This article is reprinted with the permission of Nixon Peabody LLP

On November 17, 2011, the House of Representatives and Senate passed the so-called “Minibus” legislation (H.R. 2112), which included funding for three of the twelve appropriation bills: Agriculture; Commerce, State, Justice, and Transportation; Housing, and related agencies. A short term “Continuing Resolution” funding the remaining federal agencies through December 16, 2011 was attached to this legislation; the current Continuing Resolution expires today. The House vote was 298-121; the Senate vote was 70-30. Congress is now in recess for the Thanksgiving break. The President signed the legislation today.

The bill contains authorizing language for HUD’s signature initiative, the Rental Assistance Demonstration program. This demo, which is limited to 60,000 units, will provide public housing and Section 8 Mod Rehab (Mod Rehab) properties with project-based rental assistance, which can be used to leverage private sector resources including tax-exempt bonds and low income housing tax credits to rehabilitate existing housing properties. HUD will accept applications through 2015. Funding will be provided through transfers from other public housing programs.

The bill also contains several provisions addressing the maturity of Rental Assistance Payments (RAP), Rent Supplement contracts (Rent Supp), and Mod Rehab contracts. During FY 2012 and 2013, owners may convert tenant protection vouchers to Section 8 project-based vouchers (PBV) for projects which are covered by a RAP, Rent Supp, or Mod Rehab contracts. This provision also has a “reach back” to 2006 that allows for the project basing of previously issued tenant protection vouchers. Tenants in the properties will need to be consulted about the conversion and the voucher administrator must agree to the project basing. The provision of the PBV statute which caps the number of vouchers a voucher administrator can project base at 20% is not applicable to these conversion actions. Also, the Secretary can “waive or alter” other PBV provisions including the provisions which deal with a voucher administrator plans and goals, and the 25% per project PBV cap on family projects.

Another provision provides $10 million to provide either Enhanced Vouchers or PBVs for certain properties, including i) the maturity of HUD-insured, HUD-held, or Section 202 properties that require the Secretary’s consent to prepay; ii) the expiration of a rental assistance contract for which the tenants are not eligible for enhanced vouchers under current law (RAP contracts); or iii) the expiration of mortgage affordability restrictions or a HUD preservation program (ELIHPA/LIHPRHA). This provision is limited to residents living in low-vacancy areas.

Finally, there is yet another provision which allows for the one-year extension of RAP and Rent Supp contracts expiring in FY 2012. This provision was introduced in last year’s funding bill.

The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.


There is no getting around it; the federal budget appropriations process is messy. Despite comparisons, our nation’s budget is not analogous to a family budget that you or I would prepare. At billions of dollars in size, hundreds of pages in length, its own office within the White House, and a committee in each chamber of Congress – it stands alone. Not to mention that its lack of passage brought the federal government within hours of shutting down this April. However, given its integral role in the country’s operations the constant attention that it is receiving on Capitol Hill is warranted. Regardless of party affiliation, there is broad agreement that the next budget address the need for deficit reduction and more revenue generation. Elected officials disagree on how to get there, but the end goal is the same: a more financially stable country.

Efforts to do so have seen proposals where “everything is on the table” and demands for deep cuts across the board have been made; this includes the operating budget for the U.S. Department for Housing and Urban Development (HUD). HUD submits its own budget proposal, the President does the same, and finally Congress determines the final allocations. For comparison’s sake, the enacted budget for HUD in FY10 was $43.5 billion (National Low-Income Housing Coalition, 2011) and the agency has requested $47.9 billion (HUD, 2011) for FY12; FY11 was omitted due to the lack of a budget through Congress. Though these appear to be large figures, when looked at in the context of the entire budget, perception shrinks them considerably. President Obama’s proposed budget includes a request for $41.7 billion for all housing assistance programs, which works out to 1.59% of the nation’s total budget for FY12 (Office of Management and Budget, 2011).

