WASHINGTON - State and local housing finance agencies were ready to jump into the municipal bond market five months ago after Congress and President Bush gave them $11 billion of additional housing bond capacity and removed all housing bonds from the alternative minimum tax. But their efforts have been stymied by the deepening credit crunch, which has dampened investor demand for long-term tax-exempt housing bonds and pushed interest rates higher on their variable-rate, as well as their long-term, debt.
As a result, the HFAs are seeking relief from the federal government to bring the pent-up volume of housing bonds to market so that they will not have to curtail lending to low- and moderate-income homebuyers, market participants said in interviews about the new year.
The National Council of State Housing Finance Agencies recently told members of President-elect Barack Obama's housing transition team that 38 state HFAs with a total of $30 billion of variable-rate debt outstanding are struggling to find buyers as the bonds are remarketed because traditional buyers, such as money market funds, have disappeared.
The HFAs are scrambling to keep their lending programs operating and seven already have suspended their single-family bond programs, the group said.
"In the absence of ready investors, the housing bond issuance queue continues to build, with 43 HFAs reporting a backlog of more than $7 billion in housing bonds that they need to bring to market in the next few months," said Barbara Thompson, executive director of NCSHA.
"It's hard to do deals with long-term bonds - in fact, it's virtually impossible right now, and that's forcing us to devise other short-term fixes to problems," said Marc Jahr, president of the New York City Housing Development Corp." Long term, evidently there are very few investors out there and that's why rates are so high on the long end - nobody wants to get locked into a long-term financing on those types of purchases because nobody's certain about what the future will hold."
All of these factors could bog down the agencies' fund balances and put negative pressure on their credit ratings in the coming year, sources said.
Moody's Investors Service in late November put the public housing sector on negative watch, warning that higher interest rates could pose barriers to HFAs' ability to maintain a desired spread between bond costs and mortgage earnings, forcing the agencies to curtail lending.
Even with these challenges, housing advocates are hoping to break back into the market they've been all but locked out of, claiming that there is demand for homes from first-time buyers, and that there could be investors for the bonds that finance those mortgages if the federal government is willing to provide some assistance.
HFAs were ready to go to market after Congress and Bush enacted housing and economic recovery legislation in July that provided an additional $11 billion of private-activity bond volume capacity and a permanent exemption from the alternative-minimum tax for all housing bonds. The agencies had been restricted in the amount of housing bonds they could issue under PAB caps that are established for each state according to a population-based formula. The AMT, a tax designed to prevent the wealthy from taking so many tax breaks that they ultimately pay little or no taxes, had made housing bonds less attractive to investors.
But the subprime mortgage crisis, which led to a major credit crunch and the collapse of Lehman Brothers Holdings Inc. in mid-September, prohibited many issuers, even those rated triple-A, from accessing the muni bond market. Since then, anything seen as slightly risky has been of little interest to buyers.
Housing advocates have become convinced that the Federal Reserve and the Treasury Department will provide some form of assistance to loosen liquidity in the housing bond market.
"All we're asking is to help us unlock that authority," Thompson said.
NCSHA and the National Association of Local Housing Finance Agencies want to see Fannie Mae and Freddie Mac return as major purchasers of housing bonds and low-income housing tax credits, but said the government-sponsored entities need federal direction to do so. Up until about 2004, Fannie and Freddie purchased 25% to 30% of HFA housing bonds and low-income housing tax credits, according to the housing groups.
Both NALHFA and NCSHA officials said Fannie and Freddie's absence from the market for low-income housing tax credits, which stimulate private investment in affordable rental housing, has caused the value of these credits to fall from a high of about $1.00 to less than 70 cents.
Freddie, which purchased $450 million of the tax credits in 2007 and $1.3 billion in 2006, has not bought any in 2008 and is not expected to resume purchases this year without a push from the federal government, the housing groups said. Demand for the credits has fallen along with corporate profits and their tax burdens, pushing down the price.
Developers typically sell these credits to increase equity in the development, which reduces the amount of bonds needed, and therefore the rents and the cost of debt service.
John Murphy, executive director of NALHFA, has been working with the conservator of Fannie and Freddie to step in to fill the void for the demand of housing bonds and tax credits.
"Congress provided $11 billion of additional private-activity bond volume cap and for all intents and purposes, it's just sitting there," Murphy said. "We've been talking to the conservator's staff, talking to Treasury, starting to talk to [lawmakers]. We realize that Fannie and Freddie can't take advantage of the tax exemption because they're experiencing losses, but we think their housing mission has got to override that. They have historically bought between 25% and 30% of the market. It's a logical move for them to be of help."
NALHFA, the National Association of Counties, the National Community Development Association, and the U.S. Conference of Mayors urged federal officials last fall to bring Fannie and Freddie back as purchasers of tax-exempt single-family and multifamily housing bonds.
They made their plea in a letter sent to Treasury Secretary Henry Paulson, Federal Housing Finance Agency director James Lockhart, who oversees Fannie and Freddie, as well as the chairmen of congressional committees with jurisdiction over housing.
"What would be most helpful would be simply bringing back Fannie and Freddie back to the market in a robust manner and also providing good strong guidance to the Federal Home Loan Bank board, which in New York has been enormously helpful to us," Jahr agreed.
