By Duke Dennis
If you are an apartment owner or buyer in Oklahoma, did you know that the Federal National Mortgage Association (also called “Fannie Mae”) put Oklahoma City and Tulsa under “Pre-Review” status? For the uninitiated, it begs the questions, what is “pre-review” and what are the implications? Before I answer those questions, let me begin with some color on Fannie Mae’s background for the full picture.
Fannie Mae, founded in 1938, was created with multiple purposes, one of which was to increase liquidity in the financial markets in order to increase the number of loans given for housing. By acquiring mortgages from financial institutions, Fannie Mae replaces mortgages on lenders’ books with new capital that can be injected into the markets in the form of new mortgages.
In the late 1980s, Fannie Mae created a program called DUS, which stands for delegated underwriting servicing. At that time, Fannie Mae authorized, via licenses, 25 lenders to have the ability to underwrite, close, deliver and service loans using Fannie Mae-created and controlled guidelines. In order to ensure DUS lenders are responsible in their lending practices, they must adhere to credit and underwriting standards set by Fannie Mae. To further ensure responsible practices, DUS lenders are required to retain one-third of the risk on each loan they create.
Facts about the Fannie Mae DUS Program:
- Since 1988, Fannie Mae and the DUS lenders have provided more than $270 billion in liquidity to finance more than 5.8 million units of multifamily housing.
- With the DUS program, there is an alignment of interest between those who underwrite and issue a mortgage and those who eventually hold it.
- DUS loan program is mainly used for the purchase and refinance of properties, including the following property types: apartments, affordable housing, senior housing, student housing, and manufactured housing in loan amounts greater than $750,000.
Although DUS lenders must undergo credit reviews, adhere to Fannie Mae underwriting guidelines, and retain a portion of the risk of their loans, Fannie Mae does not review most loans created by DUS lenders. Pre-review, on the other hand, basically means Fannie Mae will review the loan with a fine-tooth comb, in the midst of the DUS lender’s underwriting process before the loan is approved. Fannie Mae’s pre-review process can take up to two weeks and include stricter underwriting guidelines. Ultimately, in pre-review markets, the decision as to whether a loan can be made lies with Fannie Mae.
A recent capital placement gave us the following insight as to how Oklahoma City’s pre-review status affected Fannie Mae’s ability to quote the loan. A client of Metropolitan Capital Advisors was seeking a loan in Oklahoma City. Under normal circumstances, the client’s property would have been subjected to Fannie Mae’s Tier 2 category for underwriting standards (see below), but because Oklahoma City is now under pre-review status, any and all properties being considered for a loan in a pre-review market are automatically put into the Tier 3 category for underwriting purposes.
When comparing Tier 2 and Tier 3, it is easy to see that Tier 3 is much more conservative than a typical Fannie Mae loan. First off, leverage for a Tier 3 underwriting is limited to maximum proceeds of 65%, loan-to-value or loan-to-cost, whereas a Tier 2 loan could get proceeds up to 80%. Secondly, the debt service coverage ratio (net operating income/debt service) has been increased from 1.25x to 1.35x, meaning you must have more NOI relative to the amount of your debt service than before. However, there is a silver lining with Tier 3, given the conservative leverage and debt service coverage ratio, Fannie Mae will lower their interest rate spread by 20 basis points for loans in Tier 3 pre-review markets versus what they would offer in a Tier 2 market. The net result is a smaller loan with a lower interest rate; however, the loss in proceeds is not offset by the lower interest rate.
Oftentimes, clients seek the most aggressive financing available to increase their equity returns. Simply put, Tier 3 financing is less aggressive and, in turn, less competitive than what a lot of other lenders are willing to do. Thus, the implications of pre-review for borrowers seeking to finance a property in Oklahoma City is that they will likely consider more aggressive alternatives offered by local banks or conduit lenders.