Multifamily Finance Reform Daniel Siesser October 24th, 2012

Daniel Siesser is currently a Vice President at Key Bank. He works in Keys Real Estate Capital group as a Senior Portfolio Manager, underwriting and originating commercial real estate loans. Previously, Daniel worked at Booz Allen Hamilton as a senior consultant advising US Department of Agriculture Rural Development on modernizing their multifamily mortgage lending and servicing program. He also worked for Deutsche Bank Berkshire Mortgage for several years as an underwriter and an originator of multifamily mortgages under Fannie Maes DUS program and Freddie Macs Seller/Servicer program. Daniel received his BS in Finance from Yeshiva University and his MBA from University of Maryland, College Park.

The views expressed in this paper are those of the author and do not necessarily reflect the official policy, position, or opinions of Key Bank.

Daniel Siesser 202-299-7396

siesserd@gmail.com

 Introduction The purpose of this paper is to provide a plan for winding down government involvement in multifamily finance by incentivizing the private sector into assuming their market share. The policy changes that I am advocating would provide a long-lasting shot in the arm to the CMBS industry. They would reward debt providers and financial institutions that maintain skin-in-the-game. And they would reduce the American taxpayers unnecessary exposure to risk of nearly half a trillion dollars of debt effectively guaranteed by the federal government. The convergence of Dodd-Frank and Agency Reform presents us with a unique but brief opportunity to bring reform and renewed confidence to the commercial real estate finance sector. Implementation of the risk retention regulations to the CMBS industry in 2013, as outlined in section 15G in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), may impede a recovery to the commercial real estate debt capital markets. At the same time, the legislators are looking for a comprehensive plan for agency reform, as it is understood that government conservatorship of Fannie Mae and Freddie Mac is not sustainable over the long term. As part of agency reform, regulators and private industry need to contemplate how agency multifamily mortgage programs can be reduced or eliminated without impairing or disabling the capital markets. A viable strategy is needed to insure continued availability of mortgages for multifamily properties in the absence of the Fannie & Freddie. My recommendations will address both issues: I propose we form a risk retention policy that would strengthen the CMBS market and incentivize greater multifamily lending within the private sector.

Summary Recommendations

1. Create a multi-tiered classification for multifamily loans as measured by risk. 2. Assign FHA with the responsibility of setting, maintaining, revising, and disseminating the loan
tier underwriting standards for each tier, based on DSCR & LTV.

3. Introduce a system of Risk Retention Credits for multifamily loans that can be used to reduce
the risk retention requirements for a CMBS issuance.

4. Allocate a higher risk retention credit multiplier to multifamily loans of lower risk tiers, and a
lower risk retention credit multiplier to those of higher risk tiers.

5. Set a risk retention floor of 2.5% for every CMBS issuance. 6. Provide oversight of certifying loan tier classifications, in accordance with the guidelines set by
FHA.

7. Substantially cut back and wind down GSE multifamily finance programs.

 Scope It is not my intention to provide a comprehensive plan for Agency Reform or housing policy. GSE multifamily mortgage programs are distinct and separate from their single family mortgage programs. A comprehensive plan for Agency Reform will need to address each of the GSE programs individually. The scope of this paper is to address only the multifamily programs. In addition, this plan will not compete with any proposed housing policy solutions currently being reviewed by federal regulators. The Case for Privatization1 In other sectors, government guaranties of debt repayment of multifamily loans are not necessary. In countries abroad, commercial and multifamily debt capital markets function adequately with any government subsidies. Domestically, debt markets for commercial properties such as office, retail, industrial, and hotels function adequately without federal subsidies. Debt for multifamily properties provided by Fannie Mae and Freddie Mac does nothing to enhance affordability for renters. Were these agencies to exit the market, renters would not be adversely affected, as it has been established that there is no connection between multifamily interest rates and the rents that tenants actually pay. Furthermore, the Low Income Housing Tax Credit model provides a much more effective channel for supplying affordable products to the market. If policymakers decide that more affordable housing is needed, the government could increase the amount of tax credits it allocates for LIHTC development. The government can always re-enter the market to solve a liquidity shortage on a short-term basis. If a liquidity shortage in the future arises, government assistance could be provided to the sector by having the Federal Reserve purchase either individual multifamily mortgage-backed securities from lenders or securities of bifurcated CMBS issuances dedicated to multifamily loans. The Federal Reserve would carry this out in a similar fashion to Quantitative Easing. Without the federal subsidy, financing terms will more accurately reflect the risk. Removing the subsidy would help the sector circumvent bubbles created by cheap debt, and avoid the moral hazard of risks taken under the assumption of socialized loss. History shows that private investment is strong enough to fill the gap if Fannie Mae and Freddie Mac exit the multifamily market. The LIHTC sector serves as a model for a sector that survived an exit of Fannie Mae & Freddie Mac when the two agencies stopped buying syndicated tax credits in 2008.

