1,885 992 1,433 67

New York State 3,015 505 1,042 1,468 51

Pennsylvania 690 0 306 384 44

South Dakota 235 0 90 145 38

Idaho 800 278 0 522 35

Pennsylvania-Philadelphia 400 115 0 285 29

Montana 175 32 10 133 24

Alaska 0 0 0 0 0

Indiana 300 0 0 300 0

Louisiana 280 0 0 280 0

New York City 300 0 0 300 0

Total 42,000 12,851 22,265 6,884 84

(Table notes on next page)

Page 84 GAO/RCED-98-117 Housing Finance
Appendix I 

Allocations and Reservations of 42,000 Units

by Housing Finance Agencies With

Risk-Sharing Agreements as of September

1997

Note: Data in this table reflect activity reported by state and local agencies as of September 1997

and include only the 42,000 units authorized as of March 1996. Although additional units were

authorized in July 1997, we did not include these units because the agencies had not had time to

use them when we were conducting our audit work. Appendix II includes the units authorized in

July 1997.

a“Completed properties” are those with closed loans. Insurance has been issued for these

properties, and they are occupied.

b“Properties in the pipeline” are those for which an agency has reserved units. They may include

those for which the agency (1) has not submitted paperwork to HUD, (2) has submitted

paperwork but not received firm approval letters from HUD, or (3) has received firm approval

letters but not yet closed the loans.

Source: GAO’s analysis of data provided by HUD.

Page 85 GAO/RCED-98-117 Housing Finance
Appendix II 

Allocation of 49,500 Units to Housing

Finance Agencies With Risk-Sharing

Agreements as of October 1997

Housing finance agency

Number of units allocated as

of Sept. 1, 1997

Number of units allocated at

the end of fiscal year 1997

Total number of units

allocated as of Oct. 6, 1997

California 8,435 1,000 9,435

Florida 7,002 2,200 9,202

Colorado 4,310 850 5,160

Massachusetts 2,148 1,222 3,370

Maryland - Montgomery County 2,217 50 2,267

New York State 3,015 –995 2,020

New Jersey 1,123 850 1,973

Illinois 1,470 300 1,770

Oregon 720 550 1,270

New Mexico 925 250 1,175

Minnesota 810 350 1,160

Kentucky 745 280 1,025

Wisconsin 1,010 0 1,010

Michigan 950 0 950

Missouri 630 189 819

Idaho 800 0 800

Connecticut 610 150 760

Rhode Island 595 150 745

Pennsylvania 690 0 690

New Hampshire 600 75 675

Maryland 575 0 575

Virginia - Fairfax County 370 175 545

Pennsylvania - Philadelphia 400 100 500

Puerto Rico 250 54 304

Indiana 300 0 300

Louisiana 280 0 280

South Dakota 235 0 235

Montana 175 0 175

District of Columbia 160 0 160

Maine 150 0 150

Alaska 0 0 0

Florida - Dade County 0 0 0

New York City 300 –300 0

Total 42,000 7,500 49,500

Source: GAO’s analysis of data provided by HUD.

Page 86 GAO/RCED-98-117 Housing Finance
Appendix III 

Location of Units Reserved for Completed

and Pipeline Properties as of September

1997

Location of units Percentage of units Housing finance

agency

Total number

of units Urban Suburban Rural Urban Suburban Rural

AK 0 0 0 0 a a a

CA 7,873 3,659 3,296 918 46.5 41.9 11.6

CO 2,877 1,519 663 695 52.8 23.1 24.2

CT 569 535 34 0 94.0 6.0 0.0

DC 160 160 0 0 100.0 0.0 0.0

FL 7,002 4,290 2,712 0 61.3 38.7 0.0

ID 278 278 0 0 100.0 0.0 0.0

IL 1,470 399 1,071 0 27.1 72.9 0.0

IN 0 0 0 0 a a a

KY 711 315 117 279 44.3 16.4 39.3

LA 0 0 0 0 a a a

MA 1,698 851 815 32 50.1 48.0 1.9

MD 575 575 0 0 100.0 0.0 0.0

MD-MC 2,217 391 1,826 0 17.6 82.4 0.0

ME 140 140 0 0 100.0 0.0 0.0

MI 950 750 66 134 78.9 6.9 14.1

MN 810 327 483 0 40.3 59.7 0.0

MO 630 630 0 0 100.0 0.0 0.0

MT 42 0 0 42 0.0 0.0 100.0

NH 407 0 407 0 0.0 100.0 0.0

NJ 1,123 719 326 79 64.0 29.0 7.0

NM 909 687 0 222 75.6 0.0 24.4

NYC 0 0 0 0 a a a

NYS 1,547 599 741 207 38.7 47.9 13.4

OR 720 647 0 73 89.9 0.0 10.1

PA 306 0 275 31 0.0 90.0 10.0

PA-PH 115 115 0 0 100.0 0.0 0.0

PR 250 250 0 0 100.0 0.0 0.0

RI 595 451 144 0 75.7 24.3 0.0

SD 90 90 0 0 100.0 0.0 0.0

VA -FC 330 0 330 0 0.0 100.0 0.0

WI 722 395 285 42 54.6 39.5 5.9

Total 35,116 18,772 13,592 2,752

Percent of total 100.0% 53.5% 38.7% 7.8%

(Table notes on next page)

