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HUD's Regulation of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac)

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AGENCY:

Office of the Assistant Secretary for Housing “ Federal Housing Commissioner, HUD.

ACTION:

Final rule.

SUMMARY:

This final rule establishes new housing goal levels for the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, the “Government Sponsored Enterprises,” or the “GSEs”) for the years 2001 through 2003. The new housing goal levels are established in accordance with the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (FHEFSSA), and govern the purchase by Fannie Mae and Freddie Mac of mortgages financing low- and moderate-income housing, special affordable housing, and housing in central cities, rural areas and other underserved areas. Specifically, the final rule increases the Low- and Moderate-Income Housing Goal to 50 percent, the Geographically Targeted Goal to 31 percent, and the Special Affordable Housing Goal to 20 percent of units backing each GSE's annual eligible mortgage transactions. The Special Affordable Multifamily Subgoal increases to one percent of each GSE's average annual total dollar mortgage purchases in 1997 through 1999. This rule also establishes new provisions and clarifies certain other provisions of HUD's rules for counting different types of mortgage purchases towards the goals, including provisions regarding the use of bonus points for mortgages that are secured by certain single family rental properties and small multifamily properties; and the disallowance of goals credit for mortgage loans with predatory characteristics.

While Fannie Mae and Freddie Mac have been successful in providing stability and liquidity in the market for certain types of mortgages, their share of the affordable housing market is substantially smaller than their share of the total conventional, conforming mortgage market. There are several reasons for these disparities, related to the GSEs' purchase and underwriting guidelines; and to their relatively low level of activity in specific mortgage markets that provide financing for housing serving low- and moderate-income families, including small multifamily rental properties, single family owner-occupied rental properties, manufactured housing, and markets for seasoned mortgages on properties with affordable housing. As the GSEs continue to grow their businesses, the new goals will provide strong incentives for the two enterprises to more fully address the housing finance needs for very low-, low- and moderate-income families and residents of underserved areas and, thus, more fully realize their public purposes.

In addition, as government sponsored enterprises and market leaders, Fannie Mae and Freddie Mac have a public responsibility to help eliminate predatory mortgage lending practices which are inimical to the home financing and homeownership objectives that the GSEs were established to serve. Fannie Mae and Freddie Mac have adopted policies stating that they will not purchase mortgage loans with certain predatory characteristics. This final rule affirms the GSEs' actions by disallowing housing goals credit for mortgages having features that the GSEs themselves have identified as unacceptable.

EFFECTIVE DATE:

January 1, 2001.

Start Further Info

FOR FURTHER INFORMATION CONTACT:

Director, Office of Government Sponsored Enterprises Oversight, Office of Housing, Room 6182, telephone 202-708-2224. For questions on data or methodology, contact John L. Gardner, Director, Financial Institutions Regulation Division, Office of Policy Development and Research, Room 8234, telephone (202) 708-1464. For legal questions, contact Kenneth A. Markison, Assistant General Counsel for Government Sponsored Enterprises/RESPA, Office of the General Counsel, Room 9262, telephone 202-708-3137. The address for all of these persons is Department of Housing and Urban Development, 451 Seventh Street, SW., Washington, DC 20410. Persons with hearing and speech impairments may access the phone numbers via TTY by calling the Federal Information Relay Service at (800) 877-8399.

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SUPPLEMENTARY INFORMATION

I. General

A. Purpose

This final rule revises existing regulations implementing the Department of Housing and Urban Development's (the “Department” or “HUD”) authority to regulate the GSEs. The authority exercised by the Department is established under:

(1) The Federal National Mortgage Association Charter Act (“Fannie Mae Charter Act”), which is Title III of the National Housing Act, section 301 et seq. (12 U.S.C. 1716 et seq.);

(2) The Federal Home Loan Mortgage Corporation Act (“Freddie Mac Act”), which is Title III of the Emergency Home Finance Act of 1970, section 301 et seq. (12 U.S.C. 1451 et seq.); and

(3) FHEFSSA, enacted as Title XIII of the Housing and Community Development Act of 1992 (Pub. L. 102-550, approved October 28, 1992) (12 U.S.C. 4501-4641).

(4) Section 7(d) of the Department of Housing and Urban Development Act (42 U.S.C. 3535(d)), which provides that the Secretary may make such rules and regulations as may be necessary to carry out his functions, powers, and duties, and may delegate and authorize successive redelegations of such functions, powers, and duties to officers and employees of the Department.

FHEFSSA substantially changed the Department's regulatory authorities governing the GSEs by establishing a separate safety and soundness regulator within the Department and clarified and expanded the Department's regulation of the GSEs' missions. Regulations first implementing the Department's authorities with respect to the GSEs' missions under FHEFSSA were issued on December 1, 1995 (24 CFR part 81).

This rule revises certain portions of those regulations concerning the GSEs' affordable housing goals and provisions related to how mortgage loans are treated in the calculation of performance under the housing goals. The remaining part of the preamble contains several endnotes. These endnotes appear at the end of the preamble.

B. Background

1. Fannie Mae and Freddie Mac

Fannie Mae and Freddie Mac engage in two principal businesses: investing in residential mortgages and guaranteeing securities backed by residential mortgages. Fannie Mae and Freddie Mac are chartered by Congress as Government Sponsored Enterprises to: (1) Provide stability in the secondary market for residential mortgages; (2) respond appropriately to the private capital market; (3) provide ongoing assistance to the secondary market for residential mortgages (including activities relating to mortgages on housing for low- and moderate-income families involving a reasonable Start Printed Page 65045economic return that may be less than the return earned on other activities) by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage financing; and (4) promote access to mortgage credit throughout the nation (including central cities, rural areas, and other underserved areas) by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage financing.1

Fannie Mae and Freddie Mac receive significant explicit benefits through their status as GSEs that are not enjoyed by any other shareholder-owned corporations in the mortgage market. These benefits include: (1) Conditional access to a $2.25 billion line of credit from the U.S. Treasury; 2 (2) exemption from the securities registration requirements of the Securities and Exchange Commission and the States; 3 and (3) exemption from all State and local taxes except property taxes.4

Additionally, although the securities the GSEs guarantee and the debt instruments they issue are not backed by the full faith and credit of the United States, and nothing in this final rule should be construed otherwise, such securities and instruments trade at yields only a few basis points over those of U.S. Treasury securities and at yields lower than those for securities issued by comparable firms that are fully private but may be higher capitalized. The market prices for GSE debt and mortgage-backed securities, and the fact that the market does not require that those securities be rated by a national rating agency, suggest that investors perceive that the government implicitly backs the GSEs' debt and securities. This perception evidently arises from the GSEs' relationship to the Federal Government, including their public purposes, their Congressional charters, their potential direct access to U.S. Department of Treasury funds, and the statutory exemptions of their debt and mortgage-backed securities (MBS) from otherwise mandatory security laws. Consequently, each GSE enjoys a significant implicit benefit—its cost of doing business is significantly less than that of other firms in the mortgage market. According to a U.S. Department of Treasury 1996 study, the benefits of federal sponsorship are worth almost $6 billion annually to Fannie Mae and Freddie Mac. Of this amount, reduced operating costs (i.e., exemption from SEC filing fees and from state and local income taxes) represent approximately $500 million annually. These estimates are broadly consistent with estimates by the Congressional Budget Office and General Accounting Office. According to the Department of the Treasury, Fannie Mae and Freddie Mac appear to pass through part of these benefits to consumers through reduced mortgage costs and retain part for their own stockholders.5

The GSEs have achieved an important part of their mission: providing stability and liquidity to large segments of the housing finance markets. As a result of the GSEs' activities, many home buyers have benefited from lower interest rates and increased access to capital, contributing, in part, to a record national homeownership rate of 66.8 percent in 1999. While the GSEs have been successful in providing stability and liquidity to certain portions of the mortgage market, the GSEs must further utilize their entrepreneurial talents and power in the marketplace and “lead the mortgage finance industry” to “ensure that citizens throughout the country enjoy access to the public benefits provided by these federally related entities.” 6

Despite the record national homeownership rate in 1999, lower homeownership rates have prevailed for certain minorities, especially for African-American households (46.3 percent) and Hispanics (45.5 percent). These gaps are only partly explained by differences in income, age, and other socioeconomic factors. Disparities in mortgage lending are a contributing factor to lower homeownership rates and are reflected in loan denial rates of minority groups when compared to white applicants. Denial rates for conventional (non-government-backed) home purchase mortgage loans in 1998 were 54 percent for African Americans, 53 percent for Native American applicants, 39 percent for Hispanic applicants, 26 percent for White applicants, and 12 percent for Asian applicants.7 Despite strong economic growth, low unemployment, low mortgage interest rates, and relatively stable home prices, housing problems continue to persist for low-income families and certain minorities.

In addition to disparities across racial groups, populations who live in certain types of housing have not benefited to the same degree as have others from the advantages and efficiencies provided by Fannie Mae and Freddie Mac. The GSEs have been much less active in purchasing mortgages in markets where there is a need for additional financing to address persistent housing needs including financing for small multifamily rental properties, manufactured housing, single family owner-occupied rental properties, seasoned affordable housing mortgages, and older housing in need of rehabilitation.

While HUD recognizes that the GSEs have played a significant role in the mortgage finance industry by providing a secondary market and liquidity for mortgage financing for certain segments of the mortgage market, it is this recognition of their ability, along with HUD's comprehensive analyses of the size of the mortgage market and the opportunities available, America's unmet housing needs, identified credit gaps, and HUD's consideration of the statutory factors under FHEFSSA that causes HUD to increase the level of the housing goals so that as the GSEs grow their businesses so they will address new markets and persistent housing finance needs.

2. Regulation of the GSEs

In 1968, Congress assigned HUD general regulatory authority over Fannie Mae,[8] and in 1989, Congress granted the Department essentially identical regulatory authority over Freddie Mac.9 Under the 1968 law, HUD was authorized to require that a portion of Fannie Mae's mortgage purchases be related to the national goal of providing adequate housing for low- and moderate-income families. Accordingly, the Department established two housing goals—a goal for mortgages on low- and moderate-income housing and a goal for mortgages on housing located in central cities—by regulation, for Fannie Mae in 1978.10 Each goal was established at the level of 30 percent of mortgage purchases. Similar housing goals for Freddie Mac were proposed by the Department in 1991 but were not finalized before October 1992, when Congress revised the Department's GSE regulatory authorities including requirements for new housing goals.

In 1992, Congress enacted the Federal Housing Enterprises Financial Safety and Soundness Act (FHEFSSA) as Title XIII of the Housing and Community Development Act of 1992 (Pub. L. 102-550, approved October 28, 1992) (12 U.S.C. 4501-4641), which established the Office of Federal Housing Enterprise Oversight (OFHEO) as the GSEs' safety and soundness regulator and affirmed, clarified and expanded the Secretary of Housing and Urban Development's responsibilities for GSE mission regulation. FHEFSSA provided that, except for the specific authority of the Director of OFHEO, the Secretary retained general regulatory power over the GSEs.11 FHEFSSA also detailed and expanded the Department's specific Start Printed Page 65046powers and authorities, including the power to establish, monitor, and enforce housing goals for the GSEs' purchases of mortgages that finance housing for low-and moderate-income families; housing located in central cities, rural areas, and other underserved areas; and special affordable housing, affordable to very low-income families and low-income families in low-income areas.12 The Department is required to establish each of the goals after consideration of certain prescribed factors relevant to the particular goal.13

FHEFSSA provided for a transition period during 1993 and 1994 and required HUD to establish interim goals for the transition period (58 FR 53048; October 13, 1993) (59 FR 61504; November 30, 1994). In November 1994, HUD extended the interim goals established for 1994 for both GSEs through 1995 while the Department completed its development of post transition goals.

The Department issued proposed and final rules in 1995 establishing and implementing the housing goals for the years 1996 through 1999. The rule provided that the housing goals for 1999 would continue beyond 1999 if the Department did not change the goals, and further provided that HUD may change the level of the goals for the years 2000 and beyond based upon HUD's experience and in accordance with HUD's statutory authority and responsibility.

In addition to establishing the level of the housing goals, the 1995 final rule included counting requirements for purposes of calculating performance under the housing goals. The new regulations also prohibited the GSEs from discriminating in any manner on any prohibited basis in their mortgage purchases, implemented procedures by which HUD exercises its authority to review new programs of the GSEs, required reports from the GSEs, established a public use data base on the GSEs' mortgage purchase activities while providing protections for confidential and proprietary information, and established enforcement procedures under FHEFSSA.

C. The Proposed Rule

On March 9, 2000,14 HUD published a rule proposing new housing goal levels for Fannie Mae and Freddie Mac. The rule proposed to increase the level of the housing goals for the purchase by Fannie Mae and Freddie Mac of mortgages financing low- and moderate-income housing, special affordable housing, and housing in central cities, rural areas, and other underserved areas. The rule also proposed to clarify HUD's guidelines for counting different types of mortgage purchases under the housing goals, including treatment of missing affordability data and purchases of seasoned mortgage loans; use of bonus points for goals credit for purchases of mortgages secured by single family rental and small multifamily properties; and providing greater public access to certain types of mortgage data on the GSEs' mortgage purchases in HUD's public use database. The rule also solicited public comments on several other issues related to the housing goals including the appropriate role of credit enhancements in furthering affordable housing lending and whether the use of credit enhancements should be considered in calculating housing goal performance.

D. This Final Rule

In response to the proposed rule, HUD received over 250 comments. The comments came from the GSEs; individuals; representatives of lending institutions; non-profit organizations; community, consumer groups and civil rights organizations; local and State governments; and others. Following full consideration of the comments, HUD developed this final rule. The final rule is consistent with the approach announced in the proposed rule but does include some revisions adopted in light of the comments received. The final rule: (1) Increases the level of the housing goals for the years 2001 through 2003 as a result of HUD's review of the statutory factors under FHEFSSA to ensure that the GSEs continue and strengthen their efforts to carry out Congress' intent that the GSEs provide the benefits of the secondary market to families throughout the nation—the Low- and Moderate-Income Housing Goal increases to 50 percent, the Geographically Targeted Goal increases to 31 percent, the Special Affordable Housing Goal increases to 20 percent; and the Special Affordable Multifamily Subgoal increases to the respective average of one percent of each GSE's total mortgage purchases over 1997 through 1999; (2) establishes the use of bonus points for small multifamily properties with 5 to 50 units and for single family owner-occupied rental properties for the years 2001 through 2003; (3) establishes a temporary adjustment factor for Freddie Mac's multifamily mortgage purchases for the years 2001 through 2003; (4) prohibits the counting of high cost mortgage loans with predatory features for goals credit; (5) provides or clarifies counting rules for the treatment of missing affordability data, purchases of seasoned mortgage loans, purchases of federally insured mortgage loans and purchases of mortgage loans on properties with expiring assistance contracts; (6) provides for HUD's review of transactions to determine appropriate goal treatment; and (7) includes certain definitional and technical corrections to the regulations issued in 1995.

Specific changes included in the Final Rule from the provisions included in the Proposed Rule are as follows:

(1) The period covered by the housing goals is 2001 through 2003 and there is no transition year. The proposed rule had suggested the goals cover the period from 2000 through 2003 with 2000 serving as a transition year.

(2) The Special Affordable Multifamily Subgoal uses the average of 1997 through 1999 as the base period for establishing the level of the goal over the 2001 through 2003 period, rather than 1998 as the base period, as proposed. The subgoal remains a fixed dollar amount for each year of the period covered by the housing goals base equal to one percent of each GSE's average total mortgage purchases in 1997 through 1999.

(3) The final rule does not allow goals credit for predatory mortgage loans, and the rule describes specific characteristics, in addition to the HOEPA definition suggested in the proposed rule, to determine what types of loans are considered predatory. The final rule also identifies good lending practices with which mortgages should conform in order to count towards goals credit.

(4) The proposed provisions for the treatment of missing affordability data are retained but the final rule includes a five percent ceiling on the use of estimated affordability information for multifamily units.

(5) The guidance provided on how to determine if seasoned mortgage loan purchases meet the recycling requirements of the Special Affordable Housing Goal was expanded to (1) include additional types of lending organizations with affordable housing missions that are presumed to meet the recycling requirements; (2) adjust the Community Reinvestment Act (CRA) examination requirement for Federally regulated financial institutions to one “Satisfactory” rating for financial institutions with assets of $250 million or less to accommodate a less frequent examination schedule; and (3) specify requirements that a seller must meet for purposes of evaluating whether the seller meets the recycling requirements of 12 U.S.C. 4563(b)(1)(B).

(6) The final rule does not make changes to the definition of underserved Start Printed Page 65047area other than the inclusion of tribal lands in underserved areas and does not address the public availability of mortgage data in the public use data base. As explained below, HUD will publish a decision on which data elements will be accorded proprietary and non-proprietary treatment by separate Order following publication of this final rule.

The analysis of Fannie Mae's and Freddie Mac's affordable housing performance, which is the basis for many of the changes in the final rule, is primarily based on data from 1997, 1998 and 1999. The GSEs' actual performance is presented through 1999. However, Home Mortgage Disclosure Act (HMDA) data which provides data on the conventional, conforming market was not available for 1999 at the time HUD prepared its analysis supporting this final rule. As HMDA data for 1999 were not available, comparisons between the GSEs and the market as a whole for that year are not possible. Further, as 1998 was a year with a large percentage of refinance mortgage transactions, at times 1997 data is utilized as it presents a more normal year in terms of home purchase mortgage transactions.

In finalizing these regulations, the Department is guided by and affirms the following principles established in the 1995 rulemaking:

(1) To fulfill the intent of FHEFSSA, the GSEs should lead the industry in ensuring that access to mortgage credit is made available for very low-, low- and moderate-income families and residents of underserved areas. HUD recognizes that, to lead the mortgage industry over time, the GSEs will have to stretch to reach certain goals and close the gap between the secondary mortgage market and the primary mortgage market. This approach is consistent with Congress' recognition that “the enterprises will need to stretch their efforts to achieve” the goals.15

(2) The Department's role as a regulator is to set broad performance standards for the GSEs through the housing goals, but not to dictate the specific products or delivery mechanisms the GSEs will use to achieve a goal. Regulating two exceedingly large financial enterprises in a dynamic market requires that HUD provide the GSEs with sufficient latitude to use their innovative capacities to determine how best to develop products to carry out their respective missions. HUD's regulations should allow the GSEs to maintain their flexibility and their ability to respond quickly to market opportunities. At the same time, the Department must ensure that the GSEs' strategies serve families in underserved markets and address unmet credit needs. The addition of bonus points to the regulatory structure provides an additional means of encouraging the GSEs' affordable housing activities to address identified, persistent credit needs while leaving the specific approaches to meeting these needs to the GSEs.

(3) Discrimination in lending—albeit sometimes subtle and unintentional—has denied racial and ethnic minorities the same access to credit to purchase a home that has been available to similarly situated non-minorities. The GSEs have a central role and responsibility to promote access to capital for minorities and other identified groups and to demonstrate the benefits of such lending to industry and borrowers alike. The GSEs also have an integral role in eliminating mortgage lending practices that are predatory.

(4) In addition to the GSEs' purchases of single family home loans, the GSEs also must continue to assist in the creation of an active secondary market for multifamily loans. Affordable rental housing is essential for those families who cannot afford or choose not to become homeowners. The GSEs must assist in making capital available to assure the continued development of rental housing.

II. Discussion of Public Comments

A. Overview

1. Public Comment

Of the over 250 comments received, by far the most detailed were the submissions of the two directly affected GSEs—Fannie Mae and Freddie Mac. Each GSE's comments were in large measure supportive of the overall goal structure proposed by the Department. The GSEs, however, did provide extensive appendices questioning the Department's methodology in determining market share for the three affordable housing goals, a key component for establishing the appropriate level of the housing goals.

Other commenters included national and regional industry related groups, non-profit organizations, state and local government officials, lenders, and individuals. In large measure, these commenters were also supportive of the Department's proposal to increase the affordable housing goals and the related provisions designed to streamline the counting rules used to calculate performance under the housing goals.

Other than the goals framework, the areas generating the largest response from commenters were the treatment of high cost mortgages, the role of credit enhancements in affordable lending transactions, and the availability of data on the public use data base. It should be noted that in evaluating these comments a large number of comments were received that included substantially similar responses, in both language and tone, to those submitted by Fannie Mae.

In addressing the appropriate goals treatment for high cost mortgages, one group of commenters, comprised primarily of non-profit and housing advocacy groups, felt the provisions included in the proposed rule disallowing credit for loans that meet the HOEPA definition should be strengthened. Other commenters, consistent with the comments provided by Fannie Mae, opposed any limitation of goals credit for predatory mortgage loans.

With regard to credit enhancements, a substantial majority of commenters noted that credit enhancements are a critical component of many affordable housing transactions. There was little support for limiting goals credit for affordable housing transactions that include credit enhancements without a better understanding of how to ensure that there are not negative implications for affordable housing transactions.

The Department received comments supporting both increased data availability and limited availability of data. One group of commenters, including non-profit organizations and academic researchers, felt the provisions included in the proposed rule should be adopted and, in some instances, expanded in order to fully understand and challenge the GSEs on their affordable housing activities. Again, another group of commenters, consistent with the comments provided by Fannie Mae, opposed the availability of additional data on the public use data base. This group of commenters included both lenders and non-profit organizations which felt the additional data would release confidential business information and could compromise the privacy of individuals, respectively. This final rule does not, however, address the availability of data on the public use data base.

A discussion of the general and specific comments on the rule follows in subsequent sections. While comments are summarized, not all of the comments are addressed explicitly in this preamble. HUD fully considered all of the comments and HUD's response is either explicit in this final rule or implicit in the general discussion of the rule or other comments. HUD is appreciative of the full range of public comments received and acknowledges the value of all of the comments Start Printed Page 65048submitted in response to the proposed rule.

2. Other Public Input

As part of the public comment process, the Department conducted extensive outreach to educate and inform interested parties of the nature and extent of the GSEs' affordable housing activities. The outreach was undertaken in order to encourage comments on the proposed rule from a wide range of individuals, organizations and businesses that are interested in or are affected by Congress' charge to the GSEs to further the financing needs of underserved families and neighborhoods. The Department's outreach in this regard included two forums, three subject matter meetings, and meetings with various industry trade groups and non-profit organizations to discuss the provisions of the proposed rule. These sessions are described below. Further, additional information on these meetings is contained in the public docket file of this rule in Room 10276 at HUD Headquarters.

a. Forums. The Department conducted two forums designed to give participants an in-depth look at how well the GSEs are supporting affordable housing activities in local communities. One forum was held in Hartford, Connecticut and the other in Durham, North Carolina. Each forum had approximately 125 participants. In addition to sessions held at both forums that reviewed the GSEs' progress in meeting the affordable housing needs in the respective region, each forum had a session that addressed issues and needs specific to the region. In Hartford, a session was held on the role of multifamily housing in meeting affordable housing needs. Research was presented on how small multifamily properties disproportionately serve low- income families and data was provided on the extent of the GSEs' purchases of mortgages on small multifamily properties. Panel members discussed the unique problems of financing small multifamily properties and how Fannie Mae and Freddie Mac can better serve these markets. In Durham, a session was held on predatory lending. Panel members identified abusive practices and discussed the impacts that predatory lenders were having particularly on the elderly and in minority neighborhoods. Serious questions were raised as to whether Fannie Mae and Freddie Mac should be involved in this market.

b. Subject Matter Meetings. HUD also held three smaller discussion group sessions designed to address specific subject matters included in the proposed rule. Subject matter meetings were held on the availability of data on the public use data base, issues related to identifying and meeting the credit needs of non-metropolitan areas, and the role of credit enhancements in affordable housing lending.

c. Other Meetings. In addition to the meetings described above, the Department met with various industry trade groups and non-profit organizations to present the changes suggested in the proposed rule and the rationale for the changes. HUD also met with Fannie Mae and Freddie Mac to discuss their concerns regarding the proposed rule.

B. Subpart A—General

HUD proposed to revise the definitions of “median income,” “metropolitan area,” and “underserved area” in order to provide greater clarity, consistency and technical guidance. The few comments received on these definitions were supportive of the proposed technical changes. HUD also proposed certain changes to several aspects of the definition of underserved area to solicit public input on how best to identify the areas that are underserved by the mortgage credit markets.

1. Median Income

HUD proposed to change the definition of “median income” to require the GSEs to use HUD estimates of median family income to further clarify the appropriate process for the GSEs' determination of area incomes. HUD has implemented this change in this final rule. As part of this change to the definition of “median income,” HUD will provide the GSEs, on an annual basis, information specifying how HUD's published median family income estimates are to be applied. This change is needed because, in some cases, HUD publishes area median family income estimates for portions of areas rather than whole metropolitan statistical areas (MSAs) or primary metropolitan statistical areas (PMSAs).

2. Metropolitan Area

HUD proposed to clarify the definition of “metropolitan area” by revising the description of the relevant area for determining median incomes to eliminate the reference in § 81.2 to consolidated metropolitan statistical areas (CMSAs). HUD has implemented this change in the final rule. “Metropolitan area” was defined in § 81.2 under the 1995 final rule as an MSA, a PMSA, or a CMSA, designated by the Office of Management and Budget of the Executive Office of the President. This definition raised questions as to the definition of “underserved area” and the denominator of the affordability ratio used to compute the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal regarding whether to use the median income of the CMSA or the PMSA. HUD has consistently relied upon median incomes of PMSAs in defining underserved areas and determining denominators for the other goals and this final rule clarifies this point.

3. Underserved Area

a. Technical Definition. HUD proposed to revise the definition of “underserved area” to clarify the parameters of rural underserved areas. The definition under HUD's 1995 final rule omitted the requirement for a comparison between the “greater of the State non-metropolitan median income or nationwide non-metropolitan median income” from the “income/minority” provision even though it had provided for this comparison when qualifying mortgage purchases under the “income-only” provision. HUD proposed to add the comparative language to the “income/minority” provision for rural underserved areas. The revision applies the same median income standard to both the “income-only” and the “income/minority” definitions. HUD has implemented this change in § 81.2 of this final rule. (HUD also proposed other changes to the definition of “underserved areas.” These are discussed in Subpart B—Housing Goals.)

b. Other Changes Proposed and/or Comments Requested. The proposed rule described additional changes to the definition of underserved area relating to tribal lands and requested comments on possible changes to the income and minority requirements of the definition.

(1) Tribal Lands. HUD proposed to revise the definition of “underserved areas” in § 81.2 to designate all qualifying Indian reservations and trust lands as underserved areas.

c. Summary of Comments. Fannie Mae stated that it is “particularly appropriate” to include these lands in the definition of underserved areas. Fannie Mae added that it “does not think it is feasible, practical, or appropriate to split trust lands between served and underserved designations, depending on the designation of the surrounding tracts or counties.” Fannie Mae further commented that HUD's proposal could lead to “split or proportional treatment of any one trust land,” and that such areas should be Start Printed Page 65049included as underserved areas “without regard to income or minority status.” Fannie Mae added that HUD should consider postponing this change until “the new boundary files and data files” become available from the 2000 Census. Fannie Mae further stated that HUD's proposal to define some underserved areas in terms of income and minority composition for the balance of a county or census tract excluding the area within any Federal or State American Indian reservation or tribal or individual trust land “raises operational issues that will be difficult to overcome.”

Freddie Mac stated that “In principal [sic], Freddie Mac has no objection to treating an American Indian Reservation or tribal land as a geographic whole” for determining underserved areas. It added, however, that “adoption of a definition that would involve geocoding rural loans at the subcounty level could present formidable practical problems.” Freddie Mac recommended that HUD “designate entire tracts in metropolitan areas and entire counties in nonmetropolitan areas that contain qualifying reservations and trust lands as underserved.”

Other commenters were generally supportive of the Department's proposal. One commenter called for an expansion of the proposal to include tribal service areas and urban living Native Americans.

d. HUD's Determination. HUD believes that treating tribal lands as separate geographic entities implies that the balance of counties or tracts excluding such areas would logically be treated as separate entities, but it recognizes Fannie Mae's argument that this could raise “operational issues.” HUD will issue operational guidance on this matter prior to the effective date of this Final Rule.

HUD evaluated Fannie Mae's recommendation to classify all American Indian and Alaskan Native (AIAN) areas as underserved areas, without regard to income or minority status, in light of the problems involved in obtaining a mortgage on even the very few higher-income (or low minority) tribal lands. HUD analyzed data on 1989 median incomes and minority concentrations for AIAN areas provided by the U.S. Bureau of the Census. HUD's analysis showed that, out of 248 AIAN areas with sufficient population to determine an area median family income, 19 areas, or 6.7 percent, would be classified as served and 265 areas, or 93.3 percent, as underserved. The 19 areas include some with very low minority concentrations and some with very high median incomes. HUD concludes that implementation of Fannie Mae's recommendation would, in a small but significant number of instances, substantially breach the principle that underserved areas are areas with low median incomes and/or high minority concentrations, as established in the 1995 Final Rule. Accordingly, HUD has not implemented Fannie Mae's recommendation.

HUD believes that designating entire tracts or counties that contain qualifying tribal lands as underserved areas is not appropriate. The purpose of the definitional change in underserved areas to include all tribal lands is to focus attention on the mortgage financing needs of Native American communities. By designating the entire county or census tract as underserved by virtue of the presence of tribal lands in a portion of it, this focus is lost. HUD believes that any geocoding problems arising from this proposal can be resolved. HUD will issue operational guidance on this matter prior to the effective date of this final rule.

HUD believes that underserved areas must have relatively fixed definitions—tribal service areas are evolving over time. The underserved areas goal is defined broadly by both geographic and area wide demographic features so that borrowers living in underserved areas benefit from the increased attention paid to lending in such areas as a result of HUD's geographic goal.

(2) Enhanced Tract Definition. In the proposed rule, comments were sought on possible changes to the current metropolitan underserved areas definition to better target underserved areas with higher mortgage denial rates and thereby promote better access to mortgage credit for these areas. Specifically, HUD proposed changing the current tract income ratio to an “enhanced” tract income ratio requiring that for tracts to qualify as underserved they must have a tract income ratio at or below the maximum of 80 percent of area median income or 80 percent of U.S. median income in metropolitan areas. The proposed change would make the underserved areas definition used by the GSEs consistent with the requirements of Federally insured depository institutions under the Community Reinvestment Act (CRA). The Department believes the concept has substantial merit, and there was a sizeable group of commenters that supported the concept, at least in part. However, there were a number of commenters, including the GSEs, that said that since the redesignation of census tracts as underserved would be based on data from the 1990 Census, and since data from the 2000 Census would not be available for a few years, it would not be appropriate to make such a change at this time. Rather, they suggested that the Department wait until updated information from the 2000 Census is available to analyze. The Department agrees that, with more current information to become available from the 2000 Census in the near future, the timing is not optimal to make a change in the underserved areas designation. Once information from the 2000 Census is available, the Department will determine whether this proposal merits consideration.

(3) Minority Composition. Similarly, the proposed rule requested comment on another approach to target high mortgage denial rate areas. The alternative approach would be to increase the minority component required to identify an area as underserved by increasing the requirement from 30 percent to 50 percent minority. Several commenters noted that increasing the minority component of a census tract to qualify as underserved would have a disproportionately negative impact on the Hispanic population. Commenters observed that Hispanic residential living patterns are not as concentrated as those of other minority groups. In addition, comments were provided suggesting that any changes in this area be considered once data from the 2000 Census is available before making a final determination in this regard. The Department has determined that it will obtain and analyze 2000 Census data and consider various minority population patterns and their relationship to the availability of mortgage credit before deciding whether this proposal continues to merit consideration.

(4) Rural Areas. The proposed rule requested comments on how best to define underserved rural areas, posing questions on whether the underserved rural areas should be identified by census tract or by county. HUD received comments that supported both approaches. Again, the commenters raised the issue of the 2000 Census. Consistent with the Department's other determinations regarding significant changes to the definition of underserved areas, HUD will not make any changes at this time in defining underserved rural areas and will wait for the opportunity to analyze the data from the 2000 Census.

C. Subpart B—Housing Goals

1. Overview

Comments received overwhelmingly supported the Department's proposal to increase the level of the affordable Start Printed Page 65050housing goals. Both GSEs commented that, while meeting these goals will be a challenge (particularly the Underserved Areas Goal), they are committed to doing so. While some commenters, including the GSEs, expressed concern that the market scenarios used by HUD did not adequately consider an economic downturn, those commenters still felt that higher goals levels were appropriate. This section of the final rule reviews the statutory factors the Department must consider in setting the level of the housing goals, specific comments on the housing goals including the market methodology, and the determination made with regard to the level for each of the housing goals.

2. Statutory Considerations in Setting the Level of the Housing Goals

In establishing the housing goals, FHEFSSA requires the Department to consider six factors—national housing needs; economic, housing and demographic conditions; performance and effort of the GSEs toward achieving the goal in previous years; size of the conventional mortgage market serving the targeted population or areas, relative to the size of the overall conventional mortgage market; ability of the GSEs to lead the industry in making mortgage credit available for the targeted population or areas; and the need to maintain the sound financial condition of the GSEs. These factors are discussed in more detail in the following sections of this preamble and in the Appendices to this rule. A summary of HUD's findings relative to each factor follows:

a. National Housing Needs. Analysis and research by HUD and others in the housing industry indicate that there are, and will continue to be in the foreseeable future, substantial unmet housing needs among lower-income and minority families. Data from the American Housing Surveys demonstrate that there are substantial unmet housing needs among lower-income families. Many households are burdened by high homeownership costs or rent payments and will likely continue to face serious housing problems, given the dim prospects for earnings growth in entry-level occupations. According to HUD's “Worst Case Housing Needs” report, 21 percent of owner households faced a moderate or severe cost burden in 1997. Affordability problems were even more common among renters, with 40 percent paying more than 30 percent of their income for rent in 1997.16

Despite the growth during the 1990s in affordable housing lending, disparities in the mortgage market remain, with certain minorities, particularly African-American and Hispanic families, lagging the overall market in rate of homeownership. In addition, there is evidence that the aging stocks of single family rental properties and small multifamily properties with 5-50 units, which play a key role in lower-income housing, have experienced difficulties in obtaining financing. The ability of the nation to maintain the quality and availability of the existing affordable housing stock and to stabilize neighborhoods depends on an adequate supply of affordable credit to rehabilitate and repair older units.

(1) Single Family Mortgage Market. Many younger, minority, and lower-income families did not become homeowners during the 1980s due to the slow growth of earnings, high real interest rates, and continued house price increases. Over the past several years, economic expansion, accompanied by low interest rates and increased outreach on the part of the mortgage industry, has improved affordability conditions for lower-income families. Between 1994 and 1999, record numbers of lower-income and minority families purchased homes. First time homeowners have become a major driving force in the home purchase market over the past five years. Thus, the 1990s have seen the development of a strong affordable lending market. Despite the growth of lending to minorities, disparities in the mortgage market remain. For example, African-American applicants are still twice as likely to be denied a loan as white applicants, even after controlling for income.

(2) Multifamily Mortgage Market. Since the early 1990s, the multifamily mortgage market has become more closely integrated with global capital markets, although not to the same degree as the single family mortgage market. Loans on multifamily properties are still viewed as riskier by some than mortgages on single family properties. Property values, vacancy rates, and market rents of multifamily properties appear to be highly correlated with local job market conditions, creating greater sensitivity of loan performance to economic conditions than may be experienced for single family mortgages.

There is a need for an on-going GSE presence in the multifamily secondary market both to increase liquidity and to further affordable housing efforts. The potential for an increased GSE presence is enhanced by the fact that an increasing proportion of multifamily mortgages are now originated in accordance with secondary market standards.

The GSEs can play a role in promoting liquidity for multifamily mortgages and increasing the availability of long-term, fixed rate financing for these properties. Increased GSE presence would provide greater liquidity to lenders, i.e., a viable “exit strategy,” that in turn would serve to increase their lending. It appears that the financing of small multifamily rental properties with 5-50 units, where a substantial portion of the nation's affordable housing stock is concentrated, have been adversely affected by excessive borrowing costs. Multifamily properties with significant rehabilitation needs also appear to have experienced difficulty gaining access to mortgage financing. Moreover, the flow of capital into multifamily housing for seniors has been historically characterized by a great deal of volatility.

b. Economic, Housing, and Demographic Conditions. Studies indicate that changing population demographics will result in a need for the mortgage market to meet nontraditional credit needs and to respond to diverse housing preferences. The U.S. population is expected to grow by an average of 2.4 million persons per year over the next 20 years, resulting in 1.1 to 1.2 million new households per year. In particular, the continued influx of immigrants will increase the demand for rental housing while those who immigrated during the 1980s will be in the market to purchase owner-occupied housing. The aging of the baby-boom generation and the entry of the small baby-bust generation into prime home buying age is expected, however, to result in a lessening of housing demand. Non-traditional households have, and will, become more important as overall household formation rates slow down. With later marriages, divorce, and non-traditional living arrangements, the fastest growing household groups have been single parent and single person households. With continued house price appreciation and favorable mortgage terms, “trade-up buyers” will also increase their role in the housing market. There will also be increased credit needs from new and expanding market sectors, such as manufactured housing and housing for senior citizens. These demographic trends will lead to greater diversity in the homebuying market, which, in turn, will require greater adaptation by the primary and secondary mortgage markets.

As a result of the above demographic forces, housing starts are expected to average 1.5 million units annually between 2000 and 2003, essentially the same as in 1996-99.17 Refinancing of Start Printed Page 65051existing mortgages, which accounted for 50 percent of originations in 1998 and 34 percent in 1999, is expected to return to lower levels during 2000. The mortgage market remained strong with $1.3 trillion dollars in originations during 1999. A lower number of originations is expected in 2000 with approximately $962 billion in originations being projected by the Mortgage Bankers Association of America.

c. Performance and Effort of the GSEs Toward Achieving the Goal in Previous Years. Both Fannie Mae and Freddie Mac have improved their affordable housing loan performance since the enactment of FHEFSSA in 1992 and HUD's establishment of housing goals under the law. However, the GSEs' mortgage purchases continue to lag the overall market in providing financing for affordable housing to low- and moderate-income families, underserved borrowers and their neighborhoods, indicating that there is more that the GSEs can do to improve their performance. In addition, a large percentage of the lower-income loans purchased by the GSEs have relatively high down payments, which raises questions about whether the GSEs are adequately meeting the needs of those lower-income families who have little cash for making large down payments but can fully meet their monthly payment obligations. The discussion of the performance and effort of the GSEs toward achieving the housing goals in previous years is specific to each of the three housing goals. This topic is discussed below and further details are provided in the Appendices to this rule.

d. Size of the Mortgage Market Serving the Targeted Population or Areas, Relative to the Size of the Overall Conventional, Conforming Mortgage Market. The Department's analyses indicate that the size of the conventional, conforming market relative to each housing goal is greater than earlier estimates (based mainly on HMDA data for 1992 through 1994) used in establishing the 1996-1999 housing goals. The discussion of the size of the conventional mortgage market serving targeted populations or areas relative to the size of the overall conventional, conforming mortgage market is specific to each of the three housing goals. The Department's estimate of the size of the conventional mortgage market is discussed below and further details are provided in the Appendices to this rule.

e. Ability of the GSEs To Lead the Industry in Making Mortgage Credit Available for the Targeted Population or Areas. Research concludes that the GSEs have generally not been leading the market, but have lagged behind the primary market in financing housing for lower-income families and housing in underserved areas. However, the GSEs' state-of-the-art technology, staff resources, share of the total conventional, conforming market, and their financial strength suggest that the GSEs have the ability to lead the industry in making mortgage credit available for lower-income families and underserved neighborhoods.

The legislative history of FHEFSSA indicates Congress's strong concern that the GSEs need to do more to benefit low- and moderate-income families and residents of underserved areas that lack access to credit.18 The Senate Report on FHEFSSA emphasized that the GSEs should “lead the mortgage finance industry in making mortgage credit available for low- and moderate-income families.” 19 FHEFSSA, therefore, specifically required that HUD consider the ability of the GSEs to lead the industry in establishing the level of the housing goals. FHEFSSA also clarified the GSEs' responsibility to complement the requirements of the Community Reinvestment Act  20 and fair lending laws 21 in order to expand access to capital to those historically underserved by the housing finance market.

While leadership may be exhibited through the GSEs' introduction of innovative products, technology, and processes and through establishing partnerships and alliances with local communities and community groups, leadership must always involve increasing the availability of financing for homeownership and affordable rental housing. Thus, the GSEs' obligation to lead the industry entails leadership in facilitating access to affordable credit in the primary market for borrowers at different income levels and housing needs, as well as for underserved urban and rural areas.

While the GSEs cannot be expected to solve all of the nation's housing problems, the efforts of Fannie Mae and Freddie Mac have not matched the opportunities that are available in the primary mortgage market. Although the GSEs were directed by Congress to lead the mortgage finance industry in making mortgage credit available for low- and moderate-income families, depository and other lending institutions have been more successful than the GSEs in providing affordable loans to lower-income borrowers and in historically underserved neighborhoods. In 1998 for example, very low-income borrowers accounted for 9.9 percent of Freddie Mac's acquisitions of home purchase mortgage loans, 11.4 percent of Fannie Mae's acquisitions, 15.2 percent of such mortgage loans originated and retained by depository institutions, and 13.3 percent of such mortgage loans originated in the overall conventional, conforming market. Similarly, mortgage purchases on properties located in underserved areas accounted for 20.0 percent and 22.5 percent of Freddie Mac's and Fannie Mae's purchases of home purchase loans, respectively, 26.1 percent of home purchase mortgages originated and retained by depository institutions and 24.6 percent of home purchase mortgages originated in the overall conventional, conforming market.

Between 1993 and 1998, Fannie Mae improved its affordable lending performance and made progress toward closing the gap between its performance and that of the overall mortgage market. During that period Freddie Mac showed less improvement and, as a result, did not make as much progress in closing the gap between its performance and that of the overall market for home loans. However, during 1999, Freddie Mac's purchases of goals qualifying home loans increased significantly relative to Fannie Mae's purchases and, as a result Freddie Mac now matches or out-performs Fannie Mae in several affordable lending categories. For example, during 1999, very low-income borrowers accounted for 11.0 percent of Freddie Mac's purchases of home loans in metropolitan areas, compared with 10.8 percent of Fannie Mae's. Similarly, mortgages on properties in underserved census tracts accounted for 21.2 percent of Freddie Mac's acquisitions of home purchase mortgage loans in metropolitan areas, compared with 20.6 percent of Fannie Mae's. The extent to which Freddie Mac has closed its performance gap relative to depositories and the overall market will be clarified once HUD has the opportunity to analyze 1999 HMDA data for metropolitan areas.

The Department estimates the GSEs provided financing for 55 percent of units financed by conventional, conforming mortgages in 1998.22 However, the GSEs' mortgage market presence varies significantly by property type. While the GSEs accounted for about 68 percent of the owner-occupied units financed in the primary market in that year, their role was much less in the market for mortgages on rental properties. Specifically, HUD estimates that Fannie Mae and Freddie Mac accounted for only about 24 percent of rental units financed in 1998. Thus, the GSEs' presence in the rental mortgage market was well under half their presence in the market for mortgages on Start Printed Page 65052single family owner-occupied properties.

Within the rental category, GSE purchases have accounted for 29 percent of the multifamily dwelling units that were financed in 1998. The GSEs have yet to play a major role in financing mortgages for rental units in single family rental properties (those with at least one rental unit and no more than four units in total), where their market share was only 19 percent.

As noted above, the GSEs continue to lag the overall conforming, conventional market in providing affordable home purchase loans to lower-income families and for properties in underserved neighborhoods. Additionally, a large percentage of the lower-income loans purchased by both GSEs have relatively high down payments, which raises questions about whether the GSEs are adequately meeting the needs of those lower-income families who find it difficult to raise enough cash for a large down payment. Also, while rental properties are an important source of low- and moderate-income rental housing, they represent only a small portion of the GSEs' business.

The appendices to this rule provide more information on HUD's analysis of the extent to which the GSEs have lagged the mortgage industry in funding loans to underserved borrowers and neighborhoods. From this analysis of the GSEs' performance in comparison with the primary mortgage market and with other participants in the mortgage markets, it is clear that the GSEs need to improve their performance relative to the primary market of conventional, conforming mortgage lending. The need for improvements in the GSEs' performance is especially apparent with respect to the single family and multifamily rental markets.

f. Need To Maintain the Sound Financial Condition of the GSEs. Based on HUD's economic analysis and discussions with the Office of Federal Housing Enterprise Oversight, HUD has concluded that the level of the goals as proposed would not adversely affect the sound financial condition of the GSEs. Further discussion of this issue is found in Appendix A.

3. Determinations Regarding the Level of the Housing Goals

There are several reasons the Department, having considered all the statutory factors, is increasing the level of the housing goals.

a. Market Needs and Opportunities. First, the GSEs appear to have substantial room for growth in serving the affordable housing mortgage market. For example, as discussed above, the Department estimates that the two GSEs' mortgage purchases accounted for 55 percent of the total (single family and multifamily) conventional, conforming mortgage market during 1998. In contrast, GSE purchases comprised only 44 percent of the low- and moderate-income mortgage market in 1998, 46 percent of the underserved areas market, and, a still smaller, 33 percent of the special affordable market. As discussed above, the GSE presence in mortgage markets for rental properties, where much of the nation's affordable housing is concentrated, is far below that in the single family owner-occupied market.

The GSEs' role in the mortgage market varies somewhat from year to year in response to changes in interest rates, mortgage product types, and a variety of other factors. Underlying market trends, however, show a clear and significant increase in the GSEs' role. Specifically, OFHEO estimates that the share (in dollars) of single family mortgages outstanding accounted for by mortgage-backed securities issued by the GSEs and by mortgages held in the GSEs' portfolios has risen from 31 percent in 1990 to 42 percent in 1999. In absolute terms, the GSEs' presence has grown even more sharply, as the total volume of single family mortgage debt outstanding has increased rapidly over this period.

The GSEs have indicated that they expect their role in the mortgage market to continue to increase in the future, as they develop new products, refine existing products, and enter markets where they have not played a major role in the past. The Department's housing goals for the GSEs also anticipate that their involvement in the mortgage market will continue to increase.

There are a number of segments of the multifamily, single family owner, and single family rental markets that the GSEs have not tapped in which the GSEs might play an enhanced role thereby increasing their shares of targeted loans and their performance under the housing goals. Six such areas are discussed below.

(1) Small Multifamily Properties. One sector of the multifamily mortgage market where the GSEs could play an enhanced role involves loans on small multifamily properties—those containing 5-50 units. These loans account for 39 percent of the units in recently mortgaged multifamily properties, according to the 1991 Survey of Residential Finance. However, the GSEs typically purchase relatively few of these loans. HUD estimates that the GSEs acquired loans financing only three percent of units in small multifamily properties originated during 1998. This is substantially less than the GSEs' presence in the overall multifamily mortgage market, which the Department estimates was 29 percent in 1998.

Increased purchases of small multifamily mortgages would make a significant contribution to performance under the goals, since the percentages of these units qualifying for the income-based housing goals are high—in 1999, 95 percent of units backing Fannie Mae's multifamily mortgage transactions qualified for the Low- and Moderate-Income Housing Goal, with a corresponding figure of 90 percent for Freddie Mac. That year, 43 percent of units backing Freddie Mac's multifamily transactions qualified for the Special Affordable Housing Goal, with a corresponding figure of 56 percent for Fannie Mae.

(2) Multifamily Rehabilitation Loans. Another multifamily market segment holding potential for expanded GSE presence involves properties with significant rehabilitation needs. Properties that are more than 10 years old are typically classified as “C” or “D” properties, and are considered less attractive than newer properties by many lenders and investors. Multifamily rehabilitation loans accounted for only 0.5 percent of units backing Fannie Mae's 1998 mortgage purchases and for 1.6 percent in 1999. These loans accounted for 1.9 percent of Freddie Mac's 1998 multifamily mortgage purchase total (with none indicated in 1999).

(3) Single Family Rental Properties. Studies show that single family rental properties are a major source of affordable housing for lower-income families, yet these properties are only a small portion of the GSEs' overall business.

HUD estimates that approximately 203,000 mortgages were originated on owner-occupied single family rental properties in 1998. These mortgages financed a total of 458,000 units—the owners' units plus an additional 254,000 rental units.23 Data submitted to HUD by the GSEs indicate that, in 1998, together the GSEs acquired mortgages backed by 188,000 such units, 41 percent of the number of units financed in the primary market, well below the GSEs' overall 1998 market share of 55 percent.24

There is ample room for an enhanced GSE role in this goal-rich market. For the GSEs combined, 65 percent of the units in these properties qualified for the Low- and Moderate-Income Housing Goal in 1999, 32 percent qualified for the Special Affordable Housing Goal, and 54 percent qualified for the Start Printed Page 65053Geographically Targeted Goal. Thus, significant gains could be made in performance on all of the goals if Fannie Mae and Freddie Mac played a larger role in the market for mortgages on single family owner-occupied rental properties (two to four units).

(4) Manufactured Homes. The Manufactured Housing Institute, in its Annual Survey of Manufactured Home Financing, reported that 116 reporting institutions originated $15.6 billion in consumer loans on manufactured homes in 1998, and that, with an average loan amount of about $30,000, approximately 520,000 loans were originated.

While the GSEs have traditionally played a minimal role in financing manufactured housing, they have recently stepped up their activity in this market. However, even with their increased level of activity, the GSEs' purchases probably accounted for less than 15 percent of total loans on manufactured homes in 1998—a figure well below their overall market presence of 55 percent.

There is ample room for an enhanced GSE role in this market, with its high concentration of goals qualifying mortgage loans. In 1998, for loans reported by 21 manufactured housing lenders (that are required by HMDA to report loan data), 76 percent qualified for the Low- and Moderate-Income Housing Goal in 1998, 42 percent qualified for the Special Affordable Housing Goal, and 47 percent qualified for the Geographically Targeted Goal. Thus, manufactured housing has significantly higher shares of goal qualifying loans than all single family owner-occupied properties, though purchases of these loans are not quite as goal-rich as loans on multifamily properties. In general, goal performance could be enhanced substantially if the GSEs were to play an increased role in the manufactured housing mortgage market.

(5) A-minus Loans. Industry sources estimate that subprime mortgage originations amounted to about $160 billion in 1999, and that these loans are divided evenly between the more creditworthy (“A-minus”) borrowers and less creditworthy (“B,” “C,” and “D”) borrowers. Based on HMDA data for 200 subprime lenders, the Department estimates that 58 percent of the units financed by subprime loans qualified for the Low- and Moderate-Income Housing Goal in 1998, 29 percent qualified for the Special Affordable Housing Goal, and 45 percent qualified for the Geographically Targeted Goal.

Freddie Mac has estimated that 10 to 30 percent of subprime borrowers would qualify for a prime conventional loan. Fannie Mae Chairman Franklin Raines has stated that half of all mortgages in the high cost subprime market are candidates for purchase by Fannie Mae. Both Fannie Mae and Freddie Mac recently introduced programs aimed at borrowers with past credit problems that would lower the interest rates for those borrowers that were timely on their mortgage payments. Freddie Mac has also purchased subprime loans through structured transactions that limit Freddie Mac's risk to the “A” piece of a senior-subordinated transaction.

However, there may be ample room for further enhancement of both GSEs' roles in the A-minus market. A larger role by the GSEs might help standardize mortgage terms in this market, possibly leading to lower interest rates.

(6) Seasoned Mortgages. Over the past five years, depository institutions (banks and thrifts) have been expanding their affordable loan programs and, as a result, have originated substantial numbers of loans to low-income and minority borrowers and to low-income and predominantly minority neighborhoods, under the incentive of the Community Reinvestment Act (CRA),25 which requires many depository institutions to help meet the credit needs of their communities. As the GSEs noted in their comments, some of these loans, when originated, may not have met the GSEs' underwriting guidelines. A large number of the “CRA-type” loans that have been recently originated remain in thrift and bank portfolios; selling these loans on the secondary market would free up capital for depositories to originate new CRA loans. Given its enormous size, the CRA market segment provides an opportunity for Fannie Mae and Freddie Mac to expand their affordable housing financing programs. The Department recognizes that purchasing these loans may present some challenges for the GSEs. However, it appears these loans are beginning to be purchased by GSEs after the loans have seasoned and through various structured transactions. As explained in Appendix A, Fannie Mae's purchases of seasoned loans improved its performance on the housing goals in 1997 and 1998. Seasoned loan purchases did not have a similar impact in 1999. Freddie Mac, on the other hand, has not been as active as Fannie Mae in purchasing seasoned CRA type loans. With billions of dollars worth of CRA loans in bank portfolios, the early experience of Fannie Mae suggests that purchasing these loans could be an important strategy for reaching the housing goals and provide needed liquidity for a market that is serving the needs of low-income and minority homeowners.

(7) Lending to Minority Borrowers. The GSEs have an opportunity to play a leadership role in making mortgage credit more widely available to African American and other minority borrowers, who represent yet another underserved market. In 1998, for example, African American borrowers accounted for five percent of conventional, conforming single family mortgage loans originated in metropolitan areas, as shown in Appendix A.26 By contrast, African American borrowers accounted for only 3.1 percent of Fannie Mae's metropolitan area mortgage purchases and three percent of Freddie Mac's mortgage purchases. Hispanic borrowers accounted for 5.2 percent of the metropolitan area conventional, conforming mortgage market in 1998, 4.8 percent of Fannie Mae's mortgage purchases and 4.4 percent of Freddie Mac's mortgage purchases.27

b. Market Share Higher than Goal Levels. The shares of the mortgage markets that would qualify for each of the housing goals are higher than the goal levels as they were set through 1999. Specifically, the Low- and Moderate-Income Housing Goal for 1997 through 1999 was 42 percent, but the market share for low- and moderate-income mortgages has been estimated at 50-55 percent. The Geographically Targeted Goal for 1997 through 1999 was 24 percent, but the estimated market share of geographically targeted mortgages has been estimated at 29-32 percent. The Special Affordable Housing Goal for 1997 through 1999 was 14 percent, but the estimated special affordable market share is 23-26 percent.28 Thus, the increases in the housing goals implemented in this final rule and described below will significantly reduce the disparities that existed between the previous housing goals and HUD's market estimates. HUD's analysis indicates that the goal levels established in the final rule are reasonable and feasible and that its market estimates reflect significantly more adverse economic environments than have recently existed. Reasons for the remaining disparity between the GSE housing goals established in this final rule and the respective shares of the overall mortgage market qualifying for each of the housing goals are discussed below. See Appendix D for further discussion of these issues.

c. Need for Increased Affordable Single Family Mortgage Purchases. Higher housing goals are needed to assure that both Fannie Mae and Freddie Mac increase their purchases of Start Printed Page 65054single family mortgages for lower-income families. The GSEs lag behind depository institutions and other lenders in the conventional, conforming market in providing mortgage funds for underserved families and their neighborhoods. Numerous studies have concluded that Fannie Mae and Freddie Mac have room to increase their purchases of affordable loans originated by primary lenders. The single family affordable market, which had only begun to grow when HUD set housing goals in 1995, has now established itself with seven straight years (1993-1999) of solid performance. Current projections suggest that the demand for affordable housing by minorities, immigrants, and non-traditional households will be maintained in the post-1999 period, leading to additional opportunities for the GSEs to support mortgage lending benefiting families targeted by the housing goals.

d. Market Disparities. Despite the recent growth in affordable lending, there are many groups who continue to face problems obtaining mortgage credit and who would benefit from a more active and targeted secondary market. Homeownership rates for lower-income families, certain minorities, and central city residents are substantially below those of other families, and the disparities cannot simply be attributed to differences in income. Immigrants represent a ready supply of potential first-time home buyers and need access to mortgage credit. Special needs in the market, such as rehabilitation of older two- to four-unit properties, could be helped by new mortgage products and more flexibility in underwriting and appraisal guidelines. The GSEs, along with primary lenders and private mortgage insurers, have been making efforts to reach out to these underserved portions of the markets. However, more needs to be done, and the proposed increases in the housing goals are intended to encourage additional efforts by Fannie Mae and Freddie Mac.

e. Impact of Multifamily Mortgage Purchases. When the 1996-99 goals were established in December 1995, Freddie Mac had only recently reentered the multifamily mortgage market, after an absence from the market in the early 1990s. Freddie Mac has made progress in rebuilding its multifamily mortgage purchase program, with its purchases of these loans rising from $191 million in 1993 to $7.6 billion in 1999. Freddie Mac's limited role in the multifamily market was a significant constraint when HUD set the level of the housing goals for 1996 through 1999. While Freddie Mac has made progress in recent years in significantly increasing its multifamily mortgage purchases, Freddie Mac's smaller multifamily portfolio relative to that of Fannie Mae has meant fewer refinance opportunities from within its portfolio. Accordingly, the Department is providing Freddie Mac with a temporary adjustment factor for purchases of mortgages in multifamily properties with more than 50 units under the 2001-2003 goals as it continues to increase its multifamily mortgage purchases, as discussed in more detail, below.

f. Financial Capacity to Support Affordable Housing Lending. A wide variety of quantitative and qualitative indicators demonstrate that the GSEs' have ample, indeed robust, financial strength to improve their affordable lending performance. For example, the combined net income of the GSEs has risen steadily over the last decade, from $677 million in 1987 to over six billion dollars in 1999. This financial strength provides the GSEs with the resources to lead the industry in making mortgage financing available for families and neighborhoods targeted by the housing goals.

g. Closing the Gap Between the GSEs and the Market. This section discusses the relationship between the housing goals, the GSEs' performance and HUD's market estimates; and identifies key segments of the affordable market in which the GSEs have had only a weak presence. To lay the groundwork for this discussion, the following table summarizes the Department's findings regarding GSE performance under the 1997-2000 goals and the new goal levels for 2001-2003 as compared to HUD's estimates for 1995-1998 markets as well as HUD's projected market estimates for 2001-2003:

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It is evident from this table that the new goal levels for the Low- and Moderate-Income Housing Goal and Special Affordable Housing Goal are below HUD's projected market estimate for the years covered by the new housing goals. One reason for this disparity can be discerned by disaggregating GSE purchases by property type, which shows that the GSEs have little presence in some important segments of the affordable housing market. For example, as shown in Figure 1, in 1998, the GSEs purchased loans representing only 19 percent of rental units in single family rental properties, and only three percent of units in small multifamily properties mortgaged that year. Figure 2 provides additional detail providing unit data comparing the GSEs' with the conventional, conforming market. Typically, about 90 percent of rental units in single family rental and small multifamily properties qualify for the Low- and Moderate-Income Housing Goal. One reason that the GSEs' performance under the Low- and Moderate-Income Housing Goal falls short of HUD's market estimate is that the GSEs have had only a weak and inconsistent presence in financing these important sources of affordable housing, notwithstanding that these market segments are important components in the market estimate. In the overall conventional, conforming mortgage market, rental units in single family properties and in small multifamily properties are expected to represent approximately 21 percent of the overall mortgage market, and 33 percent of units backing mortgages qualifying for the Low- and Moderate-Income Housing Goal. Yet in 1999, units in such properties accounted for 6.6 percent of the GSEs' overall purchases, and only 11.5 percent of the GSEs' purchases meeting the Low- and Moderate-Income Housing Goal. The continuing weakness in GSE purchases of mortgages on single Start Printed Page 65056family rental and small multifamily properties is a major factor explaining the shortfall between GSE performance and that of the primary mortgage market.

For a variety of reasons, the GSEs have historically viewed the single family rental and small multifamily market segments as more difficult for them to penetrate than the single family owner-occupied mortgage market. In order to provide the GSEs with an incentive to enter these markets and to provide this housing the benefits of greater financing through the secondary market, HUD is proposing to award “bonus points” for the GSEs' purchases of mortgages on owner-occupied single family rental properties and small multifamily properties in calculating credit toward the housing goals. The bonus points will make the Department's increased housing goals easier for the GSEs to attain if they devote resources to affordable market segments where their past role has been limited and there are significant needs for greater secondary market involvement.

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4. Summary of Comments on HUD's Analysis of Statutory Factors

HUD received several comments on the factors for determining the goal levels. Fannie Mae and Freddie Mac provided numerous technical comments on HUD's analyses in the appendices to the proposed rule. Most of the comments focused on two related topics concerning HUD's market methodology: (a) HUD's model for the determining the market size for each of the three housing goals; and (b) HUD's analysis of the GSEs' performance in the single family owner-occupied portion of the conventional, conforming mortgage market. Section A of Appendices A, B and C and Section B of Appendix D provide a more extensive discussion of HUD's response to the various questions raised by the GSEs about the factors for determining the housing goals.

a. Market Share Methodology. In Appendix D, HUD estimates the following market shares for the three housing goals during 2001-2003: 50-55 percent for the Low-Mod Goal, 23-26 percent for the Special Affordable Goal, and 29-32 percent for the Geographically Targeted Goal. Neither GSE objected to HUD's basic approach to calculating these market shares, which involves estimating (1) the share of the market (in dwelling units) by type of property (single family owner-occupied, single family rental, and multifamily), (2) the proportion of dwelling units financed by mortgages for each type of property meeting each goal, and (3) projecting the size of the total market by weighting each such goal share by the corresponding market share. In fact, both Fannie Mae and Freddie Mac stated that HUD's market share model was a reasonable approach Start Printed Page 65059for estimating the goals qualifying shares of the mortgage market. Freddie Mac stated that the Department took the correct approach in estimating the size of the conventional, conforming market by examining several different data sets, using alternative methodologies, and conducting sensitivity analyses. Fannie Mae expressed similar sentiments asserting that HUD's model for assessing the size of the affordable housing market is reasonable.

Both GSEs were critical, however, of HUD's implementation of its market methodology. Their major comments on the market methodology fall into two general areas. First, the GSEs expressed concern about HUD's assumptions and use of specific data elements both in constructing the distribution of property shares among single family owner-occupied, single family rental, and multifamily properties and in estimating the goals qualifying shares for each property type. The GSEs contended that HUD chose assumptions and data sources that resulted in an overstatement of the market estimate for each of the housing goals. In particular, the GSEs claimed that HUD overstated the importance of rental properties (both single family and multifamily) in its market model and overstated the Low-and Moderate-Income, Special Affordable, and Geographically Targeted shares of the single family owner market. Second, both GSEs argued that HUD's market estimates depended heavily on a continuation of recent conditions of economic expansion and low interest rates. According to the GSEs, HUD's range of market estimates did not include periods of adverse economic and affordability conditions such as those which existed in the early 1990s.

b. GSEs' Performance in Single Family Owner-Occupied Market. Both GSEs differed with HUD's conclusions that they lag the conventional, conforming market in funding mortgages for the goals qualifying segments of the single family owner-occupied market. Rather, the GSEs hold strongly that they have led the mortgage market, from both quantitative and qualitative perspectives. The GSEs expressed concern about HUD's assumptions and treatment of HMDA data in estimating the goals qualifying shares for single family owner-occupied mortgages. The GSEs assert that certain portions of the conforming mortgage market (such as manufactured housing loans and selected CRA loans)—those market segments where they have not been very active—should be excluded from HUD's definition of the owner market. From their own analysis that excludes these markets from HMDA data, the GSEs conclude that they match or exceed the market in funding affordable loans.

