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Congress considers bill addressing Section 8 problems The Clinton Administration has sent Congress a bill to address the knotty problem of Section 8 rental assistance that subsidizes projects with rents well above market levels.

The mark-to-market, or portfolio re-engineering, legislation would deal specifically with Section 8 projects with Federal Housing Administration-insured mortgages, where the U.S. Department of Housing and Urban Development (HUD) has some control over expenses as well as income.

Under the legislation, project rents would be reduced to market levels, enabling the projects to compete for tenants with or without subsidies. In some cases, the project-based Section 8 subsidy contracts would be renewed while in others, low-income tenants would receive Section 8 certificates or vouchers, which they could use in the same project or take to another unit.

Because the lower rents couldn't support the existing debt on the project, HUD would restructure the FHA-insured mortgage, reducing or even eliminating the debt service. State and local housing agencies, nonprofit organizations and for-profit entities could handle the restructuring for HUD.

Some projects won't be financially viable at market rents, even with no mortgage, and HUD would renew their Section 8 contracts at market rents.

Since a reduction in the mortgage would mean taxable income for the project owners from forgiveness of debt, tax relief is a critical element of the mark-to-market program.

Under the administration plan, owners with debt reduction of 30% to 75% could defer any tax liability until the year in which their Section 8 contract would have expired. The tax payments would then be amortized over a period of up to 10 years, depending on the level of debt forgiveness. Unfortunately for owners with debt reduction of less than 30% or more than 75%, the plan provides no tax relief for them.

In exchange for the right to amortize their tax bills, owners would have to keep at least 40% of their units affordable to tenants with incomes no higher then 60% of area median income, the low-income housing tax credit affordability standard.

The administration's plan also provides a tax break for owners who sell their projects to nonprofits in connection with a restructuring, allowing them to amortize their capital gains tax over a seven-year period.

Other mark-to-market plans have also been proposed. Senate Housing Subcommittee Chairman Connie Mack (R ­ Fla.) has introduced legislation that would also reduce the debt on a project, but avoid the tax problem by creating a second mortgage equal to the amount of the reduction. Reps. Deborah Pryce (R ­ Ohio) and James P. Moran (D ­ Va.) have proposed legislation that would defer the tax from debt restructuring until the owner disposes of any ownership interest in the project.

Rural housing service issues Section 515 reform rules The Rural Housing Service (RHS) has issued regulations to implement reforms to the Section 515 rural rental housing program enacted in the fiscal 1997 agriculture appropriations act.

The reforms include elimination of the occupancy surcharge, which raised rents $2 per month per year to help fund equity takeout loans as an incentive to owners to continue low-income use restrictions; limitations on project transfers, to assure that the best interests of the government and the tenants are served; expansion of penalties for equity skimming, making it a criminal offense; revision of the system for determining priorities for funding to target areas of greatest need; and a limitation on overall governmental assistance to the amount needed to assure project feasibility.

The targeting changes would rank areas for need on the basis of poverty, lack of affordable housing, substandard housing, lack of mortgage credit and rural characteristics of the location. Applications already on hand will be processed by RHS only if they are for projects in areas meeting the new targeting criteria.

In determining the minimum amount of assistance needed for a project, RHS will use the fee structure of the state agency administering low-income housing tax credits. If the analysis shows that the amount of assistance to be provided will exceed the need by more than $25,000 or 1% of total development costs, whichever is less, RHS will try to work out an agreement with the applicant and the state agency to eliminate the excess. If no agreement can be reached, RHS will increase the applicant's required equity contribution by reducing the loan amount.

Commercial mortgage rates spent May in a "tight trading range," according to participants in the Barron's/John B. Levy & Co. National Mortgage Survey. On the whole-loan side, 10-year fixed rates in the range of 8% to 8 1/8% were viewed as attractive, but not irresistible, by the borrowing community.

The commercial mortgage-backed securities (CMBS) market continues to be on a growth curve that is startling even the most seasoned observers. Individual securitizations of $1 billion or more are becoming almost commonplace. Partnering seems to be the order of the day as Wall Street firms have concluded that bigger is clearly better. One large transaction has Merrill Lynch, GE Capital and Daiwa Securities partnering up.

But the transaction that most buyers are talking about is the largest conduit transaction to date: a $1.9 billion cooperative effort between Credit Suisse First Boston and Goldman Sachs. First Boston is contributing some $1.3 billion of the total collateral, which will be composed of approximately 250 loans. This larger pool will allow transaction costs to be spread among more assets. Additionally, rating agencies are willing to lower subordination levels as a result of the size of the pool. For example, the AAA tranche, for a securitization of this size, is only expected to require subordination levels in the 25% to 27% level as opposed to levels which range from the high 20s to the low 30s for smaller transactions. This deal is scheduled to have some loans with preferred equity features ­ leverage in excess of the standard 75% loan-to-value. Nevertheless, this is expected to comprise less than 10% of the portfolio as opposed to Nomura's most recent CMBS transaction wher! e 26 % of the loans have these additional debt provisions. CMBS buyers are swarming to the deal, because they view it as having increased liquidity due to its gargantuan size and the presence of two huge trading houses who will be making a secondary market in the bonds.

With the incredible spurt of CMBS offerings in June and early July, some buyers are questioning whether the market can absorb the new issuance without some spread widening.

The whole-loan market is seeing nothing like the dazzling amount of activity that the CMBS crowd is enjoying. In fact, a number of survey participants indicated that they were 10% to 20% behind their planned originations and were clearly worried about their ability to catch up as the year progresses. Institutional lenders are spending a great deal of time trying to develop a strategy for competing with the securitized market. A few lenders have developed a so-called "barbell" strategy, which allows them to offer very low spreads on low loan-to-value transactions while offering higher spreads on so-called "value-added" transactions such as hotels and assisted living facilities.

According to one institutional lender, every loan production meeting begins with a discussion of "what's the lowest spread you've heard of recently?" For low loan-to-value transactions such as a 50% loan, spreads in the 0.9% to 1.1% range are commonplace. For loans in the more traditional 70% to 75% range, spreads for 10-year loans are now in the 1.25% to 1.3% arena.

In Barron's issue dated March 31, 1997, we noted that Wall Street bankers were hoping to increase loan originations by offering mortgages which carried no prepayment penalty or prohibition against an early prepayment. Criimi Mae Inc., the New York Stock Exchange REIT, hasn't gone quite that far, but it's now offering a commercial mortgage program with no prohibitions against prepayments and no stiff yield maintenance penalties. The program does carry a fixed prepayment penalty which begins at 3% and declines, but that is viewed by many borrowers as a small price to pay for the flexibility of being able to prepay at any time. Additionally, as might be expected, these loans carry a slightly higher spread than those with yield maintenance prepayment penalties or lock-outs.

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