Page 87 GAO/RCED-98-117 Housing Finance
Appendix III 

Location of Units Reserved for Completed

and Pipeline Properties as of September

1997

Note: MD-MC is Montgomery County, Maryland; PA-PH is Philadelphia, Pennsylvania; and VA-FC

is Fairfax County, Virginia.

aNot applicable.

Source: GAO’s analysis of questionnaire data provided by housing finance agencies.

Page 88 GAO/RCED-98-117 Housing Finance
Appendix IV 

Type of Construction for Units Reserved for

Completed and Pipeline Properties as of

September 1997

Type of construction Percentage of units by type of construction Housing

finance agency

Total

units Acquisition New Rehab Refinance Acquisition New Rehab Refinance

AK 0 0 0 0 0 a a a a

CA 8,899 0 4,960 2,913 1,026 0.0 55.7 32.7 11.5

CO 1,851 0 575 1,210 66 0.0 31.1 65.4 3.6

CT 569 0 142 427 0 0.0 25.0 75.0 0.0

DC 160 0 51 109 0 0.0 32.0 68.0 0.0

FL 7,002 0 6,501 501 0 0.0 92.8 7.2 0.0

ID 278 0 278 0 0 0.0 100.0 0.0 0.0

IL 1,470 0 922 548 0 0.0 62.7 37.3 0.0

IN 0 0 0 0 0 a a a a

KY 711 0 416 153 141 0.0 58.5 21.6 19.9

LA 0 0 0 0 0 a a a a

MA 1,698 0 667 991 40 0.0 39.3 58.4 2.4

MD 575 0 0 575 0 0.0 0.0 100.0 0.0

MD-MC 2,217 269 521 0 1,427 12.1 23.5 0.0 64.4

ME 140 140 0 0 0 100.0 0.0 0.0 0.0

MI 951 0 898 53 0 0.0 94.4 5.6 0.0

MN 810 0 0 810 0 0.0 0.0 100.0 0.0

MO 630 0 340 290 0 0.0 54.0 46.0 0.0

MT 42 0 42 0 0 0.0 100.0 0.0 0.0

NH 407 0 263 144 0 0.0 64.6 35.4 0.0

NJ 1,123 0 1,101 22 0 0.0 98.0 2.0 0.0

NM 909 211 698 0 0 23.2 76.8 0.0 0.0

NYC 0 0 0 0 0 a a a a

NYS 1,547 0 1,206 341 0 0.0 78.0 22.0 0.0

OR 720 0 477 243 0 0.0 66.3 33.7 0.0

PA 306 0 306 0 0 0.0 100.0 0.0 0.0

PA-PH 115 0 63 52 0 0.0 54.8 45.2 0.0

PR 250 0 0 250 0 0.0 0.0 100.0 0.0

RI 595 0 47 548 0 0.0 8.0 92.0 0.0

SD 90 0 90 0 0 0.0 100.0 0.0 0.0

VA-FC 330 0 120 0 210 0.0 36.4 0.0 63.6

WI 722 120 222 280 100 16.6 30.7 38.8 13.9

Total 35,117 740 20,907 10,459 3,011

Percent of total 100.0% 2.1% 59.5% 29.8% 8.6%

(Table notes on next page)

Page 89 GAO/RCED-98-117 Housing Finance
Appendix IV 

Type of Construction for Units Reserved for

Completed and Pipeline Properties as of

September 1997

Note: MD-MC is Montgomery County, Maryland; PA-PH is Philadelphia, Pennsylvania; and VA-FC

is Fairfax County, Virginia.

aNot applicable.

Source: GAO’s analysis of questionnaire data provided by housing finance agencies.