It should be noted that the GSEs extend their criticism to other researchers that have examined this issue of their leading the market with HMDA and related data. Appendix A summarizes findings of several research studies that have reached the same conclusion as HUD—that the GSEs have lagged the market in affordable lending

c. Volatility of the Mortgage Market. Both GSEs claimed that HUD had not adequately considered the impact that changes in the national economy could have on the size of the affordable lending market and that HUD should significantly lower its market estimates to reflect adverse economic conditions. The GSEs commented that HUD based its market estimates on the unusually favorable economic and housing market conditions that have existed since 1995. The GSEs relied on a Freddie Mac funded study by PriceWaterhouse-Coopers (PWC) which concluded that the low- and moderate-income share of the mortgage market was heavily influenced by interest rate movements and changes in the rate of economic growth.30 PWC claims that the low-mod share of the market ranged from 35 percent to 56 percent during the 1990s, with a mean of 46 percent. HUD's analysis, on the other hand, finds that the low- and moderate-income share of the market averaged 53 percent during the 1990s.

In HUD's view, a major shortcoming of the PWC report is that it underestimates the size of the multifamily mortgage market by relying on multifamily originations reported in HMDA data. While HMDA is for many purposes a preeminent data source on single family lending, its usefulness as a multifamily data source is much more limited due to severe underreporting of loan originations. Indeed, HMDA is not widely used as a multifamily data source in published works by highly regarded independent researchers, nor by Fannie Mae in its comments submitted in response to HUD's proposed rule.

The discussion of single family lending in the PWC document initially appears to contradict HUD's analysis in Appendix D of the proposed rule, but this is mainly because HUD's analysis is based upon the conforming, conventional mortgage market, whereas PWC includes FHA loans and loans above the conforming loan limit, at least in the same years.31 Because the GSEs are prohibited from purchasing loans above the conforming limit, and because HUD is directed by statute to focus on the conventional market in setting the housing goals, it is necessary to restrict analyses of the mortgage market to the conventional, conforming market for purposes of establishing the housing goals.

As explained in Appendices A and D, HUD is aware that the mortgage market is dynamic in character and susceptible to significant changes in conditions that would affect the overall level of affordable lending to lower-income families. In response to concerns expressed about the volatility of the mortgage markets over time, HUD has estimated a range of market shares for each of the housing goals for the years 2001-2003 of 50-55 percent for the Low- and Moderate-Income Housing Goal, 23-26 percent for the Special Affordable Housing Goal, and 29-32 percent for the Geographically Targeted Goal—that reflect economic environments significantly more adverse than those which existed during the period between 1995 and 1998, when the units financed in the conventional, conforming market meeting the Low- and Moderate-Income Housing Goal averaged 56 percent, the Special Affordable Housing Goal, 28 percent, and the Geographically Targeted Goal, 33 percent.

HUD conducted detailed sensitivity analyses for each of the housing goals to reflect affordability conditions that are less conducive to lower-income homeownership than those that existed during the mid- to late-1990s. For example, the low- and moderate-income percentage for single family home purchase loans can fall to as low as 34 percent—or four-fifths of its 1995-98 average of over 42 percent—before the projected low- and moderate-income share of the overall market would fall below 50 percent. Additional sensitivity analyses examining recession and proportionately higher refinance scenarios and varying other key assumptions, such as the size of the multifamily market, show that HUD's market estimates consider a range of mortgage market and affordability conditions and provide a sound basis for setting housing goals for the years 2001-03.

HUD recognizes that under certain adverse circumstances, the goals qualifying market shares could fall below its estimates. However, as HUD stated in its 1995 GSE Rule, while the housing goals must be feasible, setting goals so that they can be met even under the very worst of circumstances is unreasonable. As HUD stated in its 1995 Final GSE Rule, policy should not be based on market estimates that include the worst possible economic scenarios. Start Printed Page 65060HUD believes that the range for the market shares should be broad enough to reflect the likely scenarios including an expected range of volatility in the mortgage market over the period during which the new housing goals will be in effect.

FHEFSSA and HUD recognize that conditions could change in ways that would require revised expectations. Thus, HUD is given the statutory discretion to revise the goals if the need arises. Further, current regulations require that, if a GSE fails or if there is a substantial probability that a GSE will fail one or more of the housing goals, notice be provided to the GSE and an opportunity provided for the GSE to explain the reason for the failure, or potential failure, and to provide information as to the feasibility of achieving the housing goal. The Department then makes a determination, taking into consideration market and economic conditions and the financial condition of the GSE, as to whether the goal was feasible. If the goal is determined not to be feasible, no further action is taken. If the goal is determined to be feasible, the GSE is given the opportunity to submit, for HUD's approval, a housing plan demonstrating how the goal will be achieved in the future. Thus, there are adequate protections for the GSEs if they are unable to achieve one or more of their housing goals due to a dramatic downturn in the market.

d. Shortcomings of Mortgage Market Data Bases. Major mortgage market data bases such as HMDA and the American Housing Survey (AHS) are used to implement HUD's market share model. The GSEs made extensive criticisms of these data bases, concluding from their critiques that the ranges for the estimates of the goals-qualifying market shares should be wider to reflect uncertainty due to inadequate data. Examples of problems asserted by the GSEs include: overstating of low-income loans in HMDA data; inability of HMDA data to identify important segments of the market (such as subprime lenders); underreporting of multifamily mortgages in HMDA data and generally unreliable reporting of rental mortgages in other data bases; underreporting of income in the AHS; and the fact that some important mortgage market data bases such as the 1991 Residential Mortgage Finance Survey are dated.

HUD agrees that a single comprehensive source of information on mortgage markets is not available. Nevertheless, HUD considered and analyzed a number of data sources for the purpose of estimating market size, since no single source could provide all the data elements needed for its market model. In the appendices, HUD carefully defines the range of uncertainty associated with each data source, pulls together estimates of important market parameters from independent sources, and conducts sensitivity analyses to show the effects of various assumptions. In fact, Freddie Mac noted that “We support the Department's approach for addressing the empirical challenges of setting the goals by examining several different data sets, using alternative methodologies, and conducting sensitivity analysis.”

While HUD recognizes the shortcomings of the various data and the inability to derive precise point estimates of various market parameters, HUD does not believe that these limitations call for expanding the range of the market estimates, as suggested by the GSEs. One purpose of the appendices is to demonstrate that careful consideration of independent data sources can lead to reliable ranges of estimates for the goals-qualifying shares of the mortgage market. HUD demonstrates the robustness of its market estimates by reporting the results of numerous sensitivity analyses that examine a range of assumptions about the existing data on the rental and owner markets. It should also be emphasized that while there are some problems with existing mortgage market data, there is a wealth of information on important components of the market. For example, HMDA data provide wide coverage of the single family owner market in metropolitan areas, yielding important information on the borrower income and census tract (underserved area) characteristics of that market, and thus providing useful information on the affordability characteristics of the single family rental and multifamily housing stock.

HUD's specific responses to the GSEs' comments on data are included mainly in Section A of Appendices A, B and C and Section B of Appendix D. For example, as noted there, HUD disagrees with the GSEs' assertions regarding the seriousness of the bias problem (i.e., overstating low-income loans) in HMDA data. HUD does not rely heavily on some of the data bases that the GSEs criticize (e.g., the borrower income data from the AHS and the 1991 Residential Finance Survey).

e. Size of the Multifamily Market. Because a high proportion of multifamily units qualify for the housing goals (e.g., 90 percent typically qualify for the Low- and Moderate-Income Housing Goal and about 50 percent for the Special Affordable Goal), the size of the multifamily market is an important determinant of the overall market shares for the housing goals, as estimated by HUD's model. Both GSEs commented that HUD overstated the role of multifamily financing, which they asserted led to HUD's overstated estimated market shares. Freddie Mac and PriceWaterhouseCoopers, in particular, advocated the use of HMDA data for measuring the size of the multifamily market.

As explained in Appendix D, HUD disagrees with Freddie Mac's and PWC's analysis of the multifamily market. That appendix contains a detailed discussion of the size of the multifamily mortgage market that considers a number of alternative data sources providing ample evidence on multifamily origination volume over the years 1990 to 1999. HUD finds that newly mortgaged multifamily units represent an average of 16-17 percent of units financed during the 1990s. HUD's estimated multifamily market shares exceed estimates prepared by PWC (averaging 8.7 percent for 1991-1998); Appendix D outlines what HUD regards as errors in the PWC study that led to its unrealistically low estimates of the multifamily origination market. The three multifamily market shares—13.5 percent, 15 percent, and 16.5 percent—that HUD emphasizes in its market share model accommodates the possibility of a recession or heavy refinance year.

f. GSEs' Affordable Lending Performance—Defining the Relevant Market. As noted earlier, HUD uses HMDA data to show that even though the GSEs have improved their performance since 1993, they have lagged depositories and others in the conventional, conforming market in funding affordable loans, both since 1993 and particularly during the more recent 1996-98 period when the new housing goals were in effect. In their analyses, the GSEs reach the opposite conclusion—each concludes that they already match or even lead the market, depending on the affordable category being considered. The GSEs obtain this result by adjusting HMDA market data to exclude single family loans that they perceive as not being available for them to purchase.

Both GSEs provided numerous comments concerning the types of mortgages that HUD should exclude from the definition of the single family owner market. Fannie Mae states that it “can only purchase or securitize mortgages that primary market lenders are willing to sell” and that “HUD fails to adjust for those housing markets that are not fully available to Fannie Mae Start Printed Page 65061and Freddie Mac.” Freddie Mac states that it “has not achieved, and is unlikely to achieve in the near term, the same penetration in the subprime and manufactured housing segments of the market as it has achieved in the conventional, conforming market” and, therefore, HUD should not include these segments in its market definition. According to the GSEs, markets that are “not available” to them or where they are not a “full participant” should be excluded from HUD's market definition. In addition to the subprime and manufactured housing markets, examples of market segments mentioned by the GSEs for exclusion consisted of the following: low-down payment mortgages (those with loan-to-value ratios greater than 80 percent) without private mortgage insurance or some other credit enhancement; loans financed through state and local housing finance agencies; below-market-interest-rate mortgages; specialized CRA mortgages; and portions of depository portfolios that are not available for purchase by the GSEs at the time of mortgage origination.

HUD disagrees with the comments offered by the GSEs advocating exclusion of those market segments that they have not yet been able to penetrate. The conventional, conforming market represents the appropriate benchmark for evaluating GSE performance as discussed previously, even if this is not the market that the GSEs perceive as available for them to purchase. However, with respect to the subprime market, HUD believes that the risky, B&C portion of that market should be excluded from the market estimates for each of the housing goals. Thus, HUD includes only the A-minus portion of the subprime market in its overall estimates of the goals-qualifying market shares.

Excluding other important segments of the mortgage market as the GSEs recommend would render the resulting market benchmark useless for evaluating the GSEs' performance. The loans that the GSEs would exclude are important sources of goals credit and, in fact, are the very loans the GSEs are supposed to be reaching out to finance. A recent report by the Department of Treasury demonstrated the targeting of CRA-type loans to lower-income and minority families. Numerous studies have shown that the manufactured home sector is an important source of low-income housing. In many of these markets, a more active secondary market could encourage lending to traditionally underserved borrowers. While HUD recognizes that some segments of the market may be more challenging for the GSEs to enter than others, the data reported in Figure 2 of this Appendix show that the GSEs have ample opportunities to purchase goals-qualifying mortgages. Furthermore, HUD recognizes the challenge of reaching segments of these markets by not setting each goal at the very top of its market estimate range.

Finally, it should also be noted that the GSEs' purchases under the housing goals are not limited to new mortgages that are originated in the current calendar year. The GSEs can purchase loans from the substantial, existing stock of affordable loans—after these loans have seasoned and the GSEs have had the opportunity to observe their payment performance.

g. HUD's Determination. HUD carefully examined the comments on its analysis of the statutory factors used to determine the appropriate level of the housing goals, particularly the methodology used to establish the market share for each of the goals. Based on that evaluation, as well as HUD's additional analysis of its estimates, HUD determined that its basic methodology is a reasonable and valid approach to estimating market share and that the percentage ranges for each of the three market share estimates do not need to be adjusted from those provided in the proposed rule. While a number of technical changes have been made in this final rule in response to the comments, the approach for determining market size has not been modified substantially. The detailed evaluations show that the methodology, as modified, produces conservative estimates of the market share for each goal. HUD recognizes the uncertainty regarding some of these estimates, which has led the Department to undertake a number of sensitivity and other analyses to reduce this uncertainty and also to provide a range of market estimates (rather than precise point estimates) for each of the housing goals.

5. Period Covered by the Housing Goals

This final rule establishes housing goals for the years 2001 through 2003. The proposed rule would have established housing goals for the GSEs for the year 2000 as well as 2001-2003, with higher housing goals than currently required for 2000, a transition year, and still higher goals for 2001-2003.

The GSEs commented that since the proposed rule would have set transitional goals for 2000, if the goals are established later in 2000, then 2001 should become the transition year.

HUD has considered the issue and concluded that while it could establish higher “transitional” goals for 2000 as were proposed late in the year, and require that the GSEs perform at the new goal levels, given the publication date of this final rule, HUD will not require that the GSEs meet higher goals for 2000.

At the same time, HUD has determined that establishing 2001 as a transition year is unnecessary and unwarranted. The goal levels for the years 2001-2003, and 2000, were announced in July 1999 and formally proposed earlier this year, providing the GSEs ample notice of the goal levels expected for these years. Indeed, data indicate that the GSEs have increased their efforts in 2000 in light of the proposed 2001-2003 levels. Moreover, the Department's analysis of the statutory factors supports establishment of the goals for 2001-2003 at the levels proposed as both reasonable and feasible. Accordingly, the housing goals for 2000 shall remain at the levels previously established in accordance with §§ 81.12(c)(3), 81.13(c)(3), and 81.14(c)(3) of the regulations as they existed prior to the effectiveness of this final rule. The housing goals for 2001-2003 are established at the levels HUD proposed.

The Department believes the new goal levels established by this rule to be appropriate based upon consideration of the statutory factors and comments received. Setting the goal levels for years 2001-2003 provides the GSEs with a level of predictability to enable them to develop and implement business strategies to achieve the goals.

6. Low- and Moderate-Income Housing Goal, § 81.12

This section discusses the Department's consideration of the statutory factors in arriving at and the comments received on the new housing goal level for the Low- and Moderate-Income Housing Goal, which targets mortgages on housing for families with incomes at or below the area median income. After consideration of these factors, this final rule establishes the goal for the percentage of dwelling units to be financed by each GSE's mortgage purchases for each of the years 2001-2003 that are affordable to low- and moderate-income families at 50 percent. A short discussion of the statutory factors received follows. Additional information analyzing each of the statutory factors is provided in Appendix A, “Departmental Considerations to Establish the Low- and Moderate-Income Housing Goal,” and Appendix D, “Estimating the Size of the Conventional Conforming Market for each Housing Goal.” Start Printed Page 65062

a. Market Estimate for the Low- and Moderate-Income Housing Goal. The Department estimates that dwelling units serving low- and moderate-income families will account for 50-55 percent of total units financed in the overall conventional, conforming mortgage market during the period 2001 through 2003. HUD has developed a reasonable range, rather than a point estimate, that accounts for significantly more adverse economic conditions than have existed recently.

b. Past Performance of the GSEs under the Low- and Moderate-Income Housing Goal. During the transition period from 1993 through 1995, Fannie Mae's performance under the Low- and Moderate-Income Housing Goal jumped sharply in one year, from 34.2 percent in 1993 to 44.8 percent in 1994, before declining to 42.3 percent in 1995. It then stabilized at just over 45 percent in 1996 and 1997. Fannie Mae's performance in 1998 declined to 44.1 percent due in large measure to the high volume of refinance loans that Fannie Mae funded in 1998, before rising to 45.9 percent in 1999.

During the same period, Freddie Mac demonstrated more consistent gains in performance under the Low- and Moderate-Income Housing Goal, from 29.7 percent in 1993 to 37.4 percent in 1994 and 38.9 percent in 1995. Freddie Mac then achieved 41.1 percent in 1996, and 42.6 percent and 42.9 percent in 1997 and 1998, respectively. In 1999, Freddie Mac's performance increased sharply to 46.1 percent.

The housing goals that have been in effect prior to this final rule specified that in 1996 at least 40 percent of the number of units financed by mortgage purchases of the GSEs and eligible to count toward the Low- and Moderate-Income Goal should qualify as low- and moderate-income, and at least 42 percent should qualify as such in each year from 1997 through 1999. Fannie Mae surpassed these goal levels by 5.6 percentage points in 1996, 3.7 percentage points in 1997, 2.1 percentage points in 1998, and 3.9 percentage points in 1999. Freddie Mac surpassed the goals by 1.1 percentage points, 0.6 percentage points, 0.9 percentage points and 4.1 percentage points in 1996, 1997, 1998 and 1999, respectively.

Fannie Mae's performance on the Low- and Moderate-Income Housing Goal has surpassed Freddie Mac's in every year but one, 1999, when Freddie Mac slightly outperformed Fannie Mae (46.1 percent versus 45.9 percent). However, Freddie Mac's 1999 performance represented a 55 percent increase over its 1993 level, exceeding the 34 percent increase by Fannie Mae over the same period, recognizing, however, that Fannie Mae's 1993 performance was significantly greater than Freddie Mac's.

The GSEs' performance under the Low- and Moderate-Income Housing Goal for the 1996 through 1999 period is summarized below:

Summary of GSEs' Performance Under the Low- and Moderate-Income Housing Goal 1996-1999 32

[In percentages]

1996199719981999
Required Goal Level40424242
Fannie Mae: Percent Low- and Moderate-Income45.645.744.145.9
Freddie Mac: Percent Low- and Moderate-Income41.142.642.946.1

Freddie Mac's improved performance since 1993 is due mainly to its increased purchases of multifamily loans as it has again become active in this market. Some housing industry observers believe that the establishment of the Low- and Moderate-Income Housing Goal has been an important factor in explaining Freddie Mac's re-entry into the multifamily market. In fact, as indicated above, multifamily mortgage purchases represent a significant component of both GSEs' activities in meeting the Low- and Moderate-Income Housing Goal, even though multifamily loans comprise a relatively small portion of the GSEs' business activities. In 1999, while Fannie Mae's multifamily purchases represented only nine percent of its total mortgage acquisition volume measured in terms of dwelling units, these purchases comprised 20 percent of units qualifying for the Low- and Moderate-Income Housing Goal. Multifamily purchases were eight percent of the units financed by Freddie Mac's 1999 mortgage purchases but represented 17 percent of the units comprising Freddie Mac's low- and moderate-income mortgage purchases.

c. Summary of Comments. A number of commenters recommended that the Low- and Moderate-Income Housing Goal include separate goals targeting a portion of the GSEs' business to multifamily housing and a portion to single family housing. While there are distinctly different issues relevant to the single family market and the multifamily market, the Department does not believe that it is necessary or appropriate to establish separate goals for those two markets. First, the increased level of the Low- and Moderate-Income Housing Goal in this final rule will require an increase in both single family and multifamily mortgage purchases. HUD's present analysis of these markets indicates that a unitary goal will best achieve increased performance in both markets. Second, this final rule adopts a number of incentives to encourage the GSEs to move into markets with unmet needs including the financing of smaller multifamily properties. HUD will, however, continue to examine market needs and evaluate the effects of the goal structure established in this final rule on the GSEs' single family and multifamily mortgage purchase performance. Based on this ongoing review, HUD may at a future date consider separate single family and multifamily goals or subgoals under the Low- and Moderate-Income Housing Goal, as warranted.

Fannie Mae expressed no objection to the higher goal level, provided the Department retains the proposed housing goals framework, including the proposed changes to the counting rules, in the final rule. Freddie Mac supports the goal framework included in the proposed rule and is committed to meeting the new goal levels. The Department's response to the issues raised by Fannie Mae and Freddie Mac relative to HUD's market share methodologies and its analysis of the statutory factors are discussed above.

Overall, other commenters were supportive of the proposed increase in the Low- and Moderate-Income Housing Goal. One group of commenters thought that, since the GSEs are mandated to lead the market, the level of the Low- and Moderate-Income Housing Goal should be increased further. Another group of commenters supported the increased level of the goal, but felt the Department needed to be prepared to Start Printed Page 65063accommodate shifts in economic conditions that may have a negative impact on the GSEs' ability to meet the housing goals.

d. HUD's Determination. The Low- and Moderate-Income Housing Goal established in this final rule is reasonable and appropriate having considered the factors set forth in FHEFSSA. HUD set the level of the housing goal conservatively, relative to the Department's market share estimates, in order to accommodate a variety of economic scenarios. Moreover, current examination of the gaps in the mortgage markets, along with the estimated size of the market available to the GSEs, demonstrates that the number of mortgages secured by housing for low- and moderate-income families is more than sufficient for the GSEs to achieve the new goal.

Therefore, having considered all the statutory factors including housing needs, projected economic and demographic conditions for 2001 to 2003, the GSEs' past performance, the size of the market serving low- and moderate-income families, and the GSEs' ability to lead the market while maintaining a sound financial condition; HUD has determined that the annual goal for mortgage purchases qualifying under the Low- and Moderate-Income Housing Goal will be 50 percent of eligible units financed in each of the years 2001, 2002 and 2003. The new goal level will increase the GSEs' current level of performance to a level that is consistent with reasonable estimates of the low- and moderate-income housing market.

7. Central Cities, Rural Areas, and Other Underserved Areas Goal, § 81.13

This section discusses the Department's consideration of the statutory factors in arriving at and comments received on the proposed new housing goal level for the Central Cities, Rural Areas, and Other Underserved Areas Housing Goal (the Geographically Targeted Goal).

The Geographically Targeted Goal focuses on areas currently underserved by the mortgage finance system. The 1995 Final Rule provided that mortgage purchases count toward the Geographically Targeted Goal if such purchases finance properties that are located in underserved census tracts. In § 81.2, HUD defined “underserved areas” for metropolitan areas (in central cities and other underserved areas) as census tracts where either: (1) The tract median income is at or below 90 percent of the area median income (AMI); or (2) the minority population is at least 30 percent and the tract median income is at or below 120 percent of AMI. The AMI ratio is calculated by dividing the tract median income by the MSA median income. The minority percent of a tract's population is calculated by dividing the tract's minority population by its total population.

For properties in non-metropolitan (rural) areas, mortgage purchases count toward the Geographically Targeted Goal where such purchases finance properties that are located in underserved counties. These are defined as counties where either: (1) The median income in the county does not exceed 95 percent of the greater of the state or nationwide non-metropolitan median income; or (2) minorities comprise at least 30 percent of the residents and the median income in the county does not exceed 120 percent of the state non-metropolitan median income.

After analyzing the statutory factors and considering the comments, this final rule establishes the goal for the percentage of dwelling units financed by each GSE's mortgage purchases on properties that are located in underserved areas for each of the years 2001-2003 be 31 percent. A short discussion of the statutory factors follows. Additional information analyzing each of the statutory factors is provided in Appendix B, “Departmental Considerations to Establish the Central Cities, Rural Areas, and Other Underserved Areas Goal,” and Appendix D, “Estimating the Size of the Conventional Conforming Market for Each Housing Goal.”

a. Market Estimate for the Geographically Targeted Goal. The Department estimates that dwelling units in underserved areas will account for 29-32 percent of total units financed in the overall conventional, conforming mortgage market during the period 2001 through 2003. HUD has developed a reasonable range, rather than a point estimate, that accounts for significantly more adverse economic conditions than have existed recently.

b. Past Performance of the GSEs under the Geographically Targeted Goal. The housing goals that have been in effect prior to this final rule required that in 1996 at least 21 percent of the units financed by the GSEs' mortgage purchases should count toward the Geographically Targeted Goal, and at least 24 percent in 1997 through 1999. Fannie Mae surpassed the goal by 7.1 percentage points in 1996, 4.8 percentage points in 1997, 3.0 percentage points in 1998, and 2.8 percentage points in 1999. Freddie Mac surpassed the goal by 4.0, 2.3, 2.1 and 3.5 percentage points in 1996, 1997, 1998, and 1999, respectively. The GSEs' performance for the 1996-99 period is summarized below:

Summary of GSE Performance Under the Geographically Targeted Goal 1996-1999 33

[In percentages]

1996199719981999
Required Goal Level21242424
Fannie Mae: Percent Geographically Targeted28.128.827.026.8
Freddie Mac: Percent Geographically Targeted25.026.326.127.5

Although both GSEs have improved their performance in underserved areas, on average, their mortgage purchases continue to lag the primary market in providing financing for housing in these areas. On average, during the 1996-1998 period, mortgage purchases on properties in underserved areas accounted for 19.9 percent of Freddie Mac's purchases of single family home purchase mortgages, compared with 22.9 percent of Fannie Mae's purchases, 25.8 percent of mortgages retained by portfolio lenders, and 24.9 percent of all home purchase mortgages originated in the conventional, conforming market. These figures indicate that Freddie Mac has been less likely than Fannie Mae to purchase mortgages on properties in underserved neighborhoods. Through 1998, Freddie Mac had not made progress in reducing the gap between its performance and that of the overall market. In 1992, underserved areas accounted for 18.6 percent of Freddie Mac's purchases of home purchase mortgages and for 22.2 percent of such mortgage loans originated in the conforming market, which yields a “Freddie Mac-to-Market” ratio 34 of Start Printed Page 650640.84. By 1998, the “Freddie Mac-to-Market” ratio had actually fallen to 0.81. During the same period, the “Fannie Mae-to-Market” ratio increased from 0.82 to 0.93. However, in 1999, Freddie Mac's purchase share for underserved area loans increased while Fannie Mae's declined. In 1999, underserved areas accounted for 21.2 percent of Freddie Mac's home purchase mortgage loan acquisitions, compared with 20.6 percent for Fannie Mae.35

In evaluating the GSEs' past performance, it should be noted that while borrowers in underserved metropolitan areas tend to have much lower incomes than borrowers in other areas, this does not mean that GSE performance in underserved areas must be derived from mortgages on housing for lower income families. In 1999, housing for above median-income households accounted for about half of the single family owner-occupied mortgages the GSEs purchased in underserved areas.

c. Summary of Comments. Fannie Mae expressed no objection to the higher goal level provided the Department retains the proposed housing goals framework, including the proposed changes to the counting rules, in the final rule. Freddie Mac supported the overall goal framework included in the proposed rule but recommended that the Geographically Targeted Goal be set at 30 percent. Freddie Mac noted that it was committed to stretching to meet the proposed new goal levels, but believed that the level of the Geographically Targeted Goal was set too far toward the high end of the market estimate, making it more difficult to achieve. The Department's response to the issues raised by both Fannie Mae and Freddie Mac relative to HUD's estimates of the markets and its analysis of the statutory factors used to set the level of the goals was discussed above.

Overall, other commenters were supportive of the proposed increase in the Geographically Targeted Goal. Certain commenters noted that by placing the level of the goal around the midpoint of the estimate of market size, the GSEs will be encouraged to move into a market leadership position. Another group of commenters supported the increased level of the goal, but felt the Department needed to be prepared to accommodate changes in economic circumstances that may have a negative impact on the GSEs' ability to meet the housing goals.

d. HUD's Determination. The Geographically Targeted Goal established in this final rule is reasonable and appropriate, considering the factors set forth in FHEFSSA. The Department's market share estimates for the Geographically Targeted Goal accommodate a variety of economic scenarios. In addition, a current examination of the gaps in the mortgage markets, along with the estimated size of the market available to the GSEs, demonstrates the opportunities for the GSEs to purchase mortgages secured by housing in underserved areas of the nation.

Therefore, having considered all statutory factors including housing needs, projected economic and demographic conditions for 2001 to 2003, the GSEs' past performance, the size of the market for central cities, rural areas and other underserved areas, and the GSEs' ability to lead the market while maintaining a sound financial condition; HUD is establishing the annual goal for mortgage purchases qualifying under the Geographically Targeted Goal to be 31 percent of eligible units financed in each of the years 2001, 2002 and 2003. The new goal level will increase the GSEs' current level of performance to a level that is consistent with reasonable estimates of the housing market in underserved areas.

8. Special Affordable Housing Goal, § 81.14

This section discusses the Department's consideration of the statutory factors in arriving at, and the comments received on, the new housing goal level for the Special Affordable Housing Goal, which counts mortgages on housing for very low-income families and low-income families living in low-income areas. After consideration of these factors and the comments received, this final rule establishes the goal for the percentage of the total number of dwelling units financed by each GSE's mortgage purchases for housing affordable to very low-income families and low-income families living in low-income areas for each of the years 2001-2003 at 20 percent. A short discussion of the statutory factors follows. Additional information analyzing each of the statutory factors is provided in Appendix C, “Departmental Considerations to Establish the Special Affordable Housing Goal,” and Appendix D, “Estimating the Size of the Conventional Conforming Market for Each Housing Goal.

a. Market Estimate for the Special Affordable Housing Goal. The Department estimates that dwelling units serving very low-income families and low-income families living in low-income areas will account for 23-26 percent of total units financed in the overall conventional, conforming mortgage market during the period 2001 through 2003. HUD has developed a reasonable range, rather than a point estimate, that accounts for significantly more adverse economic conditions than have existed recently.

b. Past Performance of the GSEs under the Special Affordable Housing Goal. The Special Affordable Housing Goal is designed to ensure that the GSEs serve the very low- and low-income portion of the housing market. However, analysis of HMDA data shows that the shares of mortgage loans for very low-income homebuyers are smaller for the GSEs' mortgage purchases than for depository institutions and others originating mortgage loans in the conforming conventional market. HUD's analysis suggests that the GSEs should improve their performance in providing financing for the very low-income housing market.

The housing goals that have been in effect prior to this final rule specified that in 1996 at least 12 percent of the number of units eligible to count toward the Special Affordable Housing Goal should qualify as special affordable, and at least 14 percent in 1997 through 1999. As indicated below, Fannie Mae surpassed the goal by 3.4 percentage points in 1996, 3.0 percentage points in 1997, 0.3 percentage points in 1998 and 3.6 percentage points in 1999. Freddie Mac surpassed the goal by 2.0, 1.2, 1.9, and 3.2 percentage points in 1996, 1997, 1998, and 1999, respectively. The GSEs' performance for the 1996-99 period is summarized below:

Summary of GSE Performance under the Special Affordable Housing Goal 1996-1999 36

1996 (in percent)1997 (in percent)1998 (in percent)1999 (in percent)
Required Goal Level12141414
Fannie Mae:
Percent Low-and Moderate-Income15.417.014.317.6
Freddie Mac:
Start Printed Page 65065
Percent Low-and Moderate-Income14.015.215.917.2

As noted above, HMDA and GSE data for metropolitan areas show that both GSEs lag depository institutions and other lenders in providing financing for home loans that qualify for the Special Affordable Housing Goal. Special affordable loans, which include loans for very low-income borrowers and low-income borrowers living in low-income areas, accounted for 9.8 percent of Freddie Mac's purchases of home purchase mortgages during 1996-98, 11.9 percent of Fannie Mae's purchases, 16.7 percent of newly originated loans retained by depository institutions, and 15.3 percent of all new originations in the conventional, conforming market. While Freddie Mac has improved its special affordable lending since the housing goals were put in place in 1993, up until 1999 it had not made as much progress as Fannie Mae in closing the gap with depository institutions and other lenders in the home loan market. In 1998, Freddie Mac's special affordable performance was 73 percent of the primary market proportion of home loans that would qualify under the Special Affordable Housing Goal, compared to Fannie Mae's performance of 85 percent during the same period. In 1999, Freddie Mac did match Fannie Mae, as special affordable loans accounted for 12.5 percent of its home loan purchases versus 12.3 percent of Fannie Mae's home loan purchases. Market data for 1999 are not yet available.

The multifamily market is especially important in the establishment of the Special Affordable Housing Goal for Fannie Mae and Freddie Mac because of the relatively high percentage of multifamily units meeting the Special Affordable Housing Goal. For example, in 1999, 56 percent of units financed by Fannie Mae's multifamily mortgage purchases met the Special Affordable Housing Goal, representing 31 percent of units counted toward the Special Affordable Housing Goal, at a time when multifamily units represented only nine percent of its total purchase volume.37

c. Summary of Comments. Fannie Mae expressed no objection to the higher goal level, provided the Department retains the proposed housing goals framework, including the proposed changes to the counting rules, in the final rule. Freddie Mac supported the goal framework included in the proposed rule and is committed to stretching to meet the new goal levels. The Department's response to the issues raised by both Fannie Mae and Freddie Mac relative to HUD's market share methodologies and its analysis of the statutory factors used to set the level of the goals was discussed above.

Overall, other commenters were supportive of the proposed increase in the Special Affordable Housing Goal. One group of commenters thought that, since the GSEs are mandated to lead the market, the level of the Special Affordable Housing Goal should be increased even more, at a minimum, to the lower range of the Department's market share, at 23-24 percent. Another group of commenters supported the increased level of the goal but felt the Department needed to be prepared to accommodate changes in economic circumstances that may have a negative impact on the GSEs' ability to meet the housing goals.

d. HUD Determination. The Special Affordable Housing Goal established in the final rule is reasonable and appropriate, considering the factors set forth in FHEFSSA. The market share estimates for this goal reflect a variety of economic scenarios significantly more adverse than have existed recently. Current examination of the gaps in the mortgage markets, along with the estimated size of the market available to the GSEs, demonstrates that the number of mortgages secured by housing for special affordable families is more than sufficient for the GSEs to achieve the goal.

Having considered all statutory factors including housing needs, projected economic and demographic conditions for 2001 to 2003, the GSEs' past performance, the size of the market serving very low-income families and low-income families living in low-income areas, and the GSEs' ability to lead the market while maintaining a sound financial condition; HUD is establishing the annual goal for mortgage purchases qualifying under the Special Affordable Housing Goal at 20 percent of eligible units financed by each GSE in each of the years 2001, 2002 and 2003. This new goal level will increase the GSEs' current level of performance to a level that is consistent with reasonable estimates of the special affordable housing market.

e. Special Affordable Housing Goal: Multifamily Subgoal. This final rule modifies the proposed rule by implementing a multifamily subgoal based upon each GSE's respective average mortgage purchase volume for the years 1997 through 1999. The proposed rule suggested that the subgoal be established at 0.9 percent of each GSE's dollar volume of combined 1998 mortgage purchases in 2000 and at 1.0 percent of combined 1998 mortgage purchases from 2001 through 2003. In this final rule, the level of the subgoal is established at a fixed level of one percent of the average of each GSE's respective dollar volume of combined (single family and multifamily) mortgage purchases in the years 1997, 1998 and 1999. This level is $2.85 billion for Fannie Mae and $2.11 billion for Freddie Mac, in each of the years 2001 through 2003.

f. Summary of Comments. Both Fannie Mae and Freddie Mac opposed establishing the special affordable multifamily subgoal as a percentage of their 1998 transaction volumes, stating that 1998 was in some respects an unusual year in the mortgage markets. Instead, they both recommended that the special affordable multifamily subgoal be established as a percentage of a five year average of each GSE's transactions volume. Freddie Mac commented further that HUD's proposed subgoal was unreasonably high.

Many other commenters supported the multifamily subgoal, although they questioned whether 1998 was the appropriate base year upon which to establish the subgoal. Some commenters asserted that the proposed subgoal was too high, in light of an expected decline in multifamily origination volume. Other commenters noted that the subgoal was too low, based on the needs of very low- and low-income families and those in rural areas. Yet, others agreed the subgoal should continue to be percentage based, but argued that the baseline year should move from year to year. Still other commenters felt that the multifamily subgoal should be eliminated, as it no longer appears to serve a purpose, particularly since Freddie Mac has re-entered the multifamily market. Start Printed Page 65066

g. HUD's Determination. Both the multifamily mortgage market and Freddie Mac's multifamily transactions volume have grown significantly during the 1990's, indicating both increased opportunity and capacity to grow by Freddie Mac. While Freddie Mac continues to lag behind Fannie Mae somewhat in its multifamily volume, it appears to be within reach of catching up with its larger competitor with regard to the multifamily proportion of total purchases. In 1999, Fannie Mae's multifamily mortgage purchases were 9.5 percent of its total mortgage purchases and Freddie Mac's multifamily mortgage purchases were 8.3 percent of its total mortgage purchases.

Freddie Mac's multifamily special affordable transactions volume was $2.7 billion in 1998 and $2.3 billion in 1999, which demonstrates Freddie Mac's capacity to generate significant multifamily special affordable volume in a favorable market environment. However, the Department is mindful of the fact that the multifamily market conditions experienced during 1998 were very favorable and may not be fully representative of future years. HUD expects conventional multifamily volume in 2001 through 2003 to be somewhat lower than the level reached during 1998.

The Special Affordable Housing Multifamily Subgoal established in this final rule is reasonable and appropriate based on the Department's analysis of this market. The Department's decision to retain the multifamily subgoal is based on the fact that HUD's analysis indicates that multifamily housing still serves the housing needs of lower-income families and families in low-income areas to a greater extent than single family housing. By retaining the multifamily subgoal, the Department ensures that the GSEs continue their activity in this market and that they achieve, at least, a minimum level of special affordable multifamily mortgage purchases that are affordable to lower-income families. Now that more recent data is available, it is apparent that taking 1999 mortgage volume into consideration, along with that of 1997 and 1998, more accurately corresponds to the relative size and respective capabilities of the GSEs over the 2001-2003 goals period. Accordingly, as noted above, this final rule establishes each GSE's special affordable multifamily subgoal at the respective average of one percent of that GSEs' combined mortgage purchases over 1997 through 1999.

h. Multifamily Subgoal Alternatives. In the proposed rule, HUD identified three alternative approaches for specifying multifamily subgoals for the GSEs based on a (i) minimum number of units; (ii) minimum percentage of multifamily acquisition volume; and (iii) minimum number of mortgages acquired. While some of these proposals did receive support from commenters, HUD does not see any compelling reason to alter the dollar based structure of the multifamily subgoal as established in the regulations, which can be updated and adapted to the current market environment by basing it upon recent acquisition volume. It is noteworthy that the Special Affordable Housing Goal, as a percentage of business goal based on the number of units financed, combines elements of options (i) and (iii). HUD's decision to award bonus points toward the housing goals for GSE transactions involving small multifamily properties with 5-50 units will achieve some of the intended policy objectives associated with option (iii).

9. Bonuses and Subgoals

a. Overview. The Department proposed to introduce a system of bonus points to encourage the GSEs to increase their activity in specified underserved markets that serve low- and moderate-income families and families in underserved areas. Bonus points were specifically proposed to encourage increased involvement by the GSEs under goals established for the years 2000-2003 for purchases of mortgages financing small multifamily properties (5-50 units) and two to four unit owner-occupied properties that contain rental units. The areas for which bonus points were suggested are areas in which the GSEs' mortgage purchases have traditionally played a minor role but which provide significant sources of affordable housing and for which the need for mortgage credit persists. As a regulatory incentive to encourage the GSEs to increase their mortgage purchase activity in underserved markets, the Department proposed the use of bonus points for mortgage purchases in these important segments of the housing market. HUD also sought comments on the utility of applying bonus points and other regulatory incentives such as subgoals to other underserved segments of the market including manufactured housing, multifamily properties in need of rehabilitation, and properties in tribal areas.

This final rule incorporates the use of bonus points for small multifamily properties and owner-occupied single family rental properties as proposed for the years 2001 through 2003.

b. Summary of Comments. Fannie Mae and Freddie Mac commented in detail on the use of bonus points and subgoals. Fannie Mae supported the use of bonus points to provide incentives to expand its presence in the markets for both the small multifamily and single family owner-occupied, 2-4 unit property. Fannie Mae opposed the use of subgoals for that purpose, however, arguing that they would result in micromanagement of its business operation. Fannie Mae added that “these two property types pose great difficulties for the secondary market to serve and will require new channels, new products, new modes of operation, and significant investments to better understand the risks.” Fannie Mae also recommended that if the Department adopts bonus points, the points should continue beyond 2003.

Freddie Mac supported using bonus points and opposed using subgoals for small multifamily and single family owner-occupied, 2-4 unit property mortgage acquisitions. As with Fannie Mae, Freddie Mac commented that subgoals would result in micromanagement of its business. Freddie Mac also recommended calculating the threshold for 2-4 unit properties based on the period from 1995-1999 instead of using a five-year rolling average. Overall, Freddie Mac commented that it would prefer bonus points to subgoals for any targeted market segments.

Other commenters were generally supportive of the use of bonus points, with many noting that bonus points were preferable to additional subgoals. This group of commenters felt that additional subgoals would result in micromanagement of the GSEs' business operations but felt that bonus points provided an incentive rather than a mandate to move into markets that were underserved.

One group of commenters was opposed to bonus points. Among many of these commenters, however, there was support for incentives for the GSEs to purchase mortgages on small rental properties, noting that the market is underserved and provides an excellent source of affordable rental housing. Specific comments regarding the use of bonus points concluded that bonus points would: (a) Allow the GSEs to meet the goals with less effort and that they might lead the GSEs to relax their single family efforts; and (b) inflate goal performance numbers. It was suggested by several commenters that subgoals would be a more appropriate vehicle to encourage the GSEs' involvement in those segments of the market as well as other segments, e.g., mortgages made to Start Printed Page 65067minority borrowers and home purchase mortgages. Some commenters suggested that since there was evidence that the small multifamily mortgage market is well served by community banks, thrifts and small life insurance companies, there is no need for HUD to award bonus points as an incentive for the GSEs to enter that market.

c. HUD's Determination. This final rule adopts the two categories for bonus points that were proposed by the Department. Bonus points are a temporary incentive for the GSEs to step up their efforts to serve this particular need. Availability of bonus points for this purpose beyond 2003, therefore, will require a determination by the Department that the bonus points continue to serve this need. HUD's research and analysis indicates that there is substantial unmet need in these two areas and believes that these are markets the GSEs should serve better. While HUD has determined to establish bonus points in the two market areas proposed, HUD does not believe that either the use of subgoals, that would be unenforceable under FHEFSSA (except for the Special Affordable Housing Goal), or bonus points amounts to micromanagement of the GSEs. By utilizing bonus points the GSEs can choose whether to increase their presence in these markets, and by evaluating the impact of these incentives on the GSEs' mortgage purchase patterns, the Department can evaluate the reasonableness and effectiveness of bonus points as a tool to increase activity in specific markets.

d. Additional Bonus Points and Subgoals. Commenters suggested a wide variety of other areas to consider for either bonus points and/or subgoals including those for which views were invited. Suggestions by commenters for subgoals included home purchase mortgages and mortgages to minority borrowers. Commenters also suggested either bonus points and/or subgoals for reverse mortgages, groups with low homeownership rates, rural multifamily housing programs, manufactured housing, and expiring Section 8 assistance contracts, among other types of transactions. While there was some support for directing bonus points for encouraging GSE financing for minorities there was, however, no consensus among the commenters for this or other specific categories that bonus points and subgoals should address. Since HUD believes that the increased goals under this rule will result in increased financing of affordable housing and increased home ownership opportunities for minorities and other families in underserved areas, HUD has determined to establish bonus points only in the two categories proposed at this time. As indicated above, HUD will, however, monitor the effectiveness of these bonus points closely, based on these results and future housing needs, may establish bonus points for other mortgage purchases in the future.

10. Temporary Adjustment Factor for Freddie Mac

a. Overview. To overcome any lingering effects of Freddie Mac's decision to dismantle and then cautiously reestablish a multifamily mortgage purchase program in the early 1990s, the Department proposed an incentive for Freddie Mac to further expand its scope of multifamily operations through the use of a temporary adjustment factor for its multifamily mortgage purchases in calculating its performance under the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal. In determining Freddie Mac's performance for each of these two goals, the Department proposed that each unit in a property with more than 50 units meeting either of these two housing goals would be counted as 1.2 units in the numerator of the respective housing goal percentage. The temporary adjustment factor would be limited to properties with more than 50 units to avoid overlap with the proposal to award bonus points for multifamily properties with 5-50 units. Comments were requested on whether the proposed temporary adjustment factor for Freddie Mac was set at an appropriate level and whether such an adjustment factor should be phased out prior to 2003.

This final rule incorporates the temporary adjustment factor for Freddie Mac for multifamily properties, other than those small multifamily units receiving bonus credit, as proposed for the years 2001 through 2003.

b. Summary of Comments. Fannie Mae and Freddie Mac commented in detail on the application of a temporary adjustment factor for Freddie Mac's multifamily business. Fannie Mae opposed the application of a temporary adjustment factor for Freddie Mac's multifamily business. Fannie Mae stated that Freddie Mac made a business decision to leave the multifamily market and HUD's action would effectively punish Fannie Mae for staying in the market. Fannie Mae recommended that instead of a temporary adjustment factor, HUD should lower Freddie Mac's goals to levels that would represent a similar “stretch” as the higher goal levels that would be established for Fannie Mae.

Freddie Mac supported the idea of a temporary adjustment factor but recommended that it be set at a multiplier of 1.35 instead of 1.2. Noting that the difference in size and age between Freddie Mac's and Fannie Mae's multifamily portfolios makes goal achievement easier for Fannie Mae, Freddie Mac also recommended that the temporary adjustment factor apply to all three goals. Freddie Mac also opposed any phasing out or elimination of the adjustment factor.

Other comments on the proposal were mixed. While there were many comments in support of the proposal, a number of commenters objected to the proposal, observing that by providing the temporary adjustment factor, HUD would be rewarding Freddie Mac for leaving the multifamily mortgage market in previous years. Commenters also suggested that the same objective could be achieved through the Special Affordable Multifamily Subgoal or by establishing separate housing goals for the single family and multifamily market. Many of these commenters said that, if the temporary adjustment factor were adopted for Freddie Mac, it should be phased out over a period of time.

c. HUD's Determination. In the period since HUD's interim housing goals took effect in January 1993, the volume of Freddie Mac's multifamily mortgage purchase transactions has grown significantly, both in absolute terms and as a proportion of its total mortgage purchases. Freddie Mac's 1993 multifamily transactions volume was only $191 million, compared with $7.6 billion in 1999. In 1999, Freddie Mac's multifamily transactions volume represented 8.3 percent of units backing its total mortgage purchases, close to the Fannie Mae proportion of 9.5 percent. Thus, while Freddie Mac continues to lag behind Fannie Mae somewhat in its multifamily volume, it appears to be within reach of catching up with Fannie Mae with regard to the multifamily proportion of total purchases.

In discussing the Department's appropriations for fiscal year 2000, the Conference Report stated in October, 1999 that “* * * the stretch affordable housing efforts required of each of Freddie Mac and Fannie Mae should be equal, so that both enterprises are similarly challenged in attaining the goals. This will require the Secretary to recognize the present composition of each enterprise's overall portfolio in order to ensure regulatory parity in the application of regulatory guidelines measuring goal compliance.” 38Start Printed Page 65068

Consistent with Congress' October 1999 guidance, HUD's analysis indicates that a 1.2 adjustment factor applied to Freddie Mac's mortgage purchases for multifamily properties of more than 50 units for purposes of the Low- and Moderate-Income and Special Affordable Housing Goals, as proposed, is sufficient both to overcome any lingering effects of Freddie Mac's decision to leave the multifamily market in the early 1990s and to “ensure regulatory parity,” taking account of the recent magnitude of difference between the GSEs' respective multifamily shares of business and the multifamily market projections detailed in Appendix D. Therefore, while the goals are set at the same levels, the Department has decided to implement the temporary adjustment factor as proposed. The temporary adjustment factor of 1.2 will be applied to the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal. The temporary adjustment factor will terminate December 31, 2003. The temporary adjustment factor will not apply to Fannie Mae.

11. High Cost Mortgages

a. Overview. The proposed rule requested comments on whether HUD should disallow goals credit for high cost mortgage loans, and if so, whether HUD should define high cost mortgage loans using the Home Ownership and Equity Protection Act (HOEPA) 39 or an alternative definition. HOEPA defines high cost mortgages as those that meet an annual percentage rate (APR) threshold (more than 10 percentage points above the yield on Treasury securities of comparable maturity; the Federal Reserve Board can adjust the threshold down to 8 percent or up to 12 percent), or a threshold for points and fees charged (exceeding the greater of 8 percent of the loan amount or $400—adjusted for inflation to $451 for the year 2000). HOEPA requires additional disclosures and restricts certain loan terms (e.g., prepayment penalties, balloon payments, and negative amortization) and practices (e.g. failing to consider a borrower's ability to repay) for those mortgages.40

The proposed rule also requested comments on the potential benefits, if any, associated with the GSEs' presence in the various higher cost mortgage markets, such as the standardization of underwriting guidelines or reductions in interest rates, as well as the potential dangers, if any, associated with the GSEs' presence in those markets. Finally, the proposed rule requested comments on what additional data would be useful for the purposes of monitoring the GSEs' activities in this area and on whether certain of these data elements should be included in the public use data base. The proposed rule noted that possible data elements that could be collected from the GSEs for monitoring include loan level data on the annual percentage rate, debt-to-income ratio, points and fees, and prepayment penalties.

b. HUD/Treasury Report. On June 20, 2000, HUD and the Department of Treasury jointly released a report entitled “Curbing Predatory Home Mortgage Lending,” which detailed predatory or abusive lending practices in connection with higher cost loans in the subprime mortgage market. These practices include charging excessive fees, lending to borrowers without regard to their ability to repay, establishing prepayment penalties that prevent high cost borrowers from refinancing into lower cost loans, abusive terms and conditions that include packing loans with products such as single premium credit insurance, and other practices, including failing to steer borrowers to the lowest-cost product for which they qualify and incomplete reporting of borrowers' payment history to credit bureaus. The report recommended legislative and regulatory action to combat predatory lending while maintaining access to credit for low- and moderate-income borrowers. Respecting the secondary mortgage market, the report recommended that HUD restrict the GSEs from funding loans with predatory features since such loans may undermine homeownership by low- and moderate-income families. HUD and Treasury noted “while the GSEs currently play a relatively small role in the subprime market today, they are beginning to reach out with new products in this marketplace.”

Recently the GSEs have each announced corporate policies against the purchase of loans with certain features. Fannie Mae has established greater limitations than Freddie Mac, although Fannie Mae has been less involved in the subprime market to date. Fannie Mae announced that “[f]or loans delivered to Fannie Mae, the points and fees charged to a borrower should not exceed 5 percent, except where this would result in an unprofitable origination,” and that Fannie Mae will not purchase high cost mortgages as defined under HOEPA. Fannie Mae announced further that it “will not purchase or securitize any mortgage for which a prepaid single-premium credit life insurance policy was sold to the borrower,” and that it will generally only allow prepayment penalties under the terms of a negotiated contract and where the lender adheres to the following criteria: A mortgage that has a prepayment penalty should provide some benefit to the borrower (such as a rate or fee reduction for accepting the prepayment premium); the borrower also should be offered the choice of another mortgage product that does not require payment of such premium; the terms of the mortgage provision that requires a prepayment penalty should be adequately disclosed to the borrower, and the prepayment penalty should not be charged when the mortgage debt is accelerated as a result of the borrower's default in making his or her mortgage payments.

Fannie Mae also announced that it will not purchase loans from lenders who steer borrowers to higher cost products if those borrowers qualify for lower cost products. Freddie Mac announced that it will not purchase HOEPA loans, nor will it purchase mortgage loans with single-premium credit life insurance. Both GSEs have announced that they will require lenders who sell them loans to file monthly full-file credit reports on every borrower. While the GSEs' policies differ somewhat in their scope and specificity, both have publicly expressed strong concern about predatory lending practices and have adopted policies requiring them to look harder at particular loan terms and their seller/servicers' business practices, and restricting their purchases of loans originated with such terms and practices. However, the GSEs' broad guidelines describing the characteristics of loans that they intend to make ineligible for purchase lack important details and are subject to changes in corporate direction, or other changes. Therefore, HUD and Treasury recognized in the report that such corporate policies may not be sufficient and that regulations would be needed to address this issue.

c. Summary of Comments. Many commenters on the proposed rule supported the disallowance of credit under the GSE housing goals for high cost mortgages. Some of these commenters commended the GSEs for beginning to offer quality loan products to credit-impaired borrowers. Those commenters argued, however, that restrictions on goals credit for certain loans would not prohibit the GSEs from purchasing all subprime loans but merely those that are likely to be predatory and wealth-stripping. Other commenters argued that without adequate controls, the GSEs' forays into the subprime market will not translate Start Printed Page 65069into lower costs for borrowers, but will only lower the cost of capital for subprime lenders.

Some commenters wrote that the GSEs should not receive credit under the housing goals for high cost mortgages that are subject to HOEPA. Many other commenters felt that such a standard would not go far enough, and that the GSEs should not receive goals credit for purchasing loans with certain features. Such features would include fees greater than 3 percent of the loan amount, prepayment penalties on high cost loans, and prepaid single premium credit life insurance that is to be financed in the loan. Commenters also provided additional features for which the GSEs should not receive goals credit, including negative amortization and accelerating indebtedness, fees to renew or modify, balloon payments, yield spread premiums, mandatory arbitration, or high cost loans for which the borrower did not receive homeownership counseling.

One commenter suggested that the Department should treat loans purchased from an institution that engages in predatory lending the same as loans that actually have predatory features in order to send a message that such lenders are not responsible business partners and to restrict further the availability of mortgage credit for such loans. Other commenters suggested that the GSEs should not be allowed to purchase subprime loans at all, so that they will have an incentive to develop conventional mortgage products to reach out to those borrowers. Another suggestion was that the GSEs should be affirmatively penalized for purchasing certain abusive mortgages (i.e., by subtracting points from the numerator but fully counting such loans in the denominator).

A number of commenters suggested that GSEs should be required to conduct fair lending reviews of subprime loans before they purchase them in order to receive credit. Such reviews would include determining whether the lending institution is reporting borrowers' full payment histories to credit bureaus.

Many of the commenters that supported the disallowance of goals credit for high cost loans and loans with certain harmful features asserted that the GSEs' support of such lending poses great risks. These commenters argued that the types of mortgage products that strip equity out of homes and lead to higher foreclosures are not consistent with the GSEs' public mission. Further, to the extent that defaults on these loans lead to losses, these commenters asserted that the GSEs' financial condition will likely be affected.

With regard to data collection and reporting, several commenters suggested that the GSEs should be required to provide full information on their subprime loans, including the APR, total closing costs, points, and fees (including financed credit insurance premiums), delinquency and foreclosure rates, and the length of time between purchase and refinance on an aggregate basis.

Both GSEs and a large group of commenters objected to the Department's proposal regarding the disallowance of goals credit for purchases of high cost mortgages. Many of those commenting in this regard provided substantially similar responses to those submitted by Fannie Mae. These commenters emphasized the difference between legitimate subprime lending and lending through the use of abusive and predatory practices such as those outlined in the HUD/Treasury report. Several of these commenters expressed concern that the Department should not take any action that would discourage the GSEs from serving the subprime market. The GSEs both remarked that they are using enhanced technology (e.g., their respective automated underwriting systems) to allow them to offer products targeted toward borrowers with impaired credit, and that they are, therefore, able to move into the legitimate subprime market in a responsible and prudent manner, bringing liquidity, standardization, and efficiency to that market. The GSEs argue that disallowing goals credit for high cost mortgages will provide a disincentive for them to reach out to those borrowers and will do nothing to combat the predatory lending practices about which the Department is concerned. Indeed, Fannie Mae argued that disallowing goals credit for high cost mortgages would simply drive predatory lending “into the government market or to secondary market sources who are less responsible than Fannie Mae on this issue.”

Fannie Mae argued that disallowing goals credit for high cost mortgages is inconsistent with the Department's inclusion of A-minus mortgages in the market estimates to which the Department compares the GSEs' performance. Fannie Mae further argued that the Department would need to “recalibrate the goals” in order to implement a system of disallowing goals credit for high cost mortgages, which would be “extremely difficult, if not impossible” due to “the lack of reliable market data on loan costs.”

Nonetheless, Fannie Mae urged the Department to work with other regulatory agencies to collect more data on the problem. Freddie Mac urged the Department to await the outcome of any Federal legislative or regulatory initiatives that may arise as a result of the widespread concern and focus on these issues among members of Congress and regulatory agencies.

The GSEs also both objected to any additional reporting requirements related to monitoring their purchases of high cost mortgages. Fannie Mae argued that the relevant information is not now captured in the primary market, and that collecting and reporting this information would force a “tremendous change to the way the market operates.” Freddie Mac similarly argued that the required data elements are not stored uniformly across lenders, and collecting and reporting such data elements would require “substantial investments,” the economic impacts of which would likely be considerable.

d. HUD's Determination. After considering the issues raised by the commenters, the Department has determined that, in accordance with the Secretary's authority under section 1336(a)(2) of FHEFSSA, the GSEs should not be assigned credit toward the Affordable Housing Goals for purchasing certain high cost mortgages including mortgages with certain unacceptable features. The GSEs have a statutory responsibility to lead the industry in making mortgage credit available to low and moderate income families and underserved areas. In carrying out this responsibility, the GSEs should seek to make the lowest cost credit available while ensuring that they do not purchase loans that actually harm borrowers and support unfair lending practices. The HUD/Treasury report recommended regulatory and/or legislative restrictions that would go beyond the matter of goals credit and would prohibit the GSEs from purchasing certain types of loans with high costs and/or predatory features altogether. These proposals stem from the concern that mortgages with predatory features undermine homeownership by low-and moderate-income families in derogation of the GSEs' Charter missions. As pointed out in the HUD/Treasury Report, “While the secondary market could be viewed as part of the problem of abusive practices in the subprime mortgage market, it may also represent a large part of the solution to the problem. If the secondary market refuses to purchase loans that carry abusive terms, or loans originated by lenders engaging in abusive practices, the primary market might Start Printed Page 65070react to the resulting loss of liquidity by ceasing to make these loans.”

Accordingly, consistent with and combining restrictions already voluntarily undertaken by both GSEs, this final rule restricts credit under the goals for purchases of high cost loans including mortgages with certain unacceptable terms and resulting from unacceptable practices. Specifically, the GSEs will not receive credit toward any of the Affordable Housing Goals for dwelling units financed by mortgages that come within HOEPA's thresholds for high cost mortgages, nor will they receive credit for mortgages with certain unacceptable features or resulting from unacceptable practices. The housing goals provide incentives to encourage GSE efforts to finance housing for low and moderate income families, housing in underserved areas, and special affordable housing. Therefore, HUD has determined that the GSEs should not receive the incentive of goals credit for purchasing high cost mortgages including mortgages with unacceptable features.

(1) Mortgages that Come Within HOEPA's Thresholds. The final rule disallows goals credit for dwelling units financed by mortgages that come within HOEPA's thresholds, i.e., with an APR of 10 percentage points or higher above the yield on Treasury securities of comparable maturity, or with points and fees that are above the greater of 8 percent of the loan amount or $451. HOEPA's thresholds provide a discernible and standard industry measure of a class of loans that are very high cost, that present a very high risk that their borrowers will lose their homes, and that the GSEs themselves have determined not to purchase. While originating such loans is not illegal, but rather made subject to additional disclosures and protections under HOEPA, loans at these levels should not be encouraged by receiving credit under the goals. In incorporating the HOEPA high cost loan standards in this rule, the thresholds are subject to adjustment by the Federal Reserve Board 41 or Congress. This rule is established to encompass such adjustments unless the GSEs are otherwise notified in writing by HUD. While HOEPA itself only covers closed end loans made to refinance existing mortgages and closed end home equity loans, this final rule also applies the HOEPA thresholds to home purchase mortgages.

(2) Mortgages with Unacceptable Terms or Conditions or Resulting from Unacceptable Practices. This final rule also disallows goals credit for dwelling units financed by mortgages with features that the GSEs themselves, either through announced policies or practices, have identified as unfair to borrowers and unacceptable. Specifically, these include mortgages with:

(a) Excessive fees, where the total points and fees charged to a borrower exceed 5 percent of the loan amount, except where this restriction would result in an unprofitable origination. For such cases, involving small loans, this rule provides a maximum dollar amount of $1000, or such other amount as may be requested by a GSE and determined appropriate by the Secretary, as an alternative to the 5 percent limit. For purposes of this provision, points and fees include: (i) Origination fees, (ii) underwriting fees, (iii) broker fees, (iv) finder's fees, and (v) charges that the lender imposes as a condition of making the loan—whether they are paid to the lender or a third party. For purposes of this provision, points and fees would not include: (i) Bona fide discount points; (ii) fees paid for actual services rendered in connection with the origination of the mortgage, such as attorneys' fees, notary's fees, and fees paid for property appraisals, credit reports, surveys, title examinations and extracts, flood and tax certifications, and home inspections; (iii) the cost of mortgage insurance or credit-risk price adjustments; (iv) the costs of title, hazard, and flood insurance policies; (v) state and local transfer taxes or fees; (vi) escrow deposits for the future payment of taxes and insurance premiums; and (vii) other miscellaneous fees and charges that, in total, do not exceed 0.25 percent of the loan amount.

This restriction on goals credit for mortgages with excessive fees does not, of course, supplant the restriction on goals credit for HOEPA loans. If a mortgage has fees that exceed 5 percent of the loan amount as described in the immediately preceding paragraph, but do not exceed the 8 percent/$451 threshold under HOEPA, the mortgage would not receive credit toward the goals. HUD, Treasury, the GSEs, and many others have recognized that mortgages with excessive fees are a particularly onerous problem and disproportionately affect the low- and moderate-income borrowers that the GSEs are to serve. Therefore, this final rule will remove any incentive under the goals for the GSEs to purchase loans with excessive fees as described above. Having said that, the HUD/Treasury report called upon the Federal Reserve Board to expand the HOEPA “points and fees” threshold to include certain additional types of fees, including (i) fees and amounts imposed by third party closing agents (except payments for escrow and primary mortgage insurance), (ii) prepayment penalties that are levied on a refinancing, and (iii) all compensation received by a mortgage broker in connection with the mortgage transaction. As mentioned above, if the Federal Reserve changes the HOEPA thresholds, such changes will be encompassed within HUD's housing goals, unless HUD notifies the GSEs otherwise.

(b) Prepayment penalties, except where: (i) the mortgage provides some benefits to the borrower (e.g., such as rate or fee reduction for accepting the prepayment premium); (ii) the borrower is offered the choice of a mortgage that does not contain such a penalty; (iii) the terms of the mortgage provision containing the prepayment penalty are adequately disclosed to the borrower; and (iv) the prepayment penalty is not charged when the mortgage debt is accelerated as the result of the borrower's default in making his or her mortgage payments.

(c) Single premium credit life insurance products sold in connection with the origination of the mortgage.

(d) Evidence that the lender did not adequately consider the borrower's ability to make payments, i.e., mortgages that are originated with underwriting techniques that focus on the borrower's equity in the home, and do not give full consideration to the borrower's income and other obligations. Ability to repay must be based upon relating the borrower's income, assets, and liabilities to the mortgage payments.

(3) Mortgages Contrary to Good Lending Practices. As the GSEs have recognized in their own policies and many of the commenters pointed out as well, while good mortgage lending practices can reduce costs to borrowers, contrary practices can result in loans that are higher cost to borrowers in ways that are not directly reflected in the interest rate, points, or fees. Therefore, to remove any goals incentive for the GSEs to purchase mortgages or categories of mortgages regarding which there is evidence that lenders engaged in specific practices contrary to good lending practices identified in the rule, this rule provides that the GSEs may not receive goals credit for such loans or categories of loans. These specific practices identified in this rule that lenders employ to avoid abusive lending include regularly reporting complete borrower information to credit agencies, avoiding steering borrowers to higher cost products, and complying with fair lending requirements.