PROPOSALS FOR FED HELP
NCSHA is proposing a number of ways that the federal government can help the housing sector.
To help HFAs deal with the volatile market, NCSHA is urging the Federal Reserve to take action to spur Fannie and Freddie to buy tax-exempt housing bonds. The Fed could condition its purchases of GSE debt and mortgage-backed securities on whether Fannie and Freddie buy HFA housing bonds and provide HFAs liquidity to support their lending programs, the group said.
To help Fannie and Freddie with that goal, federal officials should increase the GSEs' debt ceilings and relax the limit on the amount of tax-exempt bonds they can hold by removing the 2% de minimis rule, NCSHA said.
The 2% de minimis rule is a "safe harbor" provision in the tax code, under which corporations do not have to prove to the Treasury that they are writing off the cost of borrowing to buy tax-exempt bonds if tax-exempt bonds make up no more than 2% of their assets.
The group also wants the Federal Home Loan Banks to provide the HFAs with liquidity.
"Our agencies are reporting that they are seeing great demand of first-time homebuyers who want to take advantage ... because of declining home prices, because of the number of foreclosed homes ... you've got a situation where lower-income people who are served by these HFAs have greater access to homes than they've had in years. And they want to buy," Thompson said. "We believe our agencies will get this money out, they've just got to be able to sell these bonds."
NCSHA also is urging Treasury to use Troubled Asset Relief Program funds that Congress and the Bush administration enacted in October or other resources to purchase long-term, fixed-rate housing bonds at "reasonable rates" that could establish the market and bring in other investors.
In addition, NCSHA is pushing for Treasury to allocate at least $5 billion of TARP or any newly appropriated economic recovery funds from the new administration to state housing credit allocating agencies to make up for shortfalls they are facing.
Further, NCSHA is encouraging Treasury and the Fed to establish liquidity facilities for HFAs' variable-rate debt. The group wants the federal agencies to pledge that they will step in and purchase the HFA debt if there are no other buyers when it is remarketed.
The group also wants to eliminate the requirement for issuers to designate housing purposes when they carry forward unused PAB capacity from one year to the next and wants to extend the AMT exemption to housing bonds that are carried forward under a state's PAB cap and to bonds refunding PABs.
Like many other muni groups, the NCSHA wants lawmakers to increase to $30 million from $10 million the tax code's so-called bank deductibility limit. Currently, banks are allowed to deduct 80% of the costs of purchasing and carrying tax-exempt bonds issued by states and localities whose annual bond issuance does not exceed $10 million.
Any number of these things or combination of these ideas could help improve the market, Thompson said.
"The state HFAs are really primed to help this housing recovery, help get mortgages into the hands of first-time homebuyers who are lining up," Thompson said. "We can't sign them up unless we can issue bonds."
Housing advocates are expecting a strong partnership with Shaun Donovan, Obama's nominee to become the next HUD secretary, because of his vast experience in public finance as chairman of the New York City HDC and commissioner of the city's Department of Housing Preservation and Development.
"We expect he's going to be very good," Murphy said. "He was a practitioner of housing finance and that's a very rare quality to have in a secretary."
NALHFA, the Council of State Community Development Agencies, NACo, and other groups already sent a letter to Obama's housing transition team on Dec. 10, urging the new administration to increase funding for the community development block grant program, among other HUD programs. The other groups included the National Association for County Community and Economic Development, the National Association of Housing and Redevelopment Officials, the NCDA, and the U.S. Conference of Mayors.
CDBG provides grants to state and local governments to fund economic development projects and can be used in projects financed by municipal bonds, and the groups said CDBG funds have been cut by more than $800 million since fiscal 2001, before adjusting for inflation.
"The program is clearly not adequately funded to meet the rising community development, economic development, and affordable housing needs facing communities and neighborhoods across the country," the groups' letter said.
The groups are seeking at least $10 billion in emergency CDBG funding as part of the stimulus package expected to be soon introduced and are asking that the funds be distributed through the program's regular allocation process.
"We support full funding for all of the complementary programs within HUD's community and economic development toolkit. Continued funding for these programs is necessary to ensure that HUD does not lose sight of the redevelopment component of its mission," the groups told transition officials.
Because of the unprecedented challenges from the credit crunch that HFAs are facing, their programs will continue to be stressed for the next 12 to 18 months and they could face downgrades, Moody's said in their report on the housing sector last month.
The rating agency is currently monitoring the California Housing Finance Agency's housing bond program, which it contends could be downgraded because of its exposure to credit enhancers whose ratings have fallen.
Still, many state HFAs entered the stressful market conditions with strong financial positions and should be able to withstand a certain amount of pressure without affecting program ratings, Moody's said.
"Most HFAs are well positioned to handle these various pressures due to strong asset quality of HFA portfolios and experienced management that may mitigate effect on program ratings," Moody's analyst Florence Zeman said in the report. "Many are managed by experienced teams who are actively responding to the challenges facing the industry."
In any case, market participants said HFAs are going to have to bend with the wind this year because the volatility doesn't seem to be going away any time soon.
"The rules of the road have changed, the structures of deals are changing, and if you're going to get deals done, it forces you to be more flexible than you were in the past and for everybody to take maybe a little less return and take on a little more risk than they were accustomed to," Jahr said.
Ted Phillips contributed to this story.