The pie chart for how HUD allocates their funds is refreshingly simple. Though there are only three slices nearly three-quarters (72%) of their budget goes toward rental assistance, and of those HUD-assisted households, 72 percent of them are classified as “extremely low-income” meaning that they fall below 30% of area median income (HUD, 2011).
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Questions arise surrounding the default rate as the affordable housing industry fights to keep the program alive

On February 14th we posted a story on the Obama administration’s proposed elimination of the USDA Rural Development’s 538 multifamily guaranteed loan program.  In the Terminations, Reductions and Savings report that accompanied the proposed budget the administration cited the rising cost of the program caused by a dramatic increase in the program’s default rate:

…the defaults in these programs have been much higher than initially projected, and the increase has happened quickly, making them more expensive than their direct loan counterparts. In addition, the direct loan programs have very low defaults, even though they tend to serve the much lower income residents/communities

We also noted that the program’s default troubles were not news to the affordable housing industry. A CARH email newsletter had noted the troubling rise in default rate several months earlier:

In the USDA’s budget submission, the score for FY2011 appropriations increased nearly ten-fold from FY2010… It appears that certain defaults in the Section 538 program, together with changes resulting from the lack of interest credit subsidy, have been cited as reasons for this scoring increase.

Looking at the 2011 budget assumptions, we found that the subsidy rate increased from 1.15 in 2010 to 9.69 in 2011, driven by an increase in the default rate from 1.49 to 11.73.

Affordable housing advocates have since rallied around the program in an effort not only to save the program for FY2012, but also to maintain it’s funding levels in FY2011. These efforts culminated in a recent joint letter to both the house and senate:

We would urge you as you complete consideration of the Fiscal Year 2011 budget to provide the necessary appropriations to allow for a program level of $129 million and then in Fiscal Year 2012, consider allowing fees to be charged, thus making the program revenue neutral.

While the efforts to maintain a funding level of $129 million in 2011 have proven unsuccessful (the recently released FY2011 CR, H.R. 1473 only provides $30 million), the fight to keep the program alive in FY2012 goes on. The letter, signed by numerous advocacy groups, strongly contests the default rate at the center of the program’s proposed elimination:

We refute both statements, particularly the default rate… The default rate and therefore the subsidy rate for the program are incorrect as relayed by the Administration in its FY 2011 and FY 2012 budgets. The Council for Affordable and Rural Housing (CARH) has numbers that can demonstrate the default rates to be less than the agency transmitted in their budget.

The Numbers

Further investigation revealed that the increase in default resulted from just five properties going into foreclosure. The table below shows the series of loans that went into default, grouped by repurchase date to indicate which loans belonged to each of the five properties:

Also included in the table is a calculation of the default rate. This calculation, taken by summing the default amounts, and dividing the sum by the total outstanding principle in the program, results in a default rate of 8% not 11.73%. “Somewhere there is a disconnect, said Rob Hall of Bonneville Multifamily Capital.  While concerned with this disconnect, he was more troubled by the way in which the numbers do not paint an accurate picture of the program’s cost, “Historically [this default rate] is not indicative of the deals getting done in the past 7 years.”

A different program

Underlying this belief is the fact that four of the five loans were originated in the early years of the program, before updated underwriting practices went into effect: “Four of the five deals were not tax credit properties. All the deals closed in the last 5,6,7 years have been LIHTC properties. They are completely different than deals from the early days of the program, which had virtually no equity.”

The changes Mr. Hall is referring to stem from a 2004 Notice of Funding Availability that awarded points to 538 loan applicants based on Loan to Value ratios and a 2005 NOFA that awarded points for Loan to Cost ratios.  Additionally, since 2005, Rural Development has pushed to have every 538 loan securitized by the Government National Mortgage Association (GNMA). Because GNMA requires a Loan to Cost Ratio of 50% or less, this move has been accompanied by subsequently tighter NOFA requirements. The combined effect of these policies is that the agency has been funding loans that have more equity, generally in the form of tax credits. Pictured left is a clip from the 2005 Notice of Funding Availability that details the debt to cost preference scheme.

Given the historically low rate of defaults in the LIHTC program, the correlation between 538 and tax credit deals has significant implications for the 538 program’s projected cost. A recent Ernst and Young report showed the default rate for the 23-year history of the program at .83%, and an annual rate of about .03%.

“Recent 538 deals should be nearly identical to that TC rate because they are all the same deals. The default rate is well below 1% for 538 loans originated in the last 5-7 years.”  Said Mr. Hall. He also noted while the loans that went into default should never have been underwritten, “the lenders behind these loans are no longer involved with the program and the officers who originated the loans are no longer with the program.” He continued, “Members of the industry just want the default rate to reflect this, something reasonable like 2-3%. The higher default rate is leading the budget people and congress to believe the program is very expensive when it is not. “

Symptom of broader ills

A recently released GAO audit on the USDA’s 514/515 Farm Labor housing program suggests that the questions surrounding the 538 program could be indicative of broader problems for the agency. In particular, the GAO found that, “Rural Development (RD) overestimated its credit subsidy costs for the fiscal year 2010 FLH loan cohort”, attributing this overestimate to errors in calculating the default rate, “we found that the primary driver of the change from the fiscal year 2010 credit subsidy estimate to the re-estimate was the default cost component and, more specifically, how this cost component was calculated.”

