Lowering the Cost of Financing: Freddie Mac and Fannie Mae Offer New Loan Products

7 min read

Freddie Mac and Fannie Mae have recently created new affordable housing products that provide borrowers with ways to access low-cost loans that finance affordable housing for the 15-plus years of the building’s compliance life.

“This is an important part of what Freddie and Fannie do,” says Wade Norris, a Washington, D.C.-based attorney who has more than 35 years’ experience in advising on financing affordable housing.  “They are always looking for ways to meet the capital needs of the affordable multifamily market even more broadly and effectively.”

“As the country recovers from the setbacks of 2008-9, in many regions rent growth is outpacing wage growth, fueling a need to fund quality, affordable housing,” Norris says. “Entry of the post-World War II baby boom “echo” generation into the workforce, continued net immigration, and substantial tightening of single family home loan standards further fuels this demand.”

According to Norris, “Beginning in the late 1990’s, sale of unrated, non-credit enhanced tax-exempt bonds and loans to banks and other institutions began to supplant the public offering of rated, credit-enhanced bonds as the primary debt side funding mechanism for affordable multifamily projects.  This has been especially true in Community Reinvestment Act [CRA]-driven urban markets, where such executions may be 70-80 percent or more of debt-side financings.”

Especially on substantial rehab and new construction, these executions have been providing very low-rate construction funding; “draw down” funding, which eliminates project fund negative arbitrage; and a low locked-in permanent rate.

Freddie Mac TEL

With its new Direct Purchase Tax-Exempt Loan [TEL] structure announced last spring, Freddie Mac offers a tax-exempt loan product having all of these advantages, not only in CRA-driven markets, but throughout the United States through its network of Targeted Affordable Lenders.

Shaun Smith, Freddie Mac’s Senior Director, Targeted Affordable Production, provides details: “Our new product is for tax-exempt loans issued by a city, county or state housing finance entity for apartments that have affordable rents for lower income individuals.  The product is for financing for the acquisition or refinance of affordable multifamily properties with 4 percent LIHTC that has at least seven years remaining in its tax credit benefit period.”

“An approved Freddie Mac Targeted Affordable Housing [TAH] Seller/Servicer originates a direct tax-exempt loan, also called the Funding Loan, to a government entity, such as a state, city or county housing authority that has the capacity to issue tax-exempt multifamily housing bonds. Simultaneously, using the proceeds of the Funding Loan, the issuer makes another loan, known as the Project Loan, to the borrower to finance a specific multifamily residential housing project.  Freddie Mac Multifamily then purchases the Funding Loan from the TAH Seller/Servicer based on a commitment signed prior to origination of the Project Loan. Freddie Mac holds the Funding Loan on its balance sheet before aggregating it with other tax-exempt loans. The pool of tax-exempt loans is later securitized through Freddie Mac Multifamily M-Deals, which are sold to third-party investors.”

“This execution,” Smith explains, “can lower a borrower’s issuance costs and the ongoing cost of capital significantly, as well as simplify the closing process. It is an alternative financing solution to our bond credit enhancement execution and is particularly attractive for 4 percent LIHTC developments.  It also reduces legal fees due to simplified documents and processes and cuts closing costs by as much as 40 percent via private purchase efficiencies when compared to a publicly offered credit enhanced bond.”

The new Freddie Mac product offers immediate fixed-rate financing for moderate rehabilitation loans—and a floating rate, draw down structure using the Borrower’s bank for a construction loan combined with a Freddie Mac permanent loan for substantial rehab/new construction projects.  Loan amortizations extend up to 35 years with a balloon up to 18 years.

“We have closed five transactions using this instrument, and more are in the pipeline,” says Smith.  “As with any new program, there can be a few bumps, but we are very excited about prospects.”

Notwithstanding these multiple platforms for tax-exempt bond or loan private placements, public offerings of credit-enhanced bonds continue to provide a major source of debt side funding for affordable projects using 4 percent LIHTC—especially for preservation and acquisition/moderate rehab financings. Fannie Mae has long been a major player in these executions.

According to Norris, since the financial crisis in 2008, the long-term debt markets have often accepted lower coupons for even taxable pass-through securities backed by GNMA, Fannie Mae and Freddie Mac, than on traditionally structured semi-annual pay tax-exempt municipal bonds backed by the same credits.  Thus, an innovative new product from Fannie Mae attempts to lower borrowing rates for affordable housing loans by capitalizing on this market phenomenon.

Instead of providing a “credit-enhancement agreement” backing traditional semi-annual pay tax-exempt bonds, the tax-exempt bonds are secured by a widely recognized, highly valued Fannie Mae mortgage-backed security (MBS), which passes through the underlying monthly borrower mortgage loan payments each month, guaranteed by Fannie Mae.  The new bond structure passes that MBS payment through, on a tax-exempt basis, to the tax-exempt bondholder, on the business day after it is received by the bond trustee.

Fannie Mae

According to Angela Kelcher, Fannie Mae’s Director of Production for Multifamily Affordable Housing, “We’ve developed a product that allows multifamily mortgage-backed securities (MBS) to be used with tax-exempt bond deals — our new, Pass-Through Execution allows multifamily MBS to be used as collateral for either refunding tax-exempt bonds or financing new tax-exempt bonds issued in conjunction with 4 percent Low-Income Housing Tax Credits (LIHTC).  I anticipate we’ll see the most impact in the 4 percent LIHTC arena for projects that will undergo a tenant-in-place rehabilitation.”

Kelcher adds, “The new monthly tax-exempt pass-through structure, being a long-term (16+ year) municipal bond issue, may not be the optimal  structure where the available municipal issuer changes substantial ongoing fees. In these situations, Fannie Mae continues to be a major player where short-term cash backed tax-exempt bonds are issued to satisfy 4 percent low-income housing tax credit requirements, and the Fannie Mae MBS is sold in the taxable markets to achieve the lowest borrowing rate. On these financings, once the rehab is completed and the project is ‘placed in service’ under the tax credit rules, bonds can be redeemed and the MBS remains. Thus, the short-term bond structure allows borrowers to capitalize on today’s low taxable MBS rates and also reduce ongoing issuer fees.”

The result, she says, is “a lower cost of financing” for affordable housing projects.

Fannie Mae closed its first tax-exempt monthly pass-through deal in February 2015 and has quoted several more. Its new product has no minimum or maximum requirements for loan size. Pricing is competitive with other bond executions, including private placements. These transactions price 20 to 25 bps lower than traditional bond credit enhancement, and can accommodate terms from 10 to 30 years.

Norris, who was involved in the development of both of these new products, reminisces: “Early 2009 was the ‘nuclear winter’ of affordable housing finance. There were virtually no buyers of low-income housing tax credits, and almost nothing worked on the tax-exempt debt side. Today, we are in a ‘golden age’ of affordable housing finance. Huge affordable rental housing demand; robust tax credit equity pricing; and record low interest rates are producing more affordable housing than since before the financial crisis. Notwithstanding this success, these two products show that Freddie Mac and Fannie Mae are not sitting still.”

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