Patrick Sheridan
Director, Multi-Family Housing Portfolio Management Division
Rural Housing Service, USDA
Washington, D.C.
Addressing the Council for Affordable and Rural Housing:
This has been a challenging year, if nothing else. As challenging as this year will be, next year will be more so, particularly with Regulation Reinvention going on and the regulations to be issued in Proposed Rule.
We've had a number of successes — the Regulation Reinvention is one we are having, and it continues to be one of our major initiatives during the course of the year. Dealing with the staff reduction and staff reassignments will certainly be an issue in trying to bring everyone up to speed. And, there are funding reductions. One of our bigger challenges is that Chuck Wehrwein is leaving — we'll be trying to fill his shoes to keep a lot of good things going that he had the time to focus on and push as far as resources go.
Regulation Reinvention
We do think Regulation Reinvention is going very well. It is extremely intensive work; it is where we are working with ICF Kaiser as our contractor. They are doing the drafting. As you know through the Stakeholders Meetings, you provided a substantial input along with other industry groups. Our field staff has been heavily involved both in reviewing drafts out in the field and also in Details to the National Office to work with us on putting together the comments that are being received from the different parties. As far as the intensiveness goes, it seems recently that in the past few months, it has been almost every day that we receive from ICF another 30 to 40 pages of changes in the draft regulations with a turn around of 2 days for comments. It is going quickly; it is getting a lot of attention; so far, it is going to pay huge dividends.
I would like to publicly thank John Pentecost for his help on this; he is the priority contact to coordinate the work of ICF and RHS and to bring staff resources in and try to keep our focus on getting the reviews of the drafts done quickly enough so they can be implemented on time so they can be implemented by ICF Kaiser.
Purpose of Reinvention
The purpose of what we are trying to do in the Regulation Reinvention is to make it much clearer. Not just for our users, but also internal Agency staff, so we can have a clean, clear-cut place to go to learn what the major policies are. I think we have between 20 to 30 regulations involving the multi-family housing programs in one way or another. We have our major regulations, but there are corollary regulations (such as Supervised Bank Accounts). Part of what this process will do is put them all in one place. Having that one regulation will be a help for us.
Handbooks — How To Do
The Handbooks are the second piece of the Reinvention. While the Regulation will be extremely short compared to what we currently have, the Handbooks will be a bit larger. What we will have in the Handbooks will be clear-cut language in how to do the job — how to implement what the regulations require. As set up right now, there will be three Handbooks — one for Loan Origination, one for Asset Management (which will be close to the present 1930-C), and one for Servicing (account servicing, Workout Plans and Prepayment). We think it will be a good process; the thing about the Handbooks that will help us in the long run is we will be able to make changes in the Handbook much faster and allow us to do away with the issuance of Administrative Notices (ANs) which have been sort of the way we have patched together quick guidance to the field and to users on how we are implementing our regulations. Right now we are shooting for a Proposed Rule for the Regulations to be out in April with a Final Rule in November 1998. The key there is to try to get a Final Rule in place for FY 99, beginning October 1, 1998.
Loan Origination Handbook
The NOFA process is being continued in the new regulation; with the funding we're receiving, it does not make sense to use the old process; the NOFA seems to be the best way to allocate the funds. We are going to stress that properties need to be more market oriented in relation to design amenities; this is not to say we are opening the door wide open for everyone to have a garage and micro-wave and things like that. Participation leveraging will be stressed because it really helps us stretch our resources in 515; the regulations as they are currently written do not have a lot of provisions in how to work with other lenders and other Agencies. A lot of that will be put into the Regulations. The other issue, too, is we are trying to deal with comparability of market rents in relation to 515 projects with multiple financing sources and trying to make sure that when we do underwriting, we will not be in situations where the resultant Basic Rents are higher than the conventional market rents. For Reserve Accounts, there is a lot more emphasis on trying to come up with what the life-cycle replacement cost would be for components of the buildings; while we are not going to a full replacement concept with funding the complete replacement of the building in 20 years, one of the things we are trying to move to is making sure that the Reserves that are set up are based on the development cost rather than on strictly the loan amount. Obviously, as you get into leveraged deals, the 515 and the existing Reserve requirements being basically 1% of the mortgage amount for 10 years would not give you an adequate Reserve; so we are focusing on the development costs for the Reserve rather than on the loan amount.