FHEFSSA and HUD's GSE regulations at 24 CFR 81.41, prohibit the GSEs from discriminating in any manner in making Start Printed Page 65071any mortgage purchases because of race, color, religion, sex, handicap, familial status, age or national origin. Since abusive lenders often specifically target and aggressively solicit homeowners in predominantly lower-income and minority communities who may lack sufficient access to mainstream sources of credit, it is essential that the GSEs scrutinize lender practices to protect against buying loans that are the result of unlawful discrimination. For example, good lending practices that help lenders avoid unlawful discrimination include employee training programs, periodic loan sampling, specifically tailored recordkeeping and reporting requirements, and other reviews. The GSEs have reported, consistent with their pledges not to buy certain harmful loans, that they will be looking closer at the lending practices of entities with which they do business, and HUD commends those efforts. HUD will review the processes the GSEs employ to ascertain positive practices to avoid unlawful discrimination and steering borrowers to higher cost products, as well as monthly credit reporting. This final rule provides that where HUD finds evidence that loans or categories of loans do not conform to such positive practices, HUD may deny goals credit for such loans in accordance with § 81.16(d) of this rule.

HUD recognizes that the particular loan terms and practices that are identified as abusive and unacceptable may change as some unscrupulous actors adjust to new restrictions and as the GSEs and HUD gain experience with abuses. Accordingly, to allow flexibility this rule allows the Department to modify the list of terms and practices that will not receive goals credit, by providing that the GSEs may request modifications to the list and that the Secretary will after reviewing such submissions determine whether or not to change the abuses for which goals credit will be restricted. HUD also will continue to monitor the mortgage industry with regard to abusive lending practices and may determine that future modifications are necessary and require further rulemaking.

The restrictions and provisions in sections (1), (2), and (3), above, address terms and practices that are harmful to mortgage borrowers. Accordingly, these restrictions and provisions in this rule apply to mortgages purchased through the GSEs' “flow” business, as well as mortgages purchased or guaranteed through structured transactions. Since these restrictions and provisions are consistent with the GSEs' own measures, the Department does not believe that any of these restrictions will provide a disincentive for the GSEs to provide financing for borrowers with slightly impaired credit through innovative products that can bring competition and efficiencies to the legitimate subprime market.

While the GSEs themselves will presumably be obtaining certain additional data and information to carry out their previously announced purchase restrictions and to monitor lending practices, HUD is not establishing any requirements for additional data to carry out these provisions under this rule. Subsequently, HUD plans to request only such additional data as is necessary. In this regard, HUD will consult with the GSEs, as practicable, to develop reasonable data reporting requirements that will not present an undue additional burden.

12. Data On Unit Affordability, § 81.15

The GSEs have reported that at times it can be difficult and costly for them to obtain the data on incomes and rents that is necessary to establish affordability for goals purposes, especially for seasoned loan transactions and some negotiated transactions. HUD proposed to allow (1) the use of estimation techniques to approximate unit rents in multifamily properties where current rental information is unavailable and (2) the exclusion of units, both single family and multifamily, from goal calculations where it is impossible to obtain full data or estimate values, subject to certain limits.

As has been discussed, GSE purchases of mortgages on rental properties disproportionately serve the affordable housing market. Typically, around 90 percent of rental units backing GSE mortgage purchases would count towards the Low- and Moderate-Income Housing Goal and around 50 percent would meet the affordability requirements of the Special Affordable Housing Goal (excluding missing data). HUD did not want the lack of data on affordability to act as a disincentive for the GSEs to purchase mortgages in these important sectors, which have been identified by HUD as having substantial unmet credit needs in the mortgage market. While single family owner-occupied units are also affected by missing data, these units are typically not as affordable as the GSEs' rental purchases. Consequently, the provision in the proposed rule to exclude units from the numerator and denominator for single family owner-occupied properties is limited to properties located in lower income areas and is subject to a cap.

a. Multifamily Rental Units.

(1) Overview. The Department proposed allowing the use of estimated rents for multifamily units with missing data, subject to HUD review and approval of the data sources and methodologies used in computing them. The Department asked for comment on whether it should establish a percentage ceiling on the use of estimated rents.

HUD further proposed that, in cases where multifamily rents are missing and where application of estimated rents is not possible, such units be excluded from both the denominator and numerator for purposes of calculating performance under the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal. The Department requested comment on whether it should establish a percentage ceiling for the exclusion of multifamily units with missing data from the denominator for goal calculation purposes.

(2) Summary of Comments. Several commenters endorsed the concept of using estimated data to calculate performance toward the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal when multifamily rent data are missing. No commenters indicated opposition to allowing the use of estimated rents.

In its comments, Fannie Mae stated that HUD should, in order to provide operational certainty, incorporate an approved methodology into the regulations for estimating rents on multifamily properties where actual rent data are missing. Freddie Mac commented that the GSEs should be given the choice of whether to provide estimated rents or to exclude units from the denominator for purposes of calculating goals performance in instances of missing multifamily rent data.

In cases where calculation of estimated rents is not feasible, a number of commenters wrote in support of excluding the units in question from the denominator as well as the numerator for purposes of calculating performance toward the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal. One commenter opposed such exclusion, noting that by including all multifamily units in the denominator whether or not the GSEs have the required income and rent data places a more serious burden on the GSEs to obtain the data and focus on affordable lending in the multifamily area.

With regard to the issue of percentage ceilings, Freddie Mac suggested a two-percent (2%) ceiling on the exclusion of multifamily units from the denominator Start Printed Page 65072because of missing rents. Other commenters suggested alternative limits, e.g., a half-of-one percent (0.5%) ceiling or a one-percent (1%) ceiling for the combined total of multifamily units with estimated rent and units excluded from the denominator. Only Fannie Mae indicated opposition to such a ceiling, writing that “Enforcement of percentage ceilings will perpetuate penalties against and create a disincentive for Fannie Mae to engage in the very business that HUD has identified for expanded penetration—single family, owner-occupied, 2-4 unit housing and small multifamily rental properties.”

(3) HUD's Determination. In order to promote liquidity in the multifamily mortgage market, including mortgages on properties which may not have current data on the affordability of such units the Department believes that it is reasonable for the GSEs to provide estimated affordability data for such properties, which would be utilized for purposes of calculating performance toward the Low- and Moderate-Income Goal and the Special Affordable Housing Goal as long as the data sources and methodology are reliable. The data sources and methodology used by a GSE to estimate affordability data are, therefore, subject to HUD review and approval. Estimated affordability data may be used up to a maximum of five (5) percent of units backing GSE multifamily purchases in any given year.

In its evaluation of whether to accept a proposed methodology for estimating affordability data, the Department will seek to determine: (a) The reliability of the data source(s) used including the size of the sample used; (b) the accuracy of the calculations; and (c) the reasonableness of the proposed methodology with regard to providing an unbiased measure of GSE performance toward the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal, including the degree to which the methodology accurately predicts affordability information and goals performance on units backing GSE acquisitions in cases where current affordability data are known. The GSEs will be required to certify that any proposed estimated affordability methodology meets these standards. Methodologies that tend to understate actual rents, or which otherwise tend to overstate the affordability of GSE multifamily mortgage purchases or exaggerate GSE goals performance relative to actual performance, will not be considered acceptable by HUD.

Once a methodology is approved, the Department will closely monitor its implementation and its effects on calculated goals performance. Withdrawal of Departmental approval of an estimated affordability methodology could be warranted if evidence becomes available indicating that use of estimated affordability methodologies is unreliable or has undermined GSE incentives to collect and maintain rent data.

HUD does not believe it is necessary to codify in the regulations the specific methodology for estimating affordability data. The concept of estimating affordability data is new relative to the affordable housing goals. Both HUD and the GSEs need to evaluate the implications of the methodology proposed, monitor performance over time using such data, evaluate new data sources that may become available and become more predictive. HUD needs the flexibility to make changes and refinements to the approved methodology based on experience, without unnecessary limitations. In approving any methodology and data sources, HUD will, of course, be mindful of the GSEs' needs for operational certainty in making determinations.

With regard to circumstances where estimation of affordability on multifamily properties with missing data is not feasible, HUD believes it is reasonable to exclude such units from the denominator as well as the numerator for purposes of calculating performance toward the Low- and Moderate-Income Goal and the Special Affordable Housing Goal. The Department does not believe that a percentage ceiling on the exclusion of multifamily units with missing data from the denominator is needed in order to preserve incentives for data collection, and could actually be harmful from the standpoint of the reliability of the housing goals as a measure of actual GSE performance. Because the percent of multifamily units qualifying for the Low- and-Moderate Income Goal is so much higher than the average across all property types (over 90 percent for multifamily, compared with approximately 45 percent overall), an incentive will remain in place for the GSEs to collect rent data or obtain reliable estimated rents wherever it is feasible to do so. For the same reason, the Department believes that applying a ceiling on exclusion of units from the denominator as well as the numerator for goal calculation purposes would undermine the reliability of the Low- and Moderate Income Goal as a measure of actual GSE performance, since multifamily units above the ceiling would be counted as not being affordable when, in fact, there is approximately a 90 percent probability that such units do meet the requirements of the Low- and Moderate-Income Housing Goal. Similar arguments could be made with regard to the Special Affordable Housing Goal. Therefore, a percentage ceiling on removal of units from the denominator as well as the numerator is not necessary or warranted at this time.

b. Single Family Rental Units.

(1) Overview. The Department further proposed to exclude rental units in 1-4 unit properties with missing rent data from the denominator as well as the numerator in calculating performance under the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal. HUD asked for comment on whether it should establish a percentage ceiling for such exclusions.

This final rule retains the provision excluding rental units in 1-4 unit properties with missing rent data from the numerator and the denominator in calculating performance under the two goals. These properties disproportionately serve affordable housing markets and the GSEs should be active in this segment of the market. As the Department is awarding bonus points for the units in owner-occupied single family rental properties, the GSEs have a large incentive to obtain the required affordability data. When the data is not available, however, the Department does not wish to create a disincentive to purchase mortgages on these properties simply because affordability data is not available.

(2) Summary of Comments. A number of commenters wrote in favor of excluding rental units in 1-4 unit properties from the denominator as well as the numerator for purposes of calculating performance toward the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal when rent data are missing. No commenters indicated opposition to such exclusion.

Writing in support of the ceiling concept, Freddie Mac suggested a two-percent (2%) ceiling on the exclusion of single family rental units from the denominator. Fannie Mae objected to such a ceiling, commenting that a ceiling was unnecessary given that it is in Fannie Mae's interest to obtain rent data on single family rental properties when it is cost effective to do so. Other commenters endorsed a percentage ceiling on the number of single family rental units that would be excluded from the denominator as well as the numerator for purposes of calculating performance toward the Low- and Moderate-Income Housing Goal and the Start Printed Page 65073Special Affordable Housing Goal when rent data are missing.

Fannie Mae and Freddie Mac both suggested that the use of estimated rents should be permitted for single family rental properties with missing data.

(3) HUD's Determination. With regard to single family rental units with missing rent data, HUD believes it is reasonable to remove such units from the denominator as well as the numerator for purposes of calculating performance toward the Low- and Moderate-Income Goal and the Special Affordable Housing Goal. Because of the high degree of affordability of single family rental units, the Department does not believe that a percentage ceiling on exclusion of single family rental units with missing data from the denominator is needed in order to preserve incentives for data collection, and could actually be harmful from the standpoint of the reliability of the housing goals as a measure of actual GSE performance. HUD will monitor the GSEs' use of missing data provisions to ensure that they are being used in a reasonable way.

The Department has determined not to permit the use of estimated affordability data where it is missing for single family rental units. There are several reasons why HUD believes this a reasonable and prudent decision.

A decision to exclude units with missing affordability data from the numerator as well as the denominator for certain goals calculation purposes on single family rental properties removes a potential disincentive to an expanded GSE presence in the markets for mortgages on single family rental properties at the same time. The Department believes this segment of the market has unmet credit needs. To encourage the GSEs to move into this market, it is awarding bonus points for the rental and owner-occupied units in owner-occupied single family rental properties. The use of bonus points will serve as an additional incentive to the GSEs to obtain the necessary affordability data in order to obtain bonus credit.

Furthermore, HUD calculates affordability of single family rental units for purposes of the housing goals using origination-year rents, in contrast to multifamily, where acquisition year rents are used. While acquisition year rents on multifamily properties may sometimes be difficult to provide on seasoned and negotiated transactions where lenders have not continued to collect annual rent data following loan origination, this situation does not apply to single family rental properties, since information on rent at the time of loan origination is ordinarily required by lenders and secondary market institutions as part of the loan underwriting process.

The Department's decision to allow the estimation of affordability data with the limitations provided in this rule for multifamily rental units affords an opportunity to pilot the estimated rent methodology in an appropriately controlled environment.

c. Single Family Owner-Occupied Units.

(1) Overview. The Department also proposed to exclude single family owner-occupied units from the denominator as well as the numerator for purposes of calculating performance toward the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal when data on borrower income are missing, provided the unit is located in a census tract with median income less than or equal to area median. HUD proposed to restrict this exclusion up to a ceiling of one percent (1%) of the total number of single family, owner-occupied dwelling units eligible to be counted toward the respective housing goal.

This final rule retains the provision to exclude single family owner-occupied mortgages from both the numerator and the denominator when borrower income is missing for properties located in lower income areas subject to a one percent maximum.

(2) Summary of Comments. A number of commenters wrote in favor of excluding at least some single family owner-occupied units from the denominator as well as the numerator for purposes of calculating performance toward the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal when income data are missing. One commenter indicated opposition to such exclusion.

Both Fannie Mae and Freddie Mac expressed opposition to restricting the exclusion of single family owner-occupied units with missing income data from the denominator only in lower-income areas. They recommended a two percent ceiling without these geographic restrictions.

In its comments, Fannie Mae stated that “the place-based restriction that HUD proposes implies an unreasonable assumption that all the units that are missing data outside of the low-income census tracts are not affordable. The effect of the cap is to deny credit for units that are missing data and even when those units have some statistical likelihood of serving loans to low- and moderate-income borrowers. HUD's proposed methodology treats loans to low- and moderate-income borrowers differently simply because the borrower chose to purchase a property in a higher-income area.” While opposed, in principle, to the concept of a ceiling on the exclusion of missing single family owner-occupied units from the denominator for goals calculation purposes, Fannie Mae stated that any ceiling established by the Department should be set at “not less than two percent.”

Similarly, Freddie Mac wrote that “A substantial fraction of mortgages in above-average income tracts are made to low- and moderate-income families' citing 1998 HMDA data in support of this contention. Consequently, “geographic restrictions would erroneously exclude many low- and moderate-income loans from performance measures.”

Several commenters endorsed HUD's proposed one percent ceiling on exclusion of single family owner-occupied units with missing data from the denominator although some commenters thought the ceiling should be lower than one percent. A number of other commenters expressed opposition to this ceiling. No comments were received on the geographic restrictions aside from those from the GSEs.

(3) HUD's Determination.

With regard to single-family owner-occupied units with missing income data, HUD believes it is reasonable to remove such units from the denominator as well as the numerator up to one percent of the eligible total for purposes of calculating performance toward the Low- and Moderate-Income Goal and the Special Affordable Housing Goal provided such units are located in tracts where median income is less than or equal to area median income.

The percentage ceiling and the restriction to tracts where median income is less than or equal to area median income are both necessary in order to ensure that the exclusion does not result in undue exaggeration of GSE performance as calculated in achieving the housing goals as compared to actual performance. Because single family owner-occupied units are significantly less affordable than all other property types in the conventional, conforming mortgage market according to HUD's estimates (approximately 36 percent single family owner-occupied units meet the Low-and Moderate-Income Housing Goal, compared with 45 percent overall), excluding single family owner-occupied units with missing data from the denominator as well as the numerator could significantly raise the proportion of GSE acquisitions counting toward the Low-and Moderate-Income and Special Affordable Housing Goals Start Printed Page 65074above actual performance. The one-percent ceiling on exclusion of single family owner-occupied units from the denominator places a limit on the degree to which such exclusions bias or affect the data, and the restriction to tracts with income less than area median serves to increase the likelihood that the affordability characteristics of the excluded units resembles that of the “typical” GSE purchase, further limiting the bias that would otherwise be introduced.

In HUD's view, the proposed geographic restriction on the exclusion of missing single family owner-occupied units from the denominator as well as the numerator for certain goals calculation purposes is, therefore, reasonable and necessary to correct for the bias that would otherwise be introduced even with a one-percent ceiling. Fannie Mae's contention that “the place-based restriction that HUD proposes implies an unreasonable assumption that all the units that are missing data outside of the low-income census tracts are not affordable” is not pertinent to HUD's determination. The Department made no such assumption. HUD is well aware that many low-income borrowers choose to live in tracts with median income above the area median, as pointed out by Fannie Mae. Conversely, however, a significant number of above median-income borrowers choose to live in tracts with median income below the area median. HMDA data does, however, show a strong correlation between borrower income as a percent of area median and tract income as a percent of area median, suggesting that tract income serves as a useful predictor of borrower of income. For example, in 1998, 55 percent of conforming, conventional owner-occupied loans in tracts where median income was less than area median were to low-and moderate-income borrowers. In contrast, only 33 percent of loans in high-income tracts were to low-and moderate-income borrowers. (Overall, 42 percent of single family owner-occupied loans in HMDA data were to low-and moderate-income borrowers.) HUD's analysis of GSE loan-level data reveal a similar correlation between borrower income as a percent of area median and tract income as a percent of area median, although the low-mod percentage of GSE acquisitions is lower than in HMDA data.

Accordingly, HMDA findings support the conclusions that HUD's proposed geographic restrictions on the exclusion of missing single family owner-occupied data will (i) result in goals calculations that more accurately track actual performance than would otherwise be the case and (ii) respond appropriately to any perceived weakening of incentives for the GSEs to collect affordability data to the extent feasible.

d. Other Matters. Freddie Mac argued that units with missing census tract data should be excluded from the denominator as well as the numerator for purposes of calculating performance toward the Underserved Areas Goal up to a maximum of 0.5 percent of the total.

The Department has not determined, however, that it is reasonable to remove units with missing geographic information from the denominator as well as the numerator for purposes of calculating performance toward the Underserved Areas Goal. In those limited instances where census tract (for metropolitan areas) or county (for nonmetropolitan areas) cannot be determined using automated methods, manual methods can be used.

13. Seasoned Mortgage Loan Purchases “Recycling” Requirement

a. Overview. Under section 1333(b)(1)(B) of FHEFSSA, 42 special rules apply for counting purchases of portfolios of seasoned mortgages under the Special Affordable Housing Goal. Specifically, the statute requires that purchases of seasoned mortgage portfolios receive full credit toward the achievement of the Special Affordable Housing Goal if “(i) the seller is engaged in a specific program to use the proceeds of such sales to originate additional loans that meet such goal; and (ii) such purchases or refinancings support additional lending for housing that otherwise qualifies under such goal to be considered for purposes of such goal.” 43 HUD refers to this provision as the “recycling requirement.”

The proposed rule suggested changes to § 81.14(e)(4) of the current regulations. The proposed language was intended to provide guidance to the GSEs with regard to the recycling requirements described above and to provide new, simpler rules when it is evident based on the characteristics of a mortgage seller that the recycling requirements would likely be met.

The rule proposed that certain categories of lenders could be presumed to conduct a lending program meeting the recycling requirements of the statute and regulations. These categories include federally regulated financial institutions with satisfactory ratings on recent Community Reinvestment Act examinations and specific categories of lenders with affordable housing missions.

b. Guidance Provided on Recycling Requirements. Commenters were generally supportive of the overall guidance proposed by the Department with regard to determining when recycling requirements were met in order to count purchases of seasoned mortgage loans toward the Special Affordable Housing Goal, assuming they otherwise qualified for the goal. These provisions are included in the final rule with three specific changes based on the comments received. The changes made in the proposed language relate to the satisfactory CRA requirement for Federally insured financial institutions, identification of other institutions and/or organizations presumed to meet the recycling requirements, and the treatment of third party originations under the recycling provision. Changes made in the final rule on these three aspects are discussed in more detail below.

c. CRA Requirement.

(1) Summary of Comments. Overall commenters supported the proposed changes identifying specific criteria and standards for the recycling requirements. However, many commenters disagreed with HUD's requirement that a financial institution subject to CRA examinations must have received “at least a satisfactory performance evaluation rating for at least the two most recent examinations under the Community Reinvestment Act” to be presumed to meet the recycling requirements.

Fannie Mae, Freddie Mac and several other commenters suggested that a satisfactory performance evaluation rating on the most recent examination is sufficient, as opposed to the two most recent examinations, since the period between examinations can be as long as 60 months. A number of commenters noted that this could be a particularly difficult requirement for small institutions, who are examined much less frequently.

Other commenters suggested that two consecutive outstandings is a more suitable standard, as 78 percent of banks received satisfactory ratings in their 1999 CRA exams and about 75 percent received these ratings in previous years.

Still other commenters were supportive of HUD's proposal of at least a satisfactory performance evaluation rating for at least the two most recent examinations under the Community Reinvestment Act because it would reduce the compliance burden of both the GSEs and depository institutions, allowing them to spend more time on the business of financing housing loans.

(2) HUD's Determination. HUD has reviewed these comments and noted that the proposed rule, in establishing the CRA examinations and ratings of financial depository institutions as a Start Printed Page 65075basis for determining that a financial institution met the recycling requirements for seasoned loan purchases under the Special Affordable Housing Goal, did not make a distinction between small and large depository institutions as intended and reflected in the CRA regulation 44 and the Gramm-Leach-Bliley Act of 1999. 45 The 1995 CRA regulation distinguishes, for examination purposes, four different types of financial institutions based on their size, structures, and operations: Small banks, large banks, wholesale banks, and limited purpose banks. Accordingly, the 1995 regulation provides different performance procedures, standards, ratings, and cycles for small banks, large banks, wholesale banks, and limited purpose banks. All of the procedures reflect the intent of the regulation to establish performance-based CRA examinations that are complete and accurate but, to the maximum extent possible, mitigate the compliance burden for institutions.

Under section 712 of the Gramm-Leach-Bliley Act, small banks with aggregate assets of not more than $250 million will be subject to routine examination:

  • Not more than once every 60 months for an institution that has achieved a rating of “outstanding record of meeting community credit needs” at its most recent examination;
  • Not more than once every 48 months for an institution that has received a rating of “satisfactory record of meeting community credit needs” at its most recent examination.
  • As deemed necessary by the appropriate federal financial supervisory agency for an institution that has received a rating of “less than satisfactory record of meeting community credit needs” at its most recent examination.

In view of the comments received and based on its analysis of the 1995 CRA regulations and the Gramm-Leach-Bliley Act of 1999, this rule includes the recycling requirement that a financial institution have “at least a satisfactory performance evaluation rating for at least the two most recent examinations under the Community Reinvestment Act” for large banks and wholesale banks that are subject to CRA examinations. Limited purpose banks are not making home mortgage loans and therefore are not relevant for this analysis. This final rule adds a provision for small institutions with assets of no more than $250 million that such institutions must have received “a satisfactory performance evaluation rating for the most recent examination under the Community Reinvestment Act to be presumed to meet the requirements in paragraphs (e)(4)(i) through (e)(4)(iv) of this section for seasoned loans.” This safe harbor provision will also apply to the affiliates of depository institutions, provided that these affiliates are subject to the CRA examinations.

With regard to the suggestion that the standard for CRA examinations be two consecutive outstanding ratings, the Department believes that such a standard would be counterproductive. The purpose of the standard is to identify those financial institutions that are in the business of serving affordable housing markets. Using a satisfactory CRA examination rating achieves that purpose and is retained in the final rule.

d. Classes or Categories of Organizations Presumed to Meet Recycling Requirement.

(1) Summary of Comments. With regard to other additional classes of institutions or organizations that should be recognized as meeting the recycling requirements, most commenters, including the GSEs, agreed with HUD's proposal that State Housing Finance Agencies or Special Affordable Housing Loan Consortia should be presumed to meet the recycling requirements. However, both GSEs urged that HUD provide them with “as much flexibility as possible on this provision.” Fannie Mae opposed HUD approval of additional lending institutions or organizations and, instead recommended that HUD provide a list of HUD-approved institutions, and criteria for the GSEs to qualify lenders or certain kinds of lending or transactions. Freddie Mac suggested HUD “broaden the regulatory presumption of recycling to all sellers of mortgages so long as they originate or purchase qualifying special affordable housing goal mortgages in the ordinary course of business.”

A great number of commenters suggested that HUD's list also include other “non-traditional lenders” who serve targeted communities and who could potentially benefit from the liquidity that the change could provide. These commenters mentioned the following institutions: Community development financial institutions, minority owned lenders, women owned lenders, non-profit lenders, and public revolving loan funds.

Other commenters urged HUD to include all credit unions in HUD's list because credit unions originate low-cost residential loans that make housing affordable to millions of credit union members even though they are exempt from CRA requirements. At a minimum, it was suggested that “seasoned loans purchased from community development credit unions, which are chartered to serve low-income communities, should qualify for goal credit.

(2) HUD's Determination. HUD has reviewed the above comments and agreed to expand the safe harbor provision to include the following institutions or classes of institutions that the GSEs may presume meet the recycling requirements as long as these institutions have an affordable housing mission: State housing finance agencies; affordable housing loan consortia; Federally insured credit unions that are either (a) community development credit unions, or (b) credit unions that are members of the Federal Home Loan Bank System and meet the first-time homebuyer standard of the Community Support Program; community development financial institutions; public loan funds; and non-profit lenders. The final rule retains the requirement that any additional classes of institutions or organizations must be approved by the Department. The final rule establishes a reasonable set of lender characteristics that are presumed to meet the recycling provisions that cover a large portion of the affordable lending market. For those lenders falling outside of these parameters, the final rule provides the GSEs with broad guidance as to what a recycling program should include if a lender does not fall into an accepted category. The GSEs have broad latitude to evaluate the circumstances of a particular lender in counting seasoned loan purchases toward the Special Affordable Housing Goal. A GSE does not have to get prior approval to do business with a lender that does not fall into the presumptive category as long as the GSE verifies and monitors that the lender is conducting an affordable lending program consistent with the guidelines provided. Prior approval is only required if a seller of loans falls outside the boundaries established in the final rule and the GSE wants them designated among the category of institutions already identified and presumed to meet the requirements. The Department does not anticipate that such action will limit the GSEs ability to conduct business in any material way, but rather will relieve the burden of having to verify and monitor the lending programs of those entities presumed to meet the recycling requirements.

e. Third Party Transactions.

(1) Overview. In the proposed rule, HUD solicited comments on the treatment under the recycling provisions of structured transactions where the mortgage loans included in the transaction were originated by a Start Printed Page 65076depository institution or mortgage banker engaged in mortgage lending on special affordable housing but acquired, packaged and re-sold by a third-party, e.g., an investment banking firm that is not in the business of affordable housing lending.

(2) Summary of Comments. Fannie Mae believes that “the appropriate approach is to extend the streamlined application to third party deliveries.” Fannie Mae argues that when it purchases loans delivered by third parties, it “is supporting the marketplace dynamic that provides liquidity,” and therefore “the intermediate step in no way degrades the liquidity support provided to the institutions or the mortgage products.”

Freddie Mac did not address this issue directly but pointed out that Congressional intent underlying the seasoned, recycling requirement was “to ensure that the proceeds will be used in a manner that increases the availability of mortgage credit for the benefit of low-income families.” According to Freddie Mac, Congress' interest was to ensure that “mortgage proceeds were funneled back into the mortgage market, not that specific types of lending programs should be used to recycle these proceeds.” Thus, Freddie Mac recommends that HUD include all mortgage sellers that regularly engage in originating or purchasing mortgages that meet the special affordable housing goal criteria. The alternative, according to Freddie Mac, would be “adoption of the BIF/SAIF regulatory presumption while maintaining the current regulatory scheme.”

(3) HUD's Determination. HUD recognizes that Congress intended that the housing goals generally and the recycling provisions specifically were to expand the availability of affordable housing with particular emphasis on the purchase of loans that are originated in conjunction with affordable housing programs, the creation of innovative product lines, or the building of institutional capacity and infrastructure among others in the industry.46 If the mortgages were, in fact, originated by an entity that meets the new recycling presumptions, i.e., is regularly in the business of mortgage lending; is a BIF-insured or SAIF-insured depository institution; and is subject to, and has received at least a satisfactory performance evaluation rating under the Community Reinvestment Act, or is among the enumerated class or classes of organizations whose primary business is financing affordable housing mortgages; but the mortgages were delivered to the GSEs by a third party seller after a relatively short holding period, the purchase of such mortgages would meet the intent of Congress and fulfill the spirit of the recycling requirement. Therefore, in this final rule, HUD will allow mortgages delivered by such third party sellers to meet the recycling presumptions in § 81.14(e)(4)(vi) and (vii) of this final rule if the mortgages were originated by an entity that comes within the recycling presumptions; and the seller acted for, or in conjunction with, such entity in the transaction with the GSE. A seller that holds loans itself for more than six months is not presumed to be acting for, or in conjunction with, such an entity. Accordingly, the final rule excepts such sellers from the benefit of the presumption. Notwithstanding, a seller that otherwise meets the tests of the recycling provisions may qualify under the rules on its own behalf. Moreover, in any case, if the mortgages were originated by an entity that does not meet the recycling presumptions, the GSEs can still get goals credit under the Special Affordable Housing Goal if they verify and monitor that the originator, acting in conjunction with a seller, meets the recycling requirements in § 81.14(e)(4)(i) through (iv).

14. Counting Federally Insured Mortgages Including HECMs, Mortgages on Housing in Tribal Areas and Mortgages Guaranteed by the Rural Housing Service Under the Housing Goals

a. Overview. Under § 81.16(b)(3) of HUD's regulations prior to this final rule, non-conventional mortgages—mortgages that are guaranteed, insured or otherwise obligations of the United States—did not generally count under the three housing goals. However, mortgage loans under the Home Equity Conversion Mortgage (HECM) Program and the RHS's Guaranteed Rural Housing Loan Program have received credit under the Special Affordable Housing Goal. FHEFSSA specifically provides that mortgages that cannot be readily securitized through the Government National Mortgage Association (GNMA) or another Federal agency and for which a GSE's participation substantially enhances the affordability should receive full credit under the Special Affordable Housing Goal. On this basis, those two categories of mortgages would count under that goal if they finance housing for very low-income families or low-income families in low-income areas and meet recycling requirements if seasoned.

In the proposed rule, HUD proposed to amend § 81.16(b)(3) to count and give full credit for the following types of mortgage loans toward all three housing goals: mortgage loans under the HECM Program, mortgages guaranteed by RHS, and mortgage loans made under FHA's Section 248 program and HUD's Section 184 program for properties in tribal lands. (This section has also been amended as described herein at paragraph 14, Expiring Assistance Contracts.) HUD also proposed that other types of mortgages involving Federal guarantees, insurance or other Federal obligation may be eligible for credit under the goals if a GSE submits documentation to HUD that supports eligibility for HUD's approval and the Department determines, in writing, that the financing needs addressed by such programs are not well served and that the mortgage purchases under such program should count under the housing goals.

b. Summary of Comments. Commenters other than the GSEs generally supported the proposed change allowing goals credit for the GSEs' purchases of HECMs and rural and tribal mortgages. They stressed the need for liquidity for such programs and for encouraging the GSEs to better serve these markets. They pointed out that these markets are still undeveloped and underserved.

Fannie Mae supported the proposed changes with regard to government loans, but Freddie Mac made no comment.

A few commenters recommended that HUD count all reverse mortgages, not just HECMs, toward the three goals. Other commenters suggested that loans guaranteed by the RHS' Sections 538 and 515 programs should also receive goals credit as they provide high quality affordable multifamily housing for lower-income families in rural areas.

Some commenters suggested that HUD also should include all mortgages that are supported in some way by state and local governments. Others recommended that predevelopment grants or loans, interim development or bridge financing, and permanent financing be considered.

Fannie Mae objected to the proposal for HUD's review and approval of goals credit for other types of government loan programs and requested that HUD provide a set of criteria for the GSEs to apply and make their own determinations. According to Fannie Mae, the GSEs should receive goal credit for the purchase of specialized government program loans if two conditions are met: (1) Loans are made under any federally-insured programs (except for FHA loans insured under section 203(b) or VA loans insured under the VA single family insurance program); and (2) the GSEs add valuable Start Printed Page 65077liquidity, lower costs, additional credit enhancements, or some other value to the financing of these loans.

c. HUD's Determination. In view of this general support for the proposed changes and based upon its review of data on the GSEs' mortgage purchases of HECMs, RHS mortgages and loans made to Native Americans under FHA's Section 248 program and HUD's Section 184 program, this final rule amends § 81.16(b)(3) to except mortgages under the HECM program, single-family mortgages guaranteed by RHS under the Section 502 program, and loans made under FHA's Section 248 program and HUD's Section 184 program on properties in tribal lands from the general exclusion from goals credit for non-conventional loans. This final rule allows goal credit for those specific Federally insured or guaranteed mortgage loans.

As proposed, the final rule provides that HUD will review other types of mortgages involving Federal guarantees, insurance or other Federal obligation for goals credit. HUD's review of the GSEs' non-conventional mortgage purchases is needed, among other reasons, to ensure compliance with FHEFSSA, which permits mortgages that cannot be readily securitized through GNMA or another Federal agency and for which a GSE's participation substantially enhances liquidity, to receive full credit under the Special Affordable Housing Goal. In view of the ample liquidity among the great majority of FHA loans, HUD must exercise ongoing responsibility to evaluate whether the GSEs' mortgage purchases under non-conventional mortgage programs (other than HECM program, specified RHS mortgage programs, and FHA's Section 248 program and HUD's Section 184 program on properties in tribal lands) should count under the Special Affordable Housing Goal. Beyond its responsibility under the Special Affordable Housing Goal, HUD must continually determine whether goals credit should be provided for particular GSE purchases. HUD has evaluated and considered the specific programs enumerated above and, at this time, is able to determine that goals credit should be given for the GSEs purchases of mortgages under these programs because these purchases will address credit needs that are not well served. For other programs, HUD must make the same careful and complete evaluation before it can decide in accordance with FHEFSSA whether goals credit is warranted.

This final rule retains a provision that to the extent categories of non-conventional mortgage purchases that now count toward the goals, they no longer will be excluded from the denominator of the GSEs' mortgage purchases as are other non-conventional loans that do not receive credit under the goals.

15. Expiring Section 8 Assistance Contracts

a. Overview. Over 900,000 housing units in approximately 10,000 multifamily projects have been financed with FHA-insured mortgages and supported by project based Section 8 housing assistance contracts.47 Many of these contracts will expire over the next five years. A significant portion of these contracts currently provide for rents for assisted units that substantially exceed the rents for comparable unassisted units in the local market. Simply reducing rents to a level which may not support the project's debt service would risk likely defaults on the FHA-insured mortgage payments resulting in substantial claims to FHA's insurance funds.

In October 1997, Congress enacted the Multifamily Assisted Housing Reform and Affordability Act of 1997 (MAHRA; 42 U.S.C. 1737f) specifically to address the problem of expiring contract for project-based Section 8 rent subsidies for certain multifamily rental projects, most of which are insured by FHA. MAHRA authorized a new Mark-to-Market Program designed to preserve low-income rental housing affordability while reducing the long-term costs of Federal rental assistance for these projects.48 MAHRA establishes processes and standards for debt restructuring under the program where it is determined that such restructuring is appropriate and necessary.

MAHRA also amended section 1335(a) of FHEFSSA (12. U.S.C. 4565(a)(5)) to require Fannie Mae and Freddie Mac to “assist in maintaining the affordability of assisted units in eligible multifamily housing projects with expiring contracts.” MAHRA amendments further stipulate that such actions shall constitute part of the contribution of each GSE toward meeting its housing goals as determined by the Secretary. In the proposed rule, HUD proposed to provide partial to full credit under the housing goals as determined by HUD for actions that maintain the affordability of assisted units in eligible multifamily housing projects with expiring contracts include the restructuring or refinancing of mortgages, and credit enhancements or risk-sharing arrangements to modified or refinanced mortgages. HUD solicited comments on how and to what extent the GSEs should receive credit for such actions.

b. Summary of Comments. Commenters who addressed this issue were generally supportive of HUD's proposal to award credit for these activities. Although Freddie Mac did not express an opinion in its comments, Fannie Mae expressed some support for HUD's approach. However, Fannie Mae requested that HUD consider some revisions to its proposal. Specifically, Fannie Mae suggested that HUD broaden its definition of actions which would receive credit to include the purchase of FHA-insured mortgages, mortgage revenue bonds and equity investments, including Low Income Housing Tax Credits. Fannie Mae suggested that HUD strike the language “* * * as determined by HUD” from the final rule to avoid a regulatory process that requires prior HUD approval for determining goals credit. Fannie Mae also suggested that actions qualifying for credit under this section should always receive full, rather than partial, credit.

c. HUD's Determination. HUD has determined that it is both appropriate and consistent with the statutory mandates of FHEFSSA and MAHRA that actions taken by the GSEs to assist in maintaining the affordability of assisted multifamily units with expiring contracts receive goals credit as part of the GSEs' contributions in meeting their housing goals as determined by the Secretary. HUD's current counting rules permit the GSEs to receive full credit for purchases of mortgages or interests in mortgages as set forth in 24 CFR 81.16. Those rules address goals eligibility standards for credit enhancements, the purchase of refinanced mortgages, mortgage revenue bonds and risk-sharing. Because HUD intends that goals credit for actions in conjunction with expiring assistance contracts should conform to actions that are already awarded credit in other transactions, HUD has determined that it is not necessary to restate these rules with respect to eligibility of actions for goals credit that assist the Mark-to-Market program. Accordingly, this final rule revises the language to eliminate redundancies by referencing current regulations.

HUD agrees with Fannie Mae that the purchase of FHA-insured mortgages resulting from restructured financings of projects with expiring assistance contracts is an appropriate activity to include in actions eligible for goals credit. Accordingly, HUD has amended § 81.14(e)(3) to specify that purchases of mortgages on projects with expiring assistance contracts that meet the Start Printed Page 65078requirements of 12 U.S.C. 4563(b)(1)(A)(i) and (ii) will receive full credit toward achievement of the special affordable housing goal.

This final rule also clarifies the counting treatment for actions a GSE takes to modify or restructure the terms of mortgages with expiring assistance contracts which it may hold in portfolio, provided such restructuring results in lower debt service costs to the project's owner. HUD has added § 81.16(c)(9)(ii) to provide full credit under any housing goal for these activities.

HUD has reviewed comments from Fannie Mae, Freddie Mac, and others regarding awarding goals credit for equity investments, particularly Low Income Housing Tax Credits (LIHTCs). These comments, while not necessarily offered in response to this section of the proposed rule, indicate a continuing interest in counting these transactions under the goals. The Department agrees that the GSEs' participation in LIHTCs plays a vital role in the development of affordable housing. By excluding these investments from goals credit HUD does not intend to convey any lack of appreciation for their importance. However, FHEFSSA imposes certain standards on what can and cannot be counted towards the housing goals.49

Specifically, only mortgage purchases as defined in FHEFSSA and the implementing regulation meet the standard for eligibility. As described in the preamble to HUD's 1995 regulation, the purchase of LIHTCs is not a mortgage purchase or the equivalent of a mortgage purchase and, therefore, is not eligible for goals credit under HUD's general counting requirements as set forth in the implementing regulation.

While MAHRA does provide that actions to maintain the affordability of assisted units under MAHRA will count under the goals, MAHRA does not specifically impose standards for counting actions with respect to expiring assistance contracts under the goals but leaves this matter to HUD's determination. In determining whether actions count under the goals, HUD will generally be guided by definitions and counting conventions set forth in the implementing regulation. In instances where a GSE engages in actions not specified in the implementing regulation but which it believes warrant goals credit, or where a GSE provides more than one form of assistance for a single project, the GSE must submit the transaction to HUD for a determination on the appropriate level of credit to be awarded if the goals credit is sought. In making a determination, HUD will award counting treatment for those actions that are required under MAHRA and that may count under FHEFSSA.

A few commenters expressed concern about the counting treatment for mortgage purchases on projects with expiring contracts that “opt out” of the assisted program. One commenter suggested that HUD impose additional affordability requirements as a condition of awarding goals credit for such transactions. However, HUD finds that the issue of affordability relative to goals credit is already well established. HUD's current regulations address the income requirements for determining how mortgage purchases are counted under any of the housing goals. There are other statutory provisions that also address long-term affordability. Projects that rely upon or intend to rely upon equity investments from the LIHTC program must meet tax code requirements for affordability for a 15-year period.50 Mortgages secured by projects subject to restructuring plans must provide for a Use Agreement that includes affordability restrictions and remains in effect for at least 30 years.51 HUD believes that the current counting rules and statutory definitions under FHEFSSA and MAHRA are sufficient to ensure that goals credit is awarded appropriately for mortgage purchases that meet prescribed housing affordability standards.

16. Provision for HUD to Review New Activities To Determine Appropriate Counting Under the Housing Goals

a. Overview. In order to address confusion about whether a given transaction will receive credit under the housing goals, HUD proposed adding a provision at § 81.16(d) to further clarify its position regarding HUD's authority review new activities, or classes of transactions, to determine appropriate counting treatment under the housing goals.

While the GSEs participate in transactions and activities that support community and housing development in general, FHEFSSA is clear that only “mortgage purchases” count toward performance on the housing goals. Section 81.16(a) of the regulations stipulates that the Secretary shall consider whether a transaction or activity of the GSE is substantially equivalent to a mortgage purchase and either creates a new market or adds liquidity to an existing market. As provided in § 81.16(b), HUD has determined that certain transactions do not meet those criteria and, therefore, will not count toward a GSE's housing goals performance. Examples include equity investments in housing development projects; commitments, options or rights of first refusal to acquire mortgages; mortgage purchases financing secondary residences; purchases of non-conventional mortgages and government housing bonds except under certain circumstances. As provided in § 81.16(c), HUD has determined that certain other transactions, including credit enhancements in certain situations, REMIC purchases and guarantees in certain circumstances, and others, do count as mortgage purchases.

HUD believes that, in order to meet higher goal levels, the GSEs will need to continue to develop new products and approaches while also remaining mindful of FHEFSSA's requirements. HUD invited comment on this proposal.

b. Summary of Comments. Commenters who addressed this issue generally offered support for the proposal. Some commenters, however, confused HUD's proposal to review classes of transactions for goals counting treatment with the Department's New Programs Approval authority as set forth in § 81.51 which relates to HUD's review of a new GSE activity to determine whether it is a new program and whether it is authorized under the GSE's charter and in the public interest. The provision in § 81.16(d) of the proposed rule concerns instead whether a class of transactions counts as mortgage purchases that will receive credit under the housing goals. In HUD's proposed rule, no regulatory changes to the New Programs Approval authority were proposed.

Of the comments received, Fannie Mae addressed the issue of counting classes of transactions under the goals in some detail. Generally, Fannie Mae expressed an overall objection to any regulatory provisions that would require prior HUD approval for goals counting purposes, believing instead that HUD should codify clear but flexible rules that remove all uncertainty regarding goals counting treatment. Fannie Mae further stated that prior HUD review could “put in place a disincentive to the development of new and innovative products.” Fannie Mae did not suggest any specific examples of classes of transactions or characteristics that HUD should exclude from a prior review process nor did it specify how regulatory guidance could be constructed to address future events. However, Fannie Mae did suggest that HUD impose a 30-day time frame for review after which the transaction(s) would be approved for goals credit unless HUD had notified the GSE otherwise during the review period.

Another commenter expressed concern that HUD intends to count Start Printed Page 65079transactions that are not formally mortgages if HUD believes they serve a new market or add liquidity to an existing market, thereby potentially allowing the GSEs to expand their activities into areas now served by others.

c. HUD's Determination. In assessing these concerns, HUD believes that Fannie Mae's suggestions for additional codified regulatory guidance in lieu of any HUD review are impractical and unnecessary. The regulation already includes numerous provisions that address eligible transactions and their counting treatment. In fact, virtually all transactions in current use which could be substantially equivalent to a mortgage purchase have been addressed elsewhere in the counting rules. Nevertheless, given the pace of innovation in the mortgage and investment markets and the likelihood that the GSEs will devise new lending and marketing approaches in the future, providing a prior-review requirement to address goals counting treatment for these future transactions is both an efficient and practical solution while a more prescriptive approach may not be sufficiently foresighted or encompassing thereby disadvantaging both the public's and the GSEs' interests.

HUD regards concerns that by adding § 81.16(d) to the regulation, HUD is opening the door to counting non-mortgage transactions towards the goals as unwarranted. The regulatory language is explicit in stating that, in order to count towards goals performance, transactions must be “mortgage purchases” in accordance with FHEFSSA. The regulatory language does not use “liquidity” as a criteria for review and approval to count transactions for goals credit, and “liquidity” is not a defining element of “mortgage purchase” under this regulation. Further, the regulation explicitly states which classes of transactions are currently ineligible, and it provides guidance on criteria necessary for qualifying other classes of transactions. Thus the plain meaning of the regulations including the counting rule conventions set forth in the regulation would preclude a broader interpretation of § 81.16(d).

HUD has further determined that establishment of a time limit for HUD review of GSE requests to count transactions is unnecessary. While HUD is aware of the need for responsive action to a GSE's request for guidance and will respond to such requests reasonably, rigid time frames may not provide sufficient review of complex transactions to best serve the public interest. Accordingly, HUD has implemented § 81.16(d) as originally proposed.

17. Counting Rules—Clarifying Technical Provisions

a. Especially Low Income. Section 81.14(d)(1)(i) of the regulations provides that dwelling units in a multifamily property will count toward the Special Affordable Housing Goal if 20 percent of the units are affordable to families whose incomes do not exceed 50 percent of the area median income. HUD's regulations at §§ 81.17 through 81.19 stipulate that the income requirements are to be adjusted based on family size and provide adjustment tables for qualifying family income where incomes do not exceed from 60 percent to 100 percent of area median income. However, there has been no similar adjustment table provided for families whose incomes do not exceed 50 percent of area median income. HUD proposed to amend those sections to provide additional adjustment tables for such families. To be consistent, HUD also proposed to designate such families as “especially low-income families” for purposes of the Department's GSE regulations and to reflect this change in § 81.14. HUD received no comments on these proposals. Therefore, this final rule implements the changes as proposed in § 81.14 and §§ 81.17 through 81.19.

b. Defining the “Denominator”. HUD proposed amending the calculation of “Denominator” to clarify that the denominator does not include GSE transactions or activities that are not mortgages or transactions that are specifically excluded. HUD received no comments on this proposed change, and this final rule implements the change as proposed in 81.14(a)(2).

c. Balloon Note Conversions. HUD proposed to amend the definition of “Refinancing” at § 81.2 to exclude a conversion of a balloon mortgage note on a single family property to a fully amortizing mortgage note provided the GSE already owns or has an interest in the balloon note at the time of the conversion. HUD also proposed amending the counting rules at § 81.16(b)(9) to exclude these transactions from the denominator. Fannie Mae suggested deleting other proposed language which sought to clarify that single family loans with conversion features which had already been exercised prior to purchase by the GSE would count as new purchases. Fannie Mae believed this additional language created confusion and was unnecessary stating that the revised definition of “Refinancing” at § 81.2 already provided sufficient clarification. HUD agrees with this comment. Accordingly, this final rule implements the proposed changes to § 81.2 and to § 81.16(b)(9), with slight revisions to § 81.16(b)(9) to avoid any potential confusion.

d. Title I. HUD proposed awarding the GSEs half credit for purchases of mortgage loans insured under HUD's Title I property improvement and manufactured homes program. Fannie Mae and one other commenter asked that the Department award full credit for Title I mortgages saying that these mortgages support affordable housing needs. Fannie Mae noted that purchases of these loans were difficult transactions to undertake and for this reason should receive more than half credit. One other commenter recommended that no goals credit be given for Title I loans, asserting that such loans do not directly support affordable housing needs.

Given the limited number of comments and their conflicting nature, the Department decided to retain the provision in the final rule that purchases of Title I loans will receive half credit under the housing goals. As explained in more detail in the appendices to this final rule, HUD has determined that such loans finance an important source of affordable housing and an enhanced GSEs role could improve the affordability of such loans for lower-income families.

18. Credit Enhancements

a. Overview. The GSEs utilize a large variety of credit enhancements, for both single family and multifamily mortgage purchases, to reduce the credit risk to which they might otherwise be exposed. For example, the GSEs generally require the use of mortgage insurance on single family loans with loan-to-value ratios exceeding 80 percent. While more common in the multifamily mortgage market, seller-provided credit enhancements may also be required for GSE purchases of single family mortgage loans. Other types of credit enhancements include arrangements such as credit enhancements in structured transactions where a GSE may acquire a pool of loans, mortgage-backed securities (MBS), or real estate mortgage investment conduits (REMICs), and then create separate senior and subordinated securities, structured so that the subordinated securities absorb credit losses; spread accounts, in which a GSE may create a special class of unguaranteed securities where pass-through payments will cease in the event of default of the underlying mortgage collateral; acquisition of senior tranches of REMIC securities by the GSEs which are enhanced by the Start Printed Page 65080presence of subordinate tranches and where the collateral is already credit enhanced prior to purchase; and agency pool insurance coverage provided by a mortgage seller.

Since enactment of FHEFSSA in 1992, HUD's regulations have awarded full goals credit for the purchase of most mortgages or interests in mortgages that otherwise qualify under the definition for each goal regardless of the level of credit risk a GSE might bear in the transaction. However, the increasing complexity of, and prevalence in, the use of credit enhancements have raised questions about whether the GSEs should receive full credit towards the goals for transactions where their credit risk exposure is minimal. In the proposed rule, HUD sought comments on various questions regarding the appropriate goals treatment for transactions with credit enhancements. For example, assuming credit risk can be measured, HUD asked commenters to consider whether HUD should establish a sliding scale from 0 to 100 percent for awarding goals credit depending on the GSE's risk exposure in a transaction. HUD also asked for comments on other issues including whether a minimum risk threshold should be established in order for a transaction to receive any goals credit as well as comments on whether HUD should measure counterparty risk on seller-provided credit enhancements.

b. Summary of Comments. The overwhelming majority of commenters, including Fannie Mae and Freddie Mac, responded with strong opposition to the concept of basing goals credit on the level of credit risk borne by a GSE in the transaction. Freddie Mac expressed concern that, in addition to being inconsistent with the Freddie Mac Act and FHEFSSA, discounting goals credit for protections against default cost would lead to a host of unintended consequences and practical problems, including measurement problems. For example, with regard to multifamily mortgages especially, Freddie Mac stated that “when cross-default or cross-collateralization techniques are used to price credit enhancements, there is no ready and straightforward method of allocating default cost protection to the risks presented by the individual mortgages, let alone to the housing units that are financed by each of those mortgages.”

Fannie Mae also strongly opposed any goals scoring approach based on the level of credit enhancement. Fannie Mae stated that credit enhancements are essential to its safe and sound operation and, in fact, are explicitly recognized under OFHEO's risk-based capital standard as an important risk management tool. Fannie Mae further stated that reducing goals credit based on the level of credit enhancement “is contrary to our charter, misconstrues the purpose of Fannie Mae, distorts the efficient functioning of the capital markets, increases the cost of homeownership, restricts the availability of capital, and weakens the financial soundness of Fannie Mae.”

Commenters representing state and local housing finance agencies, for-profit and non-profit advocacy and consumer groups, trade associations, and the mortgage lending and investment industry were nearly unanimous in voicing objections to any regulatory approach that considered levels of credit enhancements in assigning goals credit. The recurring objection held that such an approach would undermine the purpose of the housing goals regulation by disrupting the risk-sharing partnerships that are critical to making affordable housing lending a reality, thereby resulting in a negative consequence to homeownership. For example, some commenters expressed concern that such an approach could interfere with the GSEs' incentive to develop new affordable mortgage products using risk-sharing arrangements while others felt that reducing goals credit based on the level of risk would have the effect of reducing the amount and liquidity of funds available for affordable housing lending rather than force the GSEs to take on more risk than they felt they could effectively manage. These commenters remarked that since risk sharing arrangements allow more industry partners to bring more capital to the mortgage market, they were concerned that the affordable housing market would be adversely impacted if HUD adopted a regulatory counting scheme that penalized the GSEs for sharing risk.

Two commenters, however, suggested there may be instances in which goals credit should be limited and suggested further review and study of the issue. One commenter stated that the financial benefits of GSE status can and should function as an offset for the assumption of some amount of credit risk but also cautioned that HUD must carefully consider the effects of any regulatory change in this area, especially how OFHEO and the financial markets would view encouraging the GSEs to assume certain credit risks and what effect this approach could have on mortgage rates. Another commenter suggested that HUD establish an industry working group to examine these issues in greater detail. This commenter also supported limiting goals credit on the GSEs' purchase of seasoned mortgages when the selling institution provides a credit enhancement beyond customary representations and warranties, and also supported some limitation on goals credit for loans securitized in commercial mortgage-backed securities (CMBS) and REMIC structures to the risk level of the tranches purchased by the GSEs.

One commenter suggested that, in assigning goals credit based on the GSEs' actual involvement in facilitating the flow of private capital into low/mod communities, there may be a useful prototype in the CRA provisions for allotting goals credit based upon the type of mortgage purchase transaction, i.e., the purchase of newly originated loan versus other mortgage investments. HUD appreciates this suggestion and plans to consider it further.

c. HUD's Determination. HUD has taken the position that GSE credit enhancement transactions provide needed liquidity to the mortgage markets and play a key role in affordable housing lending. As explained in a study HUD has undertaken with the Urban Institute to assess recent innovations in the secondary market for low- and moderate-income lending, the GSEs' purchase of interests in CRA loans is identified as one approach to how the enterprises facilitate liquidity for loans that do not conform to standard guidelines.52 Investment analysts also report that the GSEs' credit enhancement of CRA REMIC securities results in a more attractive debt instrument for investors and a higher return for issuers which benefits lenders seeking to liquidate their CRA portfolios and ultimately borrowers.

HUD recognizes there also are other valid reasons to grant the GSEs full credit under the housing goals for mortgage purchase transactions involving credit enhancements even where the enterprises bear relatively minimal credit risk. For example, in the absence of private mortgage insurance for multifamily mortgages, seller provided credit enhancements apparently are a viable means by which secondary market purchasers may delegate certain of their underwriting responsibilities and share risks. When a GSE purchases a mortgage subject to a recourse agreement or similar arrangement with the lender, the GSE still retains credit risk with respect to holders of the GSEs' mortgage-backed security or, where the mortgage is held in portfolio, for its own account. Of course, even if the GSE is not bearing Start Printed Page 65081substantial credit risk, the GSE may still be bearing other types of risk. For example, the protection afforded to the GSE under recourse agreements is dependent on the soundness of the party to whom the GSE has recourse. In addition, the GSE assumes interest rate risk for mortgages that are retained in portfolio.

In analyzing credit enhancement issues, thus far, there has emerged no clear approach to establishing an appropriate “risk threshold” associated with mortgages purchased by a GSE, below which credit toward the goals should not be granted. Under typical recourse agreements or similar arrangements, GSEs rarely divest themselves of credit risk associated with mortgage purchases in clear-cut percentages of risk. Some arrangements have time or dollar limits. The relative risk assumed by the GSE on one loan compared to another relates not only to the relative risk management characteristics (including mortgage insurance and recourse arrangements), but also to loan-to-value ratios, multifamily debt coverage ratios, interest rate risk, and many other parameters. Moreover, whether there is subsequent securitization or resecuritization of a GSE interest also bears upon the degree of credit risk retained by the GSE in a transaction.

Any determination about discounting goals credit based on the level of risk borne by a GSE in the transaction also must take into account consistency with the GSEs' Charter Acts which require the GSEs to obtain mortgage insurance or its equivalent for certain single family mortgages, and must consider the financial safety and soundness requirements under FHEFSSA as well as its housing goals provisions.

Accordingly, HUD has determined, based on its analysis of available information on the GSEs' credit enhanced transactions, comments and other input received on the proposed rule, as well as its analysis of the law, the complexity of these issues requires additional evaluations before changes are made to these rules. These evaluations will further assess the extent to which the GSEs' use of credit enhancements add value and liquidity to the marketplace, especially for affordable housing lending, as well as the impact their use has on the GSEs' mandate to play a leadership role in the mortgage markets. To assist its evaluations, HUD is undertaking further review and analysis on credit enhancements. Topics being covered in this review include the GSEs' use of credit enhancements provided by seller-servicers, third party vendors, and buyers of subordinated debt in the GSEs' single family and multifamily mortgage transactions. In addition, HUD will continue its assessments of credit enhancement structures including newly introduced structures to determine how and to what extent, if any, HUD's goal counting rules should be modified in the future.

19. Public Use Data Base and Public Information

Section 1323 of FHEFSSA requires that HUD make available to the public data relating to the GSEs' mortgage purchases. In the legislative history of FHEFSSA, Congress indicated its intent that the GSE public use data base is to supplement HMDA data.53 The purpose of the GSE data base is to assist the public, including mortgage lenders, planners, researchers, and housing industry groups, as well as HUD and other government agencies, in studying the GSEs' mortgage activities and the flow of mortgage credit and capital into the nation's communities. At the same time, section 1326 of FHEFSSA protects from public access and disclosure, proprietary data and information that the GSEs submit to the Department and requires HUD to protect such data or information by order or regulation.

To comply with FHEFSSA, HUD established a public use data base to collect and make available to the public, loan-level data on the GSEs' single family and multifamily mortgage purchases. In Appendix F to the December 1, 1995 final rule, the Department specified the structure of the GSE public use data base and identified the data to be withheld from public use.

The single family data was to be disclosed in three separate files—a Census Tract File (with geographic identifiers down to the census tract level), a National File A (with mortgage-level data on owner-occupied 1-unit properties), and a National File B (with unit-level data on all single family properties). The national files do not have geographic indicators. The multifamily data was to be disclosed in two separate files “a Census Tract File and a National File. Each file consists of two parts, one part containing mortgage loan level data and the other containing unit level data for all multifamily properties. For each file, Appendix F identified data elements that were considered proprietary and those that were not proprietary and available to the public, and specified further that certain proprietary elements would be recoded or categorized into ranges to protect the proprietary information and to permit the release of non-proprietary information to the public. This multi-file structure was designed to allow the greatest dissemination of loan-level data, without disclosing proprietary data of the GSEs and causing competitive harm by, for example, allowing competitors to determine the GSEs' marketing and pricing strategies at the local level.

On October 17, 1996, a Final Order describing each data element submitted by the GSEs and the proprietary or nonproprietary nature of each element was published in the Federal Register. The Final Order also recoded, adjusted, and categorized in ranges certain proprietary loan-level data elements to protect proprietary GSE information. HUD released the recoded data elements and the data elements that were identified as non-proprietary information to the public.

In the fall of 1996, the Department released the first publicly available GSE loan level data base, containing non-proprietary information on every mortgage purchased by the GSEs from 1993 to 1995. Subsequently, HUD has made the 1996, 1997, 1998, and 1999 databases available to the public. In addition, HUD issued an order determining that certain aggregations of data that may otherwise be proprietary at the loan level is not proprietary at an aggregated level. Through that order, it is possible for HUD to make available to the public specific tables of nonproprietary information about the GSEs' activities and housing goal performance.

After consideration of the current structure of the GSE public use data base, the Department proposed several changes to its classifications of the GSEs' mortgage data. Those proposed changes were either technical in nature or would, by reclassifying certain data from proprietary to non-proprietary, make available to the public the same data from the GSEs that is made available by primary lenders under the Home Mortgage Disclosure Act (HMDA).

HUD received comments from both GSEs as well as trade organizations, advocacy groups, researchers, and lenders on this issue. Comments were almost evenly divided between those groups approving of increased data disclosure at the loan-level and those that opposed the proposals, mostly out of concern for protecting the privacy of borrowers' and lenders' business strategies. Both GSEs were strongly opposed to increased disclosure, citing competitive issues resulting from the release of what each GSE considered to be proprietary, confidential business information. Fannie Mae and Freddie Mac expressed general concern that Start Printed Page 65082recoding certain loan-level data as non-proprietary at either the census tract or national file level would reveal information about lender relationships, pricing arrangements, and management of credit and interest rate risks. Fannie Mae also took issue with HUD's efforts to conform data available in the GSE public use data base to HMDA data for research purposes, contending that both databases are fundamentally different and cannot be readily reconciled. Lenders expressed a similar concern about the potential for additional public data to reveal business strategies, commenting that the more data HUD makes available through the public use data base, the more likely that other lenders would be able to discern the competition's lending strategies.

Some trade organizations viewed the proposed changes as potentially harmful to consumers. Their viewpoints were representative of similar concerns expressed by lenders and the GSEs. One organization wrote that exposing more detailed information about the consumer to the general public will only enhance the ability of sellers of credit to take unfair advantage of the consumer, particularly the urban and minority consumer.” Another urged that HUD be “sensitive to emerging technology when deciding what data elements to make public on the [public use data base] files. Consumer financial and credit information privacy must be a paramount concern to the Department.” A third organization strongly opposed releasing additional data out of concern for borrowers' privacy and “potential exposure of association members' confidential business information.” Another commenter, however, supported increased disclosure of data, contending that access to more data should lead to a better understanding of the affordable housing market and to reduced costs for those operating in the market.

Housing and community organizations generally viewed HUD's proposed changes as a series of improvements that would make the public use data base more compatible with HMDA data and, therefore, more valuable as a research tool. One commenter also supported bringing the public use data base into conformity with HMDA stating that comparisons between the two databases are “extremely important” in evaluating the GSEs” mandate to lead the primary market.

HUD recognizes the potential harm that the release of truly proprietary data could have on the GSEs as well as their lending partners and is cognizant of its responsibilities under FHEFSSA to preserve and protect such data from public disclosure. Also, any implication that additional disclosure of GSE data might in fact facilitate a further loss of borrower privacy or encourage predatory lending practices are issues that HUD believes warrant especially close scrutiny.

In recognition of its responsibilities to proceed with the utmost caution in releasing data, HUD follows a rigorous six-factor determination process in considering whether to accord proprietary treatment to mortgage data. For every data element under consideration for non-proprietary treatment, HUD evaluates:

(1) The type of data or information involved and the nature of the adverse consequences to the GSE, financial or otherwise, that could result from disclosure;

(2) The existence and applicability of any prior determinations by HUD, any other Federal agency, or a court, concerning similar data or information;

(3) The measures taken by the GSE to protect the confidentiality of the mortgage data and similar data before and after its submission to the Secretary;

(4) The extent to which the mortgage data is publicly available including whether the data or information is available from other entities, from local government offices or records, including deeds, recorded mortgages, and similar documents, or from publicly available data bases;

(5) The difficulty that a competitor, including a seller/servicer, would face in obtaining or compiling the mortgage data; and

(6) Such additional facts and legal and other authorities as the Secretary may consider appropriate, including the extent to which particular mortgage data, when considered together with other information, could reveal proprietary information.

Section 1326 of FHEFSSA and § 81.75 of the regulations provide that the Department may, by regulation or order, issue a list of information that shall be accorded proprietary treatment. HUD utilized the proposed rule to suggest changes to the proprietary treatment of certain GSE data. The comments received in response offered useful insights into concerns of many different organizations including the GSEs' respecting the proposed changes.

Based on the comments received, HUD is not making a determination on this matter as part of this rulemaking. HUD will issue a decision on which data elements will be accorded proprietary and non-proprietary treatment by separate order following publication of this final rule in accordance with the Department's regulations at §§ 81.72 through 81.74.

