More on municipal housing agencies

I got several comments here (and some at Calculated Risk ironically enough) on my post on state housing agencies. So here are some answers...

1) State housing agencies generally use either FHA or one of the GSE's lending standards. So there will be a large number of sub-prime borrowers who will not qualify and won't be helped by these programs.

2) Commenter Ben points out that FHA issuance has fallen off a cliff in the last few years. I mentioned in the original post that state housing agencies have also suffered large declines in their business. Fact is that the "creative" products were just more attractive to classic FHA/housing agency borrowers. Could there be a decent percentage of recent sub-prime borrowers who could have qualified under FHA guidelines but just choose a more creative mortgage? That's where the state agencies can help. How many borrowers? I don't know. But we can all agree the housing market is better off if they can refinance into a new mortgage versus if they go into foreclosure.

3) A commenter at Calculated Risk suggested that in order for this scheme to work, the state housing agencies would have to write off a chunk of loans. Not true. Ohio in particular has a very simple means of limiting its credit risk. After they do a series of loans, they package them and sell them to either Ginnie Mae or Fannie Mae. They use the proceeds to buy regular Ginnie Mae or Fannie Mae MBS securities. Therefore their entire portfolio is AAA/Aaa rated. What that means is that the Ohio agencies won't be writing off anything.

4) I mentioned that a primary reason why housing agencies can offer sub-prime borrowers below market rates or down payment assistance is that they enjoy a tremendous funding advantage over other lenders. This funding advantage exists even if the agency has to issue taxable bonds, as will be the case with this Ohio deal. Again, the reason why some deals are taxable has to do with IRS regulations. Anyway, state housing agencies have two things going for them when selling taxable bonds which tends to allow them to sell bonds at tighter spreads than banks. First, they are highly rated with almost no history of defaults. Second, they can use CMO tricks to decrease the funding cost. Without going into a long discussion of what that means, basically instead of just selling 30-year debt to fund 30-year mortgages, they actually sell a variety of maturities and allow some bonds to take more prepayment risk than others. Net of it all is a lower total cost of debt.

5) The Ohio refinancing deal offers a fixed rate of 6.75%. That's above market for prime borrowers, but probably below market for sub-prime. I'd conservatively estimate that Ohio's funding cost on this deal would be around 5.60% if they did it today. If we assume they let the servicer keep 50bps, they sell the portfolio to Ginnie Mae in exchange for GNMA 6% MBS, then they are making 65bps for no credit risk.

6) So while this is a bail out of sorts, because they are probably offering a better deal than the borrower could get otherwise, its a lot more free-market/tax payer friendly than one might think at a glance.

7) New Jersey is talking about starting a similar program.