2% Withdrawal
We are going to be more generous as far as withdrawal of the 2% Initial Operating Capital. It will be stretched out to seven years rather than five years, and can be taken in multiple years rather than having to take it all at once. There are a few more details that will come out in Regulation Reinvention, but that is one of the things we have heard for a number of years as being an issue. We will try to make sure it is easier for you to get your 2% back because you are not getting a Return on it.
In relation to management issues, many good things came out of the three Stakeholder Meetings. One of the areas is we are going to a national setting of management fees — this is one of the things we heard strongly from the Stakeholders. We will be working off industry publications and other resources available to look at what management fees are for Affordable Housing in rural areas, and making adjustments. Those fees will be provided to the States at that time so they can work with managers to do a reality check to make sure the fees are not too far out of line. After being checked that way, they would be issued. They are going to be based on "per occupied unit," adjusted for type of housing (obviously there are differences between Congregate, Elderly, Family), with incentives built in for superior performance, and adjustments for any unusual cases (particularly for Workouts — obviously if you are working on a "per occupied unit" and take over a 50% occupied project then "per occupied" will not sound too attractive without an adjustment).
Revised Management Agreement
We will be dropping the Management Agreement and going to more of a version of the Owner/Manager's Certification. Some changes there will make it more appropriate for the projects we have, and also to get out of telling you how to do a Management Agreement. We will be going to more of a certification format where you tell us that you agree to comply with certain issues that will cover certain aspects of management.
Change from CPA Audits
As it stands right now, it appears we will be dropping the requirements for annual CPA audits and going instead — I do not want to use "Letter of Special Engagement;" I was talking with OIG on how to phrase this, and they said to call it an "RHS Engagement Letter." I know that a lot of you with 50 year mortgages already feel we are married. But, the concept here is that it really would not look that much different from an audit, it will have a lot of the same components, and you will still have Balance Sheets, Operating Cash Flow and such. It will allow us to tell the auditors what areas to focus on. Some of the problems I think we have with audits and how audits are done under the Generally Accepted Government Auditing Standards (GAGAS) and some of the requirements the auditing industry has in reviews of materiality and such, are that they do not really make a lot of sense. Some of they things they focus on are to try to verify loan account expenses, which we obviously know if you have paid or not, taxes, and those kinds of big ticket items. Where we found problems in the past in areas we need to look at are more areas such as management operations and things like that. So what we will be able to do with a Letter of Engagement is to specify a deeper look in some areas and less in some others. We talked about this during some of our Stakeholder sessions, along with syndicators, trying to make sure we balance the needs you have to be able to report to your investors and others as to the financial conditions. I think that once this is out and some of the investors and syndicators have looked at this, they will be comfortable with what they will be getting from this compared to what they were receiving in an audit. Surprisingly, one of the recommendations we got from OIG is that they did not think it was necessary to do one every year and on every project; in particular, they asked that we consider focusing in on a sampling with cases where we have the same General Partner and the same Management Agent. We are reviewing what would be the best sampling techniques for that.
We also are incorporating the Industry Interface process and some of our other automation efforts into the Regulation rather than being done through a series of Unnumbered Letters and Administrative Notices. We will have the Industry Interface and electronic submittals addressed in the Regulation and Handbook.
Focus on Asset Management
Throughout the whole Regulation Reinvention process, we are trying to make sure the focus the field has is on asset management of the project and not micro-management of property management. It is a hard sell to get out in the field, and staff looks at projects and sees things they think should be changed; I do not want to say that is necessarily a bad thing either, but on the other hand, we do recognize as an Affordable lender (although a governmental lender with a number of additional requirements), it is more important for us to be thinking like an asset manager as opposed to a property manager.
We are putting all of our Workout policies, whether they are in existing Regulations, in handouts, ANs, or wherever, in one place in the Reinvention Regulations. The original AN by John Meyers on servicing techniques will finally find a place.