20. Other Considerations

a. Data Reporting. Many of the changes included in the final rule involve changes in data reporting requirements. The Department will not establish those requirements in this final rule, but rather will establish them in accordance with FHEFSSA and 24 CFR part 81, considering the proprietary concerns of the GSEs and other considerations in the public interest.

Specific areas where additional data will need to be collected include but are not limited to indicators for mortgages located in tribal lands, identification of units with estimated affordability data mortgage loans receiving bonus points and the temporary adjustment factor, and mortgages relating to Section 8 assistance contracts.

One area in particular that will require additional data elements is high cost mortgage loans. In order to monitor and enforce the restrictions included in this final rule, new data and reporting requirements may be required, as appropriate. The Department notes that the HUD/Treasury report recommended that the Federal Reserve amend its regulations to require the collection of similar data items under the Home Mortgage Disclosure Act (HMDA), including information on loan price (APR and cost of credit) and borrower debt-to-income ratio for HOEPA loans. If such recommendations are implemented, it may affect the data reporting required under this rule.

b. Comments Regarding Regional Issues. Several commenters offered comments on the need to inform various communities and regions around the country of the GSEs' affordable housing goal performance in those areas. Separate from this rulemaking, as described above, HUD has recently taken steps to make more MSA level information, on an aggregated basis, about the GSEs mortgage purchases available to the public. HUD encourages the residents of local communities and regions of the country to increase their knowledge of the roles the GSEs' play in their areas and, toward that end, HUD will make available information to build understanding of the GSEs' activities.

c. Technical Correction. Section 81.76(d) describes the protection of GSE information by HUD officers and employees. That section has cited HUD's Standards of Conduct regulations in 24 CFR part 0. HUD's Standards of Conduct regulations in part 0 were, however, largely superseded by new financial disclosure regulations codified in 5 CFR part 2634, new executive Start Printed Page 65083branch-wide Standards of Conduct codified in 5 CFR part 2635, and supplemental HUD-specific Standards of Conduct codified in 5 CFR part 7501. Consequently, in 1996, HUD removed the current text of 24 CFR part 0 and replaced it with a single section (§ 0.1) that provides cross-references to those provisions. (See final rules published in the Federal Register on April 5, 1996 (61 Fed. Reg. 15,350), and on July 9, 1996 (61 Fed. Reg. 36,246).) In order to correct § 81.76(d), this final rule will revise the references to those provisions accordingly.

III. Findings and Certifications

Executive Order 12866

The Office of Management and Budget (OMB) reviewed this final rule under Executive Order 12866, Regulatory Planning and Review, which the President issued on September 30, 1993. This rule was determined economically significant under E.O. 12866. Any changes made to this final rule subsequent to its submission to OMB are identified in the docket file, which is available for public inspection between 7:30 a.m. and 5:30 p.m. weekdays in the Office of the Rules Docket Clerk, Office of General Counsel, Room 10276, Department of Housing and Urban Development, 451 Seventh Street, SW., Washington, DC. The Economic Analysis prepared for this rule is also available for public inspection in the Office of the Rules Docket Clerk.

Congressional Review of Major Final Rules

This rule is a “major rule” as defined in Chapter 8 of 5 U.S.C. The rule has been submitted for Congressional review in accordance with this chapter.

Paperwork Reduction Act

HUD's collection of information on the GSEs' activities has been reviewed and authorized by the Office of Management and Budget (OMB) under the Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520), as implemented by OMB in regulations at 5 CFR part 1320. The OMB control number is 2502-0514.

Environmental Impact

In accordance with 24 CFR 50.19(c)(1) of HUD's regulations, this final rule would not direct, provide for assistance or loan and mortgage insurance for, or otherwise govern or regulate real property acquisition, disposition, lease, rehabilitation, alteration, demolition, or new construction; nor would it establish, revise, or provide for standards for construction or construction materials, manufactured housing, or occupancy. Therefore, this final rule is categorically excluded from the requirements of the National Environmental Policy Act.

Regulatory Flexibility Act

The Secretary, in accordance with the Regulatory Flexibility Act (5 U.S.C. 605(b)), has reviewed this rule before publication and by approving it certifies that this rule would not have a significant economic impact on a substantial number of small entities. This final regulation is applicable only to the GSEs, which are not small entities for purposes of the Regulatory Flexibility Act, and, thus, does not have a significant economic impact on a substantial number of small entities.

Executive Order 13132, Federalism

Executive Order 13132 (“Federalism”) prohibits, to the extent practicable and permitted by law, an agency from promulgating a regulation that has federalism implications and either imposes substantial direct compliance costs on State and local governments and is not required by statute, or preempts State law, unless the relevant requirements of section 6 of the Executive Order are met. This final rule does not have federalism implications and does not impose substantial direct compliance costs on State and local governments or preempt State law within the meaning of the Executive Order.

Unfunded Mandates Reform Act

Title II of the Unfunded Mandates Reform Act of 1995 (UMRA) establishes requirements for Federal agencies to assess the effects of their regulatory actions on State, local, and tribal governments, and the private sector. This final rule would not impose any Federal mandates on any State, local, or tribal governments, or on the private sector, within the meaning of the UMRA.

Endnotes to Preamble

1. See sec. 301 of the Federal National Mortgage Association Charter Act (Fannie Mae Charter Act) (12 U.S.C. 1716); sec. 301(b) of the Federal Home Loan Mortgage Corporation Act (Freddie Mac Act) (12 U.S.C. 1451 note).

2. Secs. 306(c)(2) of the Freddie Mac Act and 304(c) of the Fannie Mae Charter Act.

3. Secs. 306(g) of the Freddie Mac Act and 304(d) of the Fannie Mae Charter Act.

4. Secs. 303(e) of the Freddie Mac Act and 309(c)(2) of the Fannie Mae Charter Act.

5. U.S. Department of Treasury, Government Sponsorship of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation (1996), page 3.

6. S. Rep. No. 282, 102d Cong., 2d Sess. 34 (1992).

7. FFIEC Press Release, July 29, 1999.

8. Section 802(ee) of the Housing and Urban Development Act of 1968 (Pub. L. 90-448, approved August 1, 1968; 82 Stat. 476, 541).

9. See sec. 731 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) (Pub. L. 101-73, approved August 9, 1989), which amended the Freddie Mac Act.

10. See 24 CFR 81.16(d) and 81.17 (1992 codification).

11. Sec. 1321.

12. See generally secs. 1331-34.

13. Secs. 1332(b), 1333(a)(2), 1334(b).

14. 65 FR 12632-12816

15. S. Rep. No. 282, 102d Cong., 2d Sess. 34 (1992) at 35.

16. Rental Housing Assistance—The Worsening Crisis: A Report to Congress on Worst Case Housing Needs, Department of Housing and Urban Development, Office of Policy Development and Research, (March 2000).

17. Standard & Poor's DRI Review of the U.S. Economy. (June 2000), p. 57.

18. See, e.g., S. Rep. at 34.

19. S. Rep. at 34.

20. 12 U.S.C. 2901 et seq.

21. See section 1335(3)(B).

22. The following discussion is based on analysis of conventional, conforming mortgage loans which were originated in 1998, and which may have been acquired by the GSEs in 1998 or 1999. Appendix A contains further details regarding GSE acquisitions of 1997 originations as well. HUD will analyze GSE purchases in relation to the 1999 mortgage market once HUD has the opportunity to analyze 1999 HMDA data for metropolitan areas.

23. Totals do not add due to rounding.

24. This percentage differs from the GSEs' 19 percent market share for rental units in single family rental properties financed in 1998 chiefly because the 41 percent figure reported here includes owner-occupied units in 2-4 unit properties which also have rental units.

25. A recent Treasury-sponsored report on CRA found that banks and thrifts increased the share of their mortgage originations to low-income borrowers and communities from 25 percent in 1993 to 28 percent in 1998. See Robert E. Litan, Nicolas P. Retsinas, Eric S. Belsky, and Susan White Haag, The Community Reinvestment Act After Financial Modernization: A Baseline Project, U.S. Department of Treasury, April 25, 2000.

26. African American borrowers accounted for 6.5 percent of all conforming home loans, including FHA and VA loans, in metropolitan areas in 1998. Further information on the GSEs' purchases of mortgage loans to minority borrowers may be found in Appendix A.

27. Hispanic borrowers were 6.7 percent of all conforming metropolitan area home loans, including FHA and VA loans, in 1998. Further information on the GSEs' purchases of mortgage loans to minority borrowers may be found in Appendix A. Start Printed Page 65084

28. The low- and moderate-income market share is the estimated proportion of newly mortgaged units in the market serving low-and moderate-income families. The two other shares are similarly defined. HUD's conservative range of estimates (such as 50-55 percent) reflects uncertainty about future market conditions.

29. Appendix D explains the specific reasons for the 1995-98 market estimates for the low-mode and special affordable housing goals are higher than the upper end of HUD's market projections for the years 2001-2003. Based on average 1993-1998 experience, HUD's projection model assumes that refinance borrowers have higher incomes than home purchase borrowers; however, between 1995 and 1997, refinance borrowers had lower incomes. On average, the 1995-98 period also exhibited a slightly higher percentage of rental units financed than assumed in HUD's projection model. See Appendix D for other reasons the 1995-1998 average market estimates are higher than those projected for the years 2001-2003.

30. PriceWaterhouse-Coopers, “The Impact of Economic Conditions on the Size and the Composition of the Affordable Housing Market” (April 5, 2000).

31. In 1998, PWC estimates the size of the single family mortgage market at $1.5 trillion. This estimate is identical to the widely used estimate by the Mortgage Bankers Association for the entire single family mortgage market, including FHA and jumbo loans.

32. The figures presented for goal performance are based on HUD analysis of the GSEs' loan level data. Some results differ marginally from the corresponding figures presented by Fannie Mae and Freddie Mac in their respective Annual Housing Activities Reports (AHARs) to HUD, reflecting differences in application of counting rules.

33. The figures presented for goal performance are based on HUD's analysis of the GSEs' loan level data. Some results differ marginally from the corresponding figures presented by the GSEs in their AHARs, reflecting differences in application of counting rules.

34. GSE to market ratio is calculated by dividing the performance of the respective GSE by the performance of the market.

35. Freddie Mac-to-Market and Fannie Mae-to-Market ratios cannot be calculated until 1999 HMDA data is available.

36. The figures presented for goal performance are based on HUD's analysis of the GSEs' loan level data. Some results differ from the corresponding figures presented by Fannie Mae in its AHARs by one to two percentage points. The difference largely reflects differences between HUD and Fannie Mae in application of counting rules relating to counting of seasoned mortgage loans for purposes of this goal. Freddie Mac's AHAR figures for this goal differ marginally from the official figures presented above, also reflecting differences in application of counting rates.

37. The percentage of Freddie Mac's multifamily transactions counting toward the Special Affordable Goal was unusually low in 1999 relative to previous years, but the multifamily sector still contributed significantly to Freddie Mac's performance on the Special Affordable Goal. In 1999, 43 percent of units backing Freddie Mac's multifamily transactions met the Special Affordable Goal, representing 22% of units counted toward the Goal. Multifamily units were eight per cent of Freddie Mac's total purchase volume in 1999.

38. U.S. House of Representatives, Congressional Record. (October 13, 1999), p. H10014.

39. 15 U.S.C. 1601 note; Title I, Subtitle B of the Riegle Community Development and Regulatory Improvement Act of 1994, Pub. L. 103-325 (Sept. 23, 1994); 108 Stat. 2190-98.

40. Currently, HOEPA covers refinancings of mortgages. 15 U.S.C. 1601(aa)(1).

41. As mentioned above, HOEPA grants the Federal Reserve Board authority to lower the APR trigger to 8 percentage points over comparable treasuries (or to raise it to 12 percentage points above), 15 U.S.C. 1602(aa)(2), and to broaden the class of costs counted toward the fees trigger, 15 U.S.C. 1602(aa)(4)(D).

42. 12 U.S.C. 4563(b)(1)(B).

43. Id.

44. CRA regulations were published as a joint final rule on May 4, 1995. The regulation is codified at 12 CFR Part 25, CFR Parts 228 and 203, 12 CFR Part 345, and 12 CFR Part 563e for the Office of the Comptroller of the Currency, the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision, respectively.

45. Pub. L. 106-102; approved November 12, 1999.

46. See S. Rep. No. 282, 102nd Cong., 2nd Sess. 39 (1992); H.R. Rept. 206, 102nd Cong., 1st Sess. 59 (1991)

47. Ibid.

48. 24 CFR parts 401 and 402, Multifamily Housing Mortgage and Housing Assistance Restructuring Program (Mark-to-Market): Final Rule, March 22, 2000.

49. The 1992 House committee report on the bill that later became FHEFSSA emphasizes that “the goals included in this legislation are specifically not to include purchases of equity for low-income housing tax credits.” (House of Representatives Report 102-206, 102d Congress, 1st Session, p. 60.)

50. Handbook of Housing and Development Law, 1996, p. 10-8 and IRC Sec. 42 (i)(1).

51. 42 U.S.C. 1437f, sec. 514(e)(6)

52. Kenneth Temkin, Jennifer E. H. Johnston, and Charles Calhoun, An Assessment of Recent Innovations in the Secondary Market for Low- and Moderate-Income Lending, report submitted to the U.S. Department of Housing and Urban Development (March 2000).

53. See S. Rep. No. 282, 102d Cong., 2d Sess. 39 (1992).

Start List of Subjects

List of Subjects in 24 CFR Part 81

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Accordingly,

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PART 81—THE SECRETARY OF HUD'S REGULATION OF THE FEDERAL NATIONAL MORTGAGE ASSOCIATION (FANNIE MAE) AND THE FEDERAL HOME LOAN MORTGAGE CORPORATION (FREDDIE MAC)

End Part Start Amendment Part

1. The authority citation for

End Amendment Part Start Authority

Authority: 12 U.S.C. 1451 et seq., 1716-1723h, and 4501-4641; 42 U.S.C. 3535(d) and 3601-3619.

End Authority Start Amendment Part

2. Section 81.2, is amended by revising the definitions of “

End Amendment Part
Definitions.
* * * * *

HOEPA mortgage” means a mortgage for which the annual percentage rate (as calculated in accordance with the relevant provisions of section 107 of the Home Ownership Equity Protection Act (HOEPA) (15 U.S.C. 1606)) exceeds the threshold described in section 103(aa)(1)(A) of HOEPA (15 U.S.C. 1602(aa)(1)(A)), or for which the total points and fees payable by the borrower exceed the threshold described in section 103(aa)(1)(B) of HOEPA (15 U.S.C. 1602(aa)(1)(B)), as those thresholds may be increased or decreased by the Federal Reserve Board or by Congress, unless the GSEs are otherwise notified in writing by HUD. Notwithstanding the exclusions in section 103(aa)(1) of HOEPA, for purposes of this part, the term “HOEPA mortgage” includes all types of mortgages as defined in this section, including residential mortgage transactions as that term is defined in section 103(w) of HOEPA (15 U.S.C. 1602(w)), but does not include reverse mortgages.

* * * * *

Median income means, with respect to an area, the unadjusted median family income for the area as most recently determined and published by HUD. HUD will provide the GSEs annually with information specifying how HUD's published median family income estimates for metropolitan areas are to be applied for the purposes of determining median family income.

Metropolitan area means a metropolitan statistical area (“MSA”), or primary metropolitan statistical area (“PMSA”), or a portion of such an area Start Printed Page 65085for which median family income estimates are published annually by HUD.

* * * * *

Mortgages contrary to good lending practices” means a mortgage or a group or category of mortgages entered into by a lender and purchased by a GSE where it can be shown that a lender engaged in a practice of failing to:

(1) Report monthly on borrowers' repayment history to credit repositories on the status of each GSE loan that a lender is servicing;

(2) Offer mortgage applicants products for which they qualify, but rather steer applicants to high cost products that are designed for less credit worthy borrowers. Similarly, for consumers who seek financing through a lender's higher-priced subprime lending channel, lenders should not fail to offer or direct such consumers toward the lender's standard mortgage line if they are able to qualify for one of the standard products;

(3) Comply with fair lending requirements; or

(4) Engage in other good lending practices that are:

(i) Identified in writing by a GSE as good lending practices for inclusion in this definition; and

(ii) Determined by the Secretary to constitute good lending practices.

Mortgages with unacceptable terms or conditions or resulting from unacceptable practices” means a mortgage or a group or category of mortgages with one or more of the following terms or conditions:

(1) Excessive fees, where the total points and fees charged to a borrower exceed the greater of 5 percent of the loan amount or a maximum dollar amount of $1000, or an alternative amount requested by a GSE and determined by the Secretary as appropriate for small mortgages.

(i) For purposes of this definition, points and fees include:

(A) Origination fees;

(B) Underwriting fees;

(C) Broker fees;

(D) Finder's fees; and

(E) Charges that the lender imposes as a condition of making the loan, whether they are paid to the lender or a third party.

(ii) For purposes of this definition, points and fees do not include:

(A) Bona fide discount points;

(B) Fees paid for actual services rendered in connection with the origination of the mortgage, such as attorneys' fees, notary's fees, and fees paid for property appraisals, credit reports, surveys, title examinations and extracts, flood and tax certifications, and home inspections;

(C) The cost of mortgage insurance or credit-risk price adjustments;

(D) The costs of title, hazard, and flood insurance policies;

(E) State and local transfer taxes or fees;

(F) Escrow deposits for the future payment of taxes and insurance premiums; and

(G) Other miscellaneous fees and charges that, in total, do not exceed 0.25 percent of the loan amount.

(2) Prepayment penalties, except where:

(i) The mortgage provides some benefits to the borrower (e.g., such as rate or fee reduction for accepting the prepayment premium);

(ii) The borrower is offered the choice of another mortgage that does not contain payment of such a premium;

(iii) The terms of the mortgage provision containing the prepayment penalty are adequately disclosed to the borrower; and

(iv) The prepayment penalty is not charged when the mortgage debit is accelerated as the result of the borrower's default in making his or her mortgage payments.

(3) The sale or financing of prepaid single-premium credit life insurance products in connection with the origination of the mortgage;

(4) Evidence that the lender did not adequately consider the borrower's ability to make payments, i.e., mortgages that are originated with underwriting techniques that focus on the borrower's equity in the home, and do not give full consideration of the borrower's income and other obligations. Ability to repay must be determined and must be based upon relating the borrower's income, assets, and liabilities to the mortgage payments; or

(5) Other terms or conditions that are:

(i) Identified in writing by a GSE as unacceptable terms or conditions or resulting from unacceptable practices for inclusion in this definition; and

(ii) Determined by the Secretary as an unacceptable term or condition of a mortgage for which goals credit should not be received.

* * * * *

Refinancing means * * *

* * * * *

(7) A conversion of a balloon mortgage note on a single family property to a fully amortizing mortgage note where the GSE already owns or has an interest in the balloon note at the time of the conversion.

* * * * *

Underserved area means:

(1) For purposes of the definitions of “Central city” and “Other underserved area,” a census tract, a Federal or State American Indian reservation or tribal or individual trust land, or the balance of a census tract excluding the area within any Federal or State American Indian reservation or tribal or individual trust land, having:

(i) A median income at or below 120 percent of the median income of the metropolitan area and a minority population of 30 percent or greater; or

(ii) A median income at or below 90 percent of median income of the metropolitan area.

(2) For purposes of the definition of “Rural area”:

(i) In areas other than New England, a whole county, a Federal or State American Indian reservation or tribal or individual trust land, or the balance of a county excluding the area within any Federal or State American Indian reservation or tribal or individual trust land, having:

(A) A median income at or below 120 percent of the greater of the State non-metropolitan median income or the nationwide non-metropolitan median income and a minority population of 30 percent or greater; or

(B) A median income at or below 95 percent of the greater of the State non-metropolitan median income or nationwide non-metropolitan median income.

(ii) In New England, a whole county having the characteristics in paragraphs (2)(i)(A) or (2)(i)(B) of this definition; a Federal or State American Indian reservation or tribal or individual trust land, having the characteristics in paragraphs (2)(i)(A) or (2)(i)(B) of this definition; or the balance of a county, excluding any portion that is within any Federal or State American Indian reservation or tribal or individual trust land, or metropolitan area where the remainder has the characteristics in paragraphs (2)(i)(A) or (2)(i)(B) of this definition.

(3) Any Federal or State American Indian reservation or tribal or individual trust land that includes land that is both within and outside of a metropolitan area and that is designated as an underserved area by HUD. In such cases, HUD will notify the GSEs as to applicability of other definitions and counting conventions.

* * * * *
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3. Section 81.12 is amended as follows:

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a. Paragraph (b) is amended by revising the last sentence; and

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b. Paragraph (c) is revised, to read as follows:

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Start Printed Page 65086
Low- and Moderate-Income Housing Goal.
* * * * *

(b) Factors. * * * A statement documenting HUD's considerations and findings with respect to these factors, entitled “Departmental Considerations to Establish the Low-and Moderate-Income Housing Goal,” was published in the Federal Register on October 31, 2000.

(c) Goals. The annual goals for each GSE's purchases of mortgages on housing for low-and moderate-income families are:

(1) For each of the years 2001-2003, 50 percent of the total number of dwelling units financed by that GSE's mortgage purchases in each of those years unless otherwise adjusted by HUD in accordance with FHEFSSA; and

(2) For the year 2004 and thereafter HUD shall establish annual goals. Pending establishment of goals for the year 2004 and thereafter, the annual goal for each of those years shall be 50 percent of the total number of dwelling units financed by that GSE's mortgage purchases in each of those years.

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4. Section 81.13 is amended as follows:

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a. Paragraph (b) is amended by revising the last sentence; and

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b. Paragraph (c) is revised, to read as follows:

End Amendment Part
Central Cities, Rural Areas, and Other Underserved Areas Housing Goal.
* * * * *

(b) Factors. * * * A statement documenting HUD's considerations and findings with respect to these factors, entitled “Departmental Considerations to Establish the Central Cities, Rural Areas, and Other Underserved Areas Housing Goal,” was published in the Federal Register on October 31, 2000.

(c) Goals. The annual goals for each GSE's purchases of mortgages on housing located in central cities, rural areas, and other underserved areas are:

(1) For each of the years 2001-2003, 31 percent of the total number of dwelling units financed by that GSE's mortgage purchases in each of those years unless otherwise adjusted by HUD in accordance with FHEFSSA; and

(2) For the year 2004 and thereafter HUD shall establish annual goals. Pending establishment of goals for the year 2004 and thereafter, the annual goal for each of those years shall be 31 percent of the total number of dwelling units financed by that GSE's mortgage purchases in each of those years.

* * * * *
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5. Section 81.14 is amended as follows:

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a. Paragraph (b) is amended by revising the last sentence;

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b. Paragraph (c) is revised;

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c. Paragraph (d) is amended by revising paragraph (d)(1)(i);

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d. Paragraph (e) is amended by revising paragraphs (e)(2), (e)(3), and (e)(4);

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e. Paragraph (f) is redesignated as paragraph (g) and the last sentence of the newly redesignated paragraph (g) is revised; and

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f. A new paragraph (f) is added; to read as follows:

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Special Affordable Housing Goal.
* * * * *

(b) * * * A statement documenting HUD's considerations and findings with respect to these factors, entitled “Departmental Considerations to Establish the Special Affordable Housing Goal,” was published in the Federal Register on October 31, 2000.

(c) Goals. The annual goals for each GSE's purchases of mortgages on rental and owner-occupied housing meeting the then-existing, unaddressed needs of and affordable to low-income families in low-income areas and very low-income families are:

(1) For each of the years 2001, 2002, and 2003, 20 percent of the total number of dwelling units financed by that GSE's mortgage purchases in each of those years unless otherwise adjusted by HUD in accordance with FHEFSSA. The goal for each year shall include mortgage purchases financing dwelling units in multifamily housing totaling not less than 1.0 percent of the average annual dollar volume of combined (single family and multifamily) mortgages purchased by the respective GSE in 1997, 1998 and 1999, unless otherwise adjusted by HUD in accordance with FHEFSSA; and

(2) For the year 2004 and thereafter HUD shall establish annual goals. Pending establishment of goals for the year 2004 and thereafter, the annual goal for each of those years shall be 20 percent of the total number of dwelling units financed by that GSE's mortgage purchases in each of those years. The goal for each such year shall include mortgage purchases financing dwelling units in multifamily housing totaling not less than 1.0 percent of the annual average dollar volume of combined (single family and multifamily) mortgages purchased by the respective GSE in the years 1997, 1998 and 1999.

(d) * * *

(1) * * *

(i) 20 percent of the dwelling units in the particular multifamily property are affordable to especially low-income families; or

* * * * *

(e) * * *

(2) Mortgages insured under HUD's Home Equity Conversion Mortgage (“HECM”) Insurance Program, 12 U.S.C. 1715 z-20; mortgages guaranteed under the Rural Housing Service's Single Family Housing Guaranteed Loan Program, 42 U.S.C. 1472; mortgages on properties on tribal lands insured under FHA's Section 248 program, 12 U.S.C. 1715 z-13, HUD's Section 184 program, 12 U.S.C. 1515 z-13a, or Title VI of the Native American Housing Assistance and Self-Determination Act of 1996, 25 U.S.C. 4191-4195; meet the requirements of 12 U.S.C. 4563(b)(1)(A)(i) and (ii).

(3) HUD will give full credit toward achievement of the Special Affordable Housing Goal for the activities in 12 U.S.C. 4563(b)(1)(A), provided the GSE submits documentation to HUD that supports eligibility under 12 U.S.C. 4563(b)(1)(A) for HUD's approval.

(4)(i) For purposes of determining whether a seller meets the requirement in 12 U.S.C. 4563(b)(1)(B), a seller must currently operate on its own or actively participate in an on-going, discernible, active, and verifiable program directly targeted at the origination of new mortgage loans that qualify under the Special Affordable Housing Goal.

(ii) A seller's activities must evidence a current intention or plan to reinvest the proceeds of the sale into mortgages qualifying under the Special Affordable Housing Goal, with a current commitment of resources on the part of the seller for this purpose.

(iii) A seller's actions must evidence willingness to buy qualifying loans when these loans become available in the market as part of active, on-going, sustainable efforts to ensure that additional loans that meet the goal are originated.

(iv) Actively participating in such a program includes purchasing qualifying loans from a correspondent originator, including a lender or qualified housing group, that operates an on-going program resulting in the origination of loans that meet the requirements of the goal, has a history of delivering, and currently delivers qualifying loans to the seller.

(v) The GSE must verify and monitor that the seller meets the requirements in paragraphs (e)(4)(i) through (e)(4)(iv) of this section and develop any necessary mechanisms to ensure compliance with the requirements, except as provided in paragraph (e)(4)(vi) and (vii) of this section.Start Printed Page 65087

(vi) Where a seller's primary business is originating mortgages on housing that qualifies under this Special Affordable Housing Goal such seller is presumed to meet the requirements in paragraphs (e)(4)(i) through (e)(4)(iv) of this section. Sellers that are institutions that are:

(A) Regularly in the business of mortgage lending;

(B) A BIF-insured or SAIF-insured depository institution; and

(C) Subject to, and has received at least a satisfactory performance evaluation rating for

(1) At least the two most recent consecutive examinations under, the Community Reinvestment Act, if the lending institution has total assets in excess of $250 million; or

(2) The most recent examination under the Community Reinvestment Act if the lending institutions which have total assets no more than $250 million are identified as sellers that are presumed to have a primary business of originating mortgages on housing that qualifies under this Special Affordable Housing Goal and, therefore, are presumed to meet the requirements in paragraphs (e)(4)(i) through (e)(4)(iv) of this section.

(vii) Classes of institutions or organizations that are presumed have as their primary business originating mortgages on housing that qualifies under this Special Affordable Housing Goal and, therefore. are presumed in paragraphs (e)(4)(i) through (e)(4)(iv) of this section to meet the requirements are as follows: State housing finance agencies; affordable housing loan consortia; Federally insured credit unions that are:

(A) Members of the Federal Home Loan Bank System and meet the first-time homebuyer standard of the Community Support Program; or

(B) Community development credit unions; community development financial institutions; public loan funds; or non-profit mortgage lenders. HUD may determine that additional classes of institutions or organizations are primarily engaged in the business of financing affordable housing mortgages for purposes of this presumption, and if, so will notify the GSEs in writing.

(viii) For purposes of paragraph (e)(4) of this section, if the seller did not originate the mortgage loans, but the originator of the mortgage loans fulfills the requirements of either paragraphs (e)(4)(i) through (e)(4)(iv), paragraph (e)(4)(vi) or paragraph (e)(4)(vii) of this section; and the seller has held the loans for six months or less prior to selling the loans to the GSE, HUD will consider that the seller has met the requirements of this paragraph (e)(4) and of 12 U.S.C. 4563(b)(1)(B).

* * * * *

(f) Partial credit activities. Mortgages insured under HUD's Title I program, which includes property improvement and manufactured home loans, shall receive one-half credit toward the Special Affordable Housing Goal until such time as the Government National Mortgage Association fully implements a program to purchase and securitize Title I loans.

(g) No credit activities. * * * For purposes of this paragraph (g), “mortgages or mortgage-backed securities portfolios” includes mortgages retained by Fannie Mae or Freddie Mac and mortgages utilized to back mortgage-backed securities.

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6. In § 81.15, paragraph (a) is revised, paragraph (d) is amended by revising the second sentence and by adding two new sentences at the end, and paragraph (e) is amended by re-designating paragraph (e)(6) as (e)(7), and by adding a new paragraph (e)(6), to read as follows:

End Amendment Part
General requirements.

(a) Calculating the numerator and denominator. Performance under each of the housing goals shall be measured using a fraction that is converted into a percentage.

(1) The numerator. The numerator of each fraction is the number of dwelling units financed by a GSE's mortgage purchases in a particular year that count toward achievement of the housing goal.

(2) The denominator. The denominator of each fraction is, for all mortgages purchased, the number of dwelling units that could count toward achievement of the goal under appropriate circumstances. The denominator shall not include GSE transactions or activities that are not mortgages or mortgage purchases as defined by HUD or transactions that are specifically excluded as ineligible under § 81.16(b).

(3) Missing data or information. When a GSE lacks sufficient data or information to determine whether the purchase of a mortgage originated after 1992 counts toward achievement of a particular housing goal, that mortgage purchase shall be included in the denominator for that housing goal, except under the circumstances described in paragraphs (d) and (e)(6) of this section.

* * * * *

(d) Counting owner-occupied units. * * * To determine whether mortgagors may be counted under a particular family income level, i.e. especially low, very low, low or moderate income, the income of the mortgagors is compared to the median income for the area at the time of the mortgage application, using the appropriate percentage factor provided under § 81.17. When the income of the mortgagors is not available to determine whether the purchase of a mortgage originated after 1992 counts toward achievement of the Low- and Moderate-Income Housing Goal or the Special Affordable Housing Goal, a GSE may exclude single family owner-occupied units located in census tracts with median income less than or equal to area median income according to the most recent census from the denominator as well as the numerator, up to a ceiling of one percent of the total number of single family owner-occupied dwelling units eligible to be counted toward the respective housing goal in the current year. Mortgage purchases in excess of the ceiling will be included in the denominator and excluded from the numerator if they are missing data.

(e) * * *

(6) Affordability data unavailable. (i) Multifamily. When information regarding the affordability of a rental unit is not available, a GSE's performance with respect to such a unit may be evaluated with estimated affordability information, so long as the Department has reviewed and approved the data source and methodology for such estimated data. The use of estimated information to determine affordability may be used up to a maximum of five percent of the total number of units backing the GSEs' multifamily mortgage purchases in the current year, adjusted for REMIC percentage and participation percent. When the application of affordability data based on an approved market rental data source and methodology is not possible, and therefore the GSE lacks sufficient information to determine whether the purchase of a mortgage originated after 1992 counts toward the achievement of the Low- and Moderate-Income Housing Goal or the Special Affordable Housing Goal, HUD will exclude units in multifamily properties from the denominator as well as the numerator in calculating performance under those goals.

(ii) Rental units in 1-4 unit single family properties. When neither the income of prospective or actual tenants of a rental unit in a 1-4 unit single family property nor actual or average rent data is available, and, therefore, the GSE lacks sufficient information to determine whether the purchase of a mortgage originated after 1992 counts toward achievement of the Low- and Moderate-Income Housing Goal or the Start Printed Page 65088Special Affordable Housing Goal, a GSE may exclude rental units in 1-4 unit single family properties from the denominator as well as the numerator in calculating performance under those goals.

* * * * *
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7. Section 81.16 is amended as follows:

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a. Paragraph (a) is revised;

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b. Paragraph (b) is amended by revising paragraphs (b)(3) and (b)(9) and by adding a new paragraph (b)(10);

End Amendment Part Start Amendment Part

c. Paragraph (c) is amended by adding introductory text, by revising paragraph (c)(6), and by adding new paragraphs (c)(9), (c)(10), (c)(11), (c)(12), and (c)(13); and

End Amendment Part Start Amendment Part

d. A new paragraph (d) is added; to read as follows:

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Special counting requirements.

(a) General. HUD shall determine whether a GSE shall receive full, partial, or no credit for a transaction toward achievement of any of the housing goals. In this determination, HUD will consider whether a transaction or activity of the GSE is substantially equivalent to a mortgage purchase and either creates a new market or adds liquidity to an existing market, provided however that such mortgage purchase actually fulfills the GSE's purposes and is in accordance with its Charter Act.

(b) * * *

(3) Purchases of non-conventional mortgages except:

(i) Where such mortgages are acquired under a risk-sharing arrangement with a Federal agency;

(ii) Mortgages insured under HUD's Home Equity Conversion Mortgage (“HECM”) insurance program, 12 U.S.C. 1715z-20; mortgages guaranteed under the Rural Housing Service's Single Family Housing Guaranteed Loan Program, 42 U.S.C. 1472; mortgages on properties on lands insured under FHA's Section 248 program, 12 U.S.C. 1715z-13, or HUD's Section 184 program, 12 U.S.C. 1515z-13a, or Title VI of the Native American Housing Assistance and Self-Determination Act of 1996, 25 U.S.C. 4191-4195; and mortgages with expiring assistance contracts as defined at 42 U.S.C. 1737f;

(iii) Mortgages under other mortgage programs involving Federal guarantees, insurance or other Federal obligation where the Department determines in writing that the financing needs addressed by the particular mortgage program are not well served and that the mortgage purchases under such program should count under the housing goals, provided the GSE submits documentation to HUD that supports eligibility and that HUD makes such a determination, or

(iv) As provided in § 81.14(e)(3)

* * * * *

(9) Single family mortgage refinancings that result from conversion of balloon notes to fully amortizing notes, if the GSE already owns or has an interest in the balloon note at the time conversion occurs.

(10) Any combination of factors in paragraphs (b)(1) through (9) of this section.

(c) Other special rules. Subject to HUD's primary determination of whether a GSE shall receive full, partial, or no credit for a transaction toward achievement of any of the housing goals as provided in paragraph (a) of this section, the following supplemental rules apply:

* * * * *

(6) Seasoned mortgages. A GSE's purchase of a seasoned mortgage shall be treated as a mortgage purchase for purposes of these goals and shall be included in the numerator, as appropriate, and the denominator in calculating the GSE's performance under the housing goals, except where the GSE has already counted the mortgage under a housing goal applicable to 1993 or any subsequent year, or where the Department determines, based upon a written request by a GSE, that a seasoned mortgage or class of such mortgages should be excluded from the numerator and the denominator in order to further the purposes of the Special Affordable Housing Goal.

* * * * *

(9) Expiring assistance contracts. In accordance with 12 U.S.C. 4565(a)(5), actions that assist in maintaining the affordability of assisted units in eligible multifamily housing projects with expiring contracts shall receive credit under the housing goals as provided in paragraph (b)(3)(ii) and in accordance with paragraphs (b) and (c)(1) through (c)(9) of this section.

(i) For restructured (modified) multifamily mortgage loans with an expiring assistance contract where a GSE holds the loan in portfolio and facilitates modification of loan terms that results in lower debt service to the project's owner, the GSE shall receive full credit under any of the housing goals for which the units covered by the mortgage otherwise qualify.

(ii) Where a GSE undertakes more than one action to assist a single project or where a GSE engages in an activity that it believes assists in maintaining the affordability of assisted units in eligible multifamily housing projects but which is not otherwise covered in paragraph (c)(9)(i) of this section, the GSE must submit the transaction to HUD for a determination on appropriate goals counting treatment.

(10) Bonus points. The following transactions or activities, to the extent the units otherwise qualify for one or more of the housing goals, will receive bonus points toward the particular goal or goals, by receiving double weight in the numerator under a housing goal or goals and receiving single weight in the denominator for the housing goal or goals. Bonus points will not be awarded for the purposes of calculating performance under the special affordable housing multifamily subgoal described in § 81.14(c). All transactions or activities meeting the following criteria will qualify for bonus points even if a unit is missing affordability data and the missing affordability data is treated consistent with § 81.15(e)(6)(i). Bonus points are available to the GSEs for purposes of determining housing goal performance for each year 2001 through 2003. Beginning in the year 2004, bonus points are not available for goal performance counting purposes unless the Department extends their availability beyond December 31, 2003 for one or more types of activities and notifies the GSEs by letter of that determination.

(i) Small multifamily properties. HUD will assign double weight in the numerator under a housing goal or goals for each unit financed by GSE mortgage purchases in small multifamily properties (5 to 50 physical units), provided, however, that bonus points will not be awarded for properties that are aggregated or disaggregated into 5-50 unit financing packages for the purpose of earning bonus points.

(ii) Units in 2-4 unit owner-occupied properties. HUD will assign double weight in the numerator under the housing goals for each unit financed by GSE mortgage purchases in 2- to 4-unit owner-occupied properties, to the extent that the number of such units financed by mortgage purchases are in excess of 60 percent of the yearly average number of units qualifying for the respective housing goal during the five years immediately preceding the year of mortgage purchase.

(11) Temporary adjustment factor for Freddie Mac. In determining Freddie Mac's performance on the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal, HUD will count each qualifying unit in a property with more than 50 units as 1.2 units in calculating the numerator and as one unit in calculating the Start Printed Page 65089denominator, for the respective housing goal. HUD will apply this temporary adjustment factor for each year from 2001 through 2003; for the year 2004 and thereafter, this temporary adjustment factor will no longer apply.

(12) HOEPA mortgages and mortgages with unacceptable terms and conditions. HOEPA mortgages and mortgages with unacceptable terms or conditions as defined in § 81.2 will not receive credit toward any of the three housing goals.

(13) Mortgages contrary to good lending practices. The Secretary will monitor the practices and processes of the GSEs to ensure that they are not purchasing loans that are contrary to good lending practices as defined in § 81.2. Based on the results of such monitoring, the Secretary may determine in accordance with paragraph (d) of this section that mortgages or categories of mortgages where a lender has not engaged in good lending practices will not receive credit toward the three housing goals.

(d) HUD review of transactions. HUD will determine whether a class of transactions counts as a mortgage purchase under the housing goals. If a GSE seeks to have a class of transactions counted under the housing goals that does not otherwise count under the rules in this part, the GSE may provide HUD detailed information regarding the transactions for evaluation and determination by HUD in accordance with this section. In making its determination, HUD may also request and evaluate additional information from a GSE with regard to how the GSE believes the transactions should be counted. HUD will notify the GSE of its determination regarding the extent to which the class of transactions may count under the goals.

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8. Section 81.17 is amended by adding a new paragraph (d), to read as follows:

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Affordability—Income level definitions—family size and income known (owner-occupied units, actual tenants, and prospective tenants).
* * * * *

(d) Especially-low-income means, in the case of rental units, where the income of actual or prospective tenants is available, income not in excess of the following percentages of area median income corresponding to the following family sizes:

Number of persons in familyPercentage of area median income
135
240
345
450
5 or more(*)
* 50% plus (4.0% multiplied by the number of persons in excess of 4).
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9. Section 81.18 is amended by adding a new paragraph (d), to read as follows:

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Affordability—Income level definitions—family size not known (actual or prospective tenants).
* * * * *

(d) For especially-low-income, income of prospective tenants shall not exceed the following percentages of area median income with adjustments, depending on unit size:

Unit sizePercentage of area median income
Efficiency35
1 bedroom37.5
2 bedrooms45
3 bedrooms or more(*)
* 52% plus (6.0% multiplied by the number of bedrooms in excess of 3).
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10. In § 81.19, paragraph (d) is re-designated as paragraph (e), a new paragraph (d) is added and the second sentence of the newly re-designated paragraph (e) is revised, to read as follows:

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Affordability—Rent level definitions—tenant income is not known.
* * * * *

(d) For especially-low-income, maximum affordable rents to count as housing for especially-low-income families shall not exceed the following percentages of area median income with adjustments, depending on unit size:

Unit sizePercentage of area median income
Efficiency10.5
1 bedroom11.25
2 bedrooms13.5
3 bedrooms or more(*)
* 15.6% plus (1.8% multiplied by the number of bedrooms in excess of 3).
* * * * *

(e) Missing Information. * * * If a GSE makes such efforts but cannot obtain data on the number of bedrooms in particular units, in making the calculations on such units, the units shall be assumed to be efficiencies except as provided in § 81.15(e)(6)(i)

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11. In § 81.76, paragraph (d) is revised to read as follows:

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FOIA requests and protection of GSE information.
* * * * *

(d) Protection of information by HUD officers and employees. The Secretary will institute all reasonable safeguards to protect data or information submitted by or relating to either GSE, including, but not limited to, advising all HUD officers and employees having access to data or information submitted by or relating to either GSE of the legal restrictions against unauthorized disclosure of such data or information under the executive branch-wide standards of ethical conduct, 5 CFR part 2635, and the Trade Secrets Act, 18 U.S.C. 1905. Officers and employees shall be advised of the penalties for unauthorized disclosure, ranging from disciplinary action under 5 CFR part 2635 to criminal prosecution.

* * * * *
Start Signature

Dated: October 16, 2000.

William C. Apgar,

Assistant Secretary for Housing—Federal Housing Commissioner.

End Signature

Note:

The Following Appendices Will Not Appear in the Code of Federal Regulations.

Start Appendix

Appendix A—Departmental Considerations To Establish the Low- and Moderate-Income Housing Goal

A. Introduction and Response to Comments

Sections 1 and 2 provide a basic description of the rule process. Section 3 discusses comments on the proposed rule and the Department's responses. Section 4 discusses conclusions based on consideration of the factors.

1. Establishment of Goal

In establishing the Low- and Moderate-Income Housing Goals for the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), collectively referred to as the Government-Sponsored Enterprises (GSEs), Section 1332 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 4562) (FHEFSSA) requires the Secretary to consider:

1. National housing needs;

2. Economic, housing, and demographic conditions;

3. The performance and effort of the enterprises toward achieving the Low- and Moderate-Income Housing Goal in previous years;

4. The size of the conventional mortgage market serving low- and moderate-income families relative to the size of the overall conventional mortgage market;

5. The ability of the enterprises to lead the industry in making mortgage credit available for low- and moderate-income families; and

6. The need to maintain the sound financial condition of the enterprises. Start Printed Page 65090

2. Underlying Data

In considering the statutory factors in establishing these goals, HUD relied on data from the 1995 American Housing Survey (AHS), the 1990 Census of Population and Housing, the 1991 Residential Finance Survey (RFS), the 1995 Property Owners and Managers Survey (POMS), other government reports, reports submitted in accordance with the Home Mortgage Disclosure Act (HMDA), and the GSEs. In order to measure performance toward achieving the Low- and Moderate-Income Housing Goal in previous years, HUD analyzed the loan-level data on all mortgages purchased by the GSEs for 1993-99 in accordance with the goal counting provisions established by the Department in the December 1995 rule (24 CFR part 81).

3. Response to Comments

a. Introduction

Fannie Mae and Freddie Mac provided detailed comments on HUD's discussion of the factors for determining the goal levels in Appendix A of the proposed rule. A major portion of their substantive comments concerned HUD's analysis of the GSEs' performance relative to the market. Both GSEs disagreed with HUD's conclusions that they lag the conventional conforming market in funding mortgages for the goals-qualifying segments (low-mod borrowers, special affordable borrowers, and underserved neighborhoods) of the single-family owner market. The GSEs argued strongly that they have led the mortgage market, from both quantitative and qualitative perspectives (explained below). The GSEs expressed concern about HUD's assumptions and treatment of specific data in estimating the goals-qualifying shares for single-family owner mortgages. The GSEs concluded that HUD chose assumptions and data sources that result in an overstatement of the low-mod, special affordable, and underserved areas shares of owner mortgages.

It should be noted that the GSEs extended their criticisms to other researchers who have examined this issue of their targeted lending performance relative to the overall mortgage market. Section E.3 of this appendix summarizes findings of several independent studies that have also concluded that the GSEs have lagged the market in affordable lending. For the most part, these studies have used the same HMDA-based methodology described in Section E.2 of this appendix.

The GSEs focused many of their comments on the adequacy of HMDA data, the main source for the goals-qualifying shares of the conventional conforming market, against which the GSEs are compared. The GSEs argued that HMDA data are biased (i.e., overstate the goals-qualifying shares of the market) and that significant portions of HMDA data are not relevant for calculating the market standard for evaluating GSE performance in the conventional conforming market. These and related comments of the GSEs are discussed below in subsections b-f.

Both GSEs also argued that HUD's analysis and conclusions depended on a continuation of recent conditions of economic expansion and low interest rates. According to the GSEs, HUD's range of market estimates did not include periods of adverse economic and affordability conditions, such as existed in the early 1990s. HUD discusses the GSEs' comments on economic volatility in Section B of Appendix D. As explained there, HUD's ranges of market estimates for each of the housing goals are conservative, because they allow for economic and interest rate conditions much more adverse than existed during the mid- to late-1990s.

The discussion that follows summarizes HUD's responses to the GSEs' comments on the “leading the market” analysis that HUD has conducted in Section E.2 of this appendix—that section fully develops the various concepts referenced here. The final two subsections, g and h, discuss additional issues that the GSEs raised about HUD's analysis of the factors in Appendix A.

b. Overview of Leading the Owner Market—Quantitative Analysis

The analysis of HMDA data in Section E.2 of this appendix indicates demonstrates that even though the GSEs have improved their performance since 1993, they have lagged depositories and others in the conventional conforming market in funding affordable loans, both since 1993 and during the more recent 1996-98 period when the new housing goals have been in effect. For example, underserved areas accounted for 22.9 (19.9) percent of Fannie Mae's (Freddie Mac's) purchases of home loans between 1996 and 1998, compared with 24.4 percent for the entire conforming market (excluding B&C loans). Based on comparisons such as these, HUD concludes that the GSEs need to continue improving their performance so that they can match or exceed the overall market in affordable lending.

In their comments, the GSEs reached the opposite conclusion—each stated that they already match or even lead the market, depending on the affordable category being considered. The GSEs also assert that HUD's analysis does not accurately reflect their performance relative to the overall market. Freddie Mac stated that “the shares of Freddie Mac's loan purchases serving low- and moderate-income families, families in underserved areas and minority families mirror those of the primary market”. Freddie Mac said that its market calculations “account for the limitations on loans we [Freddie Mac] can purchase” (see below). Similarly, Fannie Mae stated that “an appropriate comparison between Fannie Mae and the primary single-family market shows that we [Fannie Mae] serve a higher percentage of low- and moderate-income borrowers, a higher percentage of minority borrowers, and a higher percentage of borrowers in underserved areas than does the primary market”.

Both the GSEs and HUD rely on HMDA data for the market estimates. However, as suggested by the GSEs' comments, they frequently adjust HMDA data to exclude loans in the market that they perceive as not being available for them to purchase. The types of adjustments made by the GSEs, and HUD's response to those adjustments, are discussed in the next subsection. HUD's conclusions about the appropriate definition of the conventional conforming market are also discussed in Section E of this appendix, which provides a detailed analysis of the GSEs' goals-qualifying purchases in the single-family-owner market, and in Appendix D, which provides overall (both single-family and multifamily) estimates of the goals-qualifying shares of the market. In Appendix D, HUD excludes B&C loans from its overall estimates of the market. In this appendix, HUD illustrates (to the extent HMDA data allow) the effects of excluding B&C loans on the GSE-market comparisons, as well as the effects of excluding other loan categories such as manufactured housing loans. However, as explained below, HUD does not believe that HMDA data for the conventional conforming market should be adjusted to reflect the GSEs' perceptions about the characteristics of loans that are available for them to purchase.

c. Relevant Market for Single-Family Owner Properties

Both GSEs provided numerous comments concerning the types of mortgages that HUD should exclude from the definition of the single-family owner market, both when HUD is evaluating the GSEs' performance relative to the conventional conforming owner market (i.e., determining whether the GSEs' lead or lag the market for single-family-owner mortgages) and when HUD is calculating the overall market shares for each housing goal (as described in Appendix D). Fannie Mae stated that it “can only purchase or securitize mortgages that primary market lenders are willing to sell” and that certain types of products (such as ARMs) “are particularly difficult to structure for sale to the secondary market”. Fannie Mae added that “HUD fails to adjust for those housing markets that are not fully available to Fannie Mae and Freddie Mac”. Freddie Mac stated that it “has not achieved, and is unlikely to achieve in the near term, the same penetration in the subprime and manufactured housing segments of the market as it has achieved in the conventional, conforming market” and therefore HUD should not include these segments in its market definition. According to the GSEs, markets that are “not available” to them or where they are not a “full participant” should be excluded from HUD's market definition. In addition to the subprime and manufactured housing markets, examples of market segments mentioned by the GSEs for exclusion included: low-down payment mortgages (those with loan-to-value ratios greater than 80 percent) without private mortgage insurance or some other credit enhancement; loans financed through state and local housing finance agencies; below-market-interest-rate mortgages; specialized CRA mortgages; and portions of depository portfolios that are not available at mortgage origination for purchase by the GSEs.

To analyze the availability of loans originated by depositories to the GSEs, Fannie Mae funded a study by KPMG Barefoot-Marrinan (KPMG). According to Fannie Mae, KPMG found that the advent of the Community Reinvestment Act (CRA) had encouraged depositories to hold lower-income loans in portfolio. Depositories may not offer their products for sale on the secondary market not only because they are Start Printed Page 65091outside of the GSEs' guidelines, but also because of business and portfolio strategy reasons (such as the interest-rate-duration advantage of holding ARMs in portfolio).

Freddie Mac estimated the impacts on HUD's market estimates of excluding from the market definition both specialized community development (CRA-type) loans and portions of depository portfolios. Based on Freddie Mac's analysis, the low-mod (underserved areas) share of the owner market would fall by four (three) percentage points and HUD's overall low-mod and underserved areas market estimates would each fall by about two percentage points. In commenting on whether Freddie Mac leads or lags depositories in affordable lending, Freddie Mac said that the HMDA data for depositories should be adjusted downward to exclude depositories' high-LTV loans without private mortgage insurance, their below-market rate loans, their subprime loans, and coverage bias in HMDA (see the next subsection). Based on these adjustments, Freddie Mac reduced the 1998 HMDA-reported underserved areas percentage for depositories from 26.1 percent to 20.0, which led Freddie Mac to conclude that its performance equals or exceeds the performance of depositories on loans that are likely to be sold to Freddie Mac.

HUD's Response. In general, HUD disagrees with the comments offered by the GSEs about excluding those market segments that they haven't yet been able to penetrate fully. Congress stated that HUD was to estimate the size of the conventional conforming mortgage market, not the market that the GSEs perceive as available for them to purchase. However, with respect to the subprime market, HUD believes that the risky, B&C portion of that market should be excluded from the market definition for each of the housing goals. Thus, HUD includes only the A-minus portion of the subprime market in its overall estimates of the goals-qualifying market shares. In Appendix D, HUD explains its methodology for adjusting the overall market estimates to exclude B&C loans. Section E.2 of this appendix uses HMDA data and the GSEs' loan-level data to examine the GSEs' performance in the single-family owner portion of the conventional conforming mortgage market in metropolitan areas. B&C loans are not identified in HMDA data; however, HUD shows the effects of adjusting the owner market definition for subprime and B&C loans by using a list of lenders that specialize in subprime loans (see Table A.4b).

Excluding other important segments of the lower-income mortgage market, as the GSEs recommend, would render the resulting market benchmark useless for evaluating the GSEs' performance. The loans that the GSEs would exclude are important sources of lower-income credit and, in fact, are among the very loans the GSEs are supposed to be funding. A recent report by the Department of Treasury demonstrated the targeting of CRA-type loans to lower-income and minority families. Numerous studies have shown that the manufactured home sector is an important source of low-income housing. In many of these markets, a more active secondary market would encourage lending to traditionally underserved borrowers. While HUD recognizes that some segments of the market may be more challenging for the GSEs than others, the data reported in Tables A.7a and A.7b of this Appendix show that the GSEs have ample opportunities to purchase goals-qualifying mortgages. As market leaders, the GSEs should be looking for innovative ways to pursue this business, rather than suggesting that it is not available to the secondary market. Furthermore, there is evidence that the GSEs can earn reasonable returns on their goals business. The Economic Analysis that accompanies this final rule provides evidence that the GSEs have been earning financial returns on their purchases of goals-qualifying loans that are only slightly below their 20-25 percent return on equity from their normal business.

HUD also disagrees with other specific comments offered by the GSEs. For example, HUD does not think that the data for depositories should be adjusted downward as proposed by Freddie Mac and Fannie Mae. Both types of institutions receive government benefits and both operate in the conventional conforming market. Furthermore, if a GSE makes a business decision to not pursue certain types of goals-qualifying loans in one segment of the market, they are free to pursue goals-qualifying owner and rental property mortgages in other segments of the market. With respect to loans that are originated without private mortgage insurance, the GSEs have been quite innovative in structuring transactions to provide alternative credit enhancements. Between 1997 and 1999, Freddie Mac was involved in 16 structured transactions totaling $8.1 billion, with Freddie Mac's 1999 business accounting for over $5 billion of this total.1 HUD gives full goals credit for such credit-enhanced transactions.

Finally, it should be noted that the GSEs' purchases under the housing goals are not limited to new mortgages that are originated in the current calendar year. The GSEs can purchase loans from the substantial, existing stock of affordable loans held in lenders' portfolios, after these loans have seasoned and the GSEs have had the opportunity to observe their payment performance. In fact, based on Fannie Mae's experience in 1997-98, the purchase of seasoned loans appears to be one useful strategy for purchasing goals-qualifying loans. In Section E.2, HUD's comparisons of the GSEs' single-family performance with those of depositories and the overall single-family market include the GSEs' purchases of prior-year as well newly-originated loans.

d. Bias in HMDA Data

Both GSEs refer to findings from a study by Peter Zorn and Jim Berkovec concerning potential bias in HMDA data.2 Based on a comparison of the borrower and census tract characteristics between Freddie Mac-purchased loans (from Freddie Mac's own data) and loans identified in 1993 HMDA data as sold to Freddie Mac, Zorn and Berkovec conclude that HMDA data overstates the percentage of conventional, conforming loans originated for lower-income borrowers and for properties located in underserved census tracts. The data reported in Table A.4a of this appendix, which are based on more recent data than the Zorn and Berkovec paper, do not appear to support their findings. With respect to the goals-qualifying percentages for GSE purchases, comparing columns 2 and 4 for Fannie Mae, and columns 6 and 8 for Freddie Mac, show that the HMDA-reported goals-qualifying percentages for loans sold to the GSEs are not always larger than the corresponding percentages for loans the GSEs report as purchased. In fact, the HMDA-reported percentages are more likely to be smaller than the GSE-reported percentages for the Special Affordable and Underserved Areas Goals, yielding conclusions different from those drawn by Zorn and Berkovec with regard to bias in the HMDA data. In addition, as noted in Appendix D, other research has concluded that a portion of lower-income loan originations are not even reported to HMDA. Thus it is not clear that more recent and complete data would support the Zorn and Berkovec findings.

e. Other Technical Comments Related to GSE Performance in Single-Family Owner Market

MSA-Level Analysis. In its comments, Fannie Mae raised several concerns about HUD's comparisons between Fannie Mae and the primary market at the metropolitan statistical area (MSA) level (see Table A.5 in this appendix). Essentially, Fannie Mae questioned the relevance of any analysis at the local level, given that the housing goals are national-level goals. HUD believes that its metropolitan-area analyses support and clarify the national analyses on GSE performance. While official goal performance is measured only at the national level, HUD believes that analyses of, for example, the numbers of MSAs where Fannie Mae and Freddie Mac lead or lag the local market increases public understanding of the GSEs' performance. For example, if the national aggregate data showed that one GSE lagged the market in funding loans in underserved areas, it would be of interest to the public to determine if this reflected particularly poor performance in a few large MSAs or if it reflected shortfalls in many MSAs. In this case, an analysis of individual MSA data would increase public understanding of that GSE's performance.

Missing Data. Both GSEs mentioned the increasing problem of missing information in HMDA data and in their own data bases—particularly with regard to borrower race/ethnicity. HUD agrees that treatment of missing data is an important issue when measuring GSE performance and developing estimates of the size of the affordable market. Both Appendices A and D use several techniques for situations where data are limited or missing. HUD's treatment of missing data reflects a consistent commitment to fair and reasonable analyses, and is designed to permit “apples-to-apples” comparisons between the GSEs and the market to the extent possible. When calculating portfolio percentages for different sectors of the mortgage market, HUD followed its usual procedure of excluding loans with missing data. In certain analyses involving market shares, HUD used a variety of techniques such as reallocating missing data, making adjustments for undercoverage by HMDA data, or using data from other Start Printed Page 65092sources to estimate the absolute number of mortgage originations. In general, HUD believes that methods for addressing missing data are reasonable and appropriate.

Lender-Purchased Loans. When analyzing HMDA data, Fannie Mae included loans purchased by lenders, as well as loans originated by lenders, in its market definition. HUD included only HMDA-reported mortgage originations in its market definition—mortgages purchased by lenders were not included in HUD's market data. To do so would involve double counting loan originations in the HMDA data.

Prior-Year/Current-Year Analysis. Fannie Mae raised a number of concerns about HUD's separation of its purchases into “prior-year” loans and “current-year” loans. Section E.2 of this appendix discusses this issue in some detail. Much of HUD's analysis is conducted along the lines that Fannie Mae recommends—considering each GSE's total purchases (of both prior-year mortgages and current-year mortgages) in a single calendar year. For example, see the discussion of the GSEs' past performance in Section E of this appendix and the data in Tables A.3 and A.4. But HUD believes the GSEs' performance should also be analyzed by focusing on the total number of mortgages from a particular origination year that the GSEs have purchased to date. Comparing the GSEs' current-year purchases, including prior-year originations, with newly-originated mortgages would result in somewhat of an “apples-to-oranges” comparison. Hence, to conduct more of an “apples-to-apples” comparison between the GSEs and the market, it is necessary to restrict the analysis to GSE loan acquisitions originated in a particular year (see Tables A.7a and A.7b). HUD recognizes some of the problems that result from analyses that focus on a single origination year. However, as indicated by the variety of analyses provided in Appendix A, HUD believes that both frameworks are useful for understanding the GSEs' role in the affordable lending market.

f. Leading the Market—The Qualitative Dimension

The GSEs commented that they make a sizable contribution toward serving the housing needs of a wide range of American families through their innovative outreach and the overall leadership they provide to the affordable lending market. This “qualitative” dimension of market leadership comes from their normal operations in the market. Each GSE gave numerous examples of their market leadership, similar to the discussion that HUD provides in Section G of this appendix. Fannie Mae noted its Trillion Dollar Commitment, its programs with minority-and women-owned lenders, its initiative with Community Development Financial Institutions, and its numerous initiatives in the technology area. Freddie Mac noted similar program initiatives and outreach efforts, and stated that it has been a “leader in removing historical barriers to mortgage credit” and that a recent HUD-commission study commended both Freddie Mac and Fannie Mae for their leadership in the liberalization of mortgage underwriting standards.

HUD understands the important role that the GSEs play in the market and applauds their efforts to re-examine their underwriting standards and to reach out to traditionally underserved borrowers and neighborhoods. This perspective is reflected in Section G of this appendix, which discusses qualitative dimensions of the GSEs' ability to lead the industry. HUD concludes that due to their dominant role in the market, their ability to influence the types of loans that lenders will originate, their utilization of state-of-the-art technology, and their financial strength, the GSEs have the ability to lead the market in affordable lending and to reach out to those markets that have traditionally not received the benefits of an active secondary market.

g. Linking Housing Needs to GSEs

Fannie Mae commented that HUD's analysis of housing needs in Appendix A needed to more carefully identify the appropriate roles for the public sector and the GSEs. Similar to its comments on HUD's 1995 rule, Fannie Mae expressed concern that HUD did not distinguish between general housing needs of low- and moderate-income households and those needs that the GSEs can reasonably be expected to address. In this appendix, HUD presents an analysis of general housing needs to comply with FHEFSSA, which requires the Secretary to consider such needs when establishing the housing goals. HUD's examination of national housing needs does not suggest that the GSEs can or should meet all of those needs. Rather, the analysis is intended to provide background on the evolution and current state of the housing markets for low- and moderate-income households. HUD recognizes that the GSEs alone can not mitigate some of the more extreme problems identified in this analysis.

However, with more focused effort, the GSEs can assist in addressing several problems discussed in this appendix with regard to single-family and multifamily housing. On the single-family side, the GSEs can develop secondary market programs for “untapped” markets such as 2-4 unit rental properties and properties needing rehabilitation in the nation's inner cities. The GSEs can increase their support of more customized mortgage products and underwriting, with greater outreach to those families who have not been served with traditional products, underwriting, and marketing. Particularly important in this regard, the GSEs can ensure that their automated underwriting systems recognize the special circumstances of lower-income and minority borrowers. As discussed in Section 3.d of this appendix, HUD and others are concerned about potential negative effects of mortgage scoring on industry efforts to reach out to lower-income and minority families.

On the multifamily side, with new product development and partnerships, the GSEs can more fully address the credit needs of the current market for affordable rental housing. This appendix cities several areas where the GSEs can help. One segment that would benefit from a more active secondary market is small multifamily properties—an important part of the rental housing market that is currently not being adequately served by the GSEs. The GSEs can work to improve overall efficiency and stability in this market by developing new products and promoting increased standardization and streamlined procedures.

The GSEs have been immensely successful in the financing of traditional single-family housing. HUD recognizes that “untapped” markets will present some difficulties and challenges for the GSEs. But by helping develop a secondary market in these areas, the GSEs will bring increased liquidity, added stability, and ultimately lower interest rates and rents for lower-income families in these segments of the market.

h. Barriers to Higher GSE Performance on the Housing Goals

Fannie Mae raised concerns with respect to the interplay of the housing goals and the risk-based capital standard proposed by OFHEO. Fannie Mae stated that “the risk-based capital proposal represents another potentially significant barrier to meeting the goals that was not analyzed by the Department.” OFHEO previously addressed this question in their notice of proposed rulemaking, dated April 13, 1999, concluding that “the risk-based capital standard will not affect the Enterprises' ability to purchase affordable housing loans.” 3 In part, this conclusion was based on the finding that in 1996 and 1997, Freddie Mac would have enjoyed capital surpluses under OFHEO's proposed rule, despite increased purchases of loans meeting the housing goals. OFHEO concluded that even in more adverse economic environments, “the capital cost of single family loans meeting the Enterprises' affordable housing goals should not be materially different, on average, from the cost of other loans.”