The Roadmap The recommendations below would create an imbedded subsidy for multifamily loans within CMBS lending. Policy makers did not go far enough with their proposal of an Exempt/Qualified

TheseandotherargumentsforeliminatingthefederalguarantyfirstappearedinNoFederalGuarantyfor Multifamily:AndotherideasforMultifamilyHousingFinanceReform,byTomWhiteandCharlieWilkins,July28, 2011.

 status outlined in the Notice of Proposed Rulemaking to Section 15G of Dodd Frank.2 Their criteria for achieving the Exempt/Qualified designation are far too arduous and will be seldom met. The Exempt/ Qualified status should be assessed on a loan-by-loan basis, rather than on a pool-by-pool basis, and broadened to incentivize inclusion of multifamily loans. I propose that we create a system of risk retention credits for multifamily loans according to their financial risk. These risk retention credits would incentivize conduits to include multifamily loans in CMBS pools by reducing the overall risk retention of the issuance. The incentives should be greater for lower risk loans and smaller for higher risk loans.

Recommendations

1. Create a multi-tiered classification for multifamily loans as measured by risk.

I recommend that a grading system of four tiers be introduced to multifamily loans, based on a scale of riskiness, with TIER 1 loans having the lowest risk and TIER 4 loans having the highest risk. Tiers should be based on underwriting parameters that take into account leverage and debt service coverage. The following underwriting parameters are for the purpose of illustration. Actual parameters should be collaboratively decided upon by the industry and regulators: TIER UNDERWRITING PARAMETERS for MARKET RATE PROPERTIES3
TIER ONE DSCR LTV > 1.55x < 55% > 1.30x < 55% TIER TWO DSCR LTV 1.35x 56%-65% 1.54x 1.10x 1.30x 56%-65% TIER THREE DSCR LTV 1.25x 66%-80% 1.34x 1.00x 1.09x 66%-75% TIER FOUR DSCR LTV < 1.25x > 80% < 1.00x > 75%

Fixed Rate* Structured ARM*

*DSCR calculated based on underwriting floor interest rates that vary based on tier and loan term.

2. Assign FHA with the responsibility of setting, maintaining, revising, and disseminating the loan
tier underwriting standards for each tier, based on DSCR & LTV. Tier classification underwriting parameters should vary by geography and property subtype (i.e. senior housing, student housing, military housing, affordable properties, etc.), similar to those currently used in Fannie Mae DUS and Freddie Mac Seller/Servicer underwriting guides. A lender that is originating new loans should have enough information to adequately predict the tier classification during the quoting or underwriting stages, and offer the borrower pricing appropriate to that loan tier.
ThespecificrequirementsformeetingExempt/QualifiedcanbefoundinOverviewofProposedDoddFrankRisk RetentionRegulationbyScottSinderandRhondaBoltonofSteptoe&Johnson,LLP,publishedonMarch31,2011 canbefoundathttp://www.crefc.org/. 3 ThesetiersarebasedonthesizingparametersdescribedinFannieMaesForm4660MULTIFAMILY UNDERWRITINGSTANDARDS.Pleaserefertothatformforunderwritingfloorratesandfurtherdetails.
2

3. Introduce a system of Risk Retention Credits for multifamily loans that can be used to reduce
the risk retention requirements for a CMBS issuance. TIER 1-3 loans would be excluded from the 5% risk retention requirement of a CMBS securitization. Additionally, the calculated risk retention amount would be further reduced by offsetting credits from TIER 1-3 multifamily loans as a percentage of each loan amount. TIER 4 loans would be included in the 5% risk retention requirement of a CMBS securitization. Tier 4 loans would include all multifamily loans that dont meet the criteria of TIER 1-3.

4. Allocate a higher risk retention credit multiplier to lower risk tiers and a lower risk retention
credit multiplier to higher risk tiers. The intent of the four-tiered scale is to provide greater incentive to lenders for making low-risk loans. Having higher quality loans and greater diversity of asset type would offset the potential hazard of reducing the CMBS issuers skin in the game. This structure promotes narrower pricing spreads offered to borrowers of TIER 1 loans, and wider pricing spreads for borrowers of TIER 4 loans.