The report also provides insight into the mysterious credit subsidy rate formula: “Four cost components comprise the credit subsidy estimate for the FLH program: defaults, net of recoveries; interest; fees; and a component labeled “all other,” which includes prepayments.” Going on to explain exactly how the agency erred in their default rate calculation:

Specifically, when the fiscal year 2010 budget formulation credit subsidy estimate was calculated, the estimated default cost component was inflated by a prepayment estimate. That is, RD overstated the estimated default cost component to reflect the effect of prepayment. RD, includes the impact of prepayment estimates in the all other cost component

It remains unclear whether RD uses the same credit subsidy formula for the 538 program and whether mistakes in the same prepayment calculations could have contributed to an inflated 538 default rate.  However, some industry experts find it hard not to see similarities between the two issues, “My take is that if there is a problem with determining the subsidy rate for one program, there may be issues in determining rates for other programs.” , said Colleen Fisher, Executive Director of the Council for Affordable and Rural Housing (CARH),   “I think that it shows that there are some issues that need to be worked out between OMB people and the budget people and the program people that actually know what the story is.”

She went on to reiterate that the program today is a vastly different one than produced four of the five problem-properties, “The program is too important now and we have really seen it improve since its early days. From an infancy period where it had some issues, we can now use this program to do some good”,  she continued,   “I think if we can get through FY2011, I think we might be seeing the agency reviewing the subsidy rate, that’s all premised on the crazy FY2011.”


Today, at 2pm, Governor Chris Christie will deliver his budget message to a joint session of the New Jersey State Legislature. It is expected that the governor will propose significant cutbacks to deal with an estimated $10 billion budget shortfall in the coming year. A letter, signed by numerous housing advocates, brings to light potential cutbacks in the State Rental Assistance Program (SRAP) and the possibility that the governor may allocate Housing Trust Fund dollars to help plug the budget gap.


Go to 21:30 for a summary of the changes to rental assistance programs:


Agriculture Secretary Vilsack had the following to say about the elimination of the 538 guaranteed loan program:

On the rural development side, we are proposing and suggesting some tailoring of our housing programs, reducing some of the programs and eliminating others, but still try to meet the overall housing needs through a very aggressive Guaranteed Loan Program.

Link to audio recording

Media Briefing: Remarks by Agriculture Secretary Vilsack on President’s Proposed FY 2012 Budget

Monday, February 14, 2011

MODERATOR: Good afternoon, everyone, and thank you for joining us today. Agriculture Secretary Tom Vilsack is here in this studio to talk about the proposed 2012 budget as it relates to agriculture. If you would like to ask a question of him, let us know by pressing Star/1 on your touchtone pad, and with that, we go straight to the Secretary.

SECRETARY VILSACK: Susan, thank you very much, and thank you all for joining. I am going to take a few minutes of your time this afternoon to talk about a very challenging and difficult budget that we presented today. In fact, there are several different challenges or realities that the USDA budget has to face in this year.

I think it’s no surprise that folks at USDA and across the country have become very concerned about the deficits, and the President has instructed us to take a look, a very close look, at our budget to find ways in which we can provide opportunities for reducing the deficit. USDA stepped up to the plate last year and steps up to the plate this year as well. Whenever you are talking about deficit reduction or eliminating or reducing programs, you are obviously talking about difficult and tough choices, both to reduce budgets and to reallocate resources. That’s one reality we had to face in this budget.

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HUD’s detailed 2012 budget proposal reveals the following proposed changes to the Low Income Housing Tax Credit program:

The Department’s overall preservation agenda is complemented in the Department of Treasury’s budget for fiscal year 2012, which proposes two reforms to the Low Income Housing Tax Credit (LIHTC) that will: • Replace the current cap on household income at 60 percent of area median income with

the option that properties serve households whose average income is no greater than 60 percent of AMI and with no individual household above 80 percent of AMI. These

Fiscal Year 2012 Budget Summary 7changes to the Code’s low-income occupancy threshold requirements will accomplish three things: (i) allow greater income-mixing at the project level, creating opportunities for workforce housing; (ii) help align LIHTC with HUD’s and USDA’s affordable housing programs (which define low-income at 80 percent of area median income); and (iii) lead to the creation of more units targeted to the lowest income households.

