As policymakers focus on frying the “big fish” of how to reduce taxpayers’ exposure to Fannie Mae and Freddie Mac, the little fish of our nation’s single family residential mortgage finance system known as housing finance agencies is beginning to make waves.

The epic rise, fall, and conservator-led rebirth of the nation’s government-sponsored enterprises (GSEs) is well-chronicled. But few eyes have been on housing finance agencies, also known as HFAs, despite the niche industry’s long history of promoting and financing a prudent and responsible brand of homeownership that successfully weathered the Great Recession and is doing the same through the arduously slow post-recession recovery.

Who are HFAs? And why should we care?

HFAs are state or locally chartered institutions created primarily to assist in the distribution of housing-related tax benefits made available to states through the Internal Revenue Code. For roughly four decades, using the authority granted to them under the tax code, HFAs issued tax-exempt mortgage revenue bonds (MRBs) as a mechanism for providing home loans to low- and moderate-income (LMI) households with below-market interest rates. Tax-exempt MRBs lowered borrowing costs for HFAs as investors willingly accepted a lower pre-tax yield in return for higher tax-effected yields, given that the interest earned on MRBs was exempt from federal income taxes (and in some instances, exempt from state income taxes, providing a dynamic double tax-exemption.)

Lenders lovingly refer to these programs as “bond loans.” For years, loan originators would happily refer income-eligible first-time homebuyers to the nearby bond program, where they could obtain 30-year, fixed-rate financing at rates ranging from 0.50% to 1.00% or more below market. The HFA programs have enjoyed favored status among originators and Realtors alike, but the programs are not an unlimited resource for affordable home financing. Each state is subject to an allocation of bonding authority that effectively caps the amount of below-market-rate mortgages they can fund.

In the fall of 2008, bond program disruptions surfaced. As all eyes were fixated on the GSEs’ woes and the ubiquitous mortgage lender Implode-O-Meter, the market for MRBs was crumbling. Investors fled the muni debt market for grounds perceived to be higher and safer, and the MRB market that once gave HFA bond loans a distinct rate advantage now offered no advantage at all. Making matters worse, the government’s full ownership of the GSEs caused a steep drop in rates and further neutered the tax-exempt benefit of MRBs. Some states shuttered their programs, unable to offer competitive rates for borrowers.

Today, it remains the exception rather than the norm that an HFA is able to issue tax-exempt MRBs and provide meaningfully below-market interest rates while earning enough spread to cover the cost of issuance and generating the earnings it needs to build a healthy balance sheet.

HFAs have been here before. While the HFA industry was facing political pressure to better target its subsidy, the 1981-82 recession hit housing hard, and HFAs weren’t exempt. Double-digit interest rates dried up mortgage demand and caused many HFAs to fall short of fully using their bond allocations.

It was in this recessionary and politically charged environment of the early 1980s that the Mortgage Credit Certificate (MCC) was born. A change in law enabled HFAs to use bond cap to provide a more intense and concentrated tax subsidy through issuance of MCCs on a loan-by-loan basis. MCCs give borrowers the ability to convert mortgage interest paid into a direct dollar-for-dollar reduction in federal tax liability of up to $2,000 annually for as long as they remain in the home and meet the MCC’s income and owner-occupancy requirements.

What’s past is prologue. Fast forward to 2014 and we find that many states are unable to issue MRBs and, once again, have turned to MCCs to utilize expiring bond cap. But this time around, there is no political pressure on HFAs. Rather, there is a growing current of discussion about the role HFAs can, and should, play in the reformation of the nation’s mortgage finance landscape. Policymakers are recognizing the significant role HFAs play in expanding access to affordable homeownership. One of the industry’s trade associations, the National Council of State Housing Authorities (NCSHA), notes that state HFAs have “provided affordable mortgages to 2.6 million families to buy their first homes through the MRB program.”

The current carrying HFAs into the housing policy discussion grew stronger in 2010 when Treasury tried to kick-start MRB issuance through its New Issue Bond Program (NIBP). It grew stronger still when many key Dodd Frank provisions, including the Credit Risk Retention Rule and Qualified Residential Mortgage (QRM), were introduced for comment with language that would exclude HFA loans and securities. In January 2014, the current became visible from the surface as the Ability-to-Pay/Qualified Mortgage (QM) Rule took effect and exempted loans funded under HFA programs.

And perhaps as an indication of “more to come”, the 2014 Strategic Plan for the Conservatorship of Fannie Mae and Freddie Mac released May 13, 2014, singled-out HFAs as a customer segment with which the GSEs will be required to work. To be fair, Fannie Mae has been extremely active in working with HFAs. When it released version 9.1 of its proprietary Desktop Underwriter® (DU®) automated underwriting system in November 2013, it reduced the maximum LTV to 95% for all loan programs except HFA Preferred. As such, the only way to originate a 97% LTV conventional conforming loan into the Secondary Market today is through an HFA program. This advantage, combined with more flexible underwriting criteria from private mortgage insurers like Mortgage Guaranty Insurance Corporation (MGIC), is cementing the HFA industry’s niche as the conduit for loans to LMI households and first-time homebuyers into the Secondary Market.

While the public policy tide seems to be rising behind HFAs, they continue to face daily challenges in their quest for sustainable profits and operational scale. In lieu of issuing bonds, an increasing number are selling direct to the GSEs or issuing mortgage-backed securities (MBS) to fund market-rate loans. They continue to differentiate themselves in ways others cannot – namely by providing MCCs and offering down payment and closing cost assistance. Still others are getting creative in the bond market by over-collateralizing new MRB issues, or using recycled bond funds to effectively buy down note rates and offer below-market interest rates to qualifying borrowers.

Make no mistake: HFAs are first and foremost focused on their mission. But profit is critical to their success. Most operate as fully self-sustaining authorities, deriving no taxpayer revenue from the jurisdictions which created them. As a result, they must make money and sustain healthy balance sheets in order to have the resources needed to invest in their mission and maintain strong ratings on their indentures and general obligations bonds.

Will HFAs be afforded a prominent position in the nation’s residential mortgage finance system when – or if – GSE reform happens? What role will they be asked to play? And what tools will they be provided to wield in their quest for mission? No one knows for sure, but one thing is clear: In their words and actions, the nation’s housing policymakers clearly recognize the HFA industry’s affordable housing beachhead.

And it appears the surf’s up for HFAs.

What’s your perspective of HFAs in today’s mortgage lending market? Please share in the comments.

Geoffrey Cooper

Geoffrey Cooper - Vice President Product Development

Geoff Cooper is Vice President – Product Development at Mortgage Guaranty Insurance Corporation (MGIC).

With over 28 years of experience in the mortgage and banking industries, Geoff has been with MGIC for 19 years in various positions, from leading the Company’s affordable lending efforts to overseeing its community bank strategy. He is also past Director of Single Family at Wisconsin Housing & Economic Development Authority, and served as Policy Advisor to the Wisconsin Commissioner of Banking.

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