Page 90 GAO/RCED-98-117 Housing Finance
Appendix V 

Units in Completed Properties, by Size, as of

September 1997

Number of units in size category

Housing finance agency 400 or more 200-399 100-199 50-99 Under 50

California 500 1,146 830 510 191

Colorado 200 986 447 252

Florida 2,511

Idaho 200 78

Illinois 227 97

Kentucky 84 148

Massachusetts 224 349 290 32

Maryland 212

Maryland - Montgomery County 311 236 153

Maine 140

Minnesota 148 48

Missouri 244 96

Montana 32

New Hampshire 263

New Mexico 120 164 57

New York 422 83

Oregon 113

Pennsylvania - Philadelphia 115

Rhode Island 60 8

Virginia - Fairfax County 210 120

Wisconsin 120 58 16

Total 500 5,504 3,680 2,383 784

Note: MD-MC is Montgomery County, Maryland; PA-PH is Philadelphia, Pennsylvania; and VA-FC

is Fairfax County, Virginia.

Source: GAO’s analysis of questionnaire data provided by housing finance agencies.

Page 91 GAO/RCED-98-117 Housing Finance
Appendix VI 

Income Levels Served by Completed Units

in the Credit Enhancement Program as of

September 1997

Income level targeted

Housing finance

agency

Number of units

reserved

Units targeted to

over 60% of area’s

median income

Units targeted to

60% or less of area’s

median income

Units targeted to

50% or less of area’s

median income

Percentage of units

meeting affordability

requirements

California 3,177 949 1,490 738 70

Colorado 1,885 915 486 484 51

Florida 2,511 1,169 1,015 327 53

Idaho 278 59 146 73 79

Illinois 324 45 240 39 86

Kentucky 232 0 190 42 100

Massachusetts 895 452 5 438 50

Maryland 212 0 64 148 100

Maryland -

Montgomery

County 700 94 574 32 87

Maine 140 35 77 28 75

Minnesota 196 79 78 39 60

Missouri 340 93 182 65 72

Montana 32 0 30 2 100

New Hampshire 263 210 0 53 20

New Mexico 341 132 150 59 61

New York 505 171 219 115 66

Oregon 113 0 0 113 100

Pennsylvania -

Philadelphia 115 0 75 40 100

Rhode Island 68 0 66 2 100

Virginia - Fairfax

County 330 0 330 0 100

Wisconsin 194 48 40 106 75

Total 12,851 4,451 5,457 2,943 65

Percent of total 100% 35% 42% 23%

Source: GAO’s analysis of questionnaire data provided by housing finance agencies.

Page 92 GAO/RCED-98-117 Housing Finance
Appendix VII 

Profile of Selected Loan Consortia’s

Multifamily Loan Portfolios

Table VII.1: Characteristics of Loan Consortia’s Multifamily Loan Portfolios

Loan

consortium

Year began

multifamily

finance

Average

annual

loan volume

Increased or

decreased loan

volume

Average

loan

size

Number

of

units

Chicago Community

Investment Corporation

1983 $30 million Decreased $750,000 21-50

California Community

Reinvestment Corporation

1989 $20 million Decreased $1.8 million 21-50

Central Florida Community

Reinvestment Corporation

1991 $5-6 million Decreased $2 million Over 100

Hawaii Community

Reinvestment Corporation

1991 $10 million Decreased $2.5 million 51-100

Nevada Community

Reinvestment Corporation

1992 $5 million Increased $2 million 21-50

New Hampshire Community

Reinvestment Corporation

1995 $5.5 million Increased $1 million 21-50

Network For Oregon

Affordable Housing

1991 $10 million Same $1.25 million 21-50

Savings Associations

Mortgage Company

(SAMCO)

1971 $35 million Decreased $2.5 million 51-100

Tampa Bay Community

Reinvestment Corporation

1993 $7 million Increased $1.5 million Over 100

Washington Community

Reinvestment Association

1992 $16 million Decreased $1.5 million 21-50

Page 93 GAO/RCED-98-117 Housing Finance
Appendix VII 

Profile of Selected Loan Consortia’s

Multifamily Loan Portfolios

Table VII.2: Additional Characteristics of Loan Consortia’s Multifamily Loan Portfolios

Loan consortium Location of project Type of project Type of Financing Loan Performance

Chicago Community

Investment Corporation

Urban Rehab Adjustable 1% loss on total portfolio

California Community

Reinvestment Corporation

Urban, suburban, rural New construction Fixed Very-low default rate

Central Florida Community

Reinvestment Corporation

Urban New construction and

rehab

Fixed No charge-offs, no

delinquencies

Hawaii Community

Reinvestment Corporation

Urban New construction Balloon No delinquencies

Nevada Community

Reinvestment Corporation

Urban New construction Fixed No charge-offs

New Hampshire Community

Reinvestment Corporation

Suburban New construction Fixed Too early to determine

Network For Oregon

Affordable Housing

Urban, suburban, rural New construction Fixed No charge-offs

Savings Associations

Mortgage Company

(SAMCO)

Urban, suburban, rural All types Adjustable Less than 1% loss on

delinquencies

Tampa Bay Community

Reinvestment Corporation

Urban Acquisition and refinance Adjustable No charge-offs, no

delinquencies

Washington Community

Reinvestment Association

Urban, suburban, rural New construction Fixed and adjustable No charge-offs

Note: The members of the loan consortia were asked to state their average loan volume for

1994-96. They were then asked if they expected their 1997 loan volume to be the same as the

previous 3-year average, to increase, or to decrease from that loan volume.