It’s important to note that this income averaging proposal increase our ability to preserve HUD-assisted properties. 69,224 households living in public housing and 23,271 households in multifamily housing have incomes above 60% of AMI. This proposal allows these units to be counted in basis, increasing the equity flowing to these projects for preservation.

• Make the 4% credit a more viable source of funding for the preservation of the federal affordable housing stock by giving qualifying properties a 30% basis boost in the context of preserving, recapitalizing, and rehabilitating existing affordable housing, particularly public housing targeted by TRA (as well as Multifamily Housing, 236s, BMIRs, RAP, Rent Sup, 202, 811, HOME, McKinney and CDBG funded units, USDA-RD (515s)). This means that a greater amount of equity could be raised per credit even at the higher yields required by investors for 4% investments, which in turn will generate more interest in LIHTC preservation deals within the investor and developer community.

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Citing budget constraints, the administration has proposed cuts of $68 and $104 million dollars in funding to The Housing for the Elderly (Section 202) and Housing for Persons with Disabilities (Section 811) grant programs:

Due to budget constraints, the Administration proposes to provide funding at a reduced level for new construction and awards for Section 202 and Section 811 projects.

The cut in funding has interesting implications for other affordable housing programs, most notably the Low Income Housing Tax Credit program. In the current debt-reduction and tax-reform focused political environment, the cuts in direct appropriations could have the side effect of strengthening the tax credit program’s political position. In comments made at the NCSHA’s recent HFA Institute, Pat Sheridan, Senior VP of Housing Development at Volunteers of America, Inc., said the following:

The recognition is that HUD is being cut back on their direct appropriation programs, like the 202 program, the 811 and the public housing programs. They are recognizing that the tax credit program is the place to go. It is another situation that but for the tax credits, senior housing, group homes, and public housing won’t be rehabilitated or even built new.

See also: Citing default rate, Obama budget axes USDA multifamily guaranteed loan program

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The Obama administration released it’s FY 2012 budget proposal. Among the most drastic reductions in multifamily affordable housing programs is a proposed elimination of the section 538 multifamily guaranteed loan program. The Terminations, Reductions and Savings report cited the rising cost of the program resulting from an increased default rate:

However, the defaults in these programs have been much higher than initially projected, and the increase has happened quickly, making them more expensive than their direct loan counterparts. In addition, the direct loan programs have very low defaults, even though they tend to serve the much lower income residents/communities

The problems in the 538 program surfaced several months ago in the USDA’s budget submissions. A December CARH email newsletter called attention to the curious rise in the USDA Rural Development Section 538 Guaranteed Rural Rental Housing program loan guarantee score:

In the USDA’s budget submission, the score for FY2011 appropriations increased nearly ten-fold from FY2010… It appears that certain defaults in the Section 538 program, together with changes resulting from the lack of interest credit subsidy, have been cited as reasons for this scoring increase.

The ten-fold increase in defaults was, in-part, responsible for a $13,625,000 increase in requested loan subsidies for guaranteed multi-family housing, an increase explained in the 2011 Office of Budget and Program Analysis explanatory notes:

The proposed increase supports the estimated loan obligations associated with the requested loan level in FY 2011. The increase in subsidy rate is a result of annual technical assumptions, increase in default rates, and interest changes as forecasted in the President’s 2011 budget economic assumptions.

Looking at the 2011 budget assumptions, the subsidy Rate increased from 1.15 in 2010 to 9.69 in 2011 with the program level remaining essentially constant. Underlying this rate change was an increase in the default rate from 1.49 to 11.73 (taken from the 2010 and 2011 subsidy estimates).


California Governor Jerry Brown is scheduled to introduce his January budget proposal this morning. The budget-announcement could have serious implications for state level affordable housing programs as the Governor seeks to tackle California’s massive budget deficit. A San Mateo Daily Journal article highlights the potential cuts to local Redevelopment Agencies.  RDAs typically aid in the development of affordable housing through housing set-asides.

When: Monday, January 10, 2011 at 11:00 a.m.

Where: California State Capitol, Governor’s Press Room, Room 1190, Sacramento

Governor Jerry Brown
Department of Finance Director Ana Matosantos

Web Stream: The news conference will be streamed live at www.calchannel.com.

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