Rent Comparability
We are building into the concept of servicing, making sure that we are doing comparability of the resultant rents (after a Workout or other type of servicing underwriting) to the conventional market rents. We do not want to get into the situation that we have Basic Rents higher than the market rents. That concept will be carried out throughout the Regulation Reinvention.
We are also dealing with inspections. Part of what came out of the Management Stakeholder sessions is the idea that we need to be more specific as to what we are looking for, so we have clearer standards during inspections, so we can better assess if the owners and agents have earned the incentive for their management fees. We are trying to clear that up so it is easier to do. We will continue to require an annual inspection for projects, as opposed to what we currently do with a triennial supervisory visit, which will continue. We will be requiring annual inspections, which will be "walk about inspections;" just to get out there and take a look at the project, do a quick inspection without going through the detail on tenant records and things like that. Just to make sure the buildings are still standing and the tenants are pleased with the living conditions and such.
Phantom Income on Reserve Interest
Reserve Accounts are a big area. We are probably going to get some support for this — we think we found a way to deal with the phantom income problem. What we are putting in the Regulation is an allowance as a project expense for taxes on Reserve Accounts for interest earned. How that will be implemented is that with the Annual Report, you will tell us what you earned in the way of interest on Reserves in the preceding year; in the following year there would be an allowance of 25% of that interest earned as a project expense to cover taxes. That should alleviate the disincentive for for investing those funds in high interest rate accounts.
We went and met with the IRS one last time to try to convince them that they ought to exempt interest earned as a taxable item for Partnerships. They were not too excited about that. They saw huge ramifications outside our world. We went back to the drawing board and thought this should solve it; we certainly see that while we may be giving up a little interest earned, the incentive for investing is certainly here now. The projects should certainly gain without causing a problem for you.
Subordinations
Also in the Servicing Regulation, we are handling subordinations and junior liens We will give a bit more expansive guidance there. Previously, it had not been that big of an issue, but with more leveraging and participation, it becomes a larger issue as far as how you work with other lenders in relation to our loans.
Preservation
On Preservation, one of the things we are definitely doing there is clarifying the process There is a nice flow chart that has been developed — I am not sure if it is in the Handbook or the Regulation. Basically, it will take you step by step through the process — what the options are at each step and what the next step is. We have also dealt with tenant notifications, clarifying those and trying to simplify them so the tenants will not be so alarmed when they see them. Also, we are looking at the methodology for offering incentives; we have a few things to look at here before we can iron out a final approach to it. The concept is to try to determine how much the difference is between the current rents and the market rents, using that figure as the basis for developing what would be possible for the incentive. And then offering that to the owners. We are going with this and trying to balance out the pluses and minuses; obviously, whether you give an equity loan or cash flow incentive or whatever, it has a different tax consequences for the owners; it also has different consequences for the Agency as far as budgetary subsidy costs. We are trying to look at both of these issues to make sure that when there is an offer, one way or the other, there is a balancing there of the cost both to the Agency and the owner as far as taxes.
One of the other areas is to spell out the role of the National Office in the process of Preservation.
Those are a sample of the major changes we have in the Reinvention Regulation; I know there is probably a lot more in your mind that I did not touch on. Ask me afterwards, or stay tuned and see what it looks like when it comes out.
Reforms Implemented
As far as implementing the Reforms in the FY 1998 Appropriations language, we did get the NOFA out, and the Reform Regulations. Prioritization and Subsidy Layering were the two major issues covered in those, along with others including the Occupancy Surcharge and Prepayment. The NOFA system is in place: using lack of credit, rural location, poverty rates, substandard housing, and shelter cost overburden as primary factors in determining what areas are included in the Designated Places. One of the changes that was implemented was the change from 5% to 10% of the eligible places that were announced. Of course, all places are then considered equal once they have been included in the eligible places. The NOFA came out January 22; I believe we have until March 23 for the closing of the NOFA. Some States did not participate in the NOFA process because of a carry over of unfunded AD-622's that were in designated places, and/or they may have needed to commit funds toward rehabilitation in the State.
