March 21st, 2009 10:50 AM by Lehel Szucs
The credit crunch has claimed another group of victims: housing-finance agencies operated by state governments that cater to first-time homeowners.
All states have housing-finance agencies, which either originate mortgage loans to state residents or guarantee loans made by lenders. In 2007, state housing agencies issued $17 billion in bonds that funded 126,611 mortgages. In 2008, some agencies were on track to exceed 2007's levels, until September when the credit markets froze.
Now, at a time when housing-finance agencies' services are needed more than ever, most states have sharply curtailed their housing-finance operations. A handful of states, including California, Texas and Wisconsin, have suspended their mortgage-lending programs altogether.
The agencies aren't in trouble because of bad lending. Although their borrowers tend to be of moderate or low income, they had to have good credit and stable income to get a state-backed loan. As a result, default rates and foreclosures on these mortgages are low. "They're set up to be not fool-proof, but as close as you can get," says Charles Giordano, senior director of the tax-exempt housing group at Fitch Ratings.
Nevertheless, the agencies are getting slammed by a host of market forces: rising interest rates on municipal securities, the disappearance of investors who can take advantage of tax-exempt securities and a funding mechanism designed to leverage the agencies' lending ability that backfired, prompting some agencies to begin a painful deleveraging process.
For decades, the state agencies stuck to a simple business model: They sold a mix of tax-exempt and taxable bonds to investors and used the proceeds to fund mortgages. Since states could borrow cheaply, they passed along their low cost to first-time home buyers in the way of below-market mortgage rates. Typically, state agencies could offer mortgage rates that were between 0.5% to 1% less than commercial lenders.
While the agencies are small relative to mortgage giants Fannie Mae and Freddie Mac, they play an important role in their home markets. In Wisconsin, the state originates 6% of all conventional loans and 15% of loans to poor and moderate-income households.
But that business model is no longer operable. The problems began last fall, when the market meltdown scared away buyers of mortgage bonds, some of whom didn't want to invest in anything related to real estate. As investors fled, interest rates on municipal bonds surged to the point where state agencies could no longer offer attractive mortgage rates.
In Ohio, mortgage rates rose to 7.25% in October, one percentage point higher than rates offered on loans backed by the Federal Housing Administration. "We turned the spigot off," says Doug Garver, executive director of the state's housing-finance agency. Ohio's rates have since come down more in line with FHA and the state is making loans again, but not as many as in the past.
Some state agencies also are grappling with the disappearance of variable-rate bonds, once a major source of funding. Variable-rate debt was used to fund the long-term bonds but was resold daily, weekly or monthly at low short-term rates.
By issuing variable-rate debt, states could lower their borrowing costs and more effectively compete for borrowers. In 2006, variable-rate debt comprised 35% of all debt issued by state housing agencies, up from 21% in 2003, according to Fitch Ratings.
The California Housing Finance Agency, the nation's largest state finance agency, suspended its lending program due in part to problems related to variable-rate debt. The agency relied on the cheap debt to help it meet a challenge to make $1 billion in mortgages annually. "We could expand the program" while reducing loan rates, says Bruce Gilbertson, finance director for the CalHFA. "Quite honestly, it worked very, very well for a long time."
But variable-rate debt has effectively hamstrung the agency. That is because the intermediaries that CalHFA relied on to resell the bonds to investors and that guaranteed they would be buyers of last resort for the bonds were downgraded by credit-ratings firms. That scared off investors and left state agencies with higher servicing costs for those bonds.
Variable-rate debt poses the greatest immediate risk to agencies like CalHFA because higher rates they pay on the debt could drain funds. The agency won't make loans until it resolves those problems, and state officials hope the federal government will step in as a buyer.
President Barack Obama pledged last month to work with Fannie Mae and Freddie Mac to support the state housing finance agencies but has offered no details. Congress tried last year to help state agencies by increasing by $11 billion the limits on how much agencies can lend, but bond markets collapsed almost as soon as policy makers made that available.
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