Underwriting NSP Projects

1. Underwriting NSP Projects Monte Franke, Franke Consulting Ohio Dept of Development Ohio Conference of Community Development

2. 7/28/09 OCCD Summer Quarterly Meeting 2 Objective Outline a risk-based underwriting framework to address risks of NSP projects

3. 7/28/09 OCCD Summer Quarterly Meeting 3 Agenda Why underwrite NSP? Cost principles Risk framework for underwriting Underwriting homebuyer projects Underwriting rental projects Underwriting land banking projects Wrap-up

4. Why Underwrite NSP?

5. 7/28/09 OCCD Summer Quarterly Meeting 5 Why Underwrite NSP? Rare opportunity to expand affordable stock But with distressed stock and neighborhoods Projects must be �ready� Stimulus deadlines & need for quick impact But in the rush to fund, haste can make�. Cost principles apply to NSP The OIG is watching �Longest feasible term� standard A hasty man drinks his tea with a fork.A hasty man drinks his tea with a fork.

6. 7/28/09 OCCD Summer Quarterly Meeting 6 NSP/CDBG Underwriting? Only explicit reference in CDBG rule: economic development activities (570.209) But OMB cost principles apply to CDBG & NSP Allowable public assistance based on OMB cost principles & program standards

7. 7/28/09 OCCD Summer Quarterly Meeting 7 CDBG ED Underwriting Principles Project costs are reasonable All sources of project financing are committed CDBG funds are not substituted for non-Federal financial support Project is financially feasible Return on the owner�s equity investment will not be unreasonably high Funds are disbursed on a pro rata basis with other finances provided to the project.

8. 7/28/09 OCCD Summer Quarterly Meeting 8 Application of Cost Principles CDBG rule link to principles 570.200(a)(5) & .502(a): A-87 public & A-122 nonprofit subrecipients A-87 relocated to 2 CFR Part 225 A-122 relocated to 2 CFR Part 230 85:22: 48 CFR Part 31: for-profits & non-subrecipients

9. 7/28/09 OCCD Summer Quarterly Meeting 9 NSP Requirements Affecting Underwriting Costs Purchase discount requirement & appraisal standards Reasonable developer fees (non-subrecipients) Davis-Bacon Property standards Codes Rehab standards LBP for pre-1978 properties

10. 7/28/09 OCCD Summer Quarterly Meeting 10 NSP Requirements Affecting Underwriting Initial & continued affordability: �Maximum extent practicable� & �for longest feasible term� Prices, continued affordability & enforcement HOME as �minimal� safe harbor Relocation Current occupant eligibility, budgeting relocation costs

11. Cost Principles

12. 7/28/09 OCCD Summer Quarterly Meeting 12 Purpose of Cost Principles Objectives: Provide guidelines to organizations concerning reimbursement requirements Provide uniform standards of allowability Provide uniform standards of allocation But Cost Principles do not: Supersede limitations imposed by statute Dictate how a government should use funds Relieve state/local governments of stewardship responsibilities for Federal $

13. 7/28/09 OCCD Summer Quarterly Meeting 13 Allowability of Costs Costs are allowable if: Reasonable Allocable to the program Treated consistently (GAAP & agency procedures) Allowed by regulations (program & Circulars) and by terms of written agreement Documentable

14. 7/28/09 OCCD Summer Quarterly Meeting 14 Reasonableness of Costs Ordinary & necessary Is it necessary for the completion of the project? Arm�s length transaction Is it treated as a transaction with an unrelated third party? Due prudence Would a prudent person incur the cost? Consistent with established policies/practices Is it treated consistently across agency/ program?