The other major issue in the Reforms is subsidy layering. It has been sort of a non-issue; we thought it would be an issue; or it is working very well because we have not heard too many complaints about subsidy-layering abuses as such.
50 to 30 Year
Of course, one of the biggest changes which came about in the 1998 Appropriations Act was the change from the 50 year term to the 30 year term. This is still a 50 year amortization, so it doesn't affect the debt service; it did drop our subsidy rate fairly substantially. It went from 54¢ down to 45¢. We are looking at other ways to do what we can to drop the subsidy rate more so we can stretch those dollars. It does have some interesting side-effects which we are currently still studying and trying to decide how to implement. What happens on prepayments in year 30? How do you implement this 30 year term when you are talking about reamortization of existing loans? Transfers of existing loans? Consolidations? We are currently working with the Office of General Counsel (OGC) to iron out some of the questions; we are definitely down to a 30 year term with a balloon payment. We are hoping that will last us for a while with the improvements in the subsidy rates.
FY 98 Funding
For FY 1998, the funding is $150 million; $45 million of that is set aside for rehabilitation, leaving $100 for new construction and $5 million for equity loans. There were set-asides for non-profits of $9.4 million, Underserved areas and Colonias with $5.2 million, and $2.5 million set-aside for State RA projects. The Base Allocation for each state was $1 million. The NOFA ends on March 23.
For the Section 514 and 516 programs, we did receive $25 million in total funding for the Farm Labor Housing program, made up of $15 million for loans and $10 million for grants. We have a $3 million National Office reserve set up for Migrant and Homeless projects. The Housing Preservation Grant program (HPG) was funded at $10.8 million.
Section 538
Basically, we have been quite pleased with the Section 538 program and its performance during the demonstration period. This is the third year of it; the issuance of the NOFA and the receipt of applications is dependent upon the issuance of Regulations. If we can get it out as an Interim Final Rule, that will give us substantially more time to receive applications; that is definitely good news and we are keeping our fingers crossed. As far as the priorities for Disaster Areas, we should be able to more than able to meet any need in those types of places for designated disasters, so don't be thinking that is the only kind of place we will be able to go into.
538 is a program for Moderate, Low and Very-Low income households. It does have to be in the same rural areas as the 515 program. The guarantees are made by third party lenders (whether they are private mortgage companies, banks, or Housing Finance Agencies); the guarantee is up to 90% of the loan, 90% of Loan-to-Value ratio maximum. They must be fully amortized, fixed rate loans with no more than a 40 year term. I know there has been some discussion about whether there can be some changes and do something other than a fully amortized fixed rate; a lot of the lenders are interested in that; I think those discussions will continue. Those are the provisions of the statute, so it will take a legislative change to change from fully amortizing. The loans can be either permanent or construction/permanent; they can be used with Low Income Housing Tax Credits (we have had better than 50% done with Tax Credits); we can make Interest Credit available on up to 20% of the loans we make, and the Interest Credit is different from the 515 program in that it reduces the interest rate to the lender down to the Applicable Federal Rate (AFR) rather than down to 1% as with 515; there is no deep tenant subsidy involved from the Agency, although certainly if HOME Funds (or from some other source) were available for tenant subsidies, they could be attached to the project; it will be announced through a NOFA. The latest number on what our subsidy cost is on 538 is down around 3¢ per dollar, which certainly makes it much more attractive as far as the Appropriators go as far as a production program.
In FY 1996 we funded 9 loans for approximately $16 million in guarantee; we received 50 applications, of which about 24 were eligible, so we had a real good turn out for a first year. For FY 1997, we have issued about $28.1 million in guarantees for 16 projects for about 813 units, so they are a bit bigger projects; Total Development Costs were $51.7 million, which is about a 54% Loan-to-Value ratio, so we are actually very high on leverage. The issue of the 90% LTV in the statute does not seem to be that much of a problem since most of these deals are highly leveraged. The average cost per unit is higher than in 515; the average is about $64,000 per unit; average rent is $445 per month (rent in FY 1997 ranged from $667 to $220). Depending upon location, the amount of leverage and other resources, the rents can be reduced down to almost 515 levels. In FY 1998 once the regulations are out, we should have $38.8 million available for guarantees based upon the 3¢ subsidy rate.