Of the various issues mentioned by Fannie Mae in relation to OFHEO's proposed regulation, implications of the rule for high-LTV and multifamily lending are of the greatest relevance with regard to affordable lending and the GSEs' housing goals.

High-LTV Lending. Fannie Mae stated concerns regarding the impacts of the proposed OFHEO regulation on high-LTV lending:

 The risk-based capital regulation as proposed imposes disproportionately high capital requirements on high-LTV loans. These requirements will impair our ability to serve those borrowers with limited resources. High-LTV lending is critically important to our affordable housing initiatives and outreach to first-time homebuyers.4

It is not apparent that OFHEO's proposed rulemaking would impose “disproportionate” capital requirements on high-LTV loans. Because high-LTV loans typically have higher default rates, it is reasonable to require the GSEs to hold more capital against high-LTV loans than against low-LTV loans, other things being equal.

If Fannie Mae's view is that the proposed OFHEO regulation requires the GSEs to hold more capital against high-LTV loans than is the case for other financial institutions, their comments submitted in response to HUD's proposed housing goals rule do not contain any material documenting such a claim. Start Printed Page 65093However, it is noteworthy that the GSEs enjoy benefits not conferred on other financial institutions (e.g., exemption from state and local taxes and exemption from securities registration). There is no evidence that Congress intended for the GSE risk-based capital requirements to be strictly comparable to capital standards for other regulated financial institutions.

OFHEO's proposed rule would require the GSEs to hold more capital against high-LTV loans, assuming the GSEs charge the same guarantee against such loans as they do against low-LTV loans. In practice, however, the GSEs implicitly charge higher guarantee fees on high-LTV loans, mitigating the need for additional capital beyond what is added through the guarantee fee. In its discussion of this issue, OFHEO concluded that “Both Enterprises use internal capital models that reflect the higher risk of high LTV loans and already may incorporate higher capital costs into the implicit fees charged for these loans.” 5

In addition, OFHEO observed that multifamily loans, which predominantly benefit low-and moderate-income households, act as a hedge against high-LTV loans in a down-rate environment “so that higher costs on high LTV single family loans are substantially offset by lower costs on multifamily loans,” reducing the amount of capital that the GSEs would otherwise be required to hold against high-LTV loans.

Multifamily Risk-Sharing. Fannie Mae contends that, under the provisions of OFHEO's proposed rule, its Delegated Underwriting and Servicing (DUS) multifamily program “will be impaired because of the onerous “haircuts” specified in the proposed capital regulation.” The “haircuts” mentioned by Fannie Mae refer to adjustments for counterparty risk proposed by OFHEO under risk-sharing provisions such as those governing the DUS program.

Because of the importance of counterparty risk to GSE safety and soundness, it is certainly reasonable and necessary for OFHEO to take such risk into consideration in formulating its risk-based capital regulation for the GSEs. HUD notes that OFHEO received extensive comments from the GSEs and others on this issue in response to its proposed rule. Because the OFHEO capital standard is presently at the proposed rule stage, and not a final rule, it would be premature and inappropriate for HUD to speculate at this time on the possible implications of OFHEO's capital standards on GSE multifamily performance. The multifamily market and the GSEs' capabilities within it will continue to evolve during and after the time period when OFHEO revises and finalizes its proposed capital regulation in response to comments. Any implications of the OFHEO capital standards for GSE activities related to multifamily mortgages or affordable housing will merit consideration in future rounds of HUD's GSE rulemaking.

4. Conclusions Based on Consideration of the Factors

The discussion of the first two factors covers a range of topics on housing needs and economic and demographic trends that are important for understanding mortgage markets. Information is provided which describes the market environment in which the GSEs must operate (for example, trends in refinancing activity) and is useful for gauging the reasonableness of specific levels of the Low- and Moderate-Income Housing Goal. In addition, the severe housing problems faced by lower-income families are discussed.

The third factor (past performance) and the fifth factor (ability of the GSEs to lead the industry) are also discussed in some detail in this Appendix. The fourth factor (size of the market) and the sixth factor (need to maintain the GSEs' sound financial condition) are mentioned only briefly in this Appendix. Detailed analyses of the fourth factor and the sixth factor are contained in Appendix D and in the economic analysis of this rule, respectively.

The factors are discussed in sections B through H of this appendix. Section I summarizes the findings and presents the Department's conclusions concerning the Low- and Moderate-Income Housing Goal. The consideration of the factors in this appendix has led the Secretary to the following conclusions:

  • Despite the record national homeownership rate of 66.8 percent in 1999, much lower rates prevailed for minorities, especially for African-American households (46.7 percent) and Hispanics (45.5 percent), and these lower rates are only partly accounted for by differences in income, age, and other socioeconomic factors.
  • Pervasive and widespread disparities in mortgage lending continued across the nation in 1998, when the loan denial rate was 10.2 percent for white mortgage applicants, but 23.9 percent for African Americans and 18.9 percent for Hispanics.6
  • Despite strong economic growth, low unemployment, the lowest mortgage rates in 1998-99 in 25 years, and relatively stable home prices, there is clear and compelling evidence of deep and persistent housing problems for Americans with the lowest incomes. The number of very-low-income American households with “worst case” housing needs is at an all-time high—5.4 million.7
  • Changing population demographics will result in a need for the primary and secondary mortgage markets to meet nontraditional credit needs, respond to diverse housing preferences and overcome information barriers that many immigrants and minorities face. In addition, market segments such as single-family rental properties, small multifamily properties, manufactured housing, and older inner city properties would benefit from the additional financing and pricing efficiencies of a more active secondary mortgage market.
  • The Low- and Moderate-Income Housing Goals for both GSEs were 40 percent in 1996 and 42 percent in 1997-1999. Fannie Mae surpassed these goals, with a performance of 45.6 percent in 1996, 45.7 percent in 1997, 44.1 percent in 1998, and 45.9 percent in 1999. Freddie Mac's performance of 41.1 percent in 1996, 42.6 percent in 1997 and 42.9 percent in 1998 narrowly exceeded these goals, but Freddie Mac's performance jumped sharply in 1999 to 46.1 percent, exceeding Fannie Mae's performance for the first time, by a narrow margin.
  • Several studies have shown that both Fannie Mae and Freddie Mac lag behind depository institutions and the overall conventional conforming market in providing affordable home loans to lower-income borrowers and underserved neighborhoods. Though 1998 Fannie Mae made efforts to improve its performance, while Freddie Mac made less improvement, and therefore fell behind Fannie Mae, depositories, and the overall market in serving lower-income and minority families and their neighborhoods. This indicated that there was room for both GSEs (but particularly Freddie Mac) to improve their funding of single-family home mortgages for lower-income families and underserved communities. Data on the performance of depositories and the primary market is not yet available for 1999, thus it is not possible to determine if the GSEs continued to lag these sectors of the market last year. But, based on the data provided by the GSEs to the Department, Freddie Mac's single-family low- and moderate-income performance in 1999 exceeded Fannie Mae's performance. It remains to be seen whether this represents a new trend, or a temporary reversal of the pattern for the 1996-98 period.
  • The GSEs' presence in the goal-qualifying market is significantly less than their presence in the overall mortgage market. Specifically, HUD estimates that they accounted for 40 percent of all owner-occupied and rental units financed in the primary market in 1997, but only 32 percent of low- and moderate-income units financed. Their role was even lower for low-and moderate-income rental properties, where they accounted for 26 percent of low- and moderate-income multifamily units financed and only 14 percent of low- and moderate-income single-family rental units financed. These general patterns were also evident in 1998, a heavy refinance year, except that the GSEs had a higher share of the single-family owner market.
  • Other issues have also been raised about the GSEs' affordable lending performance. A large percentage of the lower-income loans purchased by the enterprises have relatively high down payments, which raises questions about whether the GSEs are adequately meeting the mortgage credit needs of lower-income families who do not have sufficient cash to make a high down payment. Also, while single-family rental properties are an important source of low- and moderate-income rental housing, they represent only a small portion of the GSEs' business.
  • Freddie Mac has re-entered the multifamily market, after withdrawing for a time in the early 1990s. Thus, concerns regarding Freddie Mac's multifamily capabilities no longer constrain their performance with regard to the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal to the same degree that prevailed at the time the Department issued its 1995 GSE regulations. However, Freddie Mac's multifamily presence remains proportionately lower than that of Fannie Mae. For example, units in Start Printed Page 65094multifamily properties accounted for 7.3 percent of Freddie Mac's mortgage purchases during 1994-99, compared with 11.8 percent for Fannie Mae. Because a relatively large proportion of multifamily units qualify for the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal, through 1998 Freddie Mac's lower multifamily presence was a major factor contributing to its weaker overall performance on these two housing goals relative to Fannie Mae. But in 1999, multifamily units accounted for 8.2 percent of total units financed by Freddie Mac and 9.5 percent of total units financed by Fannie Mae, the narrowest gap of the 1994-99 period.
  • The overall presence of both GSEs in the multifamily mortgage market falls short of their involvement in the single-family market. Specifically, the GSEs' purchases of 1997 originations accounted for 50 percent of the owner market, but only 24 percent of the multifamily market. Further expansion of the presence of both GSEs in the multifamily market is needed in order for them to make significant progress in closing the gaps between the affordability of their mortgage purchases and that of the overall conventional market.
  • The GSEs have proceeded cautiously in expanding their multifamily purchases during the 1990s. Fannie Mae's multifamily lending has been described by Standard & Poor's as “extremely conservative,” and Freddie Mac has not experienced a single default on the multifamily mortgages it has purchased since 1993.8 By the end of 1999, both GSEs' multifamily performance had improved to the point where multifamily delinquency rates were lower than those for single-family loans.9
  • Because of the advantages conferred by Government sponsorship, the GSEs are in a unique position to provide leadership in addressing the excessive cost and difficulty in obtaining mortgage financing for underserved segments of the multifamily market, including small properties with 5-50 units and properties in need of rehabilitation.

B. Factor 1: National Housing Needs

This section reviews the general housing needs of low- and moderate-income families that exist today and are expected to continue in the near future. In so doing, the section focuses on the affordability problems of lower- income families and on racial disparities in homeownership and mortgage lending. It also notes some special problems, such as the need to rehabilitate our older urban housing stock.

1. Homeownership Gaps

Despite a record national homeownership rate, many Americans, including disproportionate numbers of racial and ethnic minorities, are shut out of homeownership opportunities. Although the national homeownership rate for all Americans was at an all-time high of 67.1 percent in the first quarter of 2000, the rate for minority households was lower. The homeownership rate for African-American households was 47.4 percent. Similarly, just 45.7 percent of Hispanic households owned a home.

Importance of Homeownership. Homeownership is one of the most common forms of property ownership as well as savings.10 Historically, home equity has been the largest source of wealth for most Americans. Only recently has stock equity exceeded home equity as a share of total household wealth. Even with stocks appreciating faster than home prices over the past decade, still 59 percent of all homeowners in 1998 held more than half of their net wealth in the form of home equity. Among low-income homeowners (household income less than $20,000), half held more than 70 percent of their wealth in home equity in 1995.11 Median net wealth for renters was less than four percent of the median net wealth for homeowners in 1998. For low-income households, renter median net wealth is less than two percent of homeowner median net wealth.12 Thus a homeownership gap translates directly into a wealth gap.

Homeownership promotes social and community stability by increasing the number of stakeholders and reducing disparities in the distributions of wealth and income. There is growing evidence that planning for and meeting the demands of homeownership may reinforce the qualities of responsibility and self-reliance. White and Green13 provide empirical support for the association of homeownership with a more responsible, self-reliant citizenry. Both private and public benefits are increased to the extent that developing and reinforcing these qualities improve prospects for individual economic opportunities.

Barriers to Homeownership. Insufficient income, high debt burdens, and limited savings are obstacles to homeownership for younger families. As home prices skyrocketed during the late 1970s and early 1980s, real incomes also stagnated, with earnings growth particularly slow for blue collar and less educated workers. Through most of the 1980s, the combination of slow income growth and increasing rents made saving for home purchase more difficult, and relatively high interest rates required large fractions of family income for home mortgage payments. Thus, during that period, fewer households had the financial resources to meet down payment requirements, closing costs, and monthly mortgage payments.

Economic expansion and lower mortgage rates substantially improved homeownership affordability during the 1990s. Many young, lower-income, and minority families who were closed out of the housing market during the 1980s re-entered the housing market during the last decade. However, many households still lack the financial resources and earning power to take advantage of today's homebuying opportunities. Several trends have contributed to the reduction in the real earnings of young adults without college education over the last 15 years, including technological changes that favor white-collar employment, losses of unionized manufacturing jobs, and wage pressures exerted by globalization. Fully 45 percent of the nation's population between the ages of 25 and 34 have no advanced education and are therefore at risk of being unable to afford homeownership.14 African Americans and Hispanics, who have lower average levels of educational attainment than whites, are especially disadvantaged by the erosion in wages among less educated workers.

In addition to low income, high debts are a primary reason households cannot afford to purchase a home. According to a 1993 Census Bureau report, nearly 53 percent of renter families have both insufficient income and excessive debt problems that may cause difficulty in financing a home purchase.15 High debt-to-income ratios frequently make potential borrowers ineligible for mortgages based on the underwriting criteria established in the conventional mortgage market.

An additional barrier to homeownership is the fear and uncertainty about the buying process and the risks of ownership. A study using focus groups with renters found that even among those whose financial status would make them capable of homeownership, many felt that the buying process was insurmountable because they feared rejection by the lender or being taken advantage of.16 Also, many feared the obligations of ownership, because of concerns about the risk of future deterioration of the house or the neighborhood.

Finally, discrimination in mortgage lending continues to be a barrier to homeownership. Disparities in treatment between borrowers of different races and neighborhoods of different racial makeup have been well documented. These disparities are discussed in the next section.

2. Disparities in Mortgage Financing

Disparities Between Borrowers of Different Races. Research based on Home Mortgage Disclosure Act (HMDA) data suggests pervasive and widespread disparities in mortgage lending across the Nation. For 1998, the denial rate for white mortgage applicants was 10.2 percent, while 23.9 percent of African-American and 18.9 percent of Hispanic applicants were denied. Even after controlling for income, the African-American denial rate was approximately twice that of white applicants. A major study by researchers at the Federal Reserve Bank of Boston found that mortgage denial rates remained substantially higher for minorities in 1991-93, even after controlling for indicators of credit risk.17 African-American and Hispanic applicants in Boston with the same borrower and property characteristics as white applicants had a 17 percent denial rate, compared with the 11 percent denial rate experienced by whites. A subsequent study conducted at the Federal Reserve Bank of Chicago reported similar findings.18

Several possible explanations for these lending disparities have been suggested. The studies by the Boston and Chicago Federal Reserve Banks found that racial disparities cannot be explained by reported differences in creditworthiness. In other words, minorities are more likely to be denied than whites with similar credit characteristics, which suggests lender discrimination. In addition, loan officers, who may believe that race is correlated with credit risk, may use race as a screening device to save time, rather Start Printed Page 65095than devote effort to distinguishing the creditworthiness of the individual applicant.19 This violates the Fair Housing Act.

Underwriting Rigidities. Underwriting rigidities may fail to accommodate creditworthy low-income or minority applicants. For example, under traditional underwriting procedures, applicants who have conscientiously paid rent and utility bills on time but have never used consumer credit would be penalized for having no credit record. Applicants who have remained steadily employed, but have changed jobs frequently, would also be penalized. Over the past few years, lenders, private mortgage insurers, and the GSEs have adjusted their underwriting guidelines to take into account these special circumstances of lower-income families. Many of the changes recently undertaken by the industry to expand homeownership have focused on finding alternative underwriting guidelines to establish creditworthiness that do not disadvantage creditworthy minority or low-income applicants.

However, because of the enhanced roles of credit scoring and automated underwriting in the mortgage origination process, it is unclear to what degree the reduced rigidity in industry standards will benefit borrowers who have been adversely impacted by the traditional guidelines. Some industry observers have expressed a concern that the greater flexibility in the industry's written underwriting guidelines may not be reflected in the numerical credit and mortgage scores which play a major role in the automated underwriting systems that the GSEs and others have developed. Thus lower-income and minority loan applicants, who often have lower credit scores than other applicants, may be dependent on the willingness of lenders to take the time to look beyond such credit scores and consider any appropriate “mitigating factors,” such as the timely payment of their bills, in the underwriting process. For example, there is a concern in the industry that a “FICO” score less than 620 means an automatic rejection of a loan application without further consideration of any such factors.20 This could disproportionately affect minority applicants. More information on the distribution of credit scores and on the effects of implementing automated underwriting systems is needed.21

Disparities Between Neighborhoods. Mortgage credit also appears to be less accessible in low-income and high-minority neighborhoods. As discussed in Appendix B, 1998 HMDA data show that mortgage denial rates are nearly twice as high in census tracts with low-income and/or high-minority composition, as in other tracts (19.4 percent versus 10.3 percent). Numerous studies have found that mortgage denial rates are higher in low-income census tracts, even accounting for other loan and borrower characteristics.22 These geographic disparities can be the result of cost factors, such as the difficulty of appraising houses in these areas because of the paucity of previous sales of comparable homes. Sales of comparable homes may also be difficult to find due to the diversity of central city neighborhoods. The small loans prevalent in low-income areas are less profitable to lenders because up-front fees to loan originators are frequently based on a percentage of the loan amount, although the costs incurred are relatively fixed. Geographic disparities in mortgage lending and the issue of mortgage redlining are discussed further in Appendix B.

3. Affordability Problems and Worst Case Housing Needs

The severe problems faced by low-income homeowners and renters are documented in HUD's “Worst Case Housing Needs” reports. These reports, which are prepared biennially for Congress, are based on the American Housing Survey (AHS), conducted every two years by the Census Bureau for HUD. The latest report analyzes data from the 1997 AHS and focuses on the housing problems faced by low-income renters, but some data is also presented on families living in owner-occupied housing. In introducing the most recent study, Secretary Cuomo noted that it found that “despite the booming economy, worst case housing needs continue to increase” and such needs “have now reached an all-time high of million households.” 23

The “Worst Cases” report measures three types of problems faced by homeowners and renters:

  • Cost or rent burdens, where housing costs or rent exceed 50 percent of income (a “severe burden”) or range from 31 percent to 50 percent of income (a “moderate burden”);
  • The presence of physical problems involving plumbing, heating, maintenance, hallway, or the electrical system, which may lead to a classification of a residence as “severely inadequate” or “moderately inadequate;” and
  • Crowded housing, where there is more than one person per room in a residence.

The study reveals that in 1997, 5.4 million households had “worst case” housing needs, defined as housing costs greater than 50 percent of household income or severely inadequate housing among unassisted households.

a. Problems Faced by Owners

Of the 65.5 million owner households in 1997, 5.5 million (8.5 percent) confronted a severe cost burden and another 8.3 million (12.7 percent) faced a moderate cost burden. There were 725,000 households with severe physical problems and 916,000 which were overcrowded. The report found that 25.4 percent of American homeowners faced at least one severe or moderate problem.

Not surprisingly, problems were most common among very low-income owners.24 More than a third of these households faced a severe cost burden, and an additional 23 percent faced a moderate cost burden. And 7 percent of these families lived in severely or moderately inadequate housing, while 2 percent faced overcrowding. Only 38 percent of very low-income owners reported no problems.

Over time the percentage of owners faced with severe or moderate physical problems has decreased, as has the portion living in overcrowded conditions. However, affordability problems have grown—the shares facing severe (moderate) cost burdens were only 3 percent (5 percent) in 1978, but rose to 5 percent (11 percent) in 1989 and 8 percent (13 percent) in 1997. The increase in affordability problems apparently reflects a rise in mortgage debt in the late 1980s and early 1990s, from 21 percent of homeowners' equity in 1983 to 36 percent in 1995.25 The Joint Center for Housing Studies also attributes this to the growing gap between housing costs and the incomes of the nation's poorest households.26 As a result of the increased incidence of severe and moderate cost burdens, the share of owners reporting no problems fell from 84 percent in 1978 to 78 percent in 1989 and 75 percent in 1997.

b. Problems Faced by Renters

Problems of all three types listed above are more common among renters than among homeowners. In 1997 there were 6.7 million renter households (20 percent of all renters) who paid more than 50 percent of their income for rent.27 Another 6.8 million faced a moderate rent burden, thus in total 40 percent of renters paid more than 30 percent of their income for rent.

Among very low-income renters, 72 percent faced an affordability problem, including 44 percent who paid more than half of their income in rent. More than one-third of renters with incomes between 51 percent and 80 percent of area median family income also paid more than 30 percent of their income for rent.

Affordability problems have increased over time among renters. The shares of renters with severe or moderate rent burdens rose from 32 percent in 1978 to 36 percent in 1989 and 42 percent in 1997.

The share of families living in inadequate housing in 1997 was higher for renters (12 percent) than for owners (4 percent), as was the share living in overcrowded housing (6 percent for renters, but only 1 percent for owners). Crowding and inadequate housing were more common among lower-income renters, but among even the lowest income group, affordability was the dominant problem. The prevalence of inadequate and crowded rental housing diminished over time until 1995, while affordability problems grew. But in 1997 there were also sharp increases in the inadequate and crowded shares of rental housing.

Other problems faced by renters discussed in the “Worst Cases” report include the loss between 1991 and 1997 of 370,000 rental units affordable to very low-income families, the increase in “worst case needs” among working families between 1991 and 1997, and the shortage of units affordable to very low-income households (especially in the West).

4. Other National Housing Needs

In addition to the broad housing needs discussed above, there are additional needs confronting specific sectors of the housing and mortgage markets. This section presents a brief discussion of three such areas and the roles that the GSEs play or might play in addressing the needs in these areas. Other needs are discussed throughout these appendices.

a. Single-family Rental Housing

The 1996 Property Owners and Managers Survey reported that 51 percent of all rental Start Printed Page 65096housing units are located in “multifamily” properties—i.e, properties that contain 5 or more rental units. The remaining 49 percent of rental units are found in the “mom and pop shops” of the rental market—”single-family” rental properties, containing 1-4 units. These small properties are largely individually-owned and managed, and in many cases the owner-managers live in one of the units in the property. They include many properties in older cities, such as the duplexes in Baltimore and the triple-deckers in Boston. A number of these single-family rental properties are in need of financing for rehabilitation, discussed in the next subsection.

Single-family rental units play an especially important role in lower-income housing. The 1997 AHS found that 59 percent of such units were affordable to very low-income families—exceeding the corresponding share of 53 percent for multifamily units. These units also play a significant role in the GSEs' performance on the housing goals, since 30 percent of the single-family rental units financed by the GSEs in 1999 were affordable to very low-income families.

There is not, however, a strong secondary market for single-family rental mortgages. While single-family rental properties comprise a large segment of the rental stock for lower-income families, they make up a small portion of the GSEs' business. In 1999 the GSEs purchased $26 billion in mortgages for such properties, but this represented 5 percent of the total dollar volume of each enterprise's 1999 business and 8 percent of total single-family units financed by each GSE. With regard to their market share, HUD estimates that the GSEs have financed only about 19 percent of all single-family rental units that received mortgages in 1998, well below the GSEs' estimated market share of 68 percent for single-family owner properties.

Given the large size of this market, the high percentage of these units which qualify for the GSEs' housing goals, and the weakness of the secondary market for mortgages on these properties, an enhanced presence by Fannie Mae and Freddie Mac in the single-family rental mortgage market would seem warranted.28

b. Rehabilitation Problems of Older Areas

A major problem facing lower-income households is that low-cost housing units continue to disappear from the existing housing stock. Older properties are in need of upgrading and rehabilitation. These aging properties are concentrated in central cities and older inner suburbs, and they include not only detached single-family homes, but also small multifamily properties that have begun to deteriorate.

The ability of the nation to maintain the quality and availability of the existing affordable housing stock and to stabilize the neighborhoods where it is found depends on an adequate supply of credit to rehabilitate and repair older units. But obtaining the funds to fix up older properties can be difficult. The owners of small rental properties in need of rehabilitation may be unsophisticated in obtaining financing. The properties are often occupied, and this can complicate the rehabilitation process. Lenders may be reluctant to extend credit because of a sometimes-inaccurate perception of high credit risk involved in such loans.

The GSEs and other market participants have recently begun to pay more attention to these needs for financing of affordable rental housing rehabilitation.29 However, extra effort is required, due to the complexities of rehabilitation financing, as there is still a need to do more.

c. Small Multifamily Properties

There is evidence that small multifamily properties with 5-50 units have been adversely affected by differentials in the cost of mortgage financing relative to larger properties.30 While mortgage loans can generally be obtained for most properties, the financing that is available is relatively expensive, with interest rates as much as 150 basis points higher than those on standard multifamily loans. Loan products are characterized by shorter terms and adjustable interest rates. Borrowers typically incur costs for origination and placement fees, environmental reviews, architectural certifications (on new construction or substantial rehabilitation projects), inspections, attorney opinions and certifications, credit reviews, appraisals, and market surveys.31 Because of a large fixed element, these costs are usually not scaled according to the mortgage loan amount or number of dwelling units in a property and consequently are often prohibitively high on smaller projects.

d. Other Needs

Further discussions of other housing needs and mortgage market problems are provided in the following sections on economic, housing, and demographic conditions. In the single-family area, for example, an important trend has been the growth of the subprime market and the GSEs' participation in the A-minus portion of that market. Manufactured housing finance and rural housing finance are areas that could be served more efficiently with an enhanced secondary market presence. In the multifamily area, properties in need of rehabilitation represent a market segment where financing has sometimes been difficult. Other housing needs and mortgage market problems are also discussed.

C. Factor 2: Economic, Housing, and Demographic Conditions: Single-Family Mortgage Market

This section discusses economic, housing, and demographic conditions that affect the single-family mortgage market. After a review of housing trends and underlying demographic conditions that influence homeownership, the discussion focuses on specific issues related to the single-family owner mortgage market. This subsection includes descriptions of recent market interest rate trends, homebuyer characteristics, and the state of affordable lending. Section D follows with a discussion of the economic, housing, and demographic conditions affecting the multifamily mortgage market.

1. Recent Trends in the Housing Market

Solid economic growth, low interest rates, price stability, and an unemployment rate of 4.2 percent, the lowest rate since 1969, combined to make 1999 a very strong year for the housing market. The employment-population ratio reached a record 64.3 percent last year, and a broad measure of labor market distress, combining the number of unemployed and the duration of unemployment, was down by 54 percent from its 1992 peak.32 Rising real wages, a strong stock market, and higher home prices all contributed to a continuation of the rise in net household worth, contributing to the strong demand for housing.

Homeownership Rate. In 1980, 65.6 percent of Americans owned their own home, but due to the unsettled economic conditions of the 1980s, this share fell to 63.8 percent by 1989. Major gains in ownership have occurred over the last few years, with the homeownership rate reaching a record level of 66.8 percent in 1999, when the number of households owning their own home was 7 million greater than in 1994, an unprecedented five-year increase.

Gains in homeownership have been widespread in over the last six years.33 As a result, the homeownership rate rose from:

  • 42.0 percent in 1993 to 46.7 percent in 1999 for African American households,
  • 39.4 percent in 1993 to 45.5 percent in 1999 for Hispanic households,
  • 73.7 percent in 1993 to 77.6 percent in 1999 for married couples with children,
  • 65.1 percent in 1993 to 67.2 percent in 1999 for household heads aged 35-44, and
  • 48.9 percent in 1993 to 50.4 percent in 1999 for central city residents.

However, as these figures demonstrate, sizable gaps in homeownership remain.

Sales of New and Existing Homes.34 New home sales rose at a rate of 7.5 percent per year between 1991 and 1999, and exceeded the previous record level (set in 1998) by 2 percent in 1999. The market for new homes has been strong throughout the nation, with record sales in the South and Midwest during 1999. New home sales in the Northeast and West, while strong, are running below the peak levels attained during their strong job markets of the mid-1980s and late-1970s, respectively.

The National Association of Realtors reported that 5.2 million existing homes were sold in 1999, overturning the old record set in 1998 by 5 percent. Combined new and existing home sales also set a record of 6.2 million last year. Since existing homes account for more than 80 percent of the total market and sales of existing homes are strong throughout the country, combined sales reach record levels in three of the four major regions of the nation and came within 97 percent of the record in the Northeast.

One of the strongest sectors of the housing market in recent years has been shipments of manufactured homes, which more than doubled between 1991 and 1996, and essentially leveled off at the 1996 record during 1997-99. Two-thirds of manufactured home placements were in the South, where they comprised more than one-third of total new homes sold in 1999.

Economy/Housing Market Prospects. As noted above, the U.S. economy is coming off Start Printed Page 65097several years of economic expansion, accompanied by low interest rates and high housing affordability. In fact, 1999 was a record year for housing sales. The remainder of this subsection discusses the future prospects for the housing market.

According to Standard & Poor's DRI, the housing market is slowing down from the record breaking pace of over five million single-family existing homes sold during 1999.35 Sales of existing single-family homes are on a pace of 4.5 million units for 2000. Between 2001 and 2004, existing single-family home sales are expected to average 4.2 million units. Housing starts are expected to average 1.5 million units over the same period. Housing should remain affordable, as indicated by out-of-pocket costs as a share of disposable income, which are expected to continue their downward trend through 2004, dipping below 24 percent by 2003. According to Standard & Poor's DRI, the 30-year fixed rate mortgage rate is expected to average 8.4 percent in 2000, and then trend down to 7.7 percent by 2004.

The Congressional Budget Office (CBO) 36 projects that real Gross Domestic Product will grow at an average rate of 2.7 percent from 2001 through 2005, down from the expected 4.9 percent growth rate during 2000. The ten-year Treasury rate is projected to average 6.0 percent between 2001 and 2005. Inflation, as measured by the Consumer Price Index (CPI) is projected to remain modest during the same period, averaging 2.7 percent. The unemployment rate is expected to remain low over the next four years, averaging 4.3 percent.

Certain risks exist, however, which could undermine the wellbeing of the economy. The probability of a recession still exists for the next couple of years. Under a pessimistic scenario (10 percent probability), Standard & Poor's DRI predicts that if a stock-market correction were to occur toward the end of 2000, housing starts could fall to 1.2 million units. With relatively low inflation, DRI anticipates that the Federal Reserve would respond quickly by lower interest rates. This would revive the housing market, although the recovery would be slow, with starts not returning to pre-recession levels until late 2004.37 An alternative scenario has a recession arriving in 2002, resulting from a Federal Reserve overreaction to higher inflation and a stock market correction in late 2001 or early 2002 (which DRI predicts with a probability of 35 percent). Under this scenario, housing starts would fall to almost one million units. As a result of lower interest rates, the housing market would rebound strongly, with starts reaching near-record levels by the end of 2004.38

In addition to DRI and CBO, the Mortgage Bankers Association predicts that for 2000/2001 housing starts will reach 1.6/1.5 million units for 2000 and 2001 and the 30-year fixed rate mortgage rate will average 8.5/9.0 percent.39 Fannie Mae predicts that the Federal Reserve will successfully engineer a soft landing, with real growth of the economy slowing to a two to three percent pace in 2001. As a result, mortgage originations should decline to $967 billion, 27 percent less than the 1998 record level.40

2. Underlying Demographic Conditions

Over the next 20 years, the U.S. population is expected to grow by an average of 2.4 million per year. This will likely result in 1.1 to 1.2 million new households per year, creating a continuing need for additional housing.41 This section discusses important demographic trends behind these overall household numbers that will likely affect housing demand in the future. These demographic forces include the baby-boom, baby-bust and echo baby-boom cycles; immigration trends; “trade-up buyers;” non-traditional and single households; and the growing income inequality between people with different levels of education.

As explained below, the role of traditional first-time homebuyers, 25-to-34 year-old married couples, in the housing market will be smaller in the next decade due to the aging of the baby-boom population.42 However, growing demand from immigrants and non-traditional homebuyers will likely fill in the void. The Joint Center for Housing Studies recently projected that the share of the U.S. population accounted for by racial and ethnic minorities would increase from 25 percent to 30 percent by the year 2010.43 The echo baby-boom (that is, children of the baby-boomers) will also add to housing demand later in the next decade. Finally, the growing income inequality between people with and without a post-secondary education will continue to affect the housing market.

The Baby-Boom Effect. The demand for housing during the 1980s and 1990s was driven, in large part, by the coming of homebuying age of the baby-boom generation, those born between 1945 and 1964. Homeownership rates for the oldest of the baby-boom generation, those born in the 1940s, rival those of the generation born in the 1930s. Due to significant house price appreciation in the late-1970s and 1980s, older baby-boomers have seen significant gains in their home equity and subsequently have been able to afford larger, more expensive homes. Circumstances were not so favorable for the middle baby-boomers. Housing was not very affordable during the 1980s, their peak homebuying age period. As a result, the homeownership rate, as well as wealth accumulation, for the group of people born in the 1950s lags that of the generations before them.44

As the youngest of the baby-boomers, those born in the 1960s, reached their peak homebuying years in the 1990s, housing became more affordable. While this cohort has achieved a homeownership rate equal to the middle baby-boomers, they live in larger, more expensive homes. As the baby-boom generation ages, demand for housing from this group is expected to wind down.45

The baby-boom generation was followed by the baby-bust generation, from 1965 through 1977. Since this population cohort is smaller than that of the baby-boom generation, it is expected to lead to reduced housing demand during the next decade, though, as discussed below, other factors have kept the housing market very strong in the 1990s. However, the echo baby-boom generation (the children of the baby-boomers, who were born after 1977), while smaller than the baby-boom generation, will reach peak homebuying age later in the first decade of the new millennium, softening the blow somewhat.46

Immigrant Homebuyers. Past, present, and future immigration will also help keep homeownership growth at a respectable level. During the 1980s, 6 million legal immigrants entered the United States, compared with 4.2 million during the 1970s and 3.2 million during the 1960s.47 As a result, the foreign-born population of the United States doubled from 9.6 million in 1970 to 19.8 million in 1990, and is expected to reach 31 million by 2010.48 While immigrants tend to rent their first homes upon arriving in the United States, homeownership rates are substantially higher among those that have lived here for at least 6 years. In 1996, the homeownership rate for recent immigrants was 14.7 percent while it was 67.4 percent for native-born households. For foreign-born naturalized citizens, the homeownership rate after six years was a remarkable 66.9 percent.49

Immigration is projected to add even more new Americans in the 1990s, which will help offset declines in the demand for housing caused by the aging of the baby-boom generation. While it is projected that immigrants will account for less than four percent of all households in 2010, without the increase in the number of immigrants, household growth would be 25 percent lower over the next 15 years. As a result of the continued influx of immigrants and the aging of the domestic population, household growth over the next decade should remain at or near its current pace of 1.1-1.2 million new households per year, even though population growth is slowing. If this high rate of foreign immigration continues, it is possible that first-time homebuyers will make up as much as half of the home purchase market over the next several years.50

Past and future immigration will lead to increasing racial and ethnic diversity, especially among the young adult population. As immigrant minorities account for a growing share of first-time homebuyers in many markets, HUD and others will have to intensify their focus on removing discrimination from the housing and mortgage finance systems. The need to meet nontraditional credit needs, respond to diverse housing preferences, and overcome the information barriers that many immigrants face will take on added importance.

Trade-up Buyers. The fastest growing demographic group in the early part of the next millennium will be 45-to 65-year olds. This will translate into a strong demand for upscale housing and second homes. The greater equity resulting from recent increases in home prices should also lead to a larger role for “trade-up buyers” in the housing market during the next 10 to 15 years.

Nontraditional and Single Homebuyers. While overall growth in new households has slowed down, nontraditional households have become more important in the homebuyer market. With later marriages and more divorces, single-person and single-parent households have increased rapidly. First-time buyers include a record number of never-married single households, although Start Printed Page 65098their ownership rates still lag those of married couple households. According to the Chicago Title and Trust's Home Buyers Surveys, the share of first-time homebuyers who were never-married singles rose from 21 percent in 1991 to 37 percent in 1996, and to a record 43 percent in 1997. However, in 1999 never-married singles fell to 30 percent of first-time homebuyers.51 The shares for divorced/separated and widowed first-time homebuyers have stayed constant over the period, at eight percent and one percent, respectively.52 The National Association of Realtors reports that “single individuals, unmarried couples and minorities are entering the market as first-time buyers in record numbers.” 53 With the increase in single person households, it is expected that there will be a greater need for apartments, condominiums and townhomes.

Due to weak house price appreciation, traditional “trade-up buyers” stayed out of the market during the early 1990s. Their absence may explain, in part, the large representation of nontraditional homebuyers during that period. However, since 1995 home prices have increased 20 percent. Single-parent households are also expected to decline as the baby-boom generation ages out of the childbearing years. For these reasons, nontraditional homebuyers may account for a smaller share of the housing market in the future.

Growing Income Inequality. The Census Bureau recently reported that the top 5 percent of American households received 21.4 percent of aggregate household income in 1998, up sharply from 16.1 percent in 1977. The share accruing to the lowest 80 percent of households fell accordingly, from 56.5 percent in 1977 to 50.8 percent in 1998. The share of aggregate income accruing to households between the 80th and 95th percentiles of the income distribution was virtually unchanged over this period.54

The increase in income inequality over the past two decades has been especially significant between those with and those without post-secondary education. The Census Bureau reports that by 1997, the mean income of householders with a high school education (or less) was less than half that for householders with a bachelor's degree (or more). According to the Joint Center for Housing Studies, inflation-adjusted median earnings of men aged 25 to 34 with only a high-school education decreased by 14 percent between 1989 and 1995.55 So, while homeownership is highly affordable, this cohort lacks the financial resources to take advantage of the opportunity. As discussed earlier, the days of the well-paying unionized factory job have passed. They have given way to technological change that favors white-collar jobs requiring college degrees, and wages in the manufacturing jobs that remain are experiencing downward pressures from economic globalization. The effect of this is that workers without the benefit of a post-secondary education find their demand for housing constrained.

3. Single-Family Owner Mortgage Market

The mortgage market has undergone a great deal of growth and change over the past few years. Low interest rates, modest increases in home prices, and growth in real household income have increased the affordability of housing and resulted in a mortgage market boom. Total originations of single-family loans increased from $458 billion in 1990 to $859 billion in 1997 and then jumped to a record $1.507 trillion during the heavy refinancing year of 1998, before declining to $1.287 billion in 1999, the second highest level recorded.56 There have also been many changes in the structure and operation of the mortgage market. Innovations in lending products, added flexibility in underwriting guidelines, the development of automated underwriting systems and the rise of the subprime market, have had impacts on both the overall market and affordable lending during the 1990s.

The section starts with a review of trends in the market for mortgages on single-family owner-occupied housing. Next, trends in affordable lending, including new initiatives and changes to underwriting guidelines and the prospects for potential homebuyers are discussed. The section concludes with a summary of the activity of the GSEs relative to originations in the primary mortgage market.

a. Basic Trends in the Mortgage Market

Interest Rate Trends. The high and volatile mortgage rates of the 1980s and early 1990s have given way to a period with much lower and more stable rates in the last six years. Interest rates on mortgages for new homes were above 12 percent as the 1980s began and quickly rose to more than 15 percent.57 After 1982, they drifted downward slowly to the 9 percent range in 1987-88, before rising back into double-digits in 1989-90. Rates then dropped by about one percentage point a year for three years, reaching a low of 6.8 percent in October-November 1993 and averaging 7.2 percent for the year as a whole.

Mortgage rates turned upward in 1994, peaking at 8.3 percent in early 1995, but fell to the 7.5 percent-7.9 percent range for most of 1996 and 1997. However, rates began another descent in late-1997 and averaged 6.95 percent for 30-year fixed rate conventional mortgages during 1998, the lowest level since 1968, before rising to an average of 7.44 percent in 1999.58

Other Loan Terms. When mortgage rates are low, most homebuyers prefer to lock in a fixed-rate mortgage (FRM). Adjustable-rate mortgages (ARMs) are more attractive when rates are high, because they carry lower rates than FRMs and because buyers may hope to refinance to a FRM when mortgage rates decline. Thus the Federal Housing Finance Board (FHFB) reports that the ARM share of the market jumped from 20 percent in the low-rate market of 1993 to 39 percent when rates rose in 1994.59 The ARM share has since trended downward, falling to 22 percent in 1997 and a record low of 12 percent in 1998, before rising back to 22 percent in 1999.

In 1997 the term-to-maturity was 30 years for 83 percent of conventional home purchase mortgages. Other maturities included 15 years (11 percent of mortgages), 20 years (2 percent), and 25 years (1 percent). The average term was 27.5 years, up slightly from 26.9 years in 1996, but within the narrow range of 25-28 years which has prevailed since 1975.

One dimension of the mortgage market which has changed in recent years is the increased popularity of low- or no-point mortgages. FHFB reports that average initial fees and charges (“points”) have decreased from 2.5 percent of loan balance in the mid-1980s to 2 percent in the late-1980s, 1.5 percent in the early 1990s, and less than 1.0 percent in 1995-97. In 1998, 21 percent of all loans were no-point mortgages. These lower transactions costs have increased the propensity of homeowners to refinance their mortgages.60

Another recent major change in the conventional mortgage market has been the proliferation of high loan-to-value ratio (LTV) mortgages. Loans with LTVs greater than 90 percent (that is, down payments of less than 10 percent) made up less than 10 percent of the market in 1989-91, but 25 percent of the market in 1994-97. Loans with LTVs less than or equal to 80 percent fell from three-quarters of the market in 1989-91 to an average of 56 percent of mortgages originated in 1994-97. As a result, the average LTV rose from 75 percent in 1989-91 to nearly 80 percent in 1994-97.61

The statistics cited above pertain only to home purchase mortgages. Refinance mortgages generally have shorter terms and lower loan-to-value ratios than home purchase mortgages.

Mortgage Originations: Refinance Mortgages. Mortgage rates affect the volume of both home purchase mortgages and mortgages used to refinance an existing mortgage. The effects of mortgage rates on the volume of home purchase mortgages are felt through their role in determining housing affordability, discussed in the next subsection. However, the largest impact of rate swings on single-family mortgage originations is reflected in the volume of refinancings.

During 1992-93, homeowners responded to the lowest rates in 25 years by refinancing existing mortgages. In 1989-90 interest rates exceeded 10 percent, and refinancings accounted for less than 25 percent of total mortgage originations.62 The subsequent sharp decline in mortgage rates drove the refinance share over 50 percent in 1992 and 1993 and propelled total single-family originations to more than $1 trillion in 1993—twice the level attained just three years earlier.

The refinance wave subsided after 1993, because most homeowners who found it beneficial to refinance had already done so and because mortgage rates rose once again.63 Total single-family mortgage originations bottomed out at $639 billion in 1995, when the refinance share was only 15 percent. This meant that refinance volume declined by more than 80 percent in just two years.

A second surge in refinancings began in late-1997, abated somewhat in early 1998, but regained momentum in June 1998. The refinance share rose above 30 percent in mid-1997, exceeded 40 percent in late-1997, and peaked at 64 percent in January, before falling to 40 percent by May 1998. This share increased steadily over the June-September 1998 period, and averaged 50 percent for Start Printed Page 650991998. The refi boom ended abruptly in early 1999, as the share of loans for refinancings fell from 60 percent in the first quarter to 27 percent in the second quarter and 22 percent in the third and fourth quarters. Total originations, driven by the volume of refinancings, amounted to $859 billion in 1997 and were $1.507 trillion in 1998, nearly 50 percent higher than the previous record level of $1.02 trillion attained in 1993, before falling to $1.287 trillion last year. Total refinance mortgage volume in 1998 was estimated to be nearly 10 times the level attained in 1995. The refinance wave from 1997 through early 1999 reflects other factors besides interest rates, including greater borrower awareness of the benefits of refinancing, a highly competitive mortgage market, and the enhanced ability of the mortgage industry (including the GSEs), utilizing automated underwriting and mortgage origination systems, to handle this unprecedented volume expeditiously.

Mortgage Originations: Home Purchase Mortgages. In 1972 the median price of existing homes in the United States was $27,000 and mortgage rates averaged 7.52 percent; thus with a 20 percent down payment, a family needed an income of $7,200 to qualify for a loan on a median-priced home. Actual median family income was $11,100, exceeding qualifying income by 55 percent. The National Association of Realtors (NAR) has developed a housing affordability index, calculated as the ratio of median income to qualifying income, which was 155 in 1972.

By 1982 NAR's affordability index had plummeted to 70, reflecting a 154 percent increase in home prices and a doubling of mortgage rates over the decade. That is, qualifying income rose by nearly 400 percent, to $33,700, while median family income barely doubled, to $23,400. With so many families priced out of the market, single-family mortgage originations amounted to only $97 billion in 1982.

Declining interest rates and the moderation of inflation in home prices have led to a dramatic turnaround in housing affordability in the last decade and a half. Remarkably, qualifying income was $27,700 in 1993—$6,000 less than it had been in 1982. Median family income reached $37,000 in 1993, thus the NAR's housing affordability index reached 133. Housing affordability remained at about 130 for 1994-97, with home price increases and somewhat higher mortgage rates being offset by gains in median family income.64 Falling interest rates and higher income led to an increase in affordability to 143 in 1998, reflecting the most affordable housing in 25 years. Affordability remained high in 1999, despite the increase in mortgage rates.

The high affordability of housing, low unemployment, and high consumer confidence meant that home purchase mortgages reached a record level in 1997. However, this record was surpassed in 1998, as a July 1998 survey by Fannie Mae found that “every single previously cited barrier to homeownership—from not having enough money for a down payment, to not having sufficient information about how to buy a home, to the confidence one has in his job, to discrimination or social barriers—has collapsed to the lowest level recorded in the seven years Fannie Mae has sponsored its annual National Housing Survey.” 65 Specifically, the Mortgage Bankers Association estimates that home purchase mortgages rose to about $754 billion in 1998, well above the previous record of $574 billion established in 1997. The boom continued in 1999, with home purchase mortgage volume increasing further, to $824 billion.

First-time Homebuyers. First-time homebuyers have been the driving force in the recovery of the nation's housing market over the past several years. First-time homebuyers are typically people in the 25-34 year-old age group that purchase modestly priced houses. As the post-World War II baby boom generation ages, the percentage of Americans in this age group decreased from 28.3 percent in 1980 to 25.4 percent in 1992.66 Even though this cohort is smaller, first-time homebuyers increased their share of home sales. First-time buyers accounted for about 45 percent of home sales in 1999. Participation rates for first-time homebuyers so far this decade are all greater than or equal to 45 percent. This follows participation rates that averaged 40 percent in the 1980s, including a low of 36 percent in 1985. The highest first-time homebuyer participation rate was achieved in 1977, when it was 48 percent.67

The Chicago Title and Trust Company reports that the average first-time buyer in 1999 was 32 years old and spent 5 months looking at 12 homes before making a purchase decision. Most such buyers are married couples, but in 1999 29 percent had never been married, 9 percent were divorced or separated, and 1 percent were widowed.

First-time buyers paid an average of 34 percent of after-tax income, or $1,090 per month, on their mortgage payments in 1999, and saved for 2.2 years to accumulate a down payment. The National Association of Realtors reports that the median mortgage amount for first-time buyers was $104,000 in 1999, corresponding to an LTV of 97 percent, compared with a median mortgage amount of $150,000 and an average LTV of 81 percent for repeat buyers.

GSEs' Acquisitions as a Share of the Primary Single-Family Mortgage Market. The GSEs' single-family mortgage acquisitions have generally followed the volume of originations in the primary market for conventional mortgages, falling from 5.3 million mortgages in the record year of 1993 to 2.2 million mortgages in 1995, but rebounding to 2.9 million mortgages in 1996. In 1997, however, single-family originations were essentially unchanged, but the GSEs' acquisitions declined to 2.7 million mortgages.68 This pattern was reversed in 1998, when originations rose by 73 percent, but the GSEs' purchases jumped to 5.8 million mortgages. In 1999 the GSEs' acquired 4.8 million single-family mortgages, a decline of 17 percent, which approximated the 15 percent decline in single-family originations.

Reflecting these trends, the Office of Federal Housing Enterprise Oversight (OFHEO) estimates that the GSEs' share of total originations in the single-family mortgage market, measured in dollars, declined from 37 percent in 1996 to 32 percent in 1997—well below the peak of 51 percent attained in 1993. OFHEO attributes the 1997 downturn in the GSEs' role to increased holdings of mortgages in portfolio by depository institutions and to increased competition with Fannie Mae and Freddie Mac by private label issuers. However, OFHEO estimates that the GSEs' share of the market rebounded sharply in 1998-99, to 43-42 percent.

Mortgage Market Prospects. The Mortgage Bankers Association (MBA) reports that mortgage originations in 1999 were $1.3 trillion. This followed the record-breaking year of 1998, with $1.5 trillion in mortgage originations. Refinancing of existing mortgages was down from 1998's 50 percent share of total mortgage originations to 34 percent in 1999, still higher than an average year. Meanwhile, the ARM share in 1999 increased from 12 percent in 1998 to 22 percent of originations, reflecting the rise in overall interest rates. The MBA predicts that mortgage originations will amount to $962 billion and $912 billion, with refinancings representing 16 and 12 percent of originations, during 2000 and 2001, which is more in line with a normal pace. ARMs are expected to account for a larger share, 32 percent in 2000 and 34 percent in 2001, of total mortgage originations.69 Fannie Mae projects that mortgage originations will fall to $967 billion for 2000, with 19 percent coming from refinancings, while 30 percent of originations will be in the form of ARMs.70

b. Affordable Lending in the Mortgage Market

In the past few years, conventional lenders, private mortgage insurers and the GSEs have begun implementing changes to extend homeownership opportunities to lower-income and historically underserved households. The industry has started offering more customized products, more flexible underwriting, and expanded outreach so that the benefits of the mortgage market can be extended to those who have not been adequately served through traditional products, underwriting, and marketing. This section summarizes recent initiatives undertaken by the industry to expand affordable housing. The section also discusses the significant role FHA plays in making affordable housing available to historically underserved groups.

Down Payments. GE Capital's 1989 Community Homebuyer Program first allowed homebuyers who completed a program of homeownership counseling to have higher than normal payment-to-income qualifying ratios, while providing less than the full 5-percent down payment from their own funds. Thus the program allowed borrowers to qualify for larger loans than would have been permitted under standard underwriting rules. Fannie Mae made this Community Homebuyer Program a part of its own offerings in 1990. Affordable Gold is a similar program introduced by Freddie Mac in 1992. Many of these programs allowed 2 percentage points of the 5-percent down payment to come from gifts from relatives or grants and unsecured loans from local governments or nonprofit organizations. Start Printed Page 65100

In 1994, the industry (including lenders, private mortgage insurers and the GSEs) began offering mortgage products that required down payments of only 3 percent, plus points and closing costs. Other industry efforts to reduce borrowers' up front costs have included zero-point-interest-rate mortgages and monthly insurance premiums with no up front component. These new plans eliminated large up front points and premiums normally required at closing.

During 1998, Fannie Mae introduced its “Flexible 97” and Freddie Mac introduced its “Alt 97” low down payment lending programs. Under these programs borrowers are required to put down only 3 percent of the purchase price. The down payment, as well as closing costs, can be obtained from a variety of sources, including gifts, grants or loans from a family member, the government, a non-profit agency and loans secured by life insurance policies, retirement accounts or other assets. While these programs started out slowly, by November 1998 both GSEs' programs reached volumes of $200 million per month.

In early 1999, Fannie Mae announced that it would introduce several changes to its mortgage insurance requirements. The planned result is to provide options for low downpayment borrowers to reduce their mortgage insurance costs. Franklin D. Raines, Fannie Mae chairman and chief executive officer stated, “Now, thanks to our underwriting technology, our success in reducing credit losses, and innovative new arrangements with mortgage insurance companies, we can increase mortgage insurance options and pass the savings directly on to consumers.” 71

Partnerships. In addition to developing new affordable products, lenders and the GSEs have been entering into partnerships with local governments and nonprofit organizations to increase mortgage access to underserved borrowers. Fannie Mae's partnership offices in more than 40 central cities, serving to coordinate Fannie Mae's programs with local lenders and affordable housing groups, are an example of this initiative. Another example is the partnership Fannie Mae and the National Association for the Advancement of Colored People (NAACP) announced in January 1999.72 Under this partnership, Fannie Mae will provide funding for technical assistance to expand the NAACP's capacity to provide homeownership information and counseling. It will also invest in NAACP-affiliated affordable housing development efforts and explore structures to assist the organization in leveraging its assets to secure downpayment funds for eligible borrowers. Furthermore, Fannie Mae will provide up to $110 million in special financing products, including a new $50 million underwriting experiment specifically tailored to NAACP clientele.

Freddie Mac does not have a partnership office structure similar to Fannie Mae's, but it has undertaken a number of initiatives in specific metropolitan areas. Freddie Mac also announced on January 15, 1999 that it entered into a broad initiative with the NAACP to increase minority homeownership. Through this alliance, Freddie Mac and the NAACP seek to expand community-based outreach, credit counseling and marketing efforts, and the availability of low-downpayment mortgage products with flexible underwriting guidelines. As part of the initiative, Freddie Mac has committed to purchase $500 million in mortgage loans.73

The programs mentioned above are examples of the partnership efforts undertaken by the GSEs. There are more partnership programs than can be adequately described here. Fuller descriptions of these programs are provided in their Annual Housing Activity Reports.

Underwriting Flexibility. Lenders, mortgage insurers, and the GSEs have also been modifying their underwriting standards to attempt to address the needs of families who find qualifying under traditional guidelines difficult. The goal of these underwriting changes is not to loosen underwriting standards, but rather to identify creditworthiness by alternative means that more appropriately measure the circumstances of lower-income households. The changes to underwriting standards include, for example:

  • Using a stable income standard rather than a stable job standard. This particularly benefits low-skilled applicants who have successfully remained employed, even with frequent job changes.
  • Using an applicant's history of rent and utility payments as a measure of creditworthiness. This measure benefits lower-income applicants who have not established a credit history.
  • Allowing pooling of funds for qualification purposes. This change benefits applicants with extended family members.
  • Making exceptions to the “declining market” rule and clarifying the treatment of mixed-use properties.74 These changes benefit applicants from inner-city underserved neighborhoods.

These underwriting changes have been accompanied by homeownership counseling to ensure homeowners are ready for the responsibilities of homeownership. In addition, the industry has engaged in intensive loss mitigation to control risks.

Increase in Affordable Lending During the 1990s.75 Home Mortgage Disclosure Act (HMDA) data suggest that the new industry initiatives may be increasing the flow of credit to underserved borrowers. Between 1993 and 1997 (prior to the heavy refinancing during 1998), conventional loans to low-income and minority families increased at much faster rates than loans to higher income and non-minority families. As shown below, over this period home purchase originations to African Americans and Hispanics grew by almost 60 percent, and purchase loans to low-income borrowers (those with incomes less than 80 percent of area median income) increased by 45 percent.

1993-97 (in percent)1995-97 (in percent)
All Borrowers28.111.1
African Americans/Hispanics.57.7−0.2
Whites21.98.9
Income Less Than 80% AMI45.115.4
Income Greater Than 120% AMI31.524.5

However, as also shown, in the latter part of this period conventional lending for some groups slowed significantly. Between 1995 and 1997, the slowing of the growth of home purchase originations was much greater for low-income borrowers than for higher-income borrowers. Moreover, even though remaining at near-peak levels in 1997, conventional home purchase originations to African Americans and Hispanics actually decreased by two-tenths of a percent over the past three years. It should be noted, however, that total loans (conventional plus government) originated to African-American and Hispanic borrowers increased between 1995 and 1997, but this was mainly the result of a 40.0 percent increase in FHA-insured loans originated for African-American and Hispanic borrowers.

Affordable Lending Shares by Major Market Sector. The focus of the different sectors of the mortgage market on affordable lending can be seen by examining Tables A.1a, A.1b, and A.1c. Tables A.1a and A.1b present affordable lending percentages for FHA, the GSEs, depositories (banks and thrift institutions), the conventional conforming sector, and the overall market.76 The discussion below will center on Table A.1a, which provides information on home purchase loans and thus, homeownership opportunities. Table A.1b, which provides information on total (both home purchase and refinance) loans, is included to give a complete picture of mortgage activity. Both 1997 and 1998 HMDA data are included in these tables; the year 1997 represents a more typical year of mortgage activity than 1998, which was characterized by heavy refinance activity. The tables also include GSE data for 1999; the 1999 HMDA data will be incorporated when it is made available.

The affordable market shares reported in parentheses for the conventional conforming market in Tables A.1a and A.1b were derived by excluding the estimated number of B&C loans from the HMDA data. HUD's method for excluding B&C loans is explained in Start Printed Page 65101Section F.3a of Appendix D. Because B&C lenders operate mainly in the refinance sector, excluding these loans from the market totals has little impact on the home purchase percentages reported in Table A.1a. The reductions in the market shares are more significant for total loans (reported in Table A.1b) which include refinance as well as home purchase loans.

The interpretation of the “distribution of business” percentages, reported in Table A.1a for several borrower and neighborhood characteristics, can be illustrated using the FHA percentage for low-income borrowers: during 1997, 47.5 percent of all FHA-insured home purchase loans in metropolitan areas were originated for borrowers with an income less than 80 percent of the local area median income. Table A.1c, on the other hand, presents “market share” percentages that measure the portion of all home purchase loans for a specific affordable lending category (such as low-income borrowers) accounted for by a particular sector of the mortgage market (FHA or the GSEs). In this case, the FHA market share of 33 percent for low-income borrowers is interpreted as follows: of all home purchase loans originated in metropolitan areas during 1997, 33 percent were FHA-insured loans. Thus, this “market share” percentage measures the importance of FHA to the market's overall funding of loans for low-income borrowers.

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Four main conclusions may be drawn from the data presented in Tables A.1a and A.1c. First, FHA places much more emphasis on affordable lending than the other market sectors. Low-income borrowers accounted for 47.5 percent of FHA-insured loans during 1997, compared with 21.2 percent of the home loans purchased by the GSEs, 29.4 percent of home loans retained by depositories, and 27.3 percent of conventional conforming loans.77 Likewise, 41.3 percent of FHA-insured loans were originated in underserved census tracts, while only 22.1 percent of the GSE-purchased loans and 25.2 percent of conventional conforming loans were originated in these tracts.78 As shown in Table A.1c, while FHA insured only 23 percent of all home purchase mortgages originated in metropolitan areas during 1997, it insured 33 percent of all mortgages originated in underserved areas.79

Second, the affordable lending shares for the conventional conforming sector are low for minority borrowers, particularly African-American borrowers. For example, African-American borrowers accounted for only 5.0 percent of all conventional conforming home purchase loans originated during 1997 and 1998, compared with over 14 percent of FHA-insured loans and over 7.5 percent of all home purchase loans originated in the market. The African-American share of the GSEs' purchases is even lower than the corresponding share for the conventional conforming market. In 1998, home purchase loans to African-Americans accounted for 3.2 percent of Freddie Mac's purchases, 3.8 percent of Fannie Mae's purchases, and 4.9 percent of loans originated in the conventional conforming market (or 4.7 percent if B&C loans are excluded from the market definition).80 As shown in Table A.1a, the results change when other minority borrowers are considered. Fannie Mae purchased mortgages for minority borrowers and their neighborhoods at higher rates than these loans were originated by primary lenders in the conventional conforming market. During 1997, 17.7 percent of Fannie Mae's purchases were mortgages for minority borrowers, compared with 16.5 percent of conventional conforming loans. During 1998, 14.0 percent of Fannie Mae's purchases financed homes in high-minority census tracts, compared with 14.1 percent of conventional conforming loans (or 13.7 percent without B&C loans). However, as suggested by the data presented above, the minority lending performance of conventional lenders has been subject to much criticism in recent studies. These studies contend that primary lenders in the conventional market are not doing their fair Start Printed Page 65104share of minority lending which forces minorities, particularly African-American and Hispanic borrowers, to the more costly FHA and subprime markets.81

Third, the GSEs, but particularly Freddie Mac, lagged the conventional conforming market in funding affordable loans for low-income families and their neighborhoods during 1997 and 1998—in 1998, for example, low-income census tracts accounted for 7.9 percent of Freddie Mac's purchases, 9.4 percent of Fannie Mae's purchases, 12.1 percent of loans retained by depositories, and 10.7 percent of all home loans originated by conventional conforming lenders. This pattern of Freddie Mac lagging all market participants during 1997 and 1998 holds up for all of the borrower and neighborhood categories examined in Table A.1a. One encouraging trend for Freddie Mac is the significant increases in its purchases of affordable loans between 1997 and 1999—for example, from 19.2 percent to 24.5 percent for low-income borrowers, resulting in Freddie Mac surpassing Fannie Mae in the funding of home loans for low-income families. With respect to the GSEs' total (combined home purchase and refinance) purchases, Freddie Mac matched or out-performed Fannie Mae in 1999 on all categories in Table A.1b except minority borrowers. A more complete analysis of the GSEs' purchases of mortgages qualifying for the housing goals is provided below in Section E.

Finally, within the conventional conforming market, depository institutions stand out as important providers of affordable lending for lower-income families and their neighborhoods (see Table A.1a).82 Depository lenders have extensive knowledge of their communities and direct interactions with their borrowers, which may enable them to introduce flexibility into their underwriting standards without unduly increasing their credit risk. Another important factor influencing the types of loans held by depository lenders is the Community Reinvestment Act, which is discussed next.

Seasoned CRA Loans. The Community Reinvestment Act (CRA) requires depository institutions to help meet the credit needs of their communities. CRA provides an incentive for lenders to initiate affordable lending programs with underwriting flexibility.83 CRA loans are typically made to low- and moderate-income borrowers earning less than 80 percent of median income for their area, and in moderate-income neighborhoods. They are usually smaller than typical conventional mortgages and also are likely to have a high LTV, high debt-to-income ratios, no payment reserves, and may not be carrying private mortgage insurance (PMI). Generally, at the time CRA loans are originated, many do not meet the underwriting guidelines required in order for them to be purchased by one of the GSEs. Therefore, many of the CRA loans are held in portfolio by lenders, rather than sold to Fannie Mae or Freddie Mac. On average, CRA loans in a pool have three to four years seasoning.84

However, because of the size, LTV and PMI characteristics of CRA loans, they have slower prepayment rates than traditional mortgages, making them attractive for securitization. CRA loan delinquencies also have very high cure rates.85 For banks, selling CRA pools will free up capital to make new CRA loans. As a result, the CRA market segment may provide an opportunity for Fannie Mae and Freddie Mac to expand their affordable lending programs. In mid-1997, Fannie Mae launched its Community Reinvestment Act Portfolio Initiative. Under this pilot program Fannie Mae purchases seasoned CRA loans in bulk transactions taking into account track record as opposed to relying just on underwriting guidelines. By the end of 1997, Fannie Mae had financed $1 billion in CRA loans through this pilot.86 With billions of dollars worth of CRA loans in bank portfolios the market for securitization should improve. Section E, below, presents data showing that Fannie Mae's purchases of CRA-type seasoned mortgages have increased recently. Fannie Mae also started another pilot program in 1998 where they purchase CRA loans on a flow basis, as they are originated. Results from this four-year $2 billion nationwide pilot should begin to be reflected in the 1999 production data.87

c. Potential Homebuyers

While the growth in affordable lending and homeownership has been strong in recent years, attaining this Nation's housing goals will not be possible without tapping into the vast pool of potential homebuyers. The National Homeownership Strategy has set a goal of achieving a homeownership rate of 67.5 percent by the end of the year 2000. Due to the aging of the baby boomers, this rate reached an annual record of 66.8 percent in 1999, and rose further to 67.1 percent in the first quarter of 2000. This section discusses the potential for further increases beyond those resulting from current demographic trends.