15. 7/28/09 OCCD Summer Quarterly Meeting 15 Allocability of Costs Allocable to a Federal program when: Incurred directly for the purposes of the program If costs benefit multiple activities, reasonable allocation method Indirect costs necessary to the overall operation of the agency Equipment items budgeted and benefiting the project may be charged entirely to project regardless of its useful life

16. 7/28/09 OCCD Summer Quarterly Meeting 16 Unallowable Cost Specifically identified in the grant/contract as being unallowable Eligible/ineligible in the Notice Eligible/ineligible under CDBG Specifically identified in Circular as being unallowable Does not meet the �allowability� criteria in the Circular On the other hand, a cost is considered unallowable to be paid with Federal program funds if is it specifically mentioned as unallowable in program regulations or program agreements. In the case of HOME, the ineligible costs are listed in 92.214, but costs must also be consistent with what is described as eligible in 92.206. In addition, a cost is considered unallowable to be paid with Federal funds if it does not meet the standards for allowability listed on the previous slide, or if it is specifically listed as unallowable in the Circular. Some of the key unallowable costs are listed on this slide, and include: Alcoholic Beverages, Bad Debts, Contingency provisions, Fines and Penalties, Lobbying Costs, Fund Raising Costs, Entertainment, Social Memberships, Fundraising Costs, and Interest on borrowed capital. For other unallowable costs, see Attachment B of the Circular.On the other hand, a cost is considered unallowable to be paid with Federal program funds if is it specifically mentioned as unallowable in program regulations or program agreements. In the case of HOME, the ineligible costs are listed in 92.214, but costs must also be consistent with what is described as eligible in 92.206. In addition, a cost is considered unallowable to be paid with Federal funds if it does not meet the standards for allowability listed on the previous slide, or if it is specifically listed as unallowable in the Circular. Some of the key unallowable costs are listed on this slide, and include: Alcoholic Beverages, Bad Debts, Contingency provisions, Fines and Penalties, Lobbying Costs, Fund Raising Costs, Entertainment, Social Memberships, Fundraising Costs, and Interest on borrowed capital. For other unallowable costs, see Attachment B of the Circular.

17. 7/28/09 OCCD Summer Quarterly Meeting 17 Sample Unallowable Costs Alcoholic Beverages Bad Debts Contingency provisions Fines and Penalties Lobbying Costs Fund Raising Costs Entertainment Social Memberships Fundraising Costs Interest on borrowed capital

18. 7/28/09 OCCD Summer Quarterly Meeting 18 Pre-Award Costs Costs incurred prior to the effective date of the award must be directly related to the award and allowable: Only to extent allowable if incurred after the effective date of the award Only with the approval of awarding agency Not a �choice limiting� action pre-environmental clearance See 24 CFR 58.22 & CPD-01-11, p. 10 There are also limitations on costs that can be incurred prior to award and still reimbursed from Federal program funds. The cost must be directly related to the performance of the activity under the award, and is allowable only to the extent the cost would have been allowable if occurring after the award. Also, the cost must be approved by the funding agency, and must not be for an action that would be considered �choice limiting� prior to environmental review (see 24 CFR 58.22 and CPD-01-11 page 10.)There are also limitations on costs that can be incurred prior to award and still reimbursed from Federal program funds. The cost must be directly related to the performance of the activity under the award, and is allowable only to the extent the cost would have been allowable if occurring after the award. Also, the cost must be approved by the funding agency, and must not be for an action that would be considered �choice limiting� prior to environmental review (see 24 CFR 58.22 and CPD-01-11 page 10.)

19. 7/28/09 OCCD Summer Quarterly Meeting 19 No Cost Shifting or Supplanting Supplanting: deliberately reducing State or local funds because of the existence of Federal funds Cost shifting: moving costs to/from other agreements or projects to relieve deficits, avoid restrictions imposed by law or agreement, or other reasons of convenience Other important OMB cost principles are that: Federal funding not replace or supplant local funding, and Costs not be shifted to or from other activities or agreements not integral to the funded activityOther important OMB cost principles are that: Federal funding not replace or supplant local funding, and Costs not be shifted to or from other activities or agreements not integral to the funded activity

20. Risk Framework for Underwriting

21. 7/28/09 OCCD Summer Quarterly Meeting 21 What is Risk Underwriting? Analyzing risks of a project & likelihood of success Why risks? Because probability of projected outcomes Risk assessment/underwriting includes: Determining project facts Making reasonable assumptions Estimating risks Making recommendations to minimize/mitigate risks

22. 7/28/09 OCCD Summer Quarterly Meeting 22 How Underwriting Fits In Project selection & funding process Threshold eligibility Priorities Underwriting/risk assessment Investment decision: underwriting informs decision Due diligence/final underwriting Closing Monitoring

