New York likes to do things its own way. So when the U.S. Treasury Department began implementing a new housing bond program to help revive housing finance agencies hurt by the mortgage meltdown, the state’s biggest issuers of such bonds wanted to adapt it to their own business models.

The result has been a headache that the New York City Housing Development Corp. and the New York State Housing Finance Agency hope is lifting after much negotiation. Even so, without an extension of the New Issue Bond Purchase program, it’s unclear whether the issuers will be able to use their full bond allocations under the program by an end-of-the-year deadline.

“I always had a rule of thumb that it took you about two years to put together a program with a pipeline and get deals done because it’s very complicated,” said HDC president Marc Jahr. “It’s always complicated on the [insurance] underwriting side, figuring out what our underwriting standards are, and it’s always very complicated on the legal side figuring out all the legal dimensions to a project and regulatory issues.”

Under the NIBP program created last fall by the Treasury, the Treasury agreed to purchase securities issued by Freddie Mac and Fannie Mae backed with bonds issued through HFAs. At the end of 2009, housing finance agencies rushed to market with $15.3 billion of short-term NIBP bonds to meet an end-of-the-year deadline. The bond proceeds were put into escrow, and issuers were expected to sell long-term bonds to replace the short-term debt to finance single-family and multifamily housing projects by the end of 2010. Doing so would require Fannie and Freddie to buy the bonds, and HFAs say they have been stymied in their efforts to refinance the short-term debt for a variety of reasons, including government rules enacted under the NIBP program. Local HFAs have asked the Treasury to extend the program.

And the New York agencies have been in negotiations with government officials to find their own solutions to their conversion problems.

In December, HDC sold $500 million of multifamily bonds, the State of New York Mortgage Agency sold $389.1 million of bonds for single-family mortgages for first-time home buyers and the HFA sold $276.1 million for multifamily affordable housing.

With 2010 more than half over, efforts to convert the escrow T-bonds into cash for housing by selling long-term bonds to Fannie and Freddie have met with challenges. Last month HDC converted approximately $60 million of bonds for five multifamily projects. HFA scrapped a plan to convert NIBP bonds to finance three multifamily projects after the construction lender said it was uncomfortable with the program. Those projects were instead included in a traditional $45.8 million pooled bond financing that closed this month.

A requirement of the program was that when mortgages used to finance construction of multifamily projects were converted to permanent mortgages, those loans would be enhanced by Freddie Mac, Fannie Mae, or the Federal Housing Administration. The HFA and the HDC wanted to use their own affiliated insurers, which are less expensive and allow them to lower the cost of funds and finance more affordable housing.

The Treasury, Fannie Mae, and Freddie Mac did not respond to queries.

“HDC and HFA do business slightly differently than many other state HFAs when it comes to their multifamily [programs],” said Marian Zucker, executive vice president of nyhomes, which represents the agencies. “Here in New York, because we have the resources of both [New York City Residential Mortgage Insurance Corp.] and SONYMA mortgage insurance fund, our transactions are just a little bit different than you might see in other parts of the country.”

New York State HFA and State of New York Mortgage Agency sold a combined $1.22 billion of bonds last year and HDC alone sold $1.22 billion, according to Thomson Reuters, making them the largest issuers of housing bonds in the nation last year.

The Treasury created another option, called the “Fourth Rail” after conversations with HDC and others as it rolled out the program, said Richard Froehlich, HDC’s executive vice president for capital markets and general counsel.

“It has evolved mostly from the responses to negotiations between HFA, HDC,” and the government-sponsored entities, Fannie and Freddie, Froehlich said.

In general, for the HDC and the HFA’s affordable housing projects that qualify for federal low-income housing tax credits, the issuer sells bonds and makes a loan to the developer from the proceeds. Then during the construction period the loan is enhanced with a construction letter of credit. The LOC provider is referred to as the construction lender because even though the issuer has made the loan that secures the bonds, the LOC provider guarantees the entire debt if the project is not completed. The developer sells the tax credits directly to investors or to syndicators and uses the proceeds to help pay for construction costs and reduce the project’s debt burden.

Once the project is built and substantially rented up, the issuer begins the process to convert the loan into a permanent mortgage. The mortgage insurer does a credit analysis of the project, called underwriting, to determine whether it can support debt-service coverage ratios for the bonds. If a project can’t support the debt service, HDC works with the parties to find a solution that could include the developer putting in more equity, the construction lender putting in its own funds, or the issuer adding more subsidies so that project revenue supports the bonds. The HFA in those situations puts responsibility for finding a solution on the construction lender and developer. Once the construction loan is converted to a permanent mortgage, the LOC is removed.

The NIBP program added some additional requirements that the issuers say has caused difficulties in using the bonds.

“The program is unusual in that you don’t have a normal bondholder here,” Froehlich said. “You have Treasury, and they wanted more control than a traditional bondholder would get.” One is a requirement that if an LOC provider is downgraded below A-plus/A1, the LOC has to be replaced within 60 days. If the LOC is not replaced in 60 days, then the LOC provider has to pay the entire cost of the project.

“That’s not normally a requirement of our program,” Zucker said. “The letter-of-credit lender is really there to protect the bondholders from the project risk. So they’re taking the real estate risk. What this introduces into the transaction is also the credit risk to the project of who the letter-of-credit provider is.”

One NIBP program requirement that was removed after talks with the HDC and the HFA would have required the bonds to be defeased if a construction lender was downgraded and the LOC couldn’t be replaced in 60 days. This would have added additional risk to investors in tax credits associated with the project. Tax credits can’t be used if the bonds are defeased before the project is completed. Revised guidelines give the issuers more flexibility to work out a solution in case of a downgrade without defeasing the bonds.

Another step in the NIBP program that raised concern is a requirement that Freddie and Fannie would have an outside firm do their own credit analysis before the loan gets converted to permanent mortgage.

“Typical bond purchasers are not doing property-level reviews,” Zucker said.

The step adds time to the process and at first it wasn’t clear that the underwriting standards would be defined, but the issuers said those standards would now be established before deals were marketed so investors wouldn’t face that uncertainty.

The HDC and the HFA hosted a meeting last week with Freddie and Fannie, developers, LOC providers, and tax-credit investors to talk about the NIBP program’s details.

“I think people left the meeting feeling more comfortable with the requirements, but before that, people were uncertain and that caused an issue as well,” Froehlich said. “Banks weren’t comfortable moving forward, because there were requirements under the program they’re unfamiliar with.”

With the program’s deadline approaching, the issuers may not be able to use their full allocations of multifamily housing bonds. Zucker wouldn’t speculate as to whether they would be able to use their full allocation, and Froehlich said that without an extension of the program allowing escrow bonds to be converted in 2011 they would likely only be able to use about $300 million of the bonds.

“We would hope the future roll-outs would be much more efficiently done,” Jahr said. “This first time around, underwriting standards were at points being devised as we moved along. I think there’s more general agreement about what deals need to look like, on both sides of the fence, and that should make things go more efficiently.”

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