Source: GAO’s analysis of questionnaire data provided by members of the loan consortia.

Page 94 GAO/RCED-98-117 Housing Finance
Appendix VIII 

Indicators of Financial Soundness of

Housing Finance Agencies

Housing finance agency Risk levela Rating agencyb Required reserve accountc

Alaska I Moody’s No

California I Standard and Poor’s No

Colorado I Moody’s No

Connecticut Bothd Standard and Poor’s No

District of Columbia II Not rated Yes

Fairfax County, Virginia I Not rated Yes

Florida I Not rated Yes

Idaho I Moody’s No

Illinois Bothd Moody’s No

Indiana Bothd Moody’s No

Kentucky II Moody’s No

Louisiana Bothd Not rated Yes

Maine Bothd Moody’s and Standard and

Poor’s

No

Maryland Bothd Moody’s Yes

Massachusetts Bothd Standard and Poor’s No

Michigan I Standard and Poor’s No

Minnesota I Standard and Poor’s No

Missouri I Standard and Poor’s No

Montana II Moody’s Yes

Montgomery County, Maryland Bothd Moody’s No

New Hampshire I Moody’s No

New Jersey Bothd Standard and Poor’s No

New Mexico II Not rated Yes

New York City Bothd Standard and Poor’s No

New York State Bothd Not rated Yes

Oregon Bothd Not rated Yes

Pennsylvania Bothd Standard and Poor’s No

Philadelphia, Pennsylvania II Not rated Yes

Puerto Rico II Not rated Yes

Rhode Island Bothd Standard and Poor’s No

South Dakota Bothd Not rated Yes

Wisconsin Bothd Not rated Yes

(Table notes on next page)

Page 95 GAO/RCED-98-117 Housing Finance
Appendix VIII 

Indicators of Financial Soundness of

Housing Finance Agencies

aLevel I: The housing finance agency assumes 50 to 90 percent of the risk and may use its own

underwriting standards and loan terms.

Level II: The housing finance agency uses underwriting standards and loan terms and conditions

approved by HUD. The agency assumes 25 percent of the risk of loss if the loan-to-value ratio is

greater that 75 percent. The agency assumes either 10 percent or 25 percent of the risk of loss, at

its option, when loan-to-value ratio is less than 75 percent.

bThe housing finance agency (1) has received the “top tier” designation from Standard and Poor’s

or another nationally recognized rating agency, (2) has received an overall “A” rating from a

nationally recognized agency or (3) can otherwise demonstrate its capacity to HUD by

establishing a dedicated reserve account of liquid assets of not less than $500,000.

cThe housing finance agency must maintain an account with an initial amount of not less than

$500,000. Thereafter, the agency must deposit at each loan closing, and thereafter maintain,

additional money as specified in the regulations—essentially, 1 percent of mortgage amounts up

to $50 million, plus 75 basis points of mortgage amounts between $50 million and $150 million,

plus 50 basis points for mortgage amounts over $150 million.

dThe risk-sharing partner can use level I or level II procedures to provide FHA insurance under its

risk-sharing agreement.

Source: HUD, New Products Division.

Page 96 GAO/RCED-98-117 Housing Finance
Appendix IX 

Comments From the Department of Housing

and Urban Development

Page 97 GAO/RCED-98-117 Housing Finance
Appendix IX 

Comments From the Department of Housing

and Urban Development

Page 98 GAO/RCED-98-117 Housing Finance
Appendix IX 

Comments From the Department of Housing

and Urban Development

Page 99 GAO/RCED-98-117 Housing Finance
Appendix X 

Major Contributors to This Report

Resources,

Community, and

Economic

Development

Division, Washington,

D.C.

Stanley Czerwinski, Associate Director

Dennis W. Fricke, Assistant Director

James Vitarello, Assistant Director

William F. Bley, Evaluator-in-Charge

Diane Brooks, Senior Evaluator

Patrick B. Doerning, Senior Operations Research Analyst

Elizabeth R. Eisenstadt, Communications Analyst

(385670) Page 100 GAO/RCED-98-117 Housing Finance
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