The Urban Institute estimated in 1995 that there was a large group of potential homebuyers among the renter population who were creditworthy enough to qualify for homeownership.88 Of 20.3 million renter households having low- or moderate-incomes, roughly 16 percent were better qualified for homeownership than half of the renter households who actually did become homeowners over the sample period. When one also considered their likelihood of defaulting relative to the average expected for those who actually moved into homeownership, 10.6 percent, or 2.15 million, low- and moderate-income renters were better qualified for homeownership, assuming the purchase of a home priced at or below median area home price. These results indicate the existence of a significant lower-income population of low-risk potential homebuyer households that might become homeowners with continuing outreach efforts by the mortgage industry.

Other surveys conducted by Fannie Mae indicate that renters desire to become homeowners, with 60 percent of all renters indicating in the July 1998 National Housing Survey that buying a home ranks from being a “very important priority” to their “number-one priority,” the highest level found in any of the seven National Housing Surveys dating back to 1992. Immigration is expected to be a major source of future homebuyers—Fannie Mae's 1995 National Housing Survey reported that immigrant renter household were 3 times as likely as renter households in general to list home purchase as their “number-one priority.”

Further increases in the homeownership rate also depend on whether or not recent gains in the homeowning share of specific groups are maintained. Minorities accounted for 18 percent of homeowners in 1999, but the Joint Center for Housing Studies has pointed out that minorities account were responsible for nearly 40 percent of the 6.9 million increase in the number of homeowners between 1994 and 1999. Minority demand for homeownership continues to be high, as reported by the Fannie Mae Foundation's April 1998 Survey of African Americans and Hispanics. For example, 38 percent of African Americans surveyed said it is fairly to very likely that they will buy a home in the next 3 years, compared with 25 percent in 1997.89 The survey also reports that 67 percent of African Americans and 65 percent of Hispanics cite homeownership as being a “very important priority” or “number-one priority.” 90

The Joint Center for Housing Studies has stated that if favorable economic and housing market trends continue, and if additional efforts to target mortgage lending to low-income and minority households are made, the homeownership rate could reach 70 percent by 2010.

d. Automated Mortgage Scoring

This, and the following two sections, discuss special topics that have impacted the primary and secondary mortgage markets in recent years. They are automated mortgage scoring, subprime loans and manufactured housing.

Automated mortgage scoring was developed as a high-tech tool with the purpose of identifying credit risks in a more efficient manner. As time and cost are reduced by the automated system, more time can be devoted by underwriters to qualifying marginal loan applicants that are referred by the automated system for more intensive review. Fannie Mae and Freddie Mac are in the forefront of new developments in automated mortgage scoring technology. Both enterprises released automated underwriting systems in 1995—Freddie Mac's Loan Prospector and Fannie Mae's Desktop Underwriter. Each system uses numerical credit scores, such as those developed by Fair, Isaac, and Company, and additional data submitted by the borrower, such as loan-to-value ratios and available assets, to calculate a mortgage score that evaluates the likelihood of a borrower defaulting on the loan. The mortgage score is in essence a recommendation to the lender to accept the application, or to refer it for further review through manual underwriting. Accepted loans benefit from reduced document requirements and expedited processing.

Along with the promise of benefits, however, automated mortgage scoring has raised concerns. These concerns are related to the possibility of disparate impact and the proprietary nature of the mortgage score inputs. The first concern is that low-income Start Printed Page 65105and minority homebuyers will not score well enough to be accepted by the automated underwriting system resulting in fewer getting loans. The second concern relates to the “black box” nature of the scoring algorithm. The scoring algorithm is proprietary and therefore it is difficult, if not impossible, for applicants to know the reasons for their scores.

Federal Reserve Study. Four economists at the Board of Governors of the Federal Reserve System conducted a conceptual and empirical study on the use of credit scoring systems in mortgage lending.91 Their broad assessment of the models was that:

 “[C]redit scoring is a technological innovation which has increased the speed and consistency of risk assessment while reducing costs. Research has uniformly found that credit history scores are powerful predictors of future loan performance. All of these features suggest that credit scoring is likely to benefit both lenders and consumers.” 92

The authors evaluated the current state-of-the-art of development of credit scoring models, focusing particularly on the comprehensiveness of statistical information used to develop the scoring equations. They presented a conceptual framework in which statistical predictors of default include regional and local market conditions, individual credit history, and applicants' characteristics other than credit history. The authors observed that the developers of credit scoring models have tended to disregard regional and local market conditions in model construction, and such neglect may tend to reduce the predictive accuracy of scoring equations. To determine the extent of the problem, they analyzed Equifax credit scores together with mortgage payment history data for households living in each of 994 randomly selected counties from across the country. The authors used these data to assess the variability of credit scores relative to county demographic and economic characteristics.

The authors found a variety of pieces of evidence which confirmed their suspicions: Credit scores tended to be relatively lower in counties with relatively high unemployment rates, areas that have experienced recent rises in unemployment rates, areas with high minority population, areas with lower median educational attainment, areas with high percentages of individuals living in poverty, areas with low median incomes and low house values, and areas with relatively high proportions of younger populations and lower proportions of older residents.

This analysis suggests the need for a two-step process of improvement of the equations and their application, in which (a) new statistical analyses would be performed to incorporate the omitted environmental variables, and (b) additional variables bearing on individuals' prospective and prior circumstances will be taken into account in determining their credit scores.

These authors also discussed the relationship between credit scoring and discrimination. They found a significant statistical relationship between credit history scores and minority composition of an area, after controlling for other locational characteristics. From this, they concluded that concerns about potential disparate impact merit future study. However, a disparate impact study must include a business justification analysis to demonstrate the ability of the score card to predict defaults and an analysis of whether any alternative, but equally-predictive, score card has a less disproportionate effect.

Urban Institute Study. The Urban Institute submitted a report to HUD in 1999 on a four-city reconnaissance study of issues related to the single-family underwriting guidelines and practices of Fannie Mae and Freddie Mac.93 The study included interviews with informants knowledgeable about mortgage markets and GSE business practices on the national level and in the four cities.

The study observed, as did the Fed study summarized above, that minorities are more likely than whites to fail underwriting guidelines. Therefore, as a general matter the GSEs' underwriting guidelines—as well as the underwriting guidelines of others in the industry—do have disproportionate adverse effects on minority loan applicants.94

Based on the field reconnaissance in four metropolitan housing markets, the study made several observations about the operation of credit scoring systems in practice, as follows: 95

  • Credit scores are used in mortgage underwriting to separate loans that must be referred to loan underwriters from loans that may be forwarded directly to loan officers; for example, a 620 score was mentioned by some respondents as the line below which the loan officer must refer the loan for manual underwriting. It is very difficult for applicants with low credit scores to be approved for a mortgage, according to the lenders interviewed by the Urban Institute.
  • Some respondents believe the GSEs are applying cutoffs inflexibly, while others believe that lenders are not taking advantage of flexibility allowed by the GSEs.
  • Some respondents believe that credit scores may not be accurate predictors of loan performance, despite the claims of users of these scores. Respondents who voiced this opinion tended to base these observations on their personal knowledge of low-income borrowers who are able to keep current on payments, rather than on an understanding of statistical validation studies of the models.
  • Respondents indicate that the “black box” nature of the credit scoring process creates uncertainty among loan applicants and enhances the intimidating nature of the process for them.

Based on these findings, the authors concluded that “the use of automated underwriting systems and credit scores may place lower-income borrowers at a disadvantage when applying for a loan, even though they are acceptable credit risks.”

The Urban Institute report included several recommendations for ongoing HUD monitoring of the GSEs' underwriting including their use of credit scoring models. One suggestion was to develop a data base on the GSEs' lending activities relevant for analysis of fair lending issues. The data would include credit scores to reveal the GSEs' patterns of loan purchase by credit score. A second suggestion was to conduct analyses of the effects of credit scoring systems using a set of “fictitious borrower profiles” that would reveal how the systems reflect borrower differences in income, work history, credit history, and other relevant factors. HUD has begun following up on the Urban Institute's recommendations. For instance, in February 1999, HUD requested the information and data needed to analyze the GSEs' automated underwriting systems.

Concluding Observations. It is important to note that both of the studies reviewed above comment on the problem of correlation of valid predictors of default (income, etc.) with protected factors (race, etc.). Both studies suggest that, ultimately, the question whether mortgage credit scoring models raise any problems of legal discrimination based on disparate effects would hinge on a business necessity analysis and analysis of whether any alternative underwriting procedures with less adverse disproportionate effect exist.

It should be noted that the GSEs have taken steps to make their automated underwriting systems more transparent. Both Fannie Mae and Freddie Mac have published the factors used to make loan purchase decisions in Desktop Underwriter and Loan Prospector, respectively. The three most predictive factors are down payment, credit performance or bureau score, and financial cushion.

In response to criticisms aimed at using FICO scores in mortgage underwriting, Fannie Mae's new version of Desktop Underwriter (DU) 5.0 replaces credit scores with specific credit characteristics and provides expanded approval product offerings for borrowers who have blemished credit. The specific credit characteristics include variables such as past delinquencies; credit records, foreclosures, and accounts in collection; credit card line and use; age of accounts; and number of credit inquiries.

e. Subprime Loans

Another major development in housing finance has been the recent growth in subprime loans. In the past borrowers traditionally obtained an “A” quality (or “investment grade”) mortgage or no mortgage. However, an increasing share of recent borrowers have obtained “subprime” mortgages, with their quality denoted as “A-minus,” “B,” “C,” or even “D.” The subprime borrower typically is someone who has experienced credit problems in the past or has a high debt-to-income ratio.96 Through the first nine months of 1998, “A-minus” loans accounted for 63 percent of the subprime market, with “B” loans representing 24 percent and “C” and “D” loans making up the remaining 13 percent.97

Because of the perceived higher risk of default, subprime loans typically carry mortgage rates that in some cases are substantially higher than the rates on prime mortgages. While in many cases these perceptions about risk are accurate, some housing advocates have expressed concern that there are a number of cases in which the perceptions are actually not accurate. The Community Reinvestment Association of North Carolina (CRA-NC), conducted a study based on HMDA data, records of deeds, and personal contacts with affected borrowers in Durham County, NC. They found that Start Printed Page 65106subprime lenders make proportionally more loans to minority borrowers and in minority neighborhoods than to whites and white neighborhoods at the same income level. African-American borrowers represented 20 percent of subprime mortgages in Durham County, but only 10 percent of the prime market.98 As a result, these borrowers can end up paying very high mortgage rates that more than compensate for the additional risks to lenders. High subprime mortgage rates make homeownership more expensive or force subprime borrowers to buy less desirable homes than they would be able to purchase if they paid lower prime rates on their mortgages.

The HMDA database does not provide information on interest rates, points, or other loan terms that would enable researchers to separate more expensive subprime loans from other loans. However, the Department has identified 200 lenders that specialize in such loans, providing some information on the growth of this market.99 This data shows that mortgages originated by subprime lenders, and reported in the HMDA data, has increased from 104,000 subprime loans in 1993 to 210,000 in 1995 and 997,000 in 1998. Most of the subprime loans reported in the HMDA data are refinance loans; for example, refinance loans accounted for 80 percent of the subprime loans reported by the specialized subprime lenders in 1997.

An important question is whether borrowers in the subprime market are sufficiently creditworthy to qualify for more traditional loans. Freddie Mac has said that one of the promises of automated underwriting is that it might be better able to identify borrowers who are unnecessarily assigned to the high-cost subprime market. It has estimated that 10-30 percent of borrowers who obtain mortgages in the subprime market could qualify for a conventional prime loan through Loan Prospector, its automated underwriting system.100

Most of the subprime loans that were purchased by the GSEs in past years were purchased through structured transactions. Under this form of transaction, whole groups of loans are purchased, and not all loans necessarily meet the GSEs' traditional underwriting guidelines. The GSEs typically guarantee the so-called “A” tranche, which is supported by a “B” tranche that covers default costs.

An expanded GSE presence in the subprime market could be of significant benefit to lower-income families, minorities, and families living in underserved areas. HUD's research shows that in 1998: African-Americans comprised 5.0 percent of market borrowers, but 19.4 percent of subprime borrowers; Hispanics made up 5.2 percent of market borrowers, but 7.8 percent of subprime borrowers; very low-income borrowers accounted for 12.1 percent of market borrowers, but 23.3 percent of subprime borrowers; and borrowers in underserved areas amounted to 24.8 percent of market borrowers, but 44.7 percent of subprime borrowers.101

The GSEs. Fannie Mae and Freddie Mac have shown increasing interest in the subprime market throughout the latter half of the 1990s. Both GSEs now purchase A-minus and Alt-A mortgages on a flow basis.102 The GSEs' interest in the subprime market has coincided with a maturation of their traditional market (the conforming conventional mortgage market), and their development of mortgage scoring systems, which they believe allows them to accurately model credit risk.

Freddie Mac has been the more aggressive GSE in the subprime market. In early 1996, Freddie Mac stated that its interest in subprime loans was for the development of a subprime module for Loan Prospector (Freddie Mac's automated underwriting system), a joint project with Standard & Poor's to score subprime mortgages.103 Freddie Mac increased its subprime business through structured transactions, with Freddie Mac guaranteeing the senior classes of senior/subordinated securities backed by home equity loans. Between 1997 and 1999, Freddie Mac was involved in 16 transactions totaling $8.1 billion, with Freddie Mac's 1999 business accounting for over $5 billion of this total.104 During 1999, Freddie Mac did four transactions with Option One Mortgage, including its largest subprime deal to date, $930.4 million, in November of that year.

Freddie Mac also offers a product for A-minus borrowers through its Loan Prospector system and it recently announced a product similar to the “Timely Payment Rewards” mortgage offered by Fannie Mae. In total, Freddie Mac purchased approximately $12 billion in subprime loans during 1999—$7 billion of A-minus and alternative-A loans through its standard flow programs and $5 billion through structured transactions.105 Freddie Mac is projecting to increase its subprime purchases to $17.5 billion in the year 2000, consisting of $9.5 billion in subprime flow purchases and $8.0 billion in security purchases.106

Fannie Mae has not focused on structured transactions as Freddie Mac has. However, Fannie Mae initiated its Timely Payments product in September 1999, under which borrowers with slightly damaged credit can qualify for a mortgage with a higher interest rate than prime borrowers. Under this product, a borrower's interest rate will be reduced by 100 basis points if the borrower makes 24 consecutive monthly payments without a delinquency. Fannie Mae has revamped its automated underwriting system (Desktop Underwriter) so loans that were traditionally referred for manual underwriting are now given four risk classifications, three of which identify potential A-minus loans.107

Because the GSEs have a funding advantage over other market participants, they have the ability to underprice their competitors and increase their market share.108 This advantage, as has been the case in the prime market, could allow the GSEs to eventually play a significant role in the subprime market. As the GSEs become more comfortable with subprime lending, the line between what today is considered a subprime loan versus a prime loan will likely deteriorate, making expansion by the GSEs look more like an increase in the prime market. Since, as explained earlier in this chapter, one could define a prime loan as one that the GSEs will purchase, the difference between the prime and subprime markets will become less clear. This melding of markets could occur even if many of the underlying characteristics of subprime borrowers and the market's (i.e., non-GSE participants) evaluation of the risks posed by these borrowers remain unchanged.

Increased involvement by the GSEs in the subprime market might result in more standardized underwriting guidelines. As the subprime market becomes more standardized, market efficiencies might possibly reduce borrowing costs. Lending to credit-impaired borrowers will, in turn, increasingly make good business sense for the mortgage market.

f. Loans on Manufactured Housing

Manufactured housing provides low-cost, basic-quality housing for millions of American households, especially younger, lower-income families in the South, West, and rural areas of the nation. Many households live in manufactured housing because they simply cannot afford site-built homes, for which the construction cost per square foot is much higher. Because of its affordability to lower-income families, manufactured housing is one of the fastest-growing parts of the American housing market.109

The American Housing Survey found that 16.3 million people lived in 6.5 million manufactured homes in the United States in 1997, and that such units accounted for 6.6 percent of the occupied housing stock, an increase from 5.4 percent in 1985. Shipments of manufactured homes rose steadily from 171,000 units in 1991 to 373,000 units in 1998, before tailing off to 348,000 units in 1999. The industry grew much faster over this period in sales volume, from $4.7 billion in 1991 to $15.3 billion in 1999, reflecting both higher sales prices and a major shift from single-section homes to multisection homes, which contain two or three units which are joined together on site.110

Despite their eligibility for mortgage financing, only about 10-20 percent of manufactured homes111 are financed with mortgages secured by the property, even though half of owners hold title to the land on which the home is sited. Most purchasers of manufactured homes take out a personal property loan on the home and, if they buy the land, a separate loan to finance the purchase of the land.

In 1995, the average loan size for a manufactured home was $24,500, with a 15 percent down payment and term of 13 years. Rates averaged about 3 percentage points higher than those paid on 15-year fixed rate mortgages, but borrowers benefit from very rapid loan-processing and underwriting standards that allow high debt payment-to-income (“back-end”) ratios.

Traditionally loans on manufactured homes have been held in portfolio, but a secondary market has emerged since trading of asset-backed securities collateralized by manufactured home loans was initiated in 1987. Investor interest has been reported as strong due to reduced loan losses, low prepayments, and eligibility for packaging of such loans into real estate mortgage investment conduits (REMICs). The GSEs' Start Printed Page 65107underwriting standards allow them to buy loans on manufactured homes that meet the HUD construction code, if they are owned, titled, and taxed as real estate.

The GSEs are beginning to expand their roles in the manufactured home loan market.112 A representative of the Manufactured Housing Institute has stated that “Clearly, manufactured housing loans would fit nicely into Fannie Mae's and Freddie Mac's affordable housing goals.” 113 Given that manufactured housing loans often carry relatively high interest rates, an enhanced GSE role could also improve the affordability of such loans to lower-income families.

D. Factor 2: Economic, Housing, and Demographic Conditions: Multifamily Mortgage Market

Since the early 1990s, the multifamily mortgage market has become more closely integrated with global capital markets, approaching the same degree as the single-family mortgage market by the end of the decade. In 1999, 58.8 percent of multifamily mortgage originations were securitized, compared with 60.8 percent of single-family originations.114

Loans on multifamily properties are typically viewed as riskier than their single-family counterparts. Property values, vacancy rates, and market rents in multifamily properties appear to be highly correlated with local job market conditions, creating greater sensitivity of loan performance to economic conditions than may be experienced in the single-family market.

Within much of the single-family mortgage market, the GSEs occupy an undisputed position of industrywide dominance, holding loans or guarantees with an unpaid principal comprising 39.0 percent of outstanding single-family mortgage debt and guarantees as of the end of 1999. In multifamily, the overall market presence of the GSEs is more modest. At the end of 1999, the GSEs' direct holdings and guarantees represented 17.3 percent of outstanding multifamily mortgage debt.115 It is estimated that GSE acquisitions of multifamily loans originated during 1997 represented 24 percent of the conventional multifamily origination market.116

1. Special Issues and Unmet Needs

Recent studies have documented a pressing unmet need for affordable housing. For example, the Harvard University Joint Center for Housing Studies, in its report State of the Nation's Housing 2000, points out that:

  • Despite recent job and income growth, renters in the bottom quarter of the income distribution experienced a decline in real income from 1996-1998, at a time when real rents increased by 2.3 percent.
  • Between 1993 and 1995, the number of unsubsidized units affordable to very low-income households decreased by nearly 900,000 units, or 8.6 percent.
  • One-quarter of very low-income working households paid 30 percent or more of their incomes for housing.
  • Rising home prices and interest rates are raising the cost of homeownership.
  • Reductions in federal subsidies may contribute to further losses in the affordable stock.

The affordable housing issues go beyond the need for greater efficiency in delivering capital to the rental housing market. In many cases, subsidies are needed in order for low-income families to afford housing that meets adequate occupancy and quality standards. Nevertheless, greater access to reasonably priced capital can reduce the rate of losses to the stock, and can help finance the development of new or rehabilitated affordable housing when combined with locally funded subsidies. Development of a secondary market for affordable housing is one of many tools needed to address these issues.

Recent scholarly research suggests that more needs to be done to develop the secondary market for affordable multifamily housing.117 Cummings and DiPasquale (1998) point to the numerous underwriting, pricing, and capacity building issues that impede the development of this market. They suggest the impediments can be addressed through the establishment of affordable lending standards, better information, and industry leadership.

  • More consistent standards are especially needed for properties with multiple layers of subordinated financing (as is often the case with affordable properties allocated Low Income Housing Tax Credits and/or local subsidies).
  • More comprehensive and accurate information, particularly with regard to the determinants of default, can help in setting standards for affordable lending.
  • Leadership from the government or from a GSE is needed to develop consensus standards; it would be unprofitable for any single purely private lender to provide because costs would be borne privately but competitors would benefit.

2. Underserved Market Segments

There is evidence that segments of the multifamily housing stock have been affected by costly, difficult, or inconsistent availability of mortgage financing. Small properties with 5-50 units represent an example. The fixed-rate financing that is available is typically structured with a 5-10 year term, with interest rates as much as 150 basis points higher than those on standard multifamily loans, which may have adverse implications for affordability.118 This market segment appears to be dominated by thrifts and other depositories who keep these loans in portfolio. In part to hedge interest rate risk, loans on small properties are often structured as adjustable-rate mortgages.

Multifamily properties with significant rehabilitation needs have experienced difficulty in obtaining mortgage financing. Properties that are more than 10 years old are typically classified as “C” or “D” properties, and are considered less attractive than newer properties by many lenders and investors.119 Multifamily rehabilitation loans accounted for only 0.5 percent of units backing Fannie Mae's 1998 purchases and for 1.6 percent in 1999. These loans accounted for 1.9 percent of Freddie Mac's 1998 multifamily total (with none indicated in 1999).

Historically, the flow of capital into housing for seniors has been characterized by a great deal of volatility. A continuing lack of long-term, fixed-rate financing jeopardizes the viability of a number of some properties. There is evidence that financing for new construction remains scarce.120 Both Fannie Mae and Freddie Mac offer Senior Housing pilot programs.

Under circumstances where mortgage financing is difficult, costly, or inconsistent, GSE intervention may be desirable. Follain and Szymanoski (1995) say that “a [market] failure occurs when the market does not provide the quantity of a particular good or service at which the marginal social benefits of another unit equal the marginal social costs of producing that unit. In such a situation, the benefits to society of having one more unit exceeds the costs of producing one more unit; thus, a rationale exists for some level of government to intervene in the market and expand the output of this good.”121 It can be argued that the GSEs have the potential to contribute to the mitigation of difficult, costly, or inconsistent availability of mortgage financing to segments of the multifamily market because of their funding cost advantage, and even a responsibility to do so as a consequence of their public missions, especially in light of the limitations on direct government resources available to multifamily housing in today's budgetary environment.

3. Recent History and Future Prospects in Multifamily

The expansion phase of the real estate cycle been well underway for several years now, at least insofar as it pertains to multifamily. Rental rates have been rising, and vacancy rates have been relatively stable, contributing to a favorable environment for multifamily construction and lending activity.122 Delinquencies on commercial mortgages reached an 18-year low in 1997.123 Some analysts have warned that recent prosperity may have contributed to overbuilding in some markets and deterioration in underwriting standards.124 A September 1998, report by the Office of the Comptroller of the Currency anticipates continued decline in credit standards at the 77 largest national banks as a consequence of heightened competition between lenders, and the Federal Deposit Insurance Corporation has expressed similar concerns regarding 1,212 banks it examined.125

Growth in the multifamily mortgage market has been fueled by investor appetites for Commercial Mortgage Backed Securities (CMBS). Nonagency securitization of multifamily and commercial mortgages received an initial impetus from the sale of nearly $20 billion in mortgages acquired by the Resolution Trust Corporation (RTC) from insolvent depositories in 1992-1993. Nonagency issuers typically enhance the credit-worthiness of their offerings through the use of senior-subordinated structures, combining investment-grade senior tranches with high-yield, below investment-grade junior tranches designed to absorb any credit losses.126

Because of their relatively low default risk in comparison with loans on other types of income property, multifamily mortgages are often included in mixed-collateral financing structures including other commercial Start Printed Page 65108property such as office buildings, shopping centers, and storage warehouses. CMBS volume reached $30 billion in 1996; $44 billion in 1997; $78 billion in 1998; and $67 billion in 1999. Approximately 25 percent of each year's total is comprised of multifamily loans.127

During the financial markets turmoil in the fall of 1998, investors expressed reluctance to purchase the subordinated tranches in CMBS transactions, jeopardizing the ability of issuers to provide a cost-effective means of credit-enhancing the senior tranches as well.128 When investor perceptions regarding credit risk on subordinated debt escalated rapidly in August and September, the GSEs, which do not typically use subordination as a credit enhancement, benefited from a “flight to quality.” 129

Depository institutions and life insurance companies, formerly among the largest holders of multifamily debt, have experienced a decline in their share of the market at the expense of CMBS conduits.130 Increasingly, depositories and life insurance companies are participating in multifamily markets by holding CMBS rather than whole loans, which are often less liquid, more expensive, and subject to more stringent risk-based capital standards.131 In recent years a rising proportion of multifamily mortgages have been originated to secondary market standards, a consequence of a combination of factors including the establishment of a smoothly functioning securitization “infrastructure;” the greater liquidity of mortgage-related securities as compared with whole loans; and the desire for an “exit strategy” on the part of investors.132

Because of their limited use of mortgage debt, increased equity ownership of multifamily properties by REITs may have contributed to increased competition among mortgage originators, servicers and investors for a smaller mortgage market than would otherwise exist. During the first quarter of 1997, REITs accounted for 45 percent of all commercial real estate transactions, and the market capitalization of REITs at the end of January 1998 exceeded that of outstanding CMBS.133

Demographic factors will contribute to continued steady growth in the new construction segment of the multifamily mortgage market. The number of apartment households is expected to grow approximately 1.1 percent per year over 2000-2005. Taking into consideration losses from the housing stock, it has been projected that approximately 250,000-275,000 additional multifamily units will be needed in order to meet anticipated demand.134 This flow is approximately half that of the mid-1980s, but twice that of the depressed early 1990s. In 1999, 291,800 apartment units were completed. 135

The high degree of volatility of multifamily new construction experienced historically is consistent with a view that this sector of the housing market is driven more by fluctuations in the availability of financing than by demographic fundamentals. The stability and liquidity of the housing finance system is therefore a significant determinant of whether the volume of new construction remains consistent with demand.

Past experience suggests that the availability of financing for all forms of commercial real estate is highly sensitive to the state of the economy. In periods of economic uncertainty, lenders and investors sometimes raise underwriting and credit standards to a degree that properties that would be deemed creditworthy under normal circumstances are suddenly unable to obtain financing. Ironically, difficulty in obtaining financing may contribute to a fall in property values that can exacerbate a credit crunch.136 The sensitivity of commercial real estate markets to investor perceptions regarding global volatility was demonstrated by the rise in CMBS spreads in September, 1998.137 Thus, market disruptions could have adverse implications on U.S. commercial and residential mortgage markets.

4. Recent Performance and Effort of the GSEs Toward Achieving the Low- and Moderate-Income Housing Goal: Role of Multifamily Mortgages

The GSEs have rapidly expanded their presence in the multifamily mortgage market in the period since the housing goals were established in 1993. Fannie Mae has played a larger role in the multifamily market, with a portfolio of $47.4 billion in retained loans and outstanding guarantees, compared with $16.8 billion for Freddie Mac.138 Freddie Mac has successfully rebuilt its multifamily program after a three-year hiatus during 1991-1993 precipitated by widespread defaults.

Multifamily loans represent a relatively small portion of the GSEs' business activities. For example, multifamily loans held in portfolio or guaranteed by the GSEs at the end of 1999 represented less than three percent of their combined single- and multi-family holdings and guarantees. In comparison, multifamily mortgages not held or guaranteed by the GSEs represent approximately ten percent of the overall non-GSE stock of mortgage debt.

However, the multifamily market contributes disproportionately to GSE purchases meeting both the Low- and Moderate-Income and Special Affordable Housing goals. In 1999, Fannie Mae's multifamily purchases represented 9.5 percent of their total acquisition volume, measured in terms of dwelling units. Yet these multifamily purchases comprised 20.4 percent of units qualifying for the Low- and Moderate-Income Housing Goal, and 31.3 percent of units meeting the Special Affordable goal. Multifamily purchases were 8.2 percent of units backing Freddie Mac's 1999 acquisitions, 16.8 percent of units meeting the Low- and Moderate-Income Housing Goal, and 21.6 percent of units qualifying for the Special Affordable Housing Goal.139 The multifamily market therefore comprises a significant share of units meeting the Low- and Moderate-Income and Special Affordable Housing Goals for both GSEs, and the goals may have contributed to increased emphasis by both GSEs on multifamily in the period since the previous final rule took effect in 1996.140

The majority of units backing GSE multifamily transactions meet the Low- and Moderate-Income Housing Goal because the great majority of rental units are affordable to families at 100 percent of median income, the standard upon which the Low- and Moderate-Income Housing Goal is defined. For example, 38.5 percent of units securing Freddie Mac's 1999 single-family, one-unit owner-occupied mortgage purchases met the Low- and Moderate-Income Housing Goal, compared with 90.0 percent of its multifamily transactions. Corresponding figures for Fannie Mae were 37.9 percent and 94.8 percent. 141 For this reason, multifamily purchases represent a crucial component of the GSEs' efforts in meeting the Low- and Moderate-Income Housing Goal.

Because such a large proportion of multifamily units qualify for the Low- and Moderate-Income Housing Goal and for the Special Affordable Housing Goal, Freddie Mac's weaker multifamily performance adversely affects its overall performance on these two housing goals relative to Fannie Mae. Units in multifamily properties accounted for 7.2 percent of Freddie Mac's mortgage purchases during 1994-1999, compared with 11.8 percent for Fannie Mae. Fannie Mae's greater emphasis on multifamily is a major factor contributing to the strength of its housing goals performance relative to Freddie Mac.

5. A Role for the GSEs in Multifamily Housing

By sustaining a secondary market for multifamily mortgages, the GSEs can extend the benefits that come from increased mortgage liquidity to many more lower-income families while helping private owners to maintain the quality of the existing affordable housing stock. In addition, standardization of underwriting terms and loan documents by the GSEs has the potential to reduce transactions costs. As the GSEs gain experience in areas of the multifamily mortgage market affected by costly, difficult, or inconsistent access to secondary markets, they gain experience that enables them to better measure and price default risk, yielding greater efficiency and further cost savings.

Ultimately, greater liquidity, stability, and efficiency in the secondary market due to a significant presence by the GSEs will benefit lower-income renters by enhancing the availability of mortgage financing for affordable rental units—in a manner analogous to the benefits the GSEs provide homebuyers. Providing liquidity and stability is the main role for the GSEs in the multifamily market, just as in the single-family market.

Recent volatility in the CMBS market underlines the need for an ongoing GSE presence in the multifamily secondary market. The potential for an increased GSE presence is enhanced by virtue of the fact that an increasing proportion of multifamily mortgages are originated to secondary market standards, as noted previously. While the GSEs have also been affected by the widening of yield spreads affecting CMBS, historical experience suggests that agency spreads will converge to historical magnitudes as a consequence of the perceived benefits of federal sponsorship.142 When this occurs, the capability of the GSEs to serve and compete Start Printed Page 65109in the multifamily secondary market will be enhanced.143

6. Multifamily Mortgage Market: GSEs' Ability To Lead the Industry

Holding 12.8 percent of the outstanding stock of multifamily mortgage debt and guarantees as of the end of 1999, Fannie Mae is regarded as an influential force within the multifamily market. Its Delegated Underwriting and Servicing (DUS) program, in which Fannie Mae delegates underwriting responsibilities to originators in return for a commitment to share in any default risk, now accounts for more than half its multifamily acquisitions, and has been regarded as highly successful.

Freddie Mac's presence in the multifamily market is not as large as that of Fannie Mae. Freddie Mac's direct holdings of multifamily mortgages and guarantees outstanding as of the end of 1999, $16.8 billion, are much smaller than that Fannie Mae's $47.4 billion, not only in absolute terms, but also a percentage of all mortgage holdings and guarantees. Freddie Mac's multifamily holdings and guarantees are 2.1 percent of its total, compared with 4.3 percent for Fannie Mae.144 However, Freddie Mac is credited with rapidly rebuilding its multifamily operations since 1993. The GSEs' ability to lead the multifamily industry is discussed further below.

7. GSEs' Performance in the Multifamily Mortgage Market

GSE activity in the multifamily mortgage market has expanded rapidly since 1993, as noted previously. However, it is not clear that the potential of the GSEs to lead the multifamily mortgage industry has been fully exploited. In particular, the GSEs' multifamily purchases do not appear to be consistently contributing to mitigation of excessive cost of mortgage financing facing small properties with 5-50 units. Based on data from the Survey of Residential Finance showing that 39.4 percent of units in recently mortgaged multifamily properties were in properties with 5-49 units, it appears reasonable to assume that loans backed by small properties account for 39.4 percent of multifamily units financed each year. As a share of units backing their multifamily transactions, however, GSE purchases of loans on small multifamily properties are typically less than 5 percent, and have never approached the estimated 39.4 percent market share, as shown in Table A.2.

Table A.2.—GSE Multifamily Transactions by Size of Property, 1994-1999 Acquisition Year

199419951996199719981999
Fannie Mae:
Small (5-50 units)8,71745,4885,8388,11164,75312,351
As % Fannie Mae Multifamily Total3.919.32.13.216.54.2
Freddie Mac:
Small (5-50 units)1,1655,4614,1003,96310,2444,068
As % Freddie Mac Multifamily Total2.63.64.24.04.62.1
 Source: GSE loan-level data.

In order to more usefully compare the GSEs with the market, it is desirable to supplement the data presented in Table A.2 by acquisition year with findings organized by year of origination. Based on HUD's analysis of loans originated in 1997 and acquired by the GSEs in 1997, 1998, and 1999, the GSEs have purchased loans backed by 24 percent of units financed in the overall conventional multifamily mortgage market in 1997, but their acquisitions of loans on small multifamily properties have been only 2.3 percent of such properties financed that year.145

GSE multifamily acquisitions tend to involve larger properties than are typical for the market as a whole.146 For example, the average number of units in Fannie Mae's 1997 multifamily transactions was 163, with a corresponding figure of 158 for Freddie Mac. Both of these averages are significantly higher than the overall market average of 33.4 units per property on 1995 originations estimated from the HUD Property Owners and Managers (POMS) survey.147 A factor possibly contributing to the GSEs' emphasis on larger properties is the relatively high fixed multifamily origination costs, including appraisal, environmental review, and legal fees typically required under GSE underwriting guidelines.148

A recent noteworthy development is Fannie Mae's announcement of a new product through its Delegated Underwriting and Servicing (DUS) program for multifamily properties with 5-50 units. Features include a streamlined underwriting process designed, in part, to reduce borrower costs for third-party reports; use of FICO scores to evaluate borrower creditworthiness; and recourse to the borrower in the event of default.149

Another area underserved by mortgage markets, in which the GSEs have not demonstrated market leadership is rehabilitation loans. Both GSEs' relatively weak performance in the multifamily rehabilitation market segment is related to the fact that, since the inception of the interim housing goals in 1993, the great majority of units backing GSE multifamily mortgage purchases have been in properties securing refinance loans with an established payment history, in a proportion exceeding 80 percent in some years.150

The GSEs have been conservative in their approach to multifamily credit risk.151 HUD's analysis of prospectus data indicates that the average loan-to-value (LTV) ratio on pools of seasoned multifamily mortgages securitized by Freddie Mac during 1995 through 1996 was 55 percent. In comparison, the average LTV on private-label multifamily conduit transactions over 1995-1996 was 73 percent based on HUD's analysis of Commercial Mortgage Backed Security data. Fannie Mae utilizes a variety of credit enhancements to further mitigate default risk on multifamily acquisitions, including loss sharing, recourse agreements, and the use of senior/subordinated debt structures.152 Freddie Mac is less reliant on credit enhancements than is Fannie Mae, possibly because of a more conservative underwriting approach.153

The GSEs' ambivalence historically regarding the perception of credit risk in lending on affordable multifamily properties is evident with regard to pilot programs established in 1991 between Freddie Mac and the Local Initiatives Managed Assets Corporation (LIMAC), a subsidiary of the Local Initiatives Support Corporation (LISC), and in 1994 between Fannie Mae and Enterprise Mortgage Investments (EMI), a subsidiary of the Enterprise Foundation. Cummings and DiPasquale (1998) conclude that both initiatives had mixed results, although the Fannie Mae/EMI pilot was more successful in a number of regards. The Freddie Mac/LIMAC initiative was suspended after two years with only one completed transaction, involving eight loans with an aggregate loan amount of $4.6 million. As of June, 1997, 15 transactions comprising $20.5 million had been completed under the Fannie Mae/EMI pilot, which is ongoing.

Both programs suffered initially from documentation requirements that borrowers perceived as burdensome. Cummings and DiPasquale observe that “The smaller, nonprofit, and CDC developers that these programs intended to bring to the market were unprepared, and perhaps unwilling or unable, to meet the high costs of Freddie Mac's and Fannie Mae's due diligence requirements.”

E. Factor 3: Performance and Effort of the GSEs Toward Achieving the Low- and Moderate-Income Housing Goal in Previous Years

This section first discusses each GSE's performance under the Low- and Moderate-Income Housing Goal over the 1993-99 period. The data presented are “official results”—i.e., they are based on HUD's in-depth analysis of the loan-level data submitted to the Department and the counting provisions contained in HUD's regulations in 24 CFR part 81, subpart B. As explained below, in some cases these “official results” differ from goal performance reported to the Department by the GSEs in their Annual Housing Activities Reports. Start Printed Page 65110

Following this analysis, the GSEs' past performance in funding low- and moderate-income borrowers in the single-family mortgage market is provided. Performance indicators for the Geographically-Targeted and Special Affordable Housing Goals are also included in order to present a complete picture in Appendix A of the GSEs' funding of single-family mortgages that qualify for the three housing goals. In addition, the findings from a wide range of studies—employing both quantitative and qualitative techniques to analyze several performance indicators and conducted by HUD, academics, and major research organizations—are summarized below.

Organization and Main Findings. Section E.1 reports the performance of Fannie Mae and Freddie Mac on the Low- and Moderate-Income Housing Goal. Section E.2 uses HMDA data and the loan-level data that the GSEs provide to HUD on their mortgage purchases to compare the characteristics of GSE purchases of single-family loans with the characteristics of all loans in the primary mortgage market and of newly-originated loans held in portfolio by depositories. Section E.3 summarizes the findings from several studies that have examined the role of the GSEs in supporting affordable lending. Section E.4 discusses the findings from a recent HUD-sponsored study of the GSEs' underwriting guidelines.154 Finally, Section E.5 reviews the GSEs' support of the single-family rental market.

The Section's main findings with respect to the GSEs' single-family mortgage purchases are as follows:

  • Both Fannie Mae and Freddie Mac surpassed the Low- and Moderate-Income Housing Goals of 40 percent in 1996 and 42 percent in 1997-99.
  • Both Fannie Mae and Freddie Mac have improved their affordable lending 155 performance over the past seven years but, on average, they have lagged the primary market in providing mortgage funds for lower-income borrowers and underserved neighborhoods. This finding is based both on HUD's analysis of GSE and HMDA data as well as on numerous studies by academics and research organizations.
  • The GSEs show very different patterns of home loan lending.156 Through 1998, Freddie Mac was less likely than Fannie Mae to fund single-family home mortgages for low-income families and their communities. However, this pattern did not continue in 1999. The percentages of Freddie Mac's purchases through 1998 benefiting historically underserved families and their neighborhoods were also substantially less than the corresponding shares of total market originations. Through 1998 Freddie Mac had not made much progress closing the gap between its performance and that of the overall home loan market. HMDA data to analyze the affordable lending shares of the primary market in 1999 were not available at the time this appendix was prepared. But since the GSEs are such major participants in the mortgage market, the fact that Freddie Mac surpassed Fannie Mae last year in many dimensions of affordable lending suggests that they may well have narrowed the gap between their performance and that of the primary market.
  • Through 1998 Fannie Mae's purchases more nearly matched the patterns of originations in the primary market than did Freddie Mac's. However, during the 1993-98 period as a whole and the 1996-98 period during which the new goals were in effect, Fannie Mae lagged depositories and others in the conforming market in providing funding for the lower-income borrowers and neighborhoods covered by the three housing goals. HMDA data are not currently available to compare Fannie Mae's performance relative to the primary market for 1999.
  • A large percentage of the lower-income loans purchased by the GSEs have relatively high down payments, which raises questions about whether the GSEs are adequately meeting the needs of lower-income families who have little cash for making large down payments.
  • A study by The Urban Institute of lender experience with the GSEs' underwriting standards finds that the enterprises have stepped up their outreach efforts and have increased the flexibility in their underwriting standards, to better accommodate the special circumstances of lower-income borrowers. However, this study concludes that the GSEs' guidelines remain somewhat inflexible and that they are often hesitant to purchase affordable loans. Lenders also told the Urban Institute that Fannie Mae has been more aggressive than Freddie Mac in market outreach to underserved groups, in offering new affordable products, and in adjusting their underwriting standards.
  • While single-family rental properties are an important source of low-income rental housing, they represent only a small portion of the GSEs' business. In addition, many of the single-family rental properties funded by the GSEs are one-unit detached units in suburban areas rather than the older, 2-4 units commonly located in urban areas.

1. Past Performance on the Low- and Moderate-Income Housing Goal

HUD's goals specified that in 1996 at least 40 percent of the number of units eligible to count toward the Low- and Moderate-Income Goal should qualify as low-or moderate-income, and at least 42 percent should qualify in 1997-99. Actual performance, based on HUD's analysis, was as follows:

1996199719981999
Fannie Mae:
Units Eligible to Count Toward Goal1,831,6901,710,5303,468,4282,925,347
Low- and Moderate-Income Units834,393782,2651,530,3081,530,308
Percent Low- and Moderate-Income45.645.744.145.9
Freddie Mac:
Units Eligible to Count Toward Goal1,293,4241,173,9152,654,8502,224,849
Low- and Moderate-Income Units532,219499,5901,137,6601,024,660
Percent Low- and Moderate-Income41.142.642.946.1

Thus, Fannie Mae surpassed the goals by 5.6 percentage points and 3.7 percentage points in 1996 in 1997, respectively, while Freddie Mac surpassed the goals by 1.1 and 0.6 percentage points. In 1998 Fannie Mae's performance fell by 1.6 percentage points, while Freddie Mac's reported performance continued to rise, by 0.3 percentage point. Freddie Mac showed a sharp gain in performance to 46.1 percent in 1999, exceeding its previous high by 3.2 percentage points. Fannie Mae's performance was also at a record level of 45.9 percent, which, for the first time, slightly lagged Freddie Mac's performance.

The figures for goal performance presented above differ from the corresponding figures presented by Fannie Mae and Freddie Mac in their Annual Housing Activity Reports to HUD by 0.2-0.3 percentage points in both 1996 and 1997, reflecting minor differences in application of counting rules. These differences also persisted for Freddie Mac for 1998-99, but the goal percentages shown above for Fannie Mae for these two years are the same as the results reported by Fannie Mae to the Department.

Fannie Mae's performance on the Low- and Moderate-Income Goal jumped sharply in just one year, from 34.1 percent in 1993 to 45.1 percent in 1994, before tailing off to 42.8 percent in 1995. As indicated, it then stabilized at the 1994 level, just over 45 percent, in 1996 and 1997, before tailing off to 44.1 percent in 1998, but rose to 45.9 percent last year. Freddie Mac has shown more steady gains in performance on the Low- and Moderate-Income Goal, from 30.0 percent in 1993 to 38.0 percent in 1994 and 39.6 percent in 1995, before surpassing 41 percent in 1996 and 42 percent 1997, and rising to nearly 43 percent in 1998 and to 46 percent last year.

Fannie Mae's performance on the Low- and Moderate-Income Goal surpassed Freddie Mac's in every year through 1998. This pattern was reversed last year, as Freddie Mac surpassed Fannie Mae in goal performance for the first time, though by only 0.2 percentage point. This improved relative performance of Freddie Mac is due to its increased purchases of multifamily loans, as it re-entered that market, and to increases in Start Printed Page 65111the goal-qualifying shares of its single-family mortgage purchases.

2. Comparisons With the Primary Mortgage Market

This section summarizes several analyses conducted by HUD on the extent to which the GSEs' loan purchases through 1998 mirror or depart from the patterns found in the primary mortgage market. The GSEs' affordable lending performance is also compared with the performance of major portfolio lenders such as commercial banks and thrift institutions. Dimensions of lending considered include the borrower income and underserved area dimensions covered by the three housing goals. In addition, this section also analyzes Fannie Mae and Freddie Mac purchases during 1999; however, market data from HMDA were not available for 1999 at the time this analysis was prepared. Subsection a defines the primary mortgage market, subsection b addresses some questions that have recently arisen about HMDA's measurement of GSE activity, and subsections c-e present the findings.157

The market analysis in this section is based mainly on HMDA data for home purchase loans originated in metropolitan areas during the years 1992 to 1998. The discussion below will often focus on the year 1997, as that year represents more typical mortgage market activity than the heavy refinancing year of 1998. Still, important shifts in mortgage funding that occurred during 1998 will be highlighted in order to offer a complete analysis.

a. Definition of Primary Market

First it is necessary to define what is meant by “primary market” in making these comparisons. In this section this term includes all mortgages on single-family owner-occupied properties that are originated in the conventional conforming market.158 The source of this market information is the data provided by loan originators to the Federal Financial Institutions Examination Council (FFIEC) in accordance with the Home Mortgage Disclosure Act (HMDA).

There is a consensus that the following loans should be excluded from the HMDA data in defining the “primary market” for the sake of comparison with the GSEs' purchases of goal-qualifying mortgages:

  • Loans with a principal balance in excess of the loan limit for purchases by the GSEs—$240,000 for a 1-unit property in most parts of the United States in 1999.159 Loans not in excess of this limit are referred to as “conforming mortgages” and larger loans are referred to as “jumbo mortgages.” 160
  • Loans which are backed by the Federal government, including those insured by the Federal Housing Administration and those guaranteed by the Department of Veterans Affairs, which are generally securitized by the Government National Mortgage Association (“Ginnie Mae”), as well as Rural Housing Loans, guaranteed by the Farmers Home Administration.161 Generally, the GSEs do not receive credit on the housing goals for purchasing loans with Federal government backing. Loans without Federal government backing are referred to as “conventional mortgages.”

Questions have arisen about whether loans on manufactured housing should be excluded when comparing the primary market with the GSEs. As discussed elsewhere in this Appendix, the GSEs have not played a significant role in the manufactured housing mortgage market in the past. However, the manufactured home mortgage market is changing in ways that make a higher percentage of such loans eligible for purchase by the GSEs, and the GSEs are looking for ways to increase their purchases of these loans. But more importantly, the manufactured housing sector is one of the most important providers of affordable housing, which makes it appropriate to include this sector in the market definition. As discussed earlier in Section A.3c, HUD believes that excluding important low-income sectors such as manufactured housing from the market definition would render the resulting market benchmark useless for evaluating the GSEs' performance. For comparison purposes, data are presented for the primary market defined both to include and exclude mortgages originated by manufactured housing lenders. This issue of the market definition is discussed further in Appendix D, which calculates the market shares for each housing goal.

Questions have also arisen about whether subprime loans should be excluded when comparing the primary market with the GSEs. Appendix D, which examines this issue in some detail, reports the effects of excluding the B&C portion of the subprime market from HUD's estimates of the goal-qualifying shares of the overall (combined owner and rental) mortgage market. As explained Section C.3.e of this appendix, the low-income and minority borrowers in the A-minus portion of the subprime market could benefit from the standardization and lower interest rates that typically accompany an active secondary market effort by the GSEs. A-minus loans are not nearly as risky as B&C loans and Freddie Mac has been purchasing A-minus loans, both on a flow basis and through negotiated transactions. Fannie Mae recently introduced a new program targeted at A-minus borrowers. Thus, HUD does not believe that A-minus loans should be excluded from the market definition.

Unfortunately, HMDA does not identify subprime loans, much less separating them into their A-minus and B&C components. There is some evidence that many subprime loans are not reported to HMDA but there is nothing conclusive on this issue.162 Thus, it is not possible to exclude B&C loans from the comparisons reported below. However, HUD staff has identified HMDA reporters that primarily originate subprime loans.163 The text below will report the effects of excluding data for these lenders from the primary market. The effects are minor mostly because the analysis below focuses on home purchase loans, which accounted for only twenty percent of the mortgages originated by the subprime lenders. During 1997 and 1998, the subprime market was primarily a refinance market.

b. Methods and Data for Measuring GSE Performance

Several issues have arisen about the methods and the data used to measure the GSEs' performance relative to the characteristics of the mortgages being originated in the primary market. While most of these issues will be discussed throughout the appendices, one issue, the reliability of HMDA data in measuring GSE performance, needs to be addressed before presenting the market comparisons, which utilize the HMDA data. Fannie Mae, in particular, has raised questions about HUD's reliance on HMDA data for measuring its performance.

There are two sources of loan-level information on the characteristics of mortgages purchased by the GSEs—the GSEs themselves and HMDA data. The GSEs provide detailed data on their mortgage purchases to HUD on an annual basis. As part of their annual HMDA reporting responsibilities, lenders are required to indicate whether their new mortgage originations or purchased loans are sold to Fannie Mae, Freddie Mac or some other entity. As discussed later, there have been numerous studies by HUD staff and other researchers that use the HMDA data to compare the borrower and neighborhood characteristics of loans sold to the GSEs with the characteristics of all loans originated in the market. One question is whether the HMDA data, which is widely available to the public, provides an accurate measure of GSE performance, as compared with the GSEs' own data.164 Fannie Mae has argued that HMDA data have understated its past performance, where performance is defined as the percentage of Fannie Mae's mortgage purchases accounted for by one of the goal-qualifying categories such as underserved areas. As explained below, HMDA provided reliable national-level information through 1997 on the goals-qualifying percentages for the GSEs' purchases of newly-originated loans but not for their purchases of prior-year loans. In 1998, HMDA data differed from data that the GSEs reported to HUD on their purchases of newly-originated loans.

In any given calendar year, the GSEs can purchase mortgages originated in that calendar year or mortgages originated in a prior calendar year. In 1997, purchases of prior-year mortgages accounted for 30 percent of the single-family units financed by Fannie Mae's mortgage purchases and 20 percent of the single-family units financed by Freddie Mac's mortgage purchases.165 HMDA data provides information mainly on newly-originated mortgages that are sold to the GSEs—that is, HMDA data on loans sold to the GSEs will not include many of their purchases of prior-year loans.166 The implications of this for measuring GSE performance can be seen in Tables A.3 and A.4a.167

Table A.3 summarizes affordable lending by the GSEs, depositories and the conforming market for the six-year period between 1993 and 1998 and for the borrower and census tract characteristics covered by the housing goals. The GSE percentages presented in Table A.3 are derived from the GSEs' own data that they provide to HUD, while the depository and market percentages are taken Start Printed Page 65112from HMDA data. Annual data on the borrower and census tract characteristics of GSE purchases are provided in Table A.4a. According to Fannie Mae's own data, 9.9 percent of its purchases during 1997 were loans for very low-income borrowers (see Table A.4a). According to HMDA data (also reported in Table A.4a), only 8.8 percent of Fannie Mae's purchases were loans for very low-income borrowers.168 Thus, in this case the HMDA data underestimate the share of Fannie Mae's mortgage purchases for very low-income borrowers. Similarly, Fannie Mae reports a very low-income percentage of 11.4 percent for its 1998 purchases while HMDA reports only 9.2 percent.

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The reason that HMDA data underestimate those purchases can be seen by disaggregating Fannie Mae's purchases during 1997 into their “Prior Year” and “Current Year” components. Table A.4a shows that the overall figure of 9.9 percent for very low-income borrowers is a weighted average of 13.4 percent for Fannie Mae's purchases during 1997 of “Prior Year” mortgages and 8.7 percent for its purchases of “Current Year” purchases. HMDA data report that 8.8 percent of Fannie Mae's 1997 purchases consisted of loans to very low-income borrowers is based mainly on newly-mortgaged (current-year originations) loans that lenders report they sold to Fannie Mae. Therefore, the HMDA data figure is similar in concept to the “Current Year” percentage from the GSEs” own data. As Table A.4a shows, HMDA data and “Current Year” figures are practically the same in this case (about nine percent). Thus, the relatively large share of very low-income mortgages in Fannie Mae's 1997 purchases of “Prior Year” mortgages is the primary reason why Fannie Mae's own data show an overall (both prior-year and current-year) percentage of very low-income loans that is higher than that reported in HMDA data.

A review of the data in Table A.4a yields the following insights about the reliability of HMDA data at the national level for metropolitan areas. First, comparing the HMDA data on GSE purchases with the GSE “Current Year” data suggests that HMDA data provided reasonable estimates of the GSEs' current year purchases through 1997.169 Second, the HMDA data percentages through 1997 are actually rather close to Freddie Mac's overall percentages because Freddie Mac's prior-year purchases often resembled their current-year originations. Fannie Mae, on the other hand, was more apt to purchase seasoned loans with a relatively high percentage of low-income loans, which means that HMDA data was more likely to underestimate its overall performance. However, this underestimation of the share of Fannie Mae's goal-qualifying loans in the HMDA data first arose in 1997, when Fannie Mae's purchases of prior-year loans were particularly targeted to affordable lending groups. For the years 1993 to 1996, Fannie Mae's prior-year loan purchases more closely resembled their current-year originations.170

Third, the 1998 data show that even the GSEs' “Current Year” data differ from the HMDA-reported data on GSE purchases. For example, special affordable loans accounted for 12.1 percent of Fannie Mae's current-year purchases in 1998 compared with only 10.7 percent of Fannie Mae's special affordable purchases as reported by HMDA. Similarly, underserved areas accounted for 21.0 percent of Fannie Mae's current-year purchases compared with only 19.6 percent of Fannie Mae's underserved area purchases as reported by HMDA. The same patterns exist for Freddie Mac's 1998 data for the special affordable and underserved area categories. Thus, 1998 HMDA data do not provide a reliable estimate at the national level of the goals-qualifying percentages for the GSEs' purchases of current-year (newly-mortgaged) loans. More research on this issue is needed.171

The next section compares the GSE performance with that of the overall market. The fact that the GSE data includes prior-year as well as current-year loans, while the market data includes only current-year originations, means that the GSE-versus-market comparisons are defined somewhat inconsistently for any particular calendar year. Each year, the GSEs have newly-originated affordable loans available for purchase, but they can also purchase loans from a large stock of seasoned loans currently being held in the portfolios of depository lenders. Depository lenders have originated a large number of CRA-type loans over the past six years and many of them remain on their books. In fact, HUD has encouraged the GSEs to purchase seasoned, CRA-type loans that have demonstrated their creditworthiness. One method for making the data more consistent is to aggregate the data over several years, instead of focusing on annual data. This provides a clearer picture of the types of loans that have been originated and are available for purchase by the GSEs. This approach is taken in Table A.3.

c. Affordable Lending by the GSEs and the Primary Market

Table A.3 summarizes goal-qualifying lending by the GSEs, depositories and the conforming market for the six-year period between 1993 and 1998 and for the more recent 1996-98 period, which covers the period since the most recent housing goals have been in effect. As noted above, the data are aggregated over time to provide a clearer picture of how the GSEs' purchases of both current-year and prior-year loans compare with the types of mortgages that have been originated during the past few years. All of the data are for home purchase mortgages in metropolitan areas. Several points stand out concerning the affordable lending performance of Freddie Mac and Fannie Mae through 1998.

Freddie Mac—1993-98 Performance Relative to Market. The data in Table A.3 show that Freddie Mac substantially lagged both Fannie Mae and the primary market in funding affordable home loans between 1993 and 1998. During that period, 7.6 percent of Freddie Mac's mortgage purchases were for very low-income borrowers, compared with 9.2 percent of Fannie Mae's purchases, 14.5 percent of loans originated and retained by depositories, and 12.4 percent of loans originated in the conforming market (or 10.7 percent if manufactured home loans are excluded from the conforming market definition).172 As shown by the annual data reported in Table A.4a, Freddie Mac did improve its funding of very low-income borrowers during this period, from 6.0 percent in 1993 to 7.6 percent in 1997, and then to 9.9 percent in 1998. However, Freddie Mac did not make as much progress as Fannie Mae (discussed below) in closing the gap between its performance and that of the overall market. During the 1996-98 period in which the new goals have been in effect, the ratio of Freddie Mac's average performance (8.4 percent) to that of the overall market (13.0 percent) was only 0.65; this “Freddie-Mac-to-market” ratio remained at only 0.76 even when manufactured homes are excluded from the market definition.

A similar conclusion about Freddie Mac's performance can be drawn for the other goal-qualifying categories presented in Tables A.3 and A.4a: Freddie Mac's performance was well below the market between 1993 and 1998. For example, during the recent 1996-98 period, mortgages financing properties in underserved areas accounted for only 19.9 percent of Freddie Mac's purchases, compared with 22.9 percent of the loans purchased by Fannie Mae and 24.9 percent of the mortgages originated in the conforming market. Similarly, mortgages originated for low- and moderate-income borrowers represented 34.9 percent of Freddie Mac's purchases during that period, compared with 42.6 percent of all mortgages originated in the conforming market.

One encouraging sign for Freddie Mac is that the borrower-income categories showed a rather large increase between 1997 and 1998, followed by another significant increase between 1998 and 1999. Special affordable (low-mod) loans increased from 9.0 (34.1) percent in 1997 to 11.3 (36.9) percent in 1998 to 12.3 (40.0) percent in 1999. The reasons for this increase require further study, but certainly, an interesting question going forward is whether Freddie Mac can continue this 1997-99 pattern and thus further close its performance gap relative to the overall market. It is somewhat surprising that Freddie Mac's purchases of home loans in underserved areas did not increase (in percentage terms) between 1997 and 1998; as shown in Table A.4a, the underserved areas share of Freddie Mac's home loan purchases remained constant at approximately 20 percent between 1994 and 1998 before rising to 21.2 percent in 1999.

Fannie Mae—1993-98 Performance Relative to the Market. The data in Table A.3 show that Fannie Mae has also lagged depositories and the primary market in the funding of homes for lower-income borrowers and underserved neighborhoods. Between 1993 and 1998, 37.4 percent of Fannie Mae's purchases were for low- and moderate-income borrowers, compared with 43.6 percent of loans originated and retained by depositories and with 41.8 percent of loans originated in the primary market. Over the more recent 1996-98 period, 22.9 percent of Fannie Mae's purchases financed properties in underserved neighborhoods, compared with 25.8 percent of loans originated by depositories and 24.9 percent of loans originated in the conventional conforming market.

However, Fannie Mae's affordable lending performance between 1993 and 1998 can be distinguished from Freddie Mac's. First, Fannie Mae performed much better than Freddie Mac on every goal-category examined here. For example, home loans for special affordable loans accounted for 13.2 percent of Fannie Mae's purchases in 1998, compared with only 11.3 percent of Freddie Mac's purchases (see Table A.4a). In that same year, 22.9 percent of Fannie Mae's purchases were in underserved census tracts, compared with only 20.0 percent of Freddie Mac's purchases.

Second, Fannie Mae improved its performance between 1993 and 1998 and made more progress than Freddie Mac in Start Printed Page 65117closing the gap between its performance and the market's performance on the goal-qualifying categories examined here. In fact, by 1998, Fannie Mae's performance was close to that of the primary market for some important components of affordable lending. For example, in 1992, very low-income loans accounted for 5.2 percent of Fannie Mae's purchases and 8.7 percent of all loans originated in the conforming market, giving a “Fannie Mae-to-market” ratio of 0.60. By 1998, this ratio had risen to 0.86, as very low-income loans had increased to 11.4 percent of Fannie Mae's purchases and to 13.3 percent of market originations.

A similar trend in market ratios can be observed for Fannie Mae on the underserved areas category. Fannie Mae improved its performance relative to the market; for example, the “Fannie-Mae-to-market” ratio for underserved areas increased from 0.82 in 1992 to 0.93 in 1998. This improved performance relative to the overall market by Fannie Mae is in sharp contrast to Freddie Mac's record during the same 1992 to 1998 period—the “Freddie-Mac-to-market” ratio for underserved areas actually declined, from 0.84 in 1992 to 0.81 in 1998. As a result, Fannie Mae approached the home loan market in underserved areas while Freddie Mac lost ground relative to overall primary market.

B&C Home Purchase Loan. As explained earlier, HMDA does not identify subprime loans, much less separate them into their A-minus and B&C components. Randall Scheessele at HUD has identified 200 HMDA reporters that primarily originate subprime loans and probably accounted for at least half of the subprime market during 1998.173 As shown in Table A.4b, excluding the home purchase loans originated by these lenders from the primary market data has only minor effects on the goal-qualifying shares of the market. The average market percentages for 1998 are reduced as follows: low- and moderate-income (43.0 to 42.6 percent); special affordable (15.5 to 15.2 percent); and underserved areas (24.6 to 23.7 percent). As explained earlier, the effects are minor mostly because this analysis focuses on home purchase loans, which accounted for only 20 percent of the mortgages originated by these 200 subprime lenders—the subprime market has been mainly a refinance market.

GSEs' Purchases of Home Loans in 1999. Although market data are not yet available for 1999, the GSEs have reported their purchase data to HUD for that year. As shown in Table A.4a, the 1993-98 pattern discussed above of Freddie Mac lagging behind Fannie Mae in funding affordable loans changed in 1999, as Freddie Mac matched or slightly out-performed Fannie Mae on all three goals-qualifying categories. For example, special affordable loans accounted for similar percentages of Freddie Mac's (12.5 percent) and Fannie Mae's (12.3 percent) purchases of home loans during 1999. Low-mod (underserved areas) loans accounted for 40.0 (21.2) percent of Freddie Mac's 1999 purchases, compared with 39.3 (20.6) percent of Fannie Mae's 1999 purchases. Between 1998 and 1999, Fannie Mae's shares of goals-qualifying home loans declined in every case while Freddie Mac's goals-qualifying shares increased. For example, the low-mod share of Freddie Mac's purchases of home loans increased by 3.1 percentage points from 36.9 percent to 40.0 percent between 1998 and 1999; this compares to a decrease of 1.1 percentage point for Fannie Mae, from 40.4 percent to 39.3 percent. Data from 1999 HMDA will enable HUD to examine the extent to which Freddie Mac has closed its performance gap relative to the overall conventional conforming market.

d. Prior-Year Loans

An important source of the past differential in affordable lending between Fannie Mae and Freddie Mac concerns the purchase of prior-year loans. As shown in Table A.4a, the prior-year mortgages that Fannie Mae was purchasing through 1998 were much more likely to be loans for lower-income families and underserved areas than the newly-originated mortgages that they were purchasing. For example, 30.1 percent of Fannie Mae's 1997 purchases of prior-year mortgages were loans financing properties in underserved areas, compared with 20.8 percent of its purchases of newly-originated mortgages. These purchases of prior-year mortgages were one reason Fannie Mae improved its performance relative to the primary market, which includes only newly-originated mortgages, in 1997. Sixteen percent of its prior-year mortgages qualified for the Special Affordable Goal, compared with only 10.2 percent of its purchases of newly-originated loans. The same patterns are exhibited by the 1998 data. For example, 17.9 percent of Fannie Mae's prior-year purchases during 1998 qualified for the Special Affordable Goal, compared with only 12.1 percent of its 1998 purchases of newly-originated loans. Through 1998, Fannie Mae seem to be purchasing affordable loans that were originated by portfolio lenders in previous years.