Multifamily Loan Designation Lower Risk TIER 1 TIER 2 TIER 3 Higher Risk TIER 4

Risk Retention Multiplier (as % of loan amount) 5% Credit 4% Credit 3% Credit 5% Risk Retention

The Risk Retention requirement would be calculated in a sample CMBS pool as the follows: EXAMPLE with Risk Retention Credits:
Property Type Office Retail Industrial Hotel Other Multifamily TIER 1 Multifamily TIER 2 Multifamily TIER 3 Multifamily TIER 4 TOTAL RISK RETENTION Loan # Balances Amount Loans (mils) Multiplier (mils) 20 $300 5.0% $15.00 20 $160 5.0% $8.00 15 $105 5.0% $5.25 10 $150 5.0% $7.50 10 $100 5.0% $5.00 5 5 5 5 95 $40 $50 $60 $35 $1,000 -5.0% -4.0% -3.0% 5.0% 3.84% -$2.00 -$2.00 -$1.80 $1.75 $38.40 TOTAL 95 $1,000 5.00% $50.00

EXAMPLE without Risk Retention Credits:

Property Type Office Retail Industrial Hotel Other Multifamily # Loans 20 20 15 10 10 20 RISK RETENTION Loan Balances Amount Multiplier (mils) (mils) $300 5.0% $15.00 $160 5.0% $8.00 $105 5.0% $5.25 $150 5.0% $7.50 $100 5.0% $5.00 $185 5.0% $9.25

5. Set a risk retention floor of 2.5% for every CMBS issuance.

A risk retention floor would have several positive effects: It would insure that every CMBS issuance maintain some risk retention. This will keep the motivations of issuers and bond investors aligned. If a B-piece buyer is selected to hold the risk retention, the minimum size of the investment would be reduced by as much as half. It would foster a more competitive marketplace for the acquisition of multifamily loans. The floor would reduce the marginal benefit of acquiring a greater volume of multifamily debt for a given CMBS issuance once the pools risk retention floor is reached. As a result, every CMBS issuer will be in the market to acquire multifamily loans, but at no point will market demand will be dominated by any single issuer.

6. Provide oversight of certifying loan tier classifications, in accordance with the guidelines set by
FHA. Unbiased oversight is necessary to insure accountability for assigning accurate tier classifications. I believe government oversight is needed. While Credit Rating Agencies may seem a natural fit for this role, their accountability may be questioned when they are incentivized by greater volume of deal production. Providing tier certification should be limited to lenders with government issued licenses. HUD/FHA or the successor entities of Fannie Mae and Freddie Mac should be responsible for a) issuing these

 licenses b) auditing licensed lenders for compliance, and c) penalizing licensed lenders that are found to be making non-compliant tier certifications.

7. Substantially cut back and wind down GSE multifamily finance programs.
This may take some time, seeing that the agencies guarantee loans with terms of 5 to 30 years long. Under a gradual withdrawal from the market (whether partially or completely), policy makers will be able to accelerate or decelerate the scaling back of new originations depending on how the private markets respond to privatization.

Considering the Industry Impact Stronger investor demand for CMBS securities. Adding prime multifamily loans to CMBS pools will enhance credit quality, increase risk diversification, and generate more demand for securities, effectively greasing the wheels for more volume of securitization. Increased profitability for CMBS issuers. The economic capital generated on each CMBS issuance will increase as risk retention is reduced by offsetting credits from TIER 1-3 multifamily loans, as compared to issuances with full risk retention. Loss sharing eliminated. Multifamily lenders will no longer profit from providing a partial guarantee on mortgage backed securities. They can generate revenue for originating and underwriting loans by collecting up-front fees paid by the Borrower, and for ongoing servicing of the loan they can collect a portion of the interest spread paid each month. Lenders that have a conduit for CMBS will be able to generate revenue from the premiums earned through securitization of their multifamily loans. Lenders that do not have a conduit may generate revenue from a premium earned on the sale of each whole loan security to a CMBS issuer. A competitive market for multifamily originators. Multifamily originators that currently hold Fannie/Freddie licenses are the obvious and likely best candidates to obtain licenses for providing tier certification. CMBS lenders will not set out to corner the multifamily market since the marginal benefit of generating high volumes of multifamily debt is limited by the cap on risk retention credit (see explanation to Recommendation #5).