Rental Assistance
On Rental Assistance, for FY 1998, we do have $541.4 million. From a servicing perspective, we would like to have more; we have a lot of projects that are troubled and could use additional RA to help with vacancies and such. We have had some good news/bad news as far as RA costs go; actually, our per unit cost seems to be holding its own or at least not increasing as fast as we have seen in past years; at this point we do not have a specific item to attribute this to other than if we take a combination of the Occupancy Surcharge being eliminated, the economy is doing better and more people may be working, and possibly the implementation of Welfare Reform — these may be helping to keep the cost per unit increases from being as great as they might have been. The total numbers for the RA program continues to increase because of the numbers of units that have to be renewed each year. While the good news is there — that the costs per unit may not be going up as fast as originally projected a few years ago — the dollar figure that is actually needed to fund all the renewals is still increasing. The other side, is even though we may be able to say that there may be increases in the contributions the family is making, I think there are some upward pressures also.
Preservation Costs
Preservation activities increase rents, which increases the cost of RA. The emphasis on trying to increase Reserve Accounts to be sure you have adequate funds for capital replacement needs is going to increase the rents, which increases the use of RA. Maybe there will be an offset, maybe not. At least the numbers are a little bit encouraging as far as costs per units go.
The Reform Regulations will clear up the Preservation process quite a bit as far as what happens and when. We are working on formulation of the Office of Preservation; what functions will be carried out by the National Office in the oversight provided to the field. Certainly, some of the minimum things we see that Office doing is providing the final determination as to whether to accept a prepayment or not, if that is the ultimate proposal; also, to do the sign-off on the prepayment incentives that are offered or recommended by the field office, so that the National Office can be the clearinghouse on the final incentives that are offered; of course, being the gateway on the allocation of funds. There are some encouraging things we have seen with Preservation and the use of third party financing sources to cover the equity; we want to try to continue that effort. We have had Housing Finance Agencies and local Public Housing Agencies (PHAs) issue bonds and get involved in funding equity for transfers to non-profits and public bodies; we have had some cases where we have been able to work with borrowers who have been able to get third party funding from other sources, and a lot of the equity paid that way. Of course, on any of those, while the dollars may not be coming from us for the actual funding of equity, it still increases the need for RA. A lot of the problems we have on Prepayment, and the focus in the future, is going to be on where do we get the resources to be able to carry out the Preservation program. And, also how do we get the legislation through that we need to clear up the Act and some of the issues that seem to be real problem areas right now as far as the administration of the program.
Portfolio Performance
On portfolio performance, I want to think every one of you as borrowers for making us look good. We have about 18,000 loans or projects in the portfolio, 456,000 units, with about $11.9 Billion outstanding. Our current delinquency rate is 2.4%; that is for all loans delinquent, including loans less than 30 days delinquent. When we compare that to other lenders, we usually drop the 30 days or less, and then we have a delinquency of 1.5%. When we talk to other lenders, they are amazed the delinquency is so low. One of the big things we were able to accomplish during the last year (ending September 30, 1997) is a big decrease in the loans that were delinquent 180 days or more — there we had a drop of 22%.
We have never had a big problem in numbers in the backlog of inventory properties, but during the last year we dropped from about 35 to 40 inventory properties to 11, including Farm Labor Housing. This is practically the lowest it has been in the last ten years.
Identity of Interest
We are going to continue our efforts to work with the OIG and our field offices on servicing efforts to make sure that where there are Identity of Interest abuses or other bad actors, we are able to take action quickly, work with U.S Attorney offices. We have some good relations going with U.S. Attorneys, and they have been very helpful in a number of areas. Just to let you know, a lot of these things we handle in relation to Identities of Interest through Administrative Notices will be incorporated in the Reinvention Regulation; making it clearer to everyone involved in the program, but also to satisfy the Inspector General that we have been able to implement a lot of their suggestions from the past.