Freddie Mac, on the other hand, does not seem to be pursuing such a strategy, or at least not to the same degree as Fannie Mae. In 1997, 1998, and 1999, Freddie Mac's purchases of prior-year mortgages and its purchases of newly-originated mortgages had similar percentages of special affordable and low-and moderate-income borrowers. As Table A.4a shows, there is a small differential between Freddie Mac's prior-year and newly-originated mortgages for the underserved areas category but it is much smaller than the differential for Fannie Mae. Thus, during 1997 and 1998, Freddie Mac's purchases of prior-year mortgages were less likely to qualify for the housing goals, and this was one reason Freddie Mac's overall affordable lending performance was below Fannie Mae's during those years. In 1999, on the other hand, there was surprisingly little difference between the goals-qualifying percentages for Fannie Mae's prior-year and its current-year purchases.

e. GSE Purchases of Total (Home Purchase and Refinance) Loans

The above sections have examined the GSEs' acquisitions of home purchase loans, which is appropriate given the importance of the GSEs for expanding homeownership opportunities. To provide a complete picture of the GSEs' mortgage purchases in metropolitan areas, this section briefly considers the GSEs' purchases of all single-family-owner mortgages, including both home purchase loans and refinance loans.174 As shown in Table A.4c, shifting the analysis to consider all (home purchase and refinance) mortgages does not change the basic finding that both GSEs lag the primary market in serving low-income borrowers and underserved neighborhoods. For example, in 1998 underserved areas accounted for 21.2 (20.9) percent of Fannie Mae's (Freddie Mac's) purchases, compared to approximately 25 percent for both depository institutions and the overall primary market. Similarly, special affordable loans accounted for 11.1 (10.9) percent of Fannie Mae's (Freddie Mac's) purchases of single-family-owner loans, compared to 14.9 percent for depository institutions and 14.2 percent for the overall primary market.

There are two changes when one shifts the analysis from only home purchase loans to include all mortgages—one concerning the relative performance of Fannie Mae and Freddie Mac and one concerning the impact of subprime mortgages on the goals-qualifying percentages. These are discussed next.

Fannie Mae versus Freddie Mac Performance—1997 to 1998. As indicated by the above percentages for 1998, the borrower-income and underserved area comparisons between Fannie Mae and Freddie Mac change when the analysis switches from their acquisitions of only home purchase loans to their acquisitions of total (both home purchase and refinance) loans—in the case of total loans, Freddie Mac's performance resembles Fannie Mae's performance in 1998 and surpasses Fannie Mae's performance in 1999 (see Table A.4c). These important shifts in the relative performance of Fannie Mae and Freddie Mac are best described by analyzing the 1997 to 1998 changes that led to Freddie Mac catching up with Fannie Mae in overall affordable lending, and then examining the 1998 to 1999 changes that led to Freddie Mac surpassing Fannie Mae in overall affordable lending.

Consider the special affordable income category for 1997 and 1998. As shown earlier in Table A.4a, special affordable loans accounted for a much higher percentage of Fannie Mae's acquisitions of home purchase loans than of Freddie Mac's in each of these two years. Similarly, in 1997, special affordable loans accounted for 11.5 percent of Fannie Mae's total (both home purchase and refinance) purchases, compared with 9.9 percent of Freddie Mac's total purchases. However, between 1997 and 1998, the special affordable percentage of Freddie Mac's total purchases increased from 9.9 percent to 10.9 percent, while the corresponding percentage for Fannie Mae actually declined from 11.5 percent to 11.1 percent. Thus, in 1998, Freddie Mac's overall special affordable percentage (10.9 percent) was approximately the same as Fannie Mae's (11.1 percent). This is reflected in Table A.4c by the “Fannie-Mae-to-Freddie-Mac” ratio of 1.02 for the special affordable category.

Further analysis shows that this improvement of Freddie Mac relative to Start Printed Page 65118Fannie Mae was due to Freddie Mac's better performance on refinance loans during 1998. The special affordable percentage of Fannie Mae's refinance loans fell from 11.1 percent in 1997 to 9.7 percent in 1998, which is not surprising given that middle-and upper-income borrowers typically dominate heavy refinance markets such as 1998. But the special affordable percentage of Freddie Mac's refinance loans did not drop very much, falling from 11.3 percent in 1997 to 10.7 percent in 1998.175 Thus, Freddie Mac's higher special affordable percentage (10.7 percent versus 9.7 percent for Fannie Mae) on refinance loans in 1998 enabled Freddie Mac to close the gap between its overall single-family performance and that of Fannie Mae.

The GSEs' low-mod and underserved areas percentages followed a somewhat similar pattern as their special affordable percentages between 1997 and 1998. In 1997, Freddie Mac's underserved area percentage (21.6 percent) for total purchases was significantly less than Fannie Mae's (23.6), but in 1998, Freddie Mac's underserved areas percentage (20.9) was about the same as Fannie Mae's (21.2 percent), as indicated by a “Fannie Mae to Freddie Mac” ratio of 1.01. This convergence was mainly due to a sharper decline in Fannie Mae's underserved area percentage for refinance loans between 1997 and 1998.

Fannie Mae versus Freddie Mac Performance—1998 to 1999. In 1998, the “Fannie-Mae-to-Freddie-Mac” ratios for all three goals-qualifying categories were approximately one, indicating similar performance for the two GSEs. As shown in Table A.4c, the 1999 ratios were 0.93 for special affordable loans, 0.95 for low-mod loans, and 0.93 for underserved areas loans—indicating that Freddie Mac, for the first time, had significantly surpassed Fannie Mae in overall performance. For instance, in 1999, underserved areas accounted for 21.8 percent of Fannie Mae's purchases, compared with 23.5 percent of Freddie Mac's purchases. For each of the three housing goal categories, Fannie Mae's performance increased between 1998 and 1999, but Freddie Mac's increased even more. For example, Fannie Mae's special affordable performance increased by 1.2 percentage points (from 11.1 percent to 12.3 percent) between 1998 and 1999 while Freddie Mac's performance increased 2.4 percentage points (from 10.9 percent to 13.3 percent).

B&C Loans. Table A.4b shows that the estimates for the home purchase market do not change much when loans for subprime lenders were excluded from the HMDA analysis; the reason was that these lenders operate primarily in the refinance market. Therefore, in this section's analysis of the total market (including refinance loans), one would expect the treatment of subprime lenders to significantly affect the market estimates. As indicated in Table A.4c, excluding 200 subprime lenders reduced the goal-qualifying shares of the total market in 1998 as follows: special affordable (from 14.2 to 12.7 percent); low-mod (from 40.9 to 39.0 percent); and underserved areas (from 24.8 to 22.6 percent). As discussed earlier, the GSEs have been entering the subprime market over the past two years, particularly the A-minus portion of that market. Industry observers estimate that A-minus loans account for 50-70 percent of all subprime loans while the more risky B&C loans account for the remaining 30-50 percent. Thus, one proxy for excluding B&C loans originated by the 200 specialized lenders from the overall market benchmark might be to reduce the goal-qualifying percentages from the HMDA data by half the above differentials; accounting for B&C loans in this manner would reduce the 1998 HMDA-reported goal-qualifying shares of the total conforming market as follows: special affordable (from 14.2 to 13.5 percent); low-mod (from 40.9 to 40.0 percent); and underserved areas (from 24.8 to 23.7 percent). However, as discussed in Appendix D, much uncertainty exists about the size of the subprime market and its different components. More data and research are obviously needed on this growing sector of the mortgage market. 176

f. GSE Mortgage Purchases in Individual Metropolitan Areas

While the above analyses, as well as earlier studies, 177 concentrate on national-level data, it is also instructive to compare the GSEs' purchases of mortgages in individual metropolitan areas (e.g. MSAs). In this section, the GSEs' purchases of single-family owner-occupied home purchase loans are compared to the market in individual MSAs. 178 To do so, total primary market mortgage originations from three years, 1995, 1996 and 1997, are summed up by year, by MSA, and for GSE purchases of these loans. The GSEs' purchases of 1995 originations include all 1995 originations purchased by each GSE between 1995 and 1998 from 324 MSAs. For their purchases of 1996 originations, all 1996 originations purchased between 1996 and 1999 from 326 MSAs are included. All 1997 originations purchased between 1997 and 1999 from 328 MSAs are included for 1997 originations. This should cover 90 to 95 percent of the 1995 through 1997 originated loans that will be purchased by the GSEs, thus making the GSE data comparable to HMDA market data. The loans are then grouped by the GSE housing goal categories for which they qualify and the ratio of the housing goal category originations to total originations in each MSA is calculated for each GSE and the market. The GSE-to-market ratio is then calculated by dividing each GSE ratio by the corresponding market ratio. For example, if it is calculated that one of the GSEs' purchases of Low- and Moderate-Income loans in a particular MSA is 47 percent of their overall purchases in that MSA, while 49 percent of all originations in that MSA are Low-Mod, then that GSE-to-market ratio is 47/49 (or 0.96).

Table A.5 shows the performance of the GSEs by MSA for 1995, 1996 and 1997 originations of home purchase loans. A GSE's performance is determined to be lagging the market if the ratio of the GSE housing goal loan purchases to their overall purchases is less than 99 percent of that same ratio for the market. 179 For the above example, that GSE is considered to be lagging the market. These results are then summarized in Table A.5, which reports the number of MSAs in which each GSE under-performs the market with respect to the housing goal categories.

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For 1996 originations, Fannie Mae:

  • Lagged the market in 268 (83 percent) of the MSAs in the purchase of Underserved Area loans,
  • Lagged the market in 288 (88 percent) of the MSAs in the purchase of Low- and Moderate-Income loans, and
  • Lagged the market in 295 (90 percent) of the MSAs in the purchase of Special Affordable loans.

Freddie Mac lagged the market to an even greater extent in 1996. Specifically, the market outperformed Freddie Mac in:

  • 296 (91 percent) of the MSAs in the purchase of Underserved Area loans,
  • 322 (99 percent) of the MSAs in the purchase of Low- and Moderate-Income loans, and
  • 323 (99 percent) of the MSAs in the purchase of Special Affordable loans.

Thus Freddie Mac was behind Fannie Mae in at least three-quarters of the MSAs for all three goal categories. As shown in Table A.5, the results for loans originated in 1995 and 1997 are similar.

g. High Down Payments on GSEs' Lower-Income Loans

Recent studies have raised questions about whether the lower-income loans purchased by the GSEs are adequately meeting the needs of some lower-income families. In particular, the lack of funds for down payments is one of the main impediments to homeownership, particularly for many lower-income families who find it difficult to accumulate enough cash for a down payment. As this section explains, a noticeable pattern among lower-income loans purchased by the GSEs is the predominance of loans with high down payments.

HUD's 1996 report to Congress on the possible privatization of Fannie Mae and Freddie Mac 180 found, rather surprisingly, that the mortgages taken out by lower-income borrowers and purchased by the GSEs were as likely to have high down payments as the mortgages taken out by higher-income borrowers and purchased by the GSEs. For example, considering the GSEs' purchases of home purchase loans in 1995, 58 percent of very low-income borrowers made a down payment of at least 20 percent, compared with less than 50 percent of borrowers from other groups. In addition, a surprisingly large percentage of the GSEs' first-time homebuyer loans had high down payments. In 1995, 35 percent of Fannie Mae's and 41 percent of Freddie Mac's first-time homebuyer loans had down payments of 20 percent or more.

Table A.6 presents similar data for the GSEs' purchases of total loans during 1999. Over three-fourths (75.1 percent) of the GSEs' very low-income loans had a down payment more than 20 percent, compared with 72.1 percent of their remaining purchases. Essentially, the GSEs have been purchasing lower-income loans with large down payments. 181

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These results are consistent with previous studies that show that the proportion of large down payment loans purchased by the GSEs from lower-income borrowers is greater than that for all loan purchases.182

As discussed in Section C, both Fannie Mae and Freddie Mac have introduced high-LTV products: “Flexible 97” and “Alt 97” respectively. By lowering the required down payment to three percent and adding flexibility to the source of the down payment, these loans should be more affordable. The down payment, as well as closing costs, can come from, gifts, grants or loans from a family member, the government, a non-profit agency and loans secured by life insurance policies, retirement accounts or other assets. Start Printed Page 65122However, in order to control default risk, these loans also have stricter credit history requirements.

Fed Study. An important study by three economists—Glenn Canner, Wayne Passmore and Brian Surette 183—at the Federal Reserve Board showed the implications of the GSEs' focus on high down payment loans. Canner, Passmore, and Surette examined the degree to which different mortgage market institutions—the GSEs, FHA, depositories and private mortgage insurers—are taking on the credit risk associated with funding affordable mortgages. The authors combined market share and down payment data with data on projected foreclosure losses to arrive at an estimate of the credit risk assumed by each institution for each borrower group. This study found that Fannie Mae and Freddie Mac together provided only 4 to 5 percent of the credit support for lower-income and minority borrowers and their neighborhoods. The relatively small role of the GSEs providing credit support is due to their low level of funding for these groups and to the fact that they purchase mainly high down payment loans. FHA, on the other hand, provided about two-thirds of the credit support for lower-income and minority borrowers, reflecting FHA's large market shares for these groups and the fact that most FHA-insured loans have less-than-five-percent down payments.

3. Other Studies of the GSEs Performance Relative to the Market

This section summarizes briefly the main findings from other studies of the GSEs' affordable housing performance. These include studies by the HUD and the GSEs as well as studies by academics and research organizations.

a. Studies by Bunce and Scheessele

Harold Bunce and Randall Scheessele of the Department have published two studies of affordable lending. In December 1996, they published a study titled The GSEs' Funding of Affordable Loans.184 This report analyzed HMDA data for 1992-95, including a detailed comparison of the GSEs' purchases with originations in the primary market. In July 1998, they updated their earlier study to analyze the mortgage market and the GSEs' activities in 1996.185 The findings were largely similar in both studies: 186

  • Both GSEs lagged the primary conventional market, depositories, and (particularly) FHA in funding mortgages for lower-income and historically underserved borrowers. FHA stands out as the major funder of affordable loans. In 1996, approximately 30 percent of FHA-insured loans were for African-American and Hispanic borrowers, compared with only 10 percent of the loans purchased by the GSEs or originated in the conventional market.
  • The two GSEs show very different patterns of lending—Fannie Mae is much more likely than Freddie Mac to serve underserved borrowers and their neighborhoods. Since 1992, Fannie Mae has narrowed the gap between its affordable lending performance and that of the other lenders in the conforming market. Freddie Mac's improvement has been more mixed—in some cases it has improved slightly relative to the market but in other cases it has actually declined relative to the market. The findings with respect to Freddie Mac are similar to those discussed earlier in Section E.2.c.

b. Studies by Freddie Mac

In 1995 Freddie Mac published Financing Homes for A Diverse America, which contained a wide variety of statistics and charts on the mortgage market. Several of the exhibits contained comparisons between the primary mortgage market and Freddie Mac's purchases in 1993 and 1994:

  • While not asserting strict parity, this report presented comparable frequency distributions of primary market originations and Freddie Mac's purchases by borrower and census tract income, concluding that Freddie Mac “finances housing for Americans of all incomes” and it “buys mortgages from neighborhoods of all incomes.”
  • With regard to minority share of census tracts, the report stated that Freddie Mac's “share of minority neighborhoods matches the primary market.”
  • The report acknowledged that Freddie Mac's purchases did not match the primary market in terms of borrower race. It found that in 1994 African-Americans and Hispanics each accounted for 4.9 percent of the primary market but only 2.7 percent and 4.0 percent respectively of Freddie Mac's purchases. On the other hand, Whites and Asian Americans accounted for 83.7 percent and 3.2 percent of the primary market, but 86.3 percent and 3.9 percent respectively of Freddie Mac's acquisitions.

In its March 1998 Annual Housing Activities Report (AHAR) submitted to the Department and Congress, Freddie Mac presented data on this issue for 1996 and 1997. This report stated that its purchases “essentially mirror[ed] the overall distribution of mortgage originations in terms of borrower income.” However, the data underlying Exhibit 4 of the AHAR indicated that the share of Freddie Mac's 1997 purchases for borrowers with income (in 1996 dollars) less than $40,000 was more than 4 percentage points below the corresponding share for the primary market in 1996. A similar pattern prevailed in terms of census tract income—the data underlying Exhibit 5 of the AHAR indicated that the share of Freddie Mac's 1997 purchases in tracts with income in excess of 120 percent of area median income exceeded the corresponding share for the primary market in 1996 by about 4 percentage points.

In its March 1998 AHAR, Freddie Mac found a much closer match between the distributions of home purchase mortgages by down payment for Freddie Mac's 1997 acquisitions and the primary market in 1997, as the latter was reported by the Federal Housing Finance Board. Specifically, Exhibit 6 of the AHAR reported that 42 percent of borrowers in each category made down payments of less than 20 percent.187

c. Studies by Fannie Mae

Fannie Mae has not published any studies on the comparability of its mortgage purchases with the primary market. However, in an October 1998 briefing for HUD staff, Fannie Mae presented the results of several comparisons of its purchases, based on the data supplied to the Department by Fannie Mae, with loans originated in the conventional conforming market, based on the HMDA data. In these analyses, Fannie Mae stated that:

  • The percentage of Fannie Mae's home purchase loans serving minorities exceeded the corresponding percentage in the conventional conforming market by 2.6 percentage points in 1995, 2.0 percentage points in 1996, and 2.7 percentage points (18.6 percent vs. 15.9 percent) in 1997;
  • The percentage of Fannie Mae's home purchase loans for low-and moderate-income households exceeded the corresponding percentage in the conventional conforming market by 0.2 percentage point in 1995, fell 0.1 percentage point short of the market in 1996, but exceeded it again, by 1.2 percentage points (38.5 percent vs. 37.3 percent), in 1997;
  • The percentage of Fannie Mae's home purchase loans for households in underserved areas fell 0.04 percentage point short of the conventional conforming market in 1996, but exceeded the corresponding percentage in the conventional conforming market by 1.4 percentage points (25.5 percent vs. 24.1 percent) in 1997;
  • The percentage of Fannie Mae's home purchase loans for very low-income households and low-income households in low-income areas fell 1.0 percentage point short of the conventional conforming market in 1995 and 0.9 percentage point short in 1996, but exceeded the corresponding percentage in the conventional conforming market by 2.2 percentage points (12.7 percent vs. 10.5 percent) in 1997.

Some of these findings by Fannie Mae differ from those of other researchers. This is due in part to the fact that most other studies have utilized HMDA data for both the primary market and sales to the GSEs, but Fannie Mae compared the primary market, based on HMDA data, with the patterns in the GSE loan-level data submitted to the Department.188189

d. Other Studies

Lind. John Lind examines HMDA data in order to compare the GSEs' loan purchase activity to mortgage originations in the primary conventional conforming market.190 Like other studies, Lind presents an aggregate comparison of GSE/primary market correspondence for Black, Hispanic, low-income borrowers, and low- and moderate-income Census tracts. Unlike other studies, however, Lind also examines market correspondence at the individual metropolitan area and regional levels.

Lind finds that the GSEs are not leading the market, but that Fannie Mae, in particular, improved its performance between 1993 and 1994. In 1994, Lind finds that the shares of Fannie Mae's home purchase loans to minority and low-income borrowers were comparable to the industry's shares. But the share of its home purchase loans for low- and moderate-income census tracts and the shares of Freddie Mac's home purchase loans for all categories examined trailed those for the industry as a whole. For refinance mortgages, on the other hand, both Start Printed Page 65123GSEs trailed the industry in terms of the shares of their loans for the groups analyzed. In a subsequent study, Lind found that the difference between the affordable lending performance of Fannie Mae and Freddie Mac was caused by differences in policy and operating procedures of the GSEs, and not differences in the make-up of their suppliers of loans.191

Ambrose and Pennington-Cross. There exists a wide variation in the market shares of the GSEs, FHA and portfolio lenders across geographic mortgage markets. Brent Ambrose and Anthony Pennington-Cross analyze FHA, GSE and portfolio lender market shares to find insights into what factors affect the market shares for FHA eligible (under the FHA loan limit) loans.192 They hypothesize that the GSEs try to mitigate higher perceived risks at the MSA level by tightening lending standards, generating a prediction of higher FHA market share in locations with characteristically higher or dynamically worsening risk. A second hypothesis is that market share of portfolio lenders increases in areas with higher risk due to “reputation effects” and GSE repurchase requirements. In their model, they account for cyclical risk, permanent risk, demographic, lender and regional differences.

Ambrose and Pennington-Cross found that the GSEs exhibit risk averse behavior as evidenced by lower GSE market presence in MSAs experiencing increasing risk and in MSAs that historically exhibit high-risk tendencies. FHA market shares, in contrast, are associated with high or deteriorating risk conditions. Portfolio lenders increase their mortgage portfolios during periods of economic distress, but increase the sale of originations out of portfolio during periods of increasing house prices. Lenders in MSAs with historically high delinquency hold more loans in portfolio. MSA risk is therefore concentrated among portfolio lenders and in FHA, with the GSEs bearing relatively little credit risk of this kind. The study does find that, other things being equal, the GSEs do have a higher presence in underserved areas and in areas where the minority population is highly segregated.

MacDonald (1998). Heather MacDonald 193 examined the impact of the central city housing goal from HUD's 1993-1995 interim housing goals. Census tracts were clustered according to five variables (median house value, median house age, proportion of renters, percent minority and proportion of 2 to 4 units) argued to impede secondary market purchases of homes in some neighborhoods. Borrower characteristics and lending patterns were compared across the clusters of tracts, and across central city and suburban tracts. Clustered tracts were found to be more strongly related to a set of key lending variables than are tracts divided according to central city/suburban boundaries. MacDonald concludes that targeting affirmative lending requirements on the basis of neighborhood characteristics rather than political or statistical divisions may provide a more appropriate framework for efforts to expand access to credit.

MacDonald (1999). In a 1999 study, Heather MacDonald investigated variations in GSE market share among a sample of 426 nonmetropolitan counties in eight census divisions.194 Conventional conforming mortgage originations were estimated using residential sales data, adjusted to exclude government-insured and nonconforming loans. Multivariate analysis was used to investigate whether GSE market shares differed significantly by location, after controlling for the economic, demographic, housing stock and credit market differences among counties that could affect use of the secondary markets. The study also investigated whether there were significant differences between the nonmetropolitan borrowers served by Fannie Mae and those served by Freddie Mac.

MacDonald found that space contributes significantly to explaining variations in GSE market shares among nonmetropolitan counties, but its effects are quite specific. One region—non-adjacent West North Central counties—had significantly lower GSE market shares than all others. The disparity persisted when analysis was restricted to underserved counties only. The study also suggested significant disparities between the income levels of the borrowers served by each agency, with Freddie Mac buying loans from borrowers with higher incomes than the incomes of borrowers served by Fannie Mae. An important limitation on any study of nonmetropolitan mortgages was found to be the lack of Home Mortgage Disclosure Act data. This meant that more precise conclusions about the extent to which the GSEs mirror primary mortgage originations in nometropolitan areas could not be reached.

McClure. Kirk McClure examined the twin mandates of FHEFSSA: to direct mortgage credit to neighborhoods that have been underserved by mortgage lenders; and to direct mortgage credit to low-income and minority households.195 Using the Kansas City metropolitan area as a case study, mortgages purchased by the GSEs in 1993-96 were compared with mortgages held by portfolio lenders in order to determine the performance of the GSEs in serving these two objectives. Kansas City provides a useful case study area for this analysis, because it includes a range of weak and strong housing market areas where homebuyers have been able to move easily to serve their housing, employment, and neighborhood needs.

McClure found that borrowers are better served if credit is directed to them independent of location. Very low-income and minority borrowers fared better, in terms of the demographic, housing, and employment opportunities of the neighborhoods into which they located, than borrowers in underserved neighborhoods, suggesting that directing credit to low-income and minority households has had the desired effect of helping these households purchase homes in areas where they would find good homes and good employment prospects. According to McClure, HUD's 1996-99 housing goals defined underserved tracts very broadly, such that nearly one-half of the tracts in the Kansas City area are categorized as underserved. Because the definition of underserved is so broad, directing credit to these tracts means only increasing the flow of mortgage credit to the lesser one-half of all tracts, which includes many areas with stable housing stocks and viable job markets.

The alternative approach of directing credit to underserved areas was found to be helpful only insofar as it has helped direct credit to neighborhoods with slightly lower household income levels and higher incidence of minorities than found elsewhere in the metropolitan area. McClure concluded that neighborhoods that receive very low levels of mortgage credit seemed to provide insufficient housing or employment opportunities to justify the effort that would be required to direct additional mortgage credit to them.

McClure concluded that whatever the approach, the GSEs have not been performing as well as the primary credit lenders in the Kansas City metropolitan area. In terms of helping underserved areas, the GSEs lagged behind the industry in the proportion of loans found in these areas. In terms of helping low-income and minority borrowers, the GSEs also lagged behind the industry. However, to the extent that the GSEs served these targeted populations, these households used this credit to move to neighborhoods with better housing and employment opportunities than were generally present in the underserved areas.

Williams.196 This study looks at mortgage lending in underserved markets in the primary and secondary mortgage markets for the MSAs in Indiana. A more extensive analysis is provided for South Bend/St. Joseph County, Indiana that looks at the GSE purchases in underserved markets by type of primary market lender in both 1992 and 1996. It shows the percentage of loans bought by the GSEs and the loan they did not buy. This study found that the GSEs were more aggressive in closing the gap in St. Joseph County than in other MSAs in Indiana. It also found that Fannie Mae's underserved market performance was slightly better than Freddie Mac's performance.

Williams compared the GSEs performance in underserved markets and CRA institutions between 1992 and 1995. It shows that the GSEs have narrowed the gap between themselves and lenders while CRA institutions have lost ground relative to non-CRA lenders. A pattern observed across all Indiana MSAs is that the GSEs do not appear to lead the market but rather almost perfectly mirrored the performance of mortgage companies.

Williams looked at the impact of size and location of lenders on the home mortgage market. Large lenders were more likely to finance mortgages for very low-income and African American borrowers than smaller lenders. Lenders headquartered in Indiana were more likely to purchase mortgages in underserved areas than lenders who only had branches or no apparent physical presence in Indiana. This suggest that served markets might benefit more than underserved areas from increased competition from non-local lenders.

Gyourko and Hu. This study focuses on the GSEs' housing goals looking at the intra-metropolitan distribution of mortgage acquisitions by Fannie Mae and Freddie Mac Start Printed Page 65124and the spatial distribution of households within 22 MSAs.197 The data on the GSEs' mortgage purchases is provided by the Census Tract File of Public Use Data Base and data on households is provided by the 1990 census. The study found that the distribution of goal-qualifying loan purchases by the GSEs does not match the distribution of goal-qualifying households. On average 44 percent of Low- and Moderate-Income Goal and 46 percent of Special Affordable Goal qualifying households are located in central cities. This compares to the GSEs' mortgage purchases where 26 percent of Low- and Moderate-Income Goal and 36 percent of Special Affordable Goal were located in central cities.

This study develops criteria for evaluating the GSEs' mortgage purchasing performance in census tracts. The first measure is a ratio. The numerator of the ratio is the share of the GSEs' mortgage purchases that qualify for the Special Affordable Housing Goal in the census tract. The denominator is the share of households that are targeted by the Special Affordable Housing Goal in the census tract. A ratio is also computed for the Low- and Moderate-Income Housing Goal. If the ratio is less than 0.80 then the census tract is called under-represented, meaning that the share of the GSEs' mortgage purchases which qualify for the housing goal is less than 80 percent of the share of the households that the goal targets. The analysis of these ratios shows that: (1) Central cities are more likely to be under-represented in terms of the share of affordable loans purchased by the GSEs, (2) in suburbs, the larger the census tracts' percent minority the greater the probability that affordable loan purchases are under-represented, and (3) the higher the tract's median income, the greater the likelihood that census tract is over-represented.

Gyourko and Hu's results are broadly consistent across the 22 MSAs analyzed; however, some noteworthy exceptions are made. In a few MSAs, particularly Miami and New York, the mismatch of affordable GSE purchases to affordable households is much less severe. In Boston, Los Angeles and New York, census tracts with higher relative median incomes are more likely to be under-represented.

Case and Gillen. This study provides a descriptive analysis of market share and logistic regression analysis of the GSEs' mortgage purchase patterns in 44 metropolitan areas over the period from 1993 to 1996.198 The study compares the GSEs and the market along several borrower and neighborhood characteristics.

This descriptive analysis of market shares finds that, compared with mortgages originated in the market, the GSEs' are less likely to purchase loans made to lower-income borrowers, minority borrowers, borrowers in lower-income neighborhoods, and borrowers in central city neighborhoods. The GSEs are more likely to purchase loans made to higher income borrowers, white borrowers, borrowers in higher income neighborhoods, and suburban borrowers than the non-GSEs. Case and Gillen find that Fannie Mae provides a higher proportion of total GSE funding for mortgage lending to lower-income and minority borrowers and to borrowers living in lower income, predominantly minority, central city, and geographically targeted areas than Freddie Mac.

A logistic regression analysis was conducted to look at the influence of specific borrower and neighborhood characteristics on the probability that a loan is purchased by one the GSEs. The results support the findings of the descriptive analysis with some exceptions. In contrast to the descriptive analysis, the impact of geographically targeted census tracts and neighborhood minority composition on the GSEs' purchasing behavior was inconsistent over the 44 areas. 199,200

The logistic regression analysis was extended to test for changes in the GSEs' purchasing behavior over time (1993-1996). Changes in the GSEs' purchasing activity are observed, but no systematic time trend was found. One explanation that was given for this result was that changes in the GSEs' purchases over time might be related to changes in overall market activity rather than changes in purchasing behavior by either of the GSEs.

Myers. Earlier studies have shown that racial minority groups—particularly African Americans and Latinos—are less likely to be approved for home mortgage loans than members of majority populations. It has been suggested that primary lenders may use the difficulty of selling loans to the GSEs on the secondary market as a pretext for not approving loans to racial minority group members. This study uses the residual difference approach to measure racial discrimination in mortgage lending and estimates differential treatment by the GSEs of minority and nonminority first-time homeowner loans in the 23 largest metropolitan statistical areas (MSAs).201

The residual difference approach decomposes racial gaps in HMDA-reported loan-rejection rates between the component that can be explained and that which cannot be explained by racial differences in characteristics. Characteristics Myers uses to explain poor credit history and denial rates include borrower, neighborhood, and loan variables from HMDA, the GSE Public Use Data Base, and Census 1990.202 Myers interprets the unexplained gap as being “discrimination”. The residual difference method permits the estimation of minority loan rejection rates when minorities are treated like equally qualified white borrowers (i.e. equal treatment values).

There are three main findings of this study. First, there are unexplained disparities in loan-rejection rates between black and white applicants for home mortgage loans in HMDA data; that is, blacks have higher denial rates than whites even after controlling for variables such as income. Second, the probability that a loan won't sell on the secondary market systematically increases the probability that a loan will be rejected by the lender.203 Third, African American and Hispanic loans are often less likely to sell on the secondary market than white loans.

The study also looks at whether the GSEs' purchasing behavior explains racial gaps in loan rejection rates. It compares the residual difference on racial disparities in loan rejection rates with and without controlling for GSE decisions. If the equal-treatment rejection rate is higher than the equal-treatment rejection rate that accounts for the GSE effect, then the purchase policies of the GSEs “explains part of the lending gap”. If the equal-treatment value without accounting for racial difference in GSE effects is equal to or lower than the corresponding value than accounts for racial difference in GSE effect, then GSEs effect does not explain racial lending gaps.

Myers concludes that there are no consistent patterns for the GSE effect, either across racial groups or across MSAs—that is, the GSE discussions do not systematically explain the observed racial disparities in loan rejection rates. In many MSAs, the GSE effect can account for some of the high rejection rates of blacks and “others”. Among other racial groups, however, there are as many MSAs where there is no such finding as there are ones where the effect seems to hold. But even in those cases where the effect seems to hold the amount explained is small. Myers finds that the impact is so small that even large differences in actual probabilities that loans are not sold to GSEs cannot explain the substantial racial difference in loan-rejection rates.

Bradford. In a case study comparison of the Chicago and Washington D.C. mortgage markets, Bradford found that minority areas received considerably lower levels of GSE purchases than white areas in the Chicago market, but about equal and sometimes higher levels of GSE purchases in the D.C. study area.204 Bradford's interprets this finding as partially the result of the exceptionally large minority population in the D.C. area living in new development and suburban areas when compared to the minority population distribution in the Chicago market. In his view, the fact that many minority homeowners in the D.C. area reside in suburban and new growth areas provides for increasing housing values and high levels of demand that help mitigate the effects of mortgage default by providing borrowers with more options to refinance or sell their homes to escape from foreclosure. This makes the minority market in the D.C. area generally more attractive to lenders and secondary market investors.

Bradford argues that the role of individual lenders is an important factor in explaining the disparate racial patterns between the Chicago and D.C. study areas. The large GSE lenders and the large lenders serving minority markets tend to be the same lenders in the D.C. market. He contends that the parity in the racial markets in the D.C. area would disappear and would be replaced by levels of disparity comparable to those in the Chicago market if just a handful of large GSE lenders in the minority areas reduced their GSE levels to the norm for the entire market.

Bradford also examines differences between Fannie Mae and Freddie Mac in the two study areas. Both Fannie Mae and Freddie Mac showed lower levels of purchases in minority areas than in white areas in the Chicago market, based on his research. While there were some instances where Freddie Mac made improvements Start Printed Page 65125relative to Fannie Mae (notably in the Chicago market in 1996), Fannie Mae's relative performance in different racial markets was better than that of Freddie Mac. In the Chicago market, for example, Fannie Mae had higher levels of market shares in the racially changing areas than in the white areas while Freddie Mac always had lower market shares in the racially changing areas compared to the white areas. In the D.C. market, Bradford found that while the GSEs as a whole showed relative parity in the different racial markets, this was largely due to Fannie Mae's performance that countered the systematic disparities in the Freddie Mac purchases.

Harrison, et. al. Theories of “information externalities,” supported by recent empirical evidence, suggest that property transactions in a particular market area generate information making similar future transactions in that same market area less risky for prospective lenders. Specifically, home sales generate information useful to independent appraisers in generating more precise value estimates. This increased precision, in turn, reduces the uncertainty (risk) faced by lenders, and hence, may increase acceptance rates and the flow of funds to the given market area.

Using a sample of GSE purchasing activities across twelve Florida counties, Harrison et al. find some evidence that both Fannie Mae and Freddie Mac are more active in neighborhoods with historically low transaction volume than they are in other neighborhoods.205 In addition, the results of their investigation are generally consistent with the previous literature suggesting Fannie Mae outperformed Freddie Mac in historically underserved market segments in 1993-95.

4. GSEs' Underwriting Guidelines

Most studies on affordability of mortgage loans are quantitative using HMDA data, HUD's GSE Public Use Database or some other related database. To complement these studies, HUD commissioned a study by the Urban Institute (UI) to examine recent trends in the GSEs' underwriting criteria and to seek attitudes and opinions of informed players in four local mortgage market markets (Boston, Detroit, Miami and Seattle).206 Interviews were conducted with mortgage lenders, community advocates and local government officials—all local actors who would be knowledgeable about the impact of the GSEs' underwriting policies on their ability to fund affordable loans for lower-income borrowers.207

The UI report reveals three major trends in the GSEs' underwriting that affects affordable lending. These include increased flexibility in standard 208 underwriting and appraisal guidelines, the introduction of affordable lending products, and the introduction of automated underwriting and credit scores in the loan application process. Through these trends, Fannie Mae and Freddie Mac have attempted to increase their capacity to serve low- and moderate-income homebuyers. They are also eliminating practices that could potentially have had disparate impacts on minority homebuyers. While both GSEs have made progress, “most [of those interviewed] thought Fannie Mae has been more aggressive than Freddie Mac in outreach efforts, implementing underwriting changes and developing new products.” 209

While the GSEs improved their ability to serve low- and moderate-income borrowers, it does not appear that they have gone as far as some primary lenders to serve these borrowers and to minimize the disproportionate effects on minority borrowers. From previous published analyses of the GSEs' mortgage purchases, differences between the income characteristics and racial composition of borrowers served by the primary mortgage market and the purchase activity of the GSEs were found. “This means that the GSEs are not serving lower-income and minority borrowers to the extent these families receive mortgages from primary lenders.” 210 From UI's discussions with lenders, it was revealed that primary lenders are originating mortgages to lower-income borrowers using underwriting guidelines that allow lower down payments, higher debt-to-income ratios and poorer credit histories than allowed by the GSEs' guidelines. These mortgages are originated to a greater extent to minority borrowers who have lower incomes and wealth. From this evidence, UI concludes that the GSEs appear to be lagging the market in servicing low- and moderate-income and minority borrowers.

Furthermore, UI found “that the GSEs' efforts to increase underwriting flexibility and outreach has been noticed and is applauded by lenders and community advocates. Despite the GSEs' efforts in recent years to review and revise their underwriting criteria, however, they could do more to serve low- and moderate-income borrowers and to minimize disproportionate effects on minorities. Moreover, the use of automated underwriting systems and credit scores may place lower-income borrowers at a disadvantage when applying for a loan, even though they are acceptable credit risks.” 211

5. The GSEs' Support of the Mortgage Market for Single-family Rental Properties

Single-family rental housing is an important part of the housing stock because it is an important source of housing for lower-income households. Based on the 1996 Property Owners and Managers Survey, 49 percent of all rental units are in properties with fewer than five units and the 1997 American Housing Survey found that approximately 59 percent of the stock of single-family rental units are affordable to very-low income families (i.e., families earning 60 percent or less of the area median income). Of the GSEs' mortgage purchases in 1999, around 30 percent of the single-family rental units financed were affordable to very-low income households.

While single-family rental properties are a large segment of the rental stock for low-income families, they make up a small portion of the GSEs' overall business. In 1999, Fannie Mae and Freddie Mac purchased more than $26 billion in mortgages for these properties. These purchases represented less than 5 percent of the total dollar amount of their overall 1999 business.

It follows that since single-family rentals make up such a small part of the GSEs business, they have not penetrated the single-family rental market to the same degree that they have penetrated the owner-occupant market. Table A.7b in Section G shows that in 1998 the GSEs financed 68 percent of owner-occupied dwelling units but only 19 percent of single-family rental units.

There are a number of factors that have limited the development of the secondary market for single-family rental property mortgages thus explaining the lack of penetration by the GSEs. Little is collectively known about these properties as a result of the wide spatial dispersion of properties and owners, as well as a wide diversity of characteristics across properties and individuality of owners. This makes it difficult for lenders to properly evaluate the probability of default and severity of loss for these properties.

Single-family rental properties are important for the GSEs housing goals, especially for meeting the needs of lower-income families. In 1999 around 73 percent of single-family rental units qualified for the Low- and Moderate-Income Goals, compared with 38 percent of one-family owner-occupied properties. This heavy focus on lower-income families meant that single-family rental properties accounted for 15 percent of the units qualifying for the Low- and Moderate-Income Goal, even though they accounted for 8 percent of the total units (single-family and multifamily) financed by the GSEs. Single-family rental properties account for 16 percent of the geographically-targeted and 23 percent of the special affordable housing goals.

A comparison of the GSEs' single-family rental and one-family owner-occupied mortgage purchases reveals the following broad patterns of borrower and neighborhood characteristics. Borrowers for single-family rental properties are more likely to be minorities than borrowers for one-family owner-occupied properties. Mortgages purchased by the GSEs for single-family rental properties compared with one-family owner-occupied properties are more likely to be located in lower-income and higher minority neighborhoods. More single-family rental than one-family owner-occupied mortgages were refinance or prior-year loans.

A closer look at borrower characteristics for single-family rental properties shows the following. First, based on ethnic/racial characteristics, borrowers for investor-owned properties are similar to borrowers for one-family owner-occupied properties. Second, borrowers for single-family rental properties, especially owner-occupied 2- to 4-unit properties, are more likely to be nonwhite than are borrowers for one-family owner-occupied and investor-owned properties. About 35 percent of the borrowers for owner-occupied 2- to 4-unit properties are non-white compared with around 17 percent for both one-family and investor-owned properties. For one-family owner-occupied and investor-owned properties about 5 percent of borrowers are African American, compared with 9 percent for owner-occupied 2- to 4-unit properties. A similar comparison applies for Hispanic borrowers, 6 percent and 15 percent respectively.

With regard to neighborhood characteristics, a comparison of different Start Printed Page 65126types of rental properties purchased by the GSEs shows that investor 1-unit properties were more likely to be located in higher-income neighborhoods than were units in 2- to 4-unit rental properties. For units in investor 1-unit properties, about 18 percent were in low-income neighborhoods, compared with 31 percent from units in 2- to 4-unit rental properties. About 40 percent of the units in investor properties were in high-minority neighborhoods, compared to only a slightly lower 37 percent for owner-occupied 2- to 4-unit properties.

The GSEs can mitigate risk by purchasing mortgages which are seasoned or refinanced. The data show that mortgages on properties with additional risk components such as being investor-owned, in low- income neighborhoods, and/or in high-minority neighborhoods are more likely to be seasoned or refinanced. For the GSEs' mortgage purchases, in general, mortgages on investor-owned properties are more likely to be prior-year than mortgages on owner-occupied 2- to 4-unit properties (based on unit counts). These patterns are consistent with the notion that investor properties are more risky than owner-occupied 2- to 4-unit properties.

F. Factor 4: Size of the Conventional Conforming Mortgage Market Serving Low- and Moderate-Income Families Relative to the Overall Conventional Conforming Market

The Department estimates that dwelling units serving low- and moderate-income families will account for 50-55 percent of total units financed in the overall conventional conforming mortgage market during 2001-2003, the period for which the Low- and Moderate-Income Housing Goal is established. The market estimates exclude B&C loans and allow for much more adverse economic conditions than have existed recently. The detailed analyses underlying these estimates are presented in Appendix D.

G. Factor 5: GSEs' Ability To Lead the Industry

FHEFSSA requires the Secretary, in determining the Low- and Moderate-Income Housing Goal, to consider the GSEs' ability to “lead the industry in making mortgage credit available for low- and moderate-income families.” Congress indicated that this goal should “steer the enterprises toward the development of an increased capacity and commitment to serve this segment of the housing market” and that it “fully expect[ed] [that] the enterprises will need to stretch their efforts to achieve [these goals].” 212

The Department and independent researchers have published numerous studies examining whether or not the GSEs have been leading the single-family market in terms of their affordable lending performance. This research, which is summarized in Section E, concludes that the GSEs have generally lagged behind other lenders in funding lower-income borrowers and their communities. As required by FHEFSSA, the Department has produced estimates of the portion of the total (single-family and multifamily) mortgage market that qualifies for each of the three housing goals (see Appendix D). Congress intended that the Department use these market estimates as one factor in setting the percentage target for each of the housing goals. The Department's estimate for the size of the Low- and Moderate-Income market is 50-55 percent, which is substantially higher than the GSEs' performance on that goal.

This section provides another perspective on the GSEs' performance by examining the share of the total mortgage market and the share of the goal-qualifying markets (low-mod, special affordable, and underserved areas) accounted for by the GSEs' purchases. This analysis, which is conducted by product type (single-family owner, single-family rental, and multifamily), shows the relative importance of the GSEs in each of the goal-qualifying markets.

1. GSEs' Role in Major Sectors of the Mortgage Market

Table A.7 compares GSE mortgage purchases with HUD's estimates of the numbers of units financed in the conventional conforming market during 1997(A.7a) and 1998 (A.76).213 Because 1997 was a more typical year then the heavy refinance year of 1998, the following discussion will focus on 1997. HUD estimates that there were 7,306,950 owner and rental units financed by new mortgages in 1997. Fannie Mae's and Freddie Mac's mortgage purchases financed 2,948,112 dwelling units, or 40 percent of all dwelling units financed. As shown in Table A.7a, the GSEs play a much smaller role in the goals-qualifying markets than they do in the overall market. During 1997, new mortgages were originated for 4,201,287 dwelling units that qualified for the Low- and Moderate-Income Goal; the GSEs low-mod purchases financed 1,330,516 dwelling units, or only 32 percent of the low-mod market. Similarly, the GSEs' purchases accounted for only 25 percent of the special affordable market and 34 percent of the underserved areas market.214 Obviously, the GSEs are not leading the industry in financing units that qualify for the three housing goals.

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While the GSEs are free to meet the Department's goals in any manner that they deem appropriate, it is useful to consider their performance relative to the industry by property type. As shown in Table A.7a, the GSEs accounted for 50 percent of the single-family owner market in 1997 but only 24 percent of the multifamily market and 14 percent of the single-family rental market (or a combined share of 20 percent of the rental market).

Single-family Owner Market. This market is the bread-and-butter of the GSEs' business, and based on the financial and other factors discussed below, they clearly have the ability to lead the primary market in providing credit for low- and moderate-income owners of single-family properties. However, the GSEs have been lagging behind the market in their funding of single-family owner loans that qualify for the housing goals, as discussed in Section E.2.c. Between 1996 and 1998, low- and moderate-income borrowers accounted for 34.9 percent of Freddie Mac's mortgage purchases and 38.4 percent of Fannie Mae's mortgage purchases, but 42.6 percent of primary market originations in metropolitan areas. The market share data reported in Table A.7. for the single-family owner market tell the same story. The GSEs' purchases of single-family owner loans represented 50 percent of all newly-originated owner loans in 1997, but only 43 percent of the low-mod loans that were originated, 35 percent of the special affordable loans, and 48 percent of the underserved area loans. Thus, the GSEs need to improve their performance and it appears that there is ample room in the non-GSE portions of the goals-qualifying markets for them to do so. For instance, the GSEs are not involved in almost two-thirds of special affordable owner market.

Single-family Rental Market. Single-family rental housing is a major source of low- and moderate-income housing. As discussed in Appendix D, data on the size of the primary market for mortgages on these properties is limited, but information from the American Housing Survey on the stock of such units Start Printed Page 65129and plausible rates of refinancing indicate that the GSEs are much less active in this market than in the single-family owner market. As shown in Table A.7a, HUD estimates that the GSEs' purchases have totaled only 14 percent of newly-mortgaged single-family rental units that were affordable to low- and moderate-income families.

Many of these properties are “mom-and-pop” operations, which may not follow financing procedures consistent with the GSEs' guidelines. Much of the financing needed in this area is for rehabilitation loans on 2-4 unit properties in older areas, a market in which the GSEs' have not played a major role. However, this sector could certainly benefit from an enhanced role by the GSEs, and the Department believes that there is room for such an enhanced role.

Multifamily Market. Fannie Mae is the largest single source of multifamily finance in the United States, and Freddie Mac has made a solid reentry into this market over the last five years. However, there are a number of measures by which the GSEs lag the multifamily market. For example, the share of GSE resources committed to the multifamily purchases falls short of the multifamily proportion prevailing in the overall mortgage market. HUD estimates that newly-mortgaged units in multifamily properties represented 17 percent all (single-family and multifamily) dwelling units financed during 1997.215 By comparison, multifamily acquisitions represented 13.5 percent all units backing Fannie Mae's purchases of mortgages originated in 1997, with a corresponding figure of only 8.8 percent for Freddie Mac.216 In other words, the GSEs place more emphasis on single-family mortgages than they do on multifamily mortgages.

The GSEs role in the multifamily market is significantly smaller than in single-family. As shown in Table A.7a, the GSEs' purchases have accounted for only 24 percent of newly financed multifamily units during 1997—a market share much lower than their 50 percent share of the single-family owner market. Thus, these data suggest that a further enlargement of the GSEs' role in the multifamily market seems feasible and appropriate in the future.

There are a number of submarkets, such as the market for mortgages on 5-50 unit multifamily properties, where the GSEs have particularly lagged the market. As mentioned above, the GSEs acquired loans representing 24 percent units multifamily units receiving conventional financing in 1997, but their acquisitions of loans on small multifamily properties represented only about 2 percent of such properties financed that year. Certainly the GSEs face a number of challenges in better meeting the needs of the multifamily secondary market. For example, thrifts and other depository institutions may sometimes retain their best loans in portfolio, and the resulting information asymmetries may act as an impediment to expanded secondary market transaction volume. 217 However, the GSEs have demonstrated that they have the depth of expertise and the financial resources to devise innovative solutions to problems in the multifamily market.

2. Qualitative Dimensions of the GSEs' Ability to Lead the Industry

This section discusses several qualitative factors that are indicators of the GSEs' ability to lead the industry in affordable lending. It discusses the GSEs' role in the mortgage market; their ability, through their underwriting standards, new programs, and innovative products, to influence the types of loans made by private lenders; their development and utilization of state-of-the-art technology; the competence, expertise and training of their staffs; and their financial resources.

a. Role in the Mortgage Market

As discussed in Section C of this Appendix, the GSEs' single-family mortgage acquisitions have generally followed the volume of originations in the primary market for conventional mortgages. However, in 1997, single-family originations rose by nearly 10 percent, while the GSEs' acquisitions declined by 7 percent. As a result, the Office of Federal Housing Enterprise Oversight (OFHEO) estimates that the GSEs' share of single-family mortgage originations declined from 37 percent in 1996 to 32 percent in 1997. The GSEs' single-family mortgage share jumped to an estimated 43 percent in 1998 and 42 percent in 1999, but that is still well below the peak of 51 percent attained in 1993.

The GSEs' high shares of originations during the 1990s led to a rise in their share of total conventional single-family mortgages outstanding, including both conforming mortgages and jumbo mortgages.218 OFHEO estimates that the GSEs' share of such mortgages outstanding jumped from 34 percent at the end of 1991 to 40 percent at the end of 1994 and an estimated 45 percent at the end of 1998.219 All of the increase in the GSEs' relative role between 1991 and 1998 was due to the growth in their portfolio holdings as a share of mortgages outstanding, from 5 percent at the end of 1991 to 17 percent at the end of 1998; relative holdings of the GSEs' mortgage-backed securities by others actually declined as a share of mortgages outstanding, from 29 percent at the end of 1991 to 28 percent at the end of 1998.

The dominant position of the GSEs in the mortgage market is reinforced by their relationships with other market institutions. Commercial banks, mutual savings banks, and savings and loans are their competitors as well as their customers—they compete to the extent they hold mortgages in portfolio, but at the same time they sell mortgages to the GSEs. They also buy mortgage-backed securities, as well as the debt securities used to finance the GSEs' portfolios. Mortgage bankers, who accounted for 58 percent of all single-family loans in 1997, sell virtually all of their conventional conforming loans to the GSEs.220 Private mortgage insurers are closely linked to the GSEs, because mortgages purchased by the enterprises that have loan-to-value ratios in excess of 80 percent are normally required to be covered by private mortgage insurance, in accordance with the GSEs' charter acts.

b. Underwriting Standards for the Primary Mortgage Market

The GSEs' underwriting guidelines are followed by virtually all originators of prime mortgages, including lenders who do not sell many of their mortgages to Fannie Mae or Freddie Mac.221 The guidelines are also commonly followed in underwriting “jumbo” mortgages, which exceed the maximum principal amount which can be purchased by the GSEs (the conforming loan limit)—such mortgages eventually might be sold to the GSEs, as the principal balance is amortized or when the conforming loan limit is otherwise increased. The GSEs, through their automated underwriting systems, have started adapting their underwriting for subprime loans and other loans that have not met their traditional underwriting standards.

Because the GSEs' guidelines set the credit standards against which the mortgage applications of lower-income families are judged, the enterprises have a profound influence on the rate at which mortgage funds flow to low- and moderate-income borrowers and underserved neighborhoods. Congress realized the crucial role played by the GSEs' underwriting guidelines when it required each enterprise to submit a study on its guidelines to the Secretary and to Congress in 1993, and when it called for the Secretary to “periodically review and comment on the underwriting and appraisal guidelines of each enterprise.” Some of the conclusions from a study of the GSEs' single-family underwriting guidelines prepared for the Department by the Urban Institute have been discussed in Section E.

c. State-of-the-Art Technology

Both GSEs are in the forefront of new developments in mortgage industry technology. Each enterprise released an automated underwriting system in 1995—Freddie Mac's “Loan Prospector” and Fannie Mae's “Desktop Underwriter.” Both systems rely on numerical credit scores, such as those developed by Fair, Isaac, and Company, and additional data submitted by the borrower, to obtain a mortgage score. The mortgage score indicates to the lender either that the GSE will accept the mortgage, based on the application submitted, or that more detailed manual underwriting is required to make the loan eligible for GSE purchase.

It is estimated that 25-40 percent of the GSEs' purchases were based on automated underwriting in 1999. These systems have also been adapted for FHA and jumbo loans. They have the potential to reduce the cost of loan origination, particularly for low-risk loans, but the systems are so new that no comprehensive studies of their effects have been conducted. As discussed earlier, concerns about the use of automated underwriting include the impact on minorities and the “black box” nature of the score algorithm.

The GSEs are using their state-of -the-art technology in certain ways to help expand homeownership opportunities. For example, Fannie Mae has developed FannieMaps, a computerized mapping service offered to lenders, nonprofit organizations, and state and local governments to help them implement community lending programs.Start Printed Page 65130

d. Staff Resources

Both Fannie Mae and Freddie Mac are well-known throughout the mortgage industry for the expertise of their staffs in carrying out their current programs, conducting basic and applied research regarding mortgage markets, developing innovative new programs, and undertaking sophisticated analyses that may lead to new programs in the future. The leaders of these corporations frequently testify before Congressional committees on a wide range of housing issues, and both GSEs have developed extensive working relationships with a broad spectrum of mortgage market participants, including various nonprofit groups, academics, and government housing authorities. They also contract with outside leaders in the finance industry for technical expertise not available in-house and for advice on a wide variety of issues.

e. Financial Strength

Fannie Mae. The benefits that accrue to the GSEs because of their GSE status, as well as their solid management, have made them two of the nation's most profitable businesses. Fannie Mae's net income has increased from $376 million in 1987 to $1.6 billion in 1992, $3.1 billion in 1997, $3.4 billion in 1998 and $3.9 billion in 1999—an average annual rate of increase of 22 percent. Through the fourth quarter of 1998, Fannie Mae has recorded 48 consecutive quarters of increased net income per share of common equity. Fannie Mae's return on equity averaged 24.0 percent over the 1995-99 period—far above the rates achieved by most financial corporations.

Investors in Fannie Mae's common stock have seen their annual dividends per share more than double since 1993, rising from $1.84 to $4.32 in 1999. If dividends were fully reinvested, an investment of $1000 in Fannie Mae common stock on December 31, 1987 would have appreciated to $27,983.98 by December 31, 1997. This annualized total rate of return of 39.5 percent over the decade exceeded that of many leading U. S. corporations, including Intel (35.9 percent), Coca-Cola (32.4 percent), and General Electric (24.3 percent).

Freddie Mac. Freddie Mac has shown similar trends. Freddie Mac's net income has increased from $301 million in 1987 to $622 million in 1992, $1.4 billion in 1997, $1.7 billion in 1998 and $2.2 billion in 1999—an average annual rate of increase of 18 percent. Freddie Mac's return on equity averaged 23.4 percent over the 1995-99 period—also well above the rates achieved by most financial corporations.

Investors in Freddie Mac's common stock have also seen their annual dividends per share more than double since 1993, rising from $0.88 to $2.40 in 1999. If dividends were fully reinvested, an investment of $1000 in Freddie Mac common stock on December 29, 1989 would have appreciated to $8,670.20 by December 31, 1997, for an annualized total rate of return of 31.0 percent over this period. This was slightly higher than the annual return on Fannie Mae common stock (29.9 percent) and substantially higher than the average gain in the S&P Financial-Miscellaneous index (24.1 percent) over the 1990-97 period.222

Other indicators. Additional indicators of the strength of the GSEs are provided by various rankings of American corporations. One survey found that at the end of 1999 Fannie Mae was third of all companies in total assets and Freddie Mac ranked 14th.223Business Week has reported that among Standard & Poor's 500 companies in 1999, Fannie Mae and Freddie Mac respectively ranked 49th and 88th in market value, and 24th and 43rd in total profits.224

f. Conclusion About Leading the Industry

In light of these considerations, the Secretary has determined that the GSEs have the ability to lead the industry in making mortgage credit available for low- and moderate-income families.

H. Factor 6: The Need To Maintain the Sound Financial Condition of the GSEs

HUD has undertaken a separate, detailed economic analysis of this final rule, which includes consideration of (a) the financial returns that the GSEs earn on low- and moderate-income loans and (b) the financial safety and soundness implications of the housing goals. Based on this economic analysis and discussions with the Office of Federal Housing Enterprise Oversight, HUD concludes that the goals raise minimal, if any, safety and soundness concerns.

I. Determination of the Low- and Moderate-Income Housing Goals

The annual goal for each GSE's purchases of mortgages financing housing for low- and moderate-income families is established at 50 percent of eligible units financed in each of calendar years 2001, 2002 and 2003. This goal will remain in effect for 2004 and thereafter, unless changed by the Secretary prior to that time. The goal represents an increase over the 1996 goal of 40 percent and the 1997-99 goal of 42 percent. These goals are in the lower portion of the range of market share estimates of 50-55 percent, presented in Appendix D. The Secretary's consideration of the six statutory factors that led to the choice of these goals is summarized in this section.

1. Housing Needs and Demographic Conditions

Data from the 1990 Census and the American Housing Surveys demonstrate that there are substantial housing needs among low- and moderate-income families, especially among lower-income and minority families in this group. Many of these households are burdened by high homeownership costs or rent payments and will likely continue to face serious housing problems, given the dim prospects for earnings growth in entry-level occupations. According to HUD's “Worst Case Housing Needs” report, 21 percent of owner households faced a moderate or severe cost burden in 1997. Affordability problems were even more common among renters, with 40 percent paying more than 30 percent of their income for rent in 1997.225

Single-family Mortgage Market. Many younger, minority and lower-income families did not become homeowners during the 1980s due to the slow growth of earnings, high real interest rates, and continued house price increases. Over the past seven years, economic expansion, accompanied by low interest rates and increased outreach on the part of the mortgage industry, has improved affordability conditions for these families. Between 1993 and 1999, record numbers of lower-income and minority families purchased homes. First-time homeowners have become a major driving force in the home purchase market over the past five years. Thus, the 1990s have seen the development of a strong affordable lending market. Despite this growth in affordable lending to minorities, disparities in the mortgage market remain. For example, African-American applicants are still twice as likely to be denied a loan as white applicants, even after controlling for income.

Several demographic changes will affect the housing finance system over the next few years. First, the U.S. population is expected to grow by an average of 2.4 million per year over the next 20 years, resulting in 1.1 to 1.2 million new households per year. The aging of the baby-boom generation and the entry of the baby-bust generation into prime home buying age will have a dampening effect on housing demand. However, the continued influx of immigrants will increase the demand for rental housing, while those who immigrated during the 1980's will be in the market for owner-occupied housing. Non-traditional households have become more important, as overall household formation rates have slowed. With later marriages, divorce, and non-traditional living arrangements, the fastest growing household groups have been single-parent and single-person households. With continued house price appreciation and favorable mortgage terms, “trade-up buyers” will increase their role in the housing market. These demographic trends will lead to greater diversity in the homebuying market, which will require adaptation by the primary and secondary mortgage markets.

As a result of the above demographic forces, housing starts are expected to average 1.5 million units between 2000 and 2004, essentially the same as in 1996-99.226 Refinancing of existing mortgages, which accounted for 50 percent of originations in 1998 and 34 percent in 1999 are returning to lower levels during 2000 and 2001 (16 and 12 percent respectively).

Multifamily Mortgage Market. Since the early 1990s, the multifamily mortgage market has become more closely integrated with global capital markets, although not to the same degree as the single-family mortgage market. Loans on multifamily properties remain viewed as riskier than their single-family counterparts. Property values, vacancy rates, and market rents in multifamily properties appear to be highly correlated with local job market conditions, creating greater sensitivity of loan performance to economic conditions than may be experienced for single-family mortgages.

Volatility during 1998 in the market for Commercial Mortgage Backed Securities (CMBS), an important source of financing for multifamily properties, underlines the need for an ongoing GSE presence in the multifamily secondary market. The potential for an increased GSE presence is enhanced Start Printed Page 65131by virtue of the fact that an increasing proportion of multifamily mortgages is now originated in accordance with secondary market standards.

The GSEs have the capability to increase the availability of long-term, fixed rate financing, thereby contributing greater liquidity in market segments where increased GSE presence can provide lenders with a more viable “exit strategy” than what is presently available. It appears that the cost of mortgage financing on properties with 5-50 units, where much of the nation's affordable housing stock is concentrated, may be higher than warranted by the degree of inherent credit risk.227 Presently, however, the GSEs purchase only about 5 percent of units in 5-50 unit properties financed annually. Borrowers have also experienced difficulty obtaining mortgage financing for multifamily properties with significant rehabilitation needs. Historically the flow of capital into multifamily housing for seniors has, moreover, been characterized by a great deal of volatility.

2. Past Performance and Ability To Lead the Industry

The GSEs have played a major role in the conventional single-family mortgage market in the 1990s. The GSEs' purchases of single-family-owner mortgages accounted for 42 percent of mortgages originated in the single-family market during 1999. Many industry observers believe that the role of the GSEs in the late-1980s and 1990s is a major reason why the decline of the thrift industry had only minor effects on the nation's housing finance system. Additionally, the American mortgage market was not impacted adversely in any way by the volatility in world financial markets in late 1998.

The enterprises' role in the mortgage market is also reflected in their use of cutting edge technology, such as the development of Loan Prospector and Desktop Underwriter, the automated underwriting systems developed by Freddie Mac and Fannie Mae, respectively. Both GSEs are also entering new and challenging fields of mortgage finance, including activities involving subprime mortgages and mortgages on manufactured housing.

The GSEs' performance on the Low- and Moderate-Income Housing Goal has also improved significantly in recent years, as shown in Figure A.1. Fannie Mae's performance increased from 34.2 percent in 1993 to 42.3 percent in 1995, 45.6 percent in 1996, and 45.7 percent in 1997, then falling slightly to 44.1 percent in 1998, but rising to 45.9 percent in 1999. Freddie Mac's performance also increased, from 29.7 percent in 1993 to 38.9 percent in 1995, 41.1 percent in 1996, 42.6 percent in 1997, 42.9 percent in 1998, and 46.1 percent in 1999. Freddie Mac's low- and moderate-income shares were below Fannie Mae's shares in every year through 1998, but its goal performance slightly exceeded Fannie Mae's performance in 1999. This increase in Freddie Mac's relative performance on the Low- and Moderate-Income Housing Goal resulted from its increased role in the multifamily mortgage market and the increase in the goal-qualifying share of its single-family mortgages.

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Single-family Affordable Lending Market. Despite these gains in goal performance, the Department remains concerned about the GSEs' support of lending for the lower-income end of the market. As shown in Figures A.2 and A.3, the lower-income shares of the GSEs' purchases are too low, particularly when compared with the corresponding shares for portfolio lenders and the primary market. Start Printed Page 65135

This appendix has reached the following findings with respect to the GSEs' purchases of affordable loans for low- and moderate-income families and their communities.

  • While Fannie Mae and Freddie Mac have both improved their support for the single-family affordable lending market over the past seven years, they have generally lagged the overall single-family market in providing affordable loans to lower-income borrowers. This finding is based on HUD's analysis of GSE and HMDA data and on numerous studies by academics and research organizations.
  • The GSEs show somewhat different patterns of mortgage purchases—through 1998, Freddie Mac was less likely than Fannie Mae to fund mortgages for lower-income families. As a result, the percentage of Freddie Mac's purchases benefiting historically underserved families and their neighborhoods was less than the corresponding shares of total market originations, while Fannie Mae's purchases were closer to the patterns of originations in the primary market (see Figure A.3). However, in 1999, Freddie Mac's purchases of home loans included a higher percentage of low-mod loans than Fannie Mae's purchases (40.0 percent and 39.3 percent, respectively). It remains to be seen whether this represents a new trend for Freddie Mac, or a temporary reversal of the pattern for the 1996-98 period.
  • A study by The Urban Institute of lender experience with the GSEs' underwriting guidelines finds that the enterprises had stepped up their outreach efforts and increased the flexibility in their standards to better accommodate the special circumstances of lower-income borrowers. However, this study concluded that the GSEs' guidelines remain somewhat inflexible and that the enterprises are often hesitant to purchase affordable loans. Lenders also told The Urban Institute that Fannie Mae has been more aggressive than Freddie Mac in market outreach to underserved groups, in offering new affordable products, and in adjusting its underwriting standards.
  • A large percentage of the lower-income loans purchased by the enterprises have relatively high down payments, which raises questions about whether the GSEs are adequately meeting the needs of lower-income families have difficulty raising enough cash for a large down payment.
  • There are important parts of the single-family market where the GSEs have played a minimal role. For example, single-family rental properties are an important source of low-income housing, but they represent only a small portion of the GSEs' business. GSE purchases have accounted for only 14 percent of the single-family rental units that received financing in 1997. An increased presence by Fannie Mae and Freddie Mac would bring lower interest rates and liquidity to this market, as well as improve their goals performance.
  • The above points can be summarized by examining the GSEs' share of the single-family mortgage market. The GSEs' total purchases have accounted for 44 percent of all single-family (both owner and rental) units financed during 1997; however, their low-mod purchases have accounted for only 34 percent of the low- and moderate-income single-family units that were financed during that year.

In conclusion, the Department's analysis suggests that the GSEs are not leading the single-family market in purchasing loans that qualify for the Low- and Moderate-Income Goal. There is room for Fannie Mae and Freddie Mac to improve their performance in purchasing affordable loans at the lower-income end of the market. Moreover, evidence suggests that there is a significant population of potential homebuyers who might respond well to aggressive outreach by the GSEs. Specifically, both Fannie Mae and the Joint Center for Housing Studies expect immigration to be a major source of future homebuyers. Furthermore, studies indicate the existence of a large untapped pool of potential homeowners among the rental population. Indeed, the GSEs' recent experience with new outreach and affordable housing initiatives is important confirmation of this potential.

Multifamily Market. Fannie Mae and, especially, Freddie Mac have rapidly expanded their presence in the multifamily mortgage market in the period since the passage of FHEFSSA. The Senate report on this legislation in 1992 referred to the GSEs' activities in the multifamily arena as “troubling,” citing Freddie Mac's September 1990 suspension of its purchases of new multifamily mortgages and criticism of Fannie Mae for “creaming” the market.228

Freddie Mac has successfully rebuilt its multifamily acquisition program, as shown by the increase in its purchases of multifamily mortgages from $27 million in 1992 to $7.6 billion in 1999. As a result, concerns regarding Freddie Mac's multifamily capabilities no longer constrain their performance with regard to low- and moderate-income families in the manner that prevailed at the time of the December 1995 rule.

Fannie Mae never withdrew from the multifamily market, but it has also stepped up its activities in this area substantially, with multifamily purchases rising from $3.0 billion in 1992 to $9.4 billion in 1999. Holding 12.8 percent of the outstanding stock of multifamily mortgage debt and guarantees as of the end of 1999, Fannie Mae is regarded as an influential force within the multifamily market. Fannie Mae's multifamily underwriting standards have been widely emulated throughout the multifamily mortgage market.

The increased role of Fannie Mae and Freddie Mac in the multifamily market has major implications for the Low- and Moderate-Income Housing Goal, since a very high percentage of multifamily units have rents which are affordable to low- and moderate-income families. However, the potential of the GSEs to lead the multifamily mortgage industry has not been fully developed. As reported earlier in Table A.7a, the GSEs' purchases (through 1999) have accounted for only 24 percent of the multifamily units that received financing during 1997. Standard & Poor's recently described both GSEs' multifamily lending as “extremely conservative.” 229 In particular, their multifamily purchases to date do not appear to be contributing to mitigation of the excessive cost of mortgage financing for small multifamily properties, nor have the GSEs demonstrated market leadership with regard to rehabilitation loans, a segment where financing has sometimes been difficult to obtain. In conclusion, it appears that both GSEs can make improvements in their underwriting policies and procedures and introduce new products that will enable them to more effectively serve segments of the multifamily market that can benefit from greater liquidity.

3. Size of the Mortgage Market for Low- and Moderate-Income Families

As detailed in Appendix D, the low- and moderate-income mortgage market accounts for 50 to 55 percent of dwelling units financed by conventional conforming mortgages. In estimating the size of the market, HUD excluded the effects of the B&C market. HUD also used alternative assumptions about future economic and market conditions that were less favorable than those that existed over the last five years. HUD is well aware of the volatility of mortgage markets and the possible impacts of changes in economic conditions on the GSEs' ability to meet the housing goals. Should conditions change such that the goals are no longer reasonable or feasible, the Department has the authority to revise the goals.

4. The Low- and Moderate-Income Housing Goals for 2001-03

There are several reasons why the Secretary is increasing the Low- and Moderate-Income Housing Goal from 42 percent in 1997-99 to 50 percent of eligible units financed in each of calendar years 2001, 2002 and 2003.

First, when the 1996-99 goals were established in December 1995, Freddie Mac had only recently reentered the multifamily mortgage market, after its absence in the early 1990s. Freddie Mac has rebuilt its multifamily acquisition program over the past several years, with its 1999 purchases at a level more than eight times what they were in 1994 (in dollar terms). The limited role of Freddie Mac in the multifamily market was a significant constraint in setting the Low- and Moderate-Income Housing Goals for 1996-99. Freddie Mac's return as a major participant in the multifamily market was an important factor in the improvement in its performance on the Low- and Moderate-Income Housing Goal, as shown in Figure A.1, and it removes an impediment to higher goals for both GSEs. These goals will create new opportunities for the GSEs to further step up their support of mortgages on properties with rents affordable to low- and moderate-income families. However, as discussed in the Preamble, to encourage Freddie Mac to further step up its role in the multifamily market, the Secretary is proposing a “temporary adjustment factor” for its purchases of loans on properties with more than 50 units. Specifically, each unit in such properties would be weighted as 1.2 units in the numerator of the housing goal percentage for both the Low and Moderate Income Goal and the Special Affordable Housing Goal for the years 2001-2003. Start Printed Page 65136

Second, the single-family affordable market had only recently begun to grow in 1993 and 1994, the latest period for which data was available when the 1996-99 goals were established in December 1995. But the historically high low-and moderate-income share of the primary mortgage market attained in 1994 has been maintained over the 1995-98 period. The three-year average estimate of the low- and moderate-income share of the single-family owner mortgage market was 38 percent for 1992-94, but 42 percent for 1995-98 and 41 percent for the 1992-98 period as a whole. The continued high affordability of housing suggests that a strong low-income market continued for a sixth straight year in 1999. Current economic forecasts suggest that housing affordability could be maintained in the post-2000 period, leading to additional opportunities for the GSEs to support mortgage lending benefiting low- and moderate-income families.230 And various surveys indicate that the demand for homeownership by minorities, immigrants, and younger households will remain strong for the foreseeable future.

Although single-family owner 1-unit properties comprise the “bread-and-butter” of the GSEs’ business, evidence presented above demonstrates that the shares of their loans for low- and moderate-income families taking out loans on such properties lag the corresponding shares for the primary market. For example, in 1997 the Department finds that these shares amounted to 34.1 percent for Freddie Mac, 37.6 percent for Fannie Mae, and 42.5 percent for the primary market; as shown in Figure A.3, a similar pattern holds for 1998. Thus the Secretary believes that the GSEs can do more to raise the low- and moderate-income shares of their mortgages on these properties. This can be accomplished by building on various programs that the enterprises have already started, including (1) their outreach efforts, (2) their incorporation of greater flexibility into their underwriting guidelines, (3) their purchases of seasoned CRA loans, (4) their entry into new single-family mortgage markets such as loans on manufactured housing, (5) their increased purchases of loans on small multifamily properties, and (6) their increased presence in other rental markets where they have had only a limited presence in the past.

Third, one particular area where the GSEs could play a greater role is in the mortgage market for single-family rental dwellings. These properties, containing 1-4 rental units, are an important source of housing for low- and moderate-income families, but the GSEs have not played a major role in this mortgage market—they accounted for only 6.5 percent of units financed by Fannie Mae and 6.4 percent of units financed by Freddie Mac in 1997. The Department believes that the GSEs' role in financing loans on such properties, which are generally owned by “mom and pop” businesses, can and should be enhanced, though it recognizes that single-family rental properties are very heterogeneous, making it more difficult to develop standardized underwriting standards for the secondary market. But the Secretary believes that the GSEs can do more to play a leadership role in providing financing for such properties.231

Finally, a wide variety of quantitative and qualitative indicators indicate that the GSEs' have the financial strength to improve their affordable lending performance. For example, combined net income has risen steadily over the last decade, from $1.244 billion in 1989 to $6.135 billion in 1999, an average annual growth rate of 17 percent per year. This financial strength provides the GSEs with the resources to lead the industry in supporting mortgage lending for units affordable to low- and moderate-income families.

Summary. Figure A.7a summarizes many of the points made in this section regarding opportunities for Fannie Mae and Freddie Mac to improve their overall performance on the Low- and Moderate-Income Goal. The GSEs' purchases have provided financing for 2,948,712 (or 40 percent) of the 7,306,950 single-family and multifamily units that were financed in the conventional conforming market during 1997. However, in the low- and moderate-income part of the market, the 1,330,516 units that were financed by GSE purchases represented only 32 percent of the 4,201,287 dwelling units that were financed in the market. Thus, there appears to ample room for the GSEs to increase their purchases of loans that qualify for the Low- and Moderate-Income Goal. Examples of specific market segments that would particularly benefit from a more active secondary market have been provided throughout this appendix.

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5. Conclusions

Having considered the projected mortgage market serving low- and moderate-income families, economic, housing and demographic conditions for 2001-03, and the GSEs' recent performance in purchasing mortgages for low- and moderate-income families, the Secretary has determined that the annual goal of 50 percent of eligible units financed in each of calendar years 2001, 2002 and 2003 is feasible. Moreover, the Secretary has considered the GSEs' ability to lead the industry as well as the GSEs' financial condition. The Secretary has determined that the goal is necessary and appropriate.

Endnotes to Appendix A

1 See “Freddie's Subprime Wrap Business Blooms in 1999”, Inside B&C Lending, December 27, 1999, pages 8-9.

2 See Jim Berkovec and Peter Zorn, “How Complete is HMDA? HMDA Coverage of Freddie Mac Purchases,” The Journal of Real Estate Research, Vol. II, No. 1, Nov. 1, 1996.

3 U.S. Department of Housing and Urban Development, Office of Federal Housing Enterprise Oversight, “Risk-Based Capital” (Notice of Proposed Rulemaking), Federal Register, April 13, 1999, p. 18116.

4 Fannie Mae (2000), p. 102.

5 OFHEO NPR, Ibid.

6 Mortgage denial rates are based on 1998 HMDA data; manufactured housing lenders are excluded from these comparisons.

7 U.S. Department of Housing and Urban Development. Rental Housing Assistance—The Worsening Crisis: A Report to Congress on Worst Case Housing Needs. (March 2000).

8 “Final Report of Standard & Poor's to the Office of Federal Housing Enterprise Oversight,” February 3, 1997; Freddie Mac, 1998 Annual Report to Shareholders, p. 6.

9 Freddie Mac reported delinquency rates of 0.14% for multifamily and 0.39% for single-family in 1999 (1999 Annual Report to Shareholders, p. 23.) Fannie Mae reported “serious delinquency rates” of 0.12% for multifamily and 0.48% for single-family in 1999 (1999 Annual Report to Shareholders, p. 27).

10 According to the National Association of Realtors, Housing Market Will Change in New Millennium as Population Shifts, (November 7, 1998), 45 percent of U.S. household wealth is in the form of home equity in 1998. Since 1968, home prices have increased each year, on average, at the rate of inflation plus up to two percentage points.

11 Joint Center for Housing Studies of Harvard University. State of the Nation's Housing 2000. (2000), p. 9.

12 Joint Center for Housing Studies of Harvard University. (2000), p. 33.

13 Michelle J. White, and Richard K. Green. “Measuring the Benefits of Homeowning: Effects on Children,” Journal of Urban Economics. 41 (May 1997), pp. 441-61. Also see “The Social Benefits and Costs of Homeownership: A Critical Assessment of the Research,” Working Paper No. 00-01, Research Institute for Housing America, May 2000.

14 Joint Center for Housing Studies of Harvard University. State of the Nation's Housing 1998 (1998).

15 Howard Savage and Peter Fronczek, Who Can Afford to Buy A House in 1991?, U.S. Bureau of the Census, Current Housing Reports H121/93-3, (July 1993), p. ix.

16 Donald S. Bradley and Peter Zorn. “Fear of Homebuying: Why Financially Able Households May Avoid Ownership,” Secondary Mortgage Markets (1996).

17 Munnell, Alicia H., Geoffrey M. B. Tootell, Lynn E. Browne, and James McEneaney, “Mortgage Lending in Boston: Interpreting HMDA Data,” American Economic Review. 86 (March 1996).

18 William C. Hunter. “The Cultural Affinity Hypothesis and Mortgage Lending Decisions,” WP-95-8, Federal Reserve Bank of Chicago, (1995). In addition, a study undertaken for HUD also found higher denial rates among FHA borrowers for minorities after controlling for credit risk. See Ann B. Schnare and Stuart A. Gabriel. “The Role of FHA in the Provision of Credit to Minorities,” ICF Incorporated, Prepared for the U.S. Department of Housing and Urban Development, (April 25, 1994).

19 See Charles W. Calomiris, Charles M. Kahn and Stanley D. Longhofer. “Housing Finance Intervention and Private Incentives: Helping Minorities and the Poor,” Journal of Money, Credit and Banking. 26 (August 1994), pp. 634-74, for more discussion of this phenomenon, which is called “statistical discrimination.”

20 The FICO score, developed by Fair, Isaac and Company, is summary index of an individual's credit history. The FICO score is based on elements from the applicant's credit report, such as number of delinquencies in the past year, number of trade lines, and the amount owed on trade lines as compared to the available maximum credit limits. The FICO score is said to reflect the credit risk of the applicant and a score of 620 is often cited as a threshold between being an acceptable and an unacceptable credit risk.

21 Section 3.b of this appendix provides a further discussion of automated underwriting.

22 Robert B. Avery, Patricia E. Beeson and Mark E. Sniderman. Understanding Mortgage Markets: Evidence from HMDA, Working Paper Series 94-21. Federal Reserve Bank of Cleveland (December 1994).

23Rental Housing Assistance—The Worsening Crisis: A Report to Congress on Worst Case Housing Needs, Department of Housing and Urban Development, (March 2000), p. i. All statistics in this subsection are taken from this report, except as noted.

24 Very low-income households are defined in the report as those whose income, adjusted for family size, is less than 50 percent of area median income. This differs from the definition adopted by Congress in the GSE Act of 1992, which uses a cutoff of 60 percent and which does not adjust income for family size for owner-occupied dwelling units.

25 Edward N. Wolff, “Recent Trends in the Size Distribution of Household Wealth,” The Journal of Economic Perspectives, 12( 3), (Summer 1998), p. 137.

26 Joint Center for Housing Studies, The State of the Nation's Housing: 2000, June 2000, p. 24.

27 Rent is measured in this report as gross rent, defined as contract rent plus the cost of any utilities which are not included in contract rent.

28 A detailed discussion of the GSEs' activities in this area is contained in Theresa R. Diventi, The GSEs' Purchases of Single-Family Rental Property Mortgages, Housing Finance Working Paper No. HF-004, Office of Policy Development and Research, Department of Housing and Urban Development, (March 1998).

29 One program that shows promise is Fannie Mae's HomeStyle Home Improvement Mortgage Loan Product. Under this program, Fannie Mae will purchase mortgages that finance the purchase and rehabilitation of 1- to 4-unit properties in “as-is” condition. The mortgage amount is limited to 90 percent of the appraised “as-completed” value, with the rehab amount not to exceed 50 percent of this value.

30 See Drew Schneider and James Follain, “A New Initiative in the Federal Housing Administration's Office of Multifamily Housing Programs: An Assessment of Small Projects Processing,” Cityscape: A Journal of Policy Development and Research 4 (1), (1998), pp. 43-58; and William Segal and Christopher Herbert, Segmentation of the Multifamily Mortgage Market: The Case of Small Properties, paper presented to annual meetings of the American Real Estate and Urban Economics Association, (January 2000).

31 These costs have been estimated at $30,000 for a typical transaction. Presentation by Jeff Stern, Vice President, Enterprise Mortgage Investments, HUD GSE Working Group, July 23, 1998. The most comprehensive account of the multifamily housing finance system as it relates to small properties is contained in Schneider and Follain (see above reference).

32 This measure is discussed in Paul B. Manchester, “A New Measure of Labor Market Distress,” Challenge, (November/December 1982).

33 Homeownership rates prior to 1993 are not strictly comparable with those beginning in 1993 because of a change in weights from the 1980 Census to the 1990 Census.

34 All of the home sales data in this section are obtained from U.S. Housing Market Conditions, 1st Quarter 2000, U.S. Department of Housing and Urban Development, (May 2000).

35 Existing home sales, housing starts, housing affordability and 30-year fixed rate mortgage rate forecasts are obtained from Standard & Poor's DRI, The U.S. Economy. (June 2000), pp. 55-7. While DRI provides forecasts through 2004, one should obviously interpret them with care.

36 Real GDP, unemployment, inflation, and treasury note interest rate projections are obtained for fiscal years 2000-2009 from The Economic and Budget Outlook: An Update, Washington DC: Congressional Budget Office, (July 2000).

37 Standard & Poor's DRI, The U.S. Economy. (June 2000), pp. 31 and 56.

38 Standard & Poor's DRI, The U.S. Economy. (June 2000), p. 56.

39 Mortgage Bankers Association of America. MBA Mortgage Finance Forecast, (July 14, 2000).

40 Fannie Mae. Berson's Housing and Economic Report, (June 2000).

41 National Association of Realtors. Housing Market Will Change in New Start Printed Page 65139Millennium as Population Shifts. (November 7, 1998).

42 Homeownership rates do not peek until population groups reach 65 to 74 years of age. Since the baby-boom population is such a large cohort, even though they will be past their homebuying peak, it is possible they will still have an impact.

43 Joint Center for Housing Studies of Harvard University. State of the Nation's Housing 2000. (2000), p. 11.

44 Joint Center for Housing Studies of Harvard University. State of the Nation's Housing 1998. (1998), p. 14.

45 Joint Center for Housing Studies of Harvard University. (1998), p. 15.

46 National Association of Realtors. Housing Market Will Change in New Millennium As population Shifts. (November 7, 1998).

47 Joint Center for Housing Studies of Harvard University. (1998).

48 John R. Pitkin and Patrick A. Simmons. “The Foreign-Born Population to 2010: A Prospective Analysis by Country of Birth, Age, and Duration of U.S. Residence,” Journal of Housing Research. 7(1) (1996), pp. 1-31.

49 Fred Flick and Kate Anderson. “Future of Housing Demand: Special Markets,” Real Estate Outlook. (1998), p. 6.

50 Mark A. Calabria. “The Changing Picture of Homebuyers,” Real Estate Outlook. (May 1999), p. 10.

51 Chicago Title and Trust Family of Insurers, Who's Buying Homes in America. (2000).

52 Chicago Title and Trust Family of Insurers, Who's Buying Homes in America. (1998 and 2000).

53 Calabria. (May 1999), p. 11.

54 U.S. Census Bureau, Current Population Reports, P60-206, Money Income in the United States: 1998, U.S. Government Printing Office, Washington, DC, (1999).

55 Joint Center for Housing Studies of Harvard University. State of the Nation's Housing 1998. (1998).

56 Data for 1990-97 from U.S. Housing Market Conditions, 1st Quarter 1999, U.S. Department of Housing and Urban Development, (May 1999), Table 17; data for 1998-99 from the Mortgage Bankers Association.

57 Interest rates in this section are effective rates paid on conventional home purchase mortgages on new homes, based on the Monthly Interest Rate Survey (MIRS) conducted by the Federal Housing Finance Board and published by the Council of Economic Advisers annually in the Economic Report of the President and monthly in Economic Indicators. These are average rates for all loan types, encompassing 30-year and 15-year fixed-rate mortgages and adjustable rate mortgages.

58U.S. Housing Market Conditions, 1st Quarter 2000, (May 2000), Table 14.

59 All statistics in this section are taken from the Federal Housing Finance Board's MIRS.

60 This is discussed in more detail in Paul Bennett, Richard Peach, and Stavros Peristani, Structural Change in the Mortgage Market and the Propensity to Refinance, Staff Report Number 45, Federal Reserve Bank of New York, (September 1998).

61 Other sources of data on loan-to-value ratios such as the American Housing Survey and the Chicago Title and Trust Company indicate that high-LTV mortgages are somewhat more common in the primary market than the Finance Board's survey. However, the Chicago Title survey does not separate FHA-insured loans from conventional mortgages.

62 Refinancing data is taken from Freddie Mac's monthly Primary Mortgage Market Survey.

63 There is some evidence that lower-income borrowers did not participate in the 1993 refinance boom as much as higher-income borrowers—see Paul B. Manchester, Characteristics of Mortgages Purchased by Fannie Mae and Freddie Mac: 1996-97 Update, Housing Finance Working Paper No. HF-006, Office of Policy Development and Research, Department of Housing and Urban Development, (August 1998), pp. 30-32.

64 Housing affordability varies markedly between regions, ranging in May 2000 from 147 in the Midwest to 93 in the West, with the South and Northeast falling in between.

65 Fannie Mae, http://www.fanniemae.com/​news/​housingsurvey/​1998, (July 16, 1998).

66 U.S. Department of Commerce, Bureau of the Census, Money Income of Households, Families, and Persons in the United States: 1992, Special Studies Series P-60, No. 184, Table B-25, (October 1993).

67 Chicago Title and Trust Family of Insurers, Who's Buying Homes in America, (1998).

68 Single-family originations rose by 10 percent in dollar terms in 1997, but the Mortgage Bankers Association estimates that they fell by 0.6 percent in terms of the number of loans.

69 Mortgage market projections obtained from the MBA's MBA Mortgage Finance Forecast, (July 14, 2000).

70 Fannie Mae. Berson's Housing and Economic Report, (June 2000).

71 Speech before the annual convention of the National Association of Home Builders in Dallas TX, (January 1999).

72 Fannie Mae News Release (January 1999).

73 Freddie Mac News Release (January 15, 1999).

74 Standard underwriting procedures characterize a property in a declining neighborhood as one at high risk of losing value. Implicitly, these underwriting standards presume that the real estate market is inefficient in economic terms, that is, prices do not reflect all available information.

75 For an update of this analysis to include 1998, see Randall M. Scheessele, 1998 HMDA Highlights, Housing Finance Working Paper HF-009, Office of Policy Development and Research, U.S. Department of Housing and Urban Development, (October 1999).

76 The “overall” market is defined as all loans (including both government and conventional) below the 1997 conforming loan limit of $214,600 and the 1998 conforming loan limit of $227,150.

77 The percentages reported in Table A.1a for the year 1998 are similar; in that year, low-income borrowers accounted for 49.1 percent of FHA-insured loans, 23.9 percent of GSE purchases, and 27.8 percent of home purchase mortgages originated in the conventional conforming market.

78 FHA, which focuses on first-time homebuyers and low down payment loans, experiences higher mortgage defaults than conventional lenders and the GSEs. Still, the FHA system is actuarially sound because it charges an insurance premium that covers the higher default costs.

79 FHA's role in the market is particularly important for African-American and Hispanic borrowers. As shown in Table A.1c, FHA insured 44 percent of all 1997 home loan originations for these borrowers.

80 It should be noted that Tables A.1a and A.1b include only the GSEs' purchases of conventional loans; the same tables in the proposed rule also included the GSEs' purchases of government (particularly FHA-insured) loans.

81 See Green and Associates. Fair Lending in Montgomery County: A Home Mortgage Lending Study, a report prepared for the Montgomery County Human Relations Commission, (March 1998).

82 However, as shown in Table A.1a, depository institutions resemble other conventional lenders in their relatively low level of originating loans for African-American, Hispanic and minority borrowers.

83 For an analysis of the impact of CRA agreements signed by lending institutions, see Alex Schwartz, “From Confrontation to Collaboration? Banks, Community Groups, and the Implementation of Community Reinvestment Agreements”, Housing Policy Debate, 9(3), (1998), pp. 631-662. Also see the Department of Treasury CRA study by Litan et al., op cit.

84 “With Securities Market Back on Track, Analysts Expect Surge in CRA Loan Securitization in 1999,” Inside MBS & ABS. (February 19, 1999), pp. 11-12.

85Inside MBS & ABS. (February 19, 1999), p. 12.

86 Fannie Mae. 1997 Annual Housing Activities Report, (1998), p. 28.

87 For an analysis of the GSEs' CRA purchases, see the HUD-sponsored study by the Urban Institute, An Assessment of Recent Innovations in the Secondary Market for Low- and Moderate-Income Lending, by Kenneth Temkin, Jennifer E.H. Johnson, and Charles Calhoun, March 2000.

88 George Galster, Laudan Y. Aron, Peter Tatain and Keith Watson. Estimating the Size, Characteristics, and Risk Profile of Potential Homebuyers. Washington: The Urban Institute, (1995). Report Prepared for the Department of Housing and Urban Development.

89 Fannie Mae Foundation. African American and Hispanic Attitudes on Homeownership: A Guide for Mortgage Industry Leaders, (1998), p. 3.

90 Fannie Mae Foundation. (1998), p. 14.

91 Robert B. Avery, Raphael W. Bostic, Paul S. Calem, and Glenn B. Canner, Credit Scoring: Issues and Evidence from Credit Bureau Files, mimeo., (1998).

92 Avery et al. (1998), p. 24.

93 Kenneth Temkin, Roberto Quercia, George Galster, and Sheila O'Leary, A Study of the GSEs' Single Family Underwriting Guidelines: Final Report. Washington DC: Start Printed Page 65140U.S. Department of Housing and Urban Development, (April 1999). This study involves an analysis of the GSEs' underwriting guidelines in general. This section reviews only the aspects of the study related to mortgage scoring. A broader review of this paper is provided below in section E.4.

94 Temkin, et al. (1999), p. 2.

95 Temkin, et al. (1999), p. 5; pp. 26-27.

96 Standard & Poor's B and C mortgage guidelines can be used to illustrate that underwriting criteria in the subprime market becomes more flexible as the grade of borrower moves from the most creditworthy A-borrowers to the riskier D borrowers. For Example, the A-grade borrower is allowed to be delinquent 30 days on his mortgage twice in the last year whereas the D grade borrower is allowed to be delinquent 30 days on his mortgage credit five times in the last year. Moreover, the A-borrower is permitted to have a 45 percent debt-to-income ratio compared to the D grade borrower's 60 percent.

97 “Subprime Product Mix, Strategies Changed During a Turbulent 1998,” Inside B&C Lending. (December 21, 1998), p. 2.

98 “Renewed Attack on ‘Predatory’ Subprime Lenders.” Fair Lending/CRA Compass, (June 1999) and http://cra-cn.home.mindspring.com.

99 See Randall M. Scheessele. 1998 HMDA Highlights, Housing Finance Working Paper HF-009, Office of Policy Development and Research, U.S. Department of Housing and Urban Development, (October 1999). Nonspecialized lenders such as banks and thrifts also make subprime loans, but no data is available to estimate the number of these loans.

100 Freddie Mac, We Open Doors for America's Families, Freddie Mac's Annual Housing Activities Report for 1997, (March 16, 1998), p. 23.

101 The statistics cited for the “market” refer to all conforming conventional mortgages (both home purchase and refinance). The data for the subprime market are for 200 lenders that specialize in such loans; see Scheessele, op. cit.

102 Alternative—A (or Alt—A) mortgages are made to prime borrowers who desire low down payments or do not want to provide full documentation for loans.

103 Freddie Mac and Standard & Poor's tested the new module in a pilot during early 1996 and marketed it to lenders at the end of that year.

104 See “Freddie's Subprime Wrap Business Blooms in 1999”, Inside B&C Lending, December 27, 1999, pages 8-9.

105 David A. Andrukonis, “Entering the Subprime Arena,” Mortgage Banking, May 2000, pages 57-60.

106 The figures include their purchases of Alt A mortgages. Inside B&C Lending, May 22, 2000, page 12.

107 See Lederman, et al., op cit.

108 For an explanation of the GSEs funding advantage see “Government Sponsorship of FNMA and FHLMC,” United States Department of the Treasury, July 11, 1996.

109 A detailed discussion of manufactured housing is contained in Kimberly Vermeer and Josephine Louie, The Future of Manufactured Housing, Joint Center for Housing Studies, Harvard University, (January 1997).

110 Data on industry shipments and sales has been obtained from “U.S. Housing Market Conditions,” U.S. Department of Housing and Urban Development (May, 2000), p. 49.

111 Although the terms are sometimes used interchangeably, manufactured housing and mobile homes differ in significant ways relative to construction standards, mobility, permanence, and financing (These distinctions are spelled out in detail in Donald S. Bradley, “Will Manufactured Housing Become Home of First Choice?” Secondary Mortgage Markets, (July 1997)). Mobile homes are not covered by national construction standards, though they may be subject to State or local siting requirements. Manufactured homes must be built according to the National Manufactured Housing Construction Safety and Standards Act of 1974. In accordance with this act, HUD developed minimum building standards in 1976 and upgraded them in 1994. Manufactured homes, like mobile homes, are constructed on a permanent chassis and include both axles and wheels. However, with manufactured housing, the axles and wheels are intended to be removed at the time the unit is permanently affixed to a foundation. Manufactured homes, unlike mobile homes, are seldom, if ever, moved. Mobile homes are financed with personal property loans, but manufactured homes are eligible for conventional-mortgage financing if they are located on land owned by or under long-term lease to the borrower. Other types of factory-built housing, such as modular and panelized homes, are not included in this definition of “manufactured housing.” These housing types are often treated as “site built” for purposes of eligibility for mortgage financing.

112 Freddie Mac, the Manufactured Housing Institute and the Low Income Housing Fund have formed an alliance to utilize manufactured housing along with permanent financing and secondary market involvement to bring affordable, attractive housing to underserved, low- and moderate-income urban neighborhoods. Origination News. (December 1998), p. 18.

113Mortgage-Backed Securities Letter. (September 7, 1998), p. 3.

114The Mortgage Market Statistical Annual for 2000 (Washington, DC: Inside Mortgage Finance Publications), 1, 286. A conventional multifamily mortgage market of $46 billion is assumed in this calculation. B and C mortgages are excluded from the calculation.

115The Mortgage Market Statistical Annual for 2000 (Washington, DC: Inside Mortgage Finance Publications), 1, 286. A conventional multifamily mortgage market of $46 billion is assumed in this calculation. B and C mortgages are excluded from the calculation.

116 This calculation incorporates GSE multifamily transactions involving loans originated during 1997 and acquired during 1997-1999. A multifamily conventional origination market of $38 billion and a per-unit loan amount of $27,266 is assumed per Appendix D.

117 Jean L. Cummings and Denise DiPasquale, “Developing a Secondary Market for Affordable Rental Housing: Lessons From the LIMAC/Freddie Mac and EMI/Fannie Mae Programs,” Cityscape: A Journal of Policy Development and Research, 4(1), (1998), pp. 19-41.

118 Drew Schneider and James Follain assert that interest rates on small property mortgages are as high as 300 basis points over comparable maturity Treasuries in “A New Initiative in the Federal Housing Administration's Office of Multifamily Housing Programs: An Assessment of Small Projects Processing,” Cityscape: A Journal of Policy Development and Research 4(1): 43-58, 1998. Berkshire Realty, a Fannie Mae Delegated Underwriting and Servicing (DUS) lender based in Boston, was quoting spreads of 135 to 150 basis points in “Loans Smorgasbord,” Multi-Housing News, August-September 1996. Additional information on the interest rate differential between large and small multifamily properties is contained in William Segal and Christopher Herbert, Segmentation of the Multifamily Mortgage Market: The Case of Small Properties, paper presented to annual meetings of the American Real Estate and Urban Economics Association, (January 2000).

119 On the relation between age of property and quality classification see Jack Goodman and Brook Scott, “Rating the Quality of Multifamily Housing,” Real Estate Finance, (Summer, 1997).

120 W. Donald Campbell. Seniors Housing Finance, prepared for American Association of Retired Persons White House Conference on Aging Mini-Conference on Expanding Housing Choices for Older People, (January 26-27, 1995).

121 James R. Follain and Edward J. Szymanoski. “A Framework for Evaluating Government's Evolving Role in Multifamily Mortgage Markets,” Cityscape: A Journal of Policy Development and Research 1(2), (1995), p. 154.

122 Despite sustained economic expansion, however, the rise in homeownership, has not fallen below 9 percent in recent years. (Regis J. Sheehan, “Steady Growth,” Units, (November/December 1998), pp. 40-43). Regarding rents and vacancy rates see also Ted Cornwell. “Multifamily Lending Approaches Record Level,” National Mortgage News, (September 23, 1996); and David Berson, Monthly Economic and Mortgage Market Report, Fannie Mae, (November 1998).

123 American Council of Life Insurance data reported in Inside MBS & ABS, (March 20, 1998).

124 A November, 1998 “Review of the Short-Term Supply/Demand Conditions for Apartments” by Peter P. Kozel of Standard and Poor's concludes that “in some markets, the supply of units exceeds the likely level of demand, and in only a few MSAs should the pace of development accelerate.” See also “Apartment Projects Find Lenders Are Ready with Financing,” Lew Sichelman, National Mortgage News, (April 14, 1997); Commercial Lenders Warned That They Could Spur Overbuilding, National Mortgage News, (March 30, 1998); “Multifamily, Commercial Markets Grow Up,” Neil Morse, Secondary Marketing Executive, (February 1998);” Start Printed Page 65141“Recipe for Disaster,” National Mortgage News editorial, (July 6, 1998).

1251998 Survey of Credit Underwriting Practices, Comptroller of the Currency, National Credit Committee. “For the fourth consecutive year, underwriting standards for commercial loans have eased,” states the OCC report. “Examiners again cite competitive pressure as the primary reason for easing underwriting standards.” The weakening of underwriting practices is especially concentrated in commercial real estate lending according to a the Federal Deposit Insurance Corporation's Report on Underwriting Practices, (October 1997-March 1998). See also Donna Tanoue, “Underwriting Concerns Grow,” National Mortgage News, (September 21, 1998), and “Making the Risk-Takers Pay,” National Mortgage News, (October 12, 1998).

126 On the effects of multifamily mortgage securitization see “Financing Multifamily Properties: A Play With new Actors and New Lines,” Donald S. Bradley, Frank E. Nothaft, and James L. Freund, Cityscape, A Journal of Policy Development and Research, vol. 4, No. 1 (1998); and “Financing Multifamily Properties,” Donald S. Bradley, Frank E. Nothaft, and James L. Freund, Urban Land (November 1998).

127 CMBS Database, Commercial Mortgage Alert, Harrison-Scott Publications, Hoboken, NJ.

128 “New CMBS Headache: B-Piece Market Softens,” Commercial Mortgage Alert, (September 21, 1998); “Criimi Bankruptcy Accelerates CMBS Freefall,” Commercial Mortgage Alert, (October 12, 1998); “Capital America Halts Lending Amid Woes,” Commercial Mortgage Alert, (October 12, 1998).

129 On CMBS spreads see “Turmoil Hikes Loan Rates” in Wall Street Mortgage Report, (September 14, 1998). Regarding implications for the GSEs of the conduit pullback see “No Credit Crunch for First Mortgages” in Commercial Mortgage Alert, (October 12, 1998).

130 “Financing Multifamily Properties: A Play With New Actors and New Lines,” Donald S. Bradley, Frank E. Nothaft, and James L. Freund, Cityscape: A Journal of Policy Development and Research, 4(1), (1998).

131The Impact of Public Capital Markets on Urban Real Estate, Clement Dinsmore, discussion paper, Brookings Institution Center on Urban and Metropolitan Policy, July 1998; “Capital Availability Fuels Commercial Market Growth,” Marshall Taylor, Real Estate Finance Today, (February 17, 1997).

132 Board of Governors of the Federal Reserve System and U.S. Securities and Exchange Commission, Report to the Congress on Markets for Small-Business-and Commercial-Mortgage-Backed Securities, (September 1998).

133 “REITs Tally Nearly Half of All Big CRE Deals in First Quarter,” National Mortgage News, (July 7, 1997); “Will REITs, Mortgage-Backeds Make Difference in Downturn,” Jennifer Goldblatt, American Banker, (February 18, 1998).

134 “Apartment Demographics: Good for the Long Haul?” Jack Goodman, Real Estate Finance, (Winter 1997); “The Multifamily Outlook,” Jack Goodman, Urban Land, (November 1998).

135U.S. Housing Market Conditions, U.S. Department of Housing and Urban Development (May 2000), Table 4.

136 Howard Esaki, a principal in CMBS Research at Morgan Stanley Dean Witter stated at a recent conference that volatility in global markets contributed to a 10-20 percent decline in commercial real estate values in late 1998. John Hackett, “CRE Seen Down 10% to 20%,” National Mortgage News, (November 23, 1998), p. 1.

137 John Holusha, “As Financing Pool Dries Up, Some See Opportunity,” New York Times, November 1, 1998.

138Federal Reserve Bulletin, June 2000, A 35.

139 1997 Annual Housing Activity Reports, Table 1.

140 William Segal and Edward J. Szymanoski. The Multifamily Secondary Mortgage Market: The Role of Government-Sponsored Enterprises. Housing Finance Working Paper No. HF-002, Office of Policy Development and Research, Department of Housing and Urban Development, (March 1997).

141 HUD analysis of GSE loan-level data.

142Fundingnotes, Vol. 3, Issue 9; (September 1998), Eric Avidon, “PaineWebber Lauds Fannie DUS Paper,” National Mortgage News, (September 14, 1998),p. 21.

143 There is evidence that the GSEs have benefited from recent widening in CMBS spreads because of their funding cost advantage. See “No Credit Crunch for First Mortgages,” Commercial Mortgage Alert, (October 12, 1998); and “Turmoil a Bonanza for Freddie,” Commercial Mortgage Alert, (November 2, 1998).

144Federal Reserve Bulletin, June 2000, A 35.

145 See Table A.7a for details. It is assumed that units in small multifamily properties represented approximately 39.4 percent of multifamily units financed in 1997, per the 1991 Residential Finance Survey, as discussed above. Additionally, it is assumed that 1997 multifamily conventional origination volume was $38 billion, as discussed in Appendix D. An average loan amount per unit of $27,266 is used, the GSE average for 1997 acquisitions.

146 Larger properties may be perceived as less subject to income volatility caused by vacancy losses. Scale economies in securitization may also favor purchase of larger multifamily mortgages by the GSEs. Scale economies refer to the fixed costs in creating a mortgage backed security, and the smaller reduction in yield (higher security price) if these costs can be spread over larger unpaid principal balances.

147 1995 POMS data are used because 1995 represents the year with the most complete mortgage origination information in the Survey. 1996 GSE data are used because of number of units of property exhibited atypical behavior during 1995.

148 These costs have been estimated at $30,000 for a typical transaction. Presentation by Jeff Stern, Vice President, Enterprise Mortgage Investments, HUD GSE Working Group, (July 23, 1998).

149 “Fannie Mae Announces New 5-50(SM) Streamlined Mortgage for Small Multifamily Properties is Now Available Through DUS Lenders; 10-Year Volume Goal is $18 Billion,” Fannie Mae press release, May 10, 2000.

150 Data from the HUD Property Owners and Managers Survey (POMS) suggests that, in and of itself, the GSEs' emphasis on refinance loans may roughly track that of the overall market.

151 Standard & Poor's described Fannie Mae's multifamily lending as “extremely conservative” in “Final Report of Standard & Poor's to the Office of Federal Housing Enterprise Oversight (OFHEO),” (February 3, 1997), p. 10.

152 See William Segal and Edward J. Szymanoski. “Fannie Mae, Freddie Mac, and the Multifamily Mortgage Market,” Cityscape: A Journal of Policy Development and Research, vol. 4, no. 1 (1998), pp. 59-91.

153 Freddie Mac's policy of re-underwriting each multifamily acquisition is a response to widespread defaults affecting its multifamily portfolio during the late 1980s according to Follain and Szymanoski (1995).

154 A more detailed discussion of underwriting guidelines is contained in the analysis below regarding Factor 5, “The GSEs” Ability to Lead the Industry.”

155 The term “affordable lending” is used generically here to refer to lending for lower-income families and neighborhoods that have historically been underserved by the mortgage market.

156 Throughout these appendices, the terms “home loan” or “home mortgage” will refer to a “home purchase loan,” as opposed to a “refinance loan.”

157 Subsections b-d of this section focus on the single-family mortgage market for home purchase loans, which is the relevant market for analysis of homeownership opportunities. Subsection e extends the analysis to include single-family refinance loans. For a discussion of past performance in the multifamily mortgage market, see Section D of this Appendix.

158 Thus, the market definition in this section is narrower than the data presented earlier in Section C and Tables A.1a and A.1b, which covered all loans (both government and conventional) less than or equal to the conforming loan limit. As in that section, only the GSEs' purchases of conventional conforming loans are considered; their purchases of FHA-insured, VA-guaranteed, and Rural Housing Service loans are excluded from this analysis.

159 Higher limits apply for loans on 2-, 3-, and 4-unit properties and for properties in Alaska, Hawaii, Guam, and the Virgin Islands.

160 “Jumbo mortgages” in any given year might become eligible for purchase by the GSEs in later years as the loan limits rise and the outstanding principal balance is reduced.

161 However, in analyzing the provision of mortgage finance more generally, it is often appropriate to include government loans; see Tables A.1a, A.1b and A.2 in Section C.3.b.

162Fair Lending/CRA Compass, (June 1999), p. 3.

163 Randall M. Scheessele developed a list of 42 subprime lenders that was used by Start Printed Page 65142HUD and others in analyzing HMDA data through 1997. In 1998, Scheessele updated the list to 200 subprime lenders. For analysis comparing various lists of subprime lenders, see Appendix D of Scheessele (1999), op. cit. That paper also discusses Scheessele's lists of manufactured housing lenders.

164 See Randall M. Scheessele, HMDA Coverage of the Mortgage Market, Housing Finance Working Paper HF-007, Office of Policy Development and Research, Department of Housing and Urban Development, July 1998. Scheessele reports that HMDA data covered 81.6 percent of the loans acquired by Fannie Mae and Freddie Mac in 1996. The main reason for the under-reporting of GSE acquisitions is a few large lenders failed to report the sale of a significant portion of their loan originations to the GSEs. Also see the analysis of HMDA coverage by Jim Berkovec and Peter Zorn. “Measuring the Market: Easier Said than Done,” Secondary Mortgage Markets. McLean VA: Freddie Mac (Winter 1996), pp. 18-21. Section A.4 of this appendix also discusses several issues regarding HMDA data that were raised by the GSEs in their comments on the proposed rule.

165 Since 1993, the GSEs have increased their purchases of seasoned loans. See Paul B. Manchester, Characteristics of Mortgages Purchased by Fannie Mae and Freddie Mac: 1996-1997 Update, Housing Finance Working Paper HF-006, Office of Policy Development and Research, Department of Housing and Urban Development, (August 1998), p.17.

166 For a discussion of the impact of the GSEs' seasoned mortgage purchases on HMDA data coverage, see Scheessele (1998), op. cit.

167 Table A.4b, which reports similar GSE information as Table A.4a, provides several alternative estimates of the conventional conforming market depending on the treatment of small loans, manufactured housing loans, and subprime loans. The data in Table A.4b will be referenced throughout the discussion.

168 Any HMDA data reported in the appendices on borrower incomes excludes loans where the loan-to-borrower-income ratio is greater than six.

169 For example, in 1997 Fannie Mae reported that 20.8 percent of the loans they purchased, that were originated during 1997, were for properties in underserved areas. HMDA reports that 21.0 percent of the loans sold to Fannie Mae during 1997 were for properties in underserved areas. The corresponding numbers for Freddie Mac, in 1997, are 19.3 percent reported by them and 18.6 percent reported by HMDA. During 1997, both Fannie Mae and HMDA reported that approximately 37 percent of the “current year” loans purchased by Fannie Mae were for low- and moderate-income borrowers. Freddie Mac reported that 34.2 percent of the current year loans they purchased were for low-mod borrowers, compared to the 35.4 low-mod percent that HMDA reported as sold to Freddie Mac.

170 Notice that while Fannie Mae's 1998 purchases resembled their 1997 purchases with prior-year loans having higher goals-qualifying percentages than current-year loans, the pattern for 1999 was similar to that for 1993 to 1996 when there were smaller differentials between the goals-qualifying percentages of prior-year and current-year mortgages.

171 Referencing the study by Peter Zorn and Jim Berkovec, op cit., the GSEs argued in their comments on the proposed rule that HMDA overstates goals-qualifying loans. See Section A.3d for HUD's response which questions the findings of the Zorn-Berkovec study.

172 The borrower income distributions in Tables A.3 and A.4a for the “market without manufactured housing” exclude loans less than $15,000 as well as all loans originated by lenders that primarily originate manufactured housing loans. See Table A.4b for market definitions that show the separate effects of excluding small loans and manufactured housing loans. Also, Table A.4b shows that excluding subprime loans has only a minor effect on the goals-qualifying percentages in the mortgage market.

173 See Scheessele (1999), op. cit. As explained in Appendix D of Scheessele's paper, the number of subprime lenders varies by year; the 200 figure cited in the text applies to 1998. The number of loans identified as subprime in these appendices is the same as reported by Scheessele in Table D.2b of his paper.

174 Table A.1b in Section C.3.b provides several comparisons of the GSEs' total purchases with primary market originations. As shown there, many of the same patterns described above for home purchase loans can be seen in the data for the GSEs' total purchases.

175 In general, the HMDA-reported affordability percentages for GSE purchases of refinance loans have matched the corresponding GSE-reported percentages. For example, in 1997, both GSEs reported to HUD that special affordable loans accounted for about 11 percent of their purchases of refinance loans in metropolitan areas; HMDA reported the same percentage for each GSE. Similarly, in 1998, both HMDA and Fannie Mae reported that special affordable loans accounted for 9.7 percent of Fannie Mae's refinance purchases. However, in 1998, the Freddie-Mac-reported special affordable percentage (10.7 percent) for its refinance loans was significantly higher than the corresponding percentage (9.5 percent) reported in the HMDA data. The reasons for this discrepancy require further study.

176 The Mortgage Information Corporation (MIC) has recently started publishing origination and default performance data for the subprime market. For an explanation of their data and some early findings, see Dan Feshbach and Michael Simpson, “Tools for Boosting Portfolio Performance”, Mortgage Banking: The Magazine of Real Estate Finance, (October 1999), pp. 137-150.

177 For example, see Bunce and Scheessele (1996 and 1998), op. cit.

178 This analysis is limited to the conventional conforming market.

179 To test the robustness of these statistics, this analysis was conducted where the “lag” determination is made at 95 percent instead of 99 percent. The results are consistent with those shown in Table A.5. For example, at the 95 percent cutoff, Fannie Mae lagged the market in 286 MSAs (88 percent) in the purchase of 1996 originated Special Affordable category loans. Likewise, Freddie Mac lagged the market in 322 MSAs (99 percent).

180Privatization of Fannie Mae and Freddie Mac: Desirability and Feasibility. Office of Policy Development and Research, Department of Housing and Urban Development, (July 1996).

181 The Treasury Department reached similar conclusions in its 1996 report on the privatization of the GSEs, Government Sponsorship of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, U.S. Department of the Treasury (July 11, 1996). Based on data such as the above, the Treasury Department questioned whether the GSEs were influencing the availability of affordable mortgages and suggested that the lower-income loans purchased by the GSEs would have been funded by private market entities if the GSEs had not purchased them.

182 See Glenn B. Canner, and Wayne Passmore. “Credit Risk and the Provision of Mortgages to Lower-Income and Minority Homebuyers,” Federal Reserve Bulletin. 81 (November 1995), pp. 989-1016; Glenn B. Canner, Wayne Passmore and Brian J. Surette. “Distribution of Credit Risk among Providers of Mortgages to Lower-Income and Minority Homebuyers.” Federal Reserve Bulletin. 82 (December 1996), pp. 1077-1102; Harold L. Bunce, and Randall M. Scheessele, The GSEs' Funding of Affordable Loans: A 1996 Update, Housing Finance Working Paper HF-005, Office of Policy Development and Research, Department of Housing and Urban Development, (July 1998); and Manchester, (1998), p. 24.

183 Canner, et al. (1996).

184 Harold L. Bunce and Randall M. Scheessele, The GSEs' Funding of Affordable Loans, Housing Finance Working Paper HF-001, Office of Policy Development and Research, U.S. Department of Housing and Urban Development, (December 1996).

185 Harold L. Bunce and Randall M. Scheessele, The GSEs' Funding of Affordable Loans: A 1996 Update, Housing Finance Working Paper HF-005, Office of Policy Development and Research, U.S. Department of Housing and Urban Development, (July 1998), pp. 15-16.

186 Statistics cited are from Table B.1 of Bunce and Scheessele, (1998) and are based on sales to the GSEs as reported by lenders in accordance with the HMDA. “Lagging the market” means, for example, that the percentage of the GSEs' loans for very low- and low-income borrowers is less than the corresponding percentage for the primary market, depositories, and the FHA.

187 Under their charter acts, loans purchased by the GSEs with down payments of less than 20 percent must carry private mortgage insurance or a comparable form of credit enhancement.

188 It is generally agreed that HMDA does not capture all loans originated in the primary market—for example, small lenders need not report under HMDA. But Fannie Mae believes that the undercount is not Start Printed Page 65143spread uniformly across all borrower classes—in particular, it argues that the HMDA data exclude relatively more loans made to minorities and lower-income families.

189 Bunce and Scheessele (1998) contained a comparison (Table A.1) of HMDA-reported and GSE-reported data on the characteristics of GSE mortgage purchases in 1996. In most cases the differences between the results utilizing the two different data sources were minimal, but in some cases (such as lending in underserved areas) the evidence lent some support to Fannie Mae's assertion that the HMDA data underreports their level of activity. The discrepancies between HMDA data and GSE data at the national level are also due to the seasoned loan effect (see Section E.2.e above and Table A.4a).

190 John E. Lind. Community Reinvestment and Equal Credit Opportunity Performance of Fannie Mae and Freddie Mac from the 1994 HMDA Data. San Francisco: Caniccor. Report, (February 1996).

191 John E. Lind. A Comparison of the Community Reinvestment and Equal Credit Opportunity Performance of Fannie Mae and Freddie Mac Portfolios by Supplier from the 1994 HMDA Data. San Francisco: Cannicor. Report, (April 1996).

192 Brent W. Ambrose and Anthony Pennington-Cross, Spatial Variation in Lender Market Shares, Research Study submitted to the Office of Policy Development and Research, Department of Housing and Urban Development, (1999).

193 Heather MacDonald. “Expanding Access to the Secondary Mortgage Markets: The Role of Central City Lending Goals,” Growth and Change. (27), (1998), pp. 298-312.

194 Heather MacDonald, Fannie Mae and Freddie Mac in Non-metropolitan Housing Markets: Does Space Matter, Research Study submitted to the Office of Policy Development and Research, Department of Housing and Urban Development, (1999).

195 Kirk McClure, The Twin Mandates Given to the GSEs: Which Works Best, Helping Low-Income Homebuyers or Helping Underserved Areas in the Kansas City Metropolitan Area? Research Study submitted to the Office of Policy Development and Research, Department of Housing and Urban Development, (1999).

196 Richard Williams, The Effect of GSEs, CRA, and Institutional Characteristics on Home Mortgage Lending to Underserved Markets,” Research Study submitted to the Office of Policy Development and Research, Department of Housing and Urban Development, (1999).

197 Joseph Gyourko and Dapeng Hu. The Spatial Distribution of Secondary Market Purchases in Support of Affordable Lending, Research Study submitted to the Office of Policy Development and Research, Department of Housing and Urban Development, (1999).

198 Bradford Case and Kevin Gillen. Studies of Mortgage Purchases by Fannie Mae and Freddie Mac: Spatial Variation in GSE Mortgage Purchase Activity. Research Study submitted to the Office of Policy Development and Research, Department of Housing and Urban Development, (1999).

199 The coefficient for geographic targeting was significant and negative in 19 MSAs, significant and positive in another eight, and not significant in the remaining 17 MSAs.

200 The coefficient for the highest minority-concentration category (census tracts with greater than 50% minority population) was significantly negative in 21 MSAs, but significantly positive in 10 MSAs and not significantly different from zero in the remaining 13.

201 Samuel L. Myers, Jr. The Effects of Government-Sponsored Enterprise Secondary Market Decisions on Racial Disparities in Loan Rejection Rates. Research Study submitted to the Office of Policy Development and Research, Department of Housing and Urban Development, (1999).

202 Variables from the GSE Public Use Data Base include the income and gender of the borrower, the gender and race of the coborrower, first-time homebuyer, and loan amount. Variables from Census 1990 include the following information for the census tract in which the property is located: percent of owner-occupied houses, average size of household, average number of persons per owner-occupied house, average number of persons per renter-occupied unit, percentage of white, black, Asian, American Indian, and other minority households, average poverty rate, median monthly rent, median house value, percent of persons 65 or older, percent of persons under 18, and percent of female-headed households. Variables from HMDA include reason for denial, whether or not loan is sold to GSE, type of loan (conventional), type of agency, and origination year.

203 The unconditional probability that a loan will not be sold, P(NS), to a GSE is computed using Bayes' rule. It is based on the conditional probability that a loan is sold to GSEs given that it was originated, P(SO), and the probability that a loan is originated which are obtained using HMDA data. The unconditional probability that a loan will be sold to a GSE can not be obtained from either the HMDA data which does not include details of which loans were sent for review and which were declined by the secondary purchaser—or from the HUD-GSE data, which only includes approved loans. However, we know from Bayes' rule that

where S mean that the loan was sold and O means that the loan was originated and where all loan sold by the lender must have been originated such that P(OS)=1. We can obtain a measure of the unconditional probability that a loan will not be sold from

204 Calvin Bradford, The Patterns of GSE Participation in Minority and Racially Changing Markets Reviewed from the Context of the Levels of distress Associated with High Levels of FHA Lending, Research Study submitted to the Office of Policy Development and Research, Department of Housing and Urban Development (2000).

205 David M. Harrison, Wayne R. Archer, David C. Ling, and Marc T. Smith, Mitigating Information Externalities in Mortgage Markets: The Role of Government Sponsored Enterprises, Research Study submitted to the Office of Policy Development and Research, Department of Housing and Urban Development (2000).

206 Kenneth Temkin, Roberto Quercia, George Galster and Sheila O'Leary. A Study of the GSEs' Single Family Underwriting Guidelines: Final Report. Washington DC: U.S. Department of Housing and Urban Development, (April 1999).

207 In following up on the Urban Institute study, HUD began in February 2000 a review of Fannie Mae's and Freddie Mac's automated underwriting systems.

208 Standard guidelines refer to guidelines not associated with affordable lending programs.

209 Temkin, et al. (1999), p. 4.

210 Temkin, et al. (1999), p. 5.

211 Temkin, et al. (1999), p. 28.

212 Senate Report 102-282, (May 15, 1992), p. 35.

213 Table A.7a(A.7b) considers GSE purchases during 1997, 1998, and 1999 (1998 and 1999) of conventional mortgages that were originated during 1997 (1998). HUD's methodology for deriving the market estimates is explained in Appendix D. B&C loans have been excluded from the market estimates in Table A.7.

214 Two caveats about the data in Table A.7 should be mentioned here. First, the various market totals for underserved areas are probably understated due to the model's underestimation of mortgage activity in non-metropolitan underserved counties and of manufactured housing originations in non-metropolitan areas. Second, as discussed in Appendix D, some uncertainty exists around the adjustment for B&C single-family owner loans.

215 Table A.7a shows that multifamily represented 19 percent of total units financed during 1997 (obtained by dividing 1,393,677 multifamily units by 7,306,950 “Total Market” units). Increasing the single-family-owner number in Table A.7 by 732,182 to account for excluded B&C mortgages increases the “Total Market” number to 8,039,132 which is consistent with the percent multifamily share reported in the text. See Appendix D for discussion of the B&C market.

216 A similar imbalance is evident with regard to figures on the stock of mortgage debt published by the Federal Reserve Board. Within the single-family mortgage market the GSEs held loans or guarantees with an unpaid principal balance (UPB) of $1.5 trillion, comprising 36 percent of $4.0 trillion in outstanding single-family mortgage debt as of the end of 1997. At the end of 1997, the GSEs direct holdings and guarantees of $41.4 billion represented 13.7 percent of $301 billion in multifamily mortgage debt outstanding. (Federal Reserve Bulletin, June 1998, A 35.)

217 The problem of secondary market “adverse selection” is described in James R. Follain and Edward J. Szymanoski. “A Framework for Evaluating Government's Evolving Role in Multifamily Mortgage Markets,” Cityscape: A Journal of Policy Development and Research 1(2), (1995). Start Printed Page 65144

218 A jumbo mortgage is one for which the loan amount exceeds the maximum principal amount for mortgages purchased by the enterprises—$240,000 for mortgages on 1-unit properties in 1999, with limits that are 50 percent higher in Alaska, Hawaii, Guam, and the Virgin Islands.

219 Office of Federal Housing Enterprise Oversight, 1998 Report to Congress, (June 15, 1998), Figure 9, p. 32; and unpublished OFHEO estimates for 1998.

220 Mortgage originations for 1997 were reported in the Department of Housing and Urban Development, HUD Survey of Mortgage Lending Activity: Fourth Quarter/Annual 1997, (September 24, 1998).

221 The underwriting guidelines published by the two GSEs are similar in most aspects. And since November 30, 1992, Fannie Mae and Freddie Mac have provided lenders the same Uniform Underwriting and Transmittal Summary (Fannie Mae Form 1008/Freddie Mac Form 1077), which is used by originators to collect certain mortgage information that they need for data entry when mortgages are sold to either GSE.

222 Freddie Mac stock was not publicly traded until after the passage of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), thus it is not possible to calculate a 10-year annualized rate of return.

223Fortune, (April 17, 2000), pp. F-1, F-2.

224Business Week, (March 27, 2000), p. 197.

225 U.S. Department of Housing and Urban Development. Rental Housing Assistance—The Worsening Crisis: A Report to Congress on Worst Case Housing Needs. (March 2000).

226 Standard & Poor's DRI, The U.S. Economy. (June 2000), p. 56.

227 See Drew Schneider and James Follain, “A New Initiative in the Federal Housing Administration's Office of Multifamily Housing Programs: An Assessment of Small Projects Processing,” Cityscape: A Journal of Policy Development and Research 4(1), (1998), pp. 43-58.

228 Senate Report 102-282, (May 15, 1992), p. 36.

229 “Final Report of Standard & Poor's to the Office of Federal Housing Enterprise Oversight (OFHEO),” (February 3, 1997), p. 10.

230 However, the Department's goals for the GSEs have been set so that they will be feasible even under less favorable conditions in the housing market.

231 Another area where stepped-up GSE involvement could benefit low- and moderate-income families is lending for the rehabilitation of properties, which is especially needed in our urban areas. The GSEs have made some efforts in this complex area, but the benefits of stepped-up roles by the GSE could be sizable.

End Appendix Start Appendix

Appendix B—Departmental Considerations to Establish the Central Cities, Rural Areas, and Other Underserved Areas Goal

A. Introduction and Response to Comments

1. Establishment of Goal

The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (FHEFSSA) requires the Secretary to establish an annual goal for the purchase of mortgages on housing located in central cities, rural areas, and other underserved areas (the “Geographically Targeted Goal”).

In establishing this annual housing goal, Section 1334 of FHEFSSA requires the Secretary to consider:

1. Urban and rural housing needs and the housing needs of underserved areas;

2. Economic, housing, and demographic conditions;

3. The performance and effort of the enterprises toward achieving the Geographically Targeted Goal in previous years;

4. The size of the conventional mortgage market for central cities, rural areas, and other underserved areas relative to the size of the overall conventional mortgage market;

5. The ability of the enterprises to lead the industry in making mortgage credit available throughout the United States, including central cities, rural areas, and other underserved areas; and

6. The need to maintain the sound financial condition of the enterprises.

Organization of Appendix. The remainder of Section A first defines the Geographically Targeted Goal for both metropolitan areas and nonmetropolitan areas and then discusses HUD's response to the public comments raised in this appendix. Sections B and C address the first two factors listed above, focusing on findings from the literature on access to mortgage credit in metropolitan areas (Section B) and in nonmetropolitan areas (Section C). Separate discussions are provided for metropolitan and nonmetropolitan (rural) areas because of differences in the underlying markets and the data available to measure them. Section D discusses the past performance of the GSEs on the Geographically Targeted Goal (the third factor) and Sections E-G report the Secretary's findings for the remaining factors. Section H summarizes the Secretary's rationale for setting the level for the Geographically Targeted Goal.

2. HUD's Geographically Targeted Goal

HUD's definition of the geographic areas targeted by this goal is basically the same as that used during 1996-99. It is divided into a metropolitan component and a nonmetropolitan component.

Metropolitan Areas. This rule provides that within metropolitan areas, mortgage purchases will count toward the goal when those mortgages finance properties that are located in census tracts where (1) median income of families in the tract does not exceed 90 percent of area (MSA) median income or (2) minorities comprise 30 percent or more of the residents and median income of families in the tract does not exceed 120 percent of area median income.

The definition includes 20,326 of the 43,232 census tracts (47 percent) in metropolitan areas, which include 44 percent of the metropolitan population.1 The tracts included in this definition suffer from poor mortgage access and distressed socioeconomic conditions. The average mortgage denial rate in these tracts is 19.4 percent, almost twice the denial rate in excluded tracts. The tracts include 73 percent of the number of poor persons in metropolitan areas.

This definition is based on studies of mortgage lending and mortgage credit flows conducted by academic researchers, community groups, the GSEs, HUD and other government agencies. While more research must be done before mortgage access for different types of people and neighborhoods is fully understood, one finding from the existing research literature stands out—high-minority and low-income neighborhoods continue to have higher mortgage denial rates and lower mortgage