23. 7/28/09 OCCD Summer Quarterly Meeting 23 Public v. Conventional Conventional underwriting: market risk project risk borrower risk portfolio risk Public underwriting adds: public purpose regulatory compliance affordability gap analysis layering analysis

24. 7/28/09 OCCD Summer Quarterly Meeting 24 Layering of Risk Layering: interaction of many small risk factors Multiple small problems tend to be deceptive (appear to be insignificant) & may overwhelm borrower Pay attention to market & borrower risks as well as project risks, and consider interaction of risk factors

25. 7/28/09 OCCD Summer Quarterly Meeting 25 Public Underwriting Principles Invest only what is necessary to make project feasible, affordable, & viable Contain costs but don�t cut essential investments Keep fees/profits reasonable Optimize private debt/other funds Determine appropriate amount of assistance for affordability period Fiduciary responsibility to protect public investment -- public funds put to private use Ensure public purpose - statutory intent/public good Invest, monitor, recapture

26. 7/28/09 OCCD Summer Quarterly Meeting 26 Reasonable Fees/Profit Methods to establish reasonable fee Competition/procurement % cap on fees Beware fixed % as biases larger projects Fixed $ fees � performance based fixed payments for services

27. 7/28/09 OCCD Summer Quarterly Meeting 27 NSP Requirements & Risk Framework Market risk: targeting AGNs Borrower risk: developer timely implementation; buyer affordability Project risk: readiness; sustainability Portfolio risk: concentration to achieve impact

28. 7/28/09 OCCD Summer Quarterly Meeting 28 Suggested NSP Underwriting Principles Costs are reasonable, necessary, allocable, documentable Fees/profit are reasonable All sources are identified & committed NSP assistance amount is appropriate (given all public sources) to achieve affordability

29. 7/28/09 OCCD Summer Quarterly Meeting 29 Suggested Principles, cont. Project is ready to proceed within program deadlines Project is feasible & sustainable for affordability period Concentration of investments will help stabilize target area Investment terms protect the public investment for the affordability period

30. Underwriting NSP Homebuyer Projects

31. 7/28/09 OCCD Summer Quarterly Meeting 31 Market Issues Wider range of eligible buyers (up to 120% AMI) Define minimum income required for affordability But stricter mortgage underwriting narrows the pool Areas of Greatest Need Selected based on stress characteristics But what is the long-term prospect for stability?

32. 7/28/09 OCCD Summer Quarterly Meeting 32 Market, cont. Market impact of NSP activities Discount requirement: impact of NSP volume on values Impact of sales price not exceeding cost Long-term value/marketability Concentration of investment to overcome neg. factors How long will the buyer be upside down? Transportation/access

33. 7/28/09 OCCD Summer Quarterly Meeting 33 Borrower Issues: Developer Experience Marketing Buyer intake & pipeline Active buyer pool? Affirmatively further fair housing (affirmative marketing?) Counseling: 8 hour minimum Lender relationships/mortgage programs

34. 7/28/09 OCCD Summer Quarterly Meeting 34 Borrower Issues: Homebuyers Affordability Action Plan amendment definition Mortgage standards Lender participation Lender underwriting metrics: min. credit scores (impact of reduced credit lines), front & back ratios, LTV limit Getting to 50% AMI with homeownership?

35. 7/28/09 OCCD Summer Quarterly Meeting 35 Project Issues Completion issues Commitment & expenditure deadlines Timely AGN implementation for impact Feasibility issues Costs v. value; pricing Improvements: codes, rehab standards Marketing/sales process

36. 7/28/09 OCCD Summer Quarterly Meeting 36 Sustainable Homeownership The downpayment � what�s their stake? Sensible mortgages: avoid ARMs & high ratios Post-closing cash Energy efficiency � adding U to PITI Structure/systems useful life � adding M to PITI Post-closing counseling/relationship Resubordination policy

37. 7/28/09 OCCD Summer Quarterly Meeting 37 Structuring NSP Assistance Amount of assistance Developer assistance: Will it all pass thru to buyers? Buyer assistance: pricing based on cost v. FMV Program compliance Income level targeted: 120%; 50%? Pricing/affordability: price limited to costs Improvements/property standards Counseling: at least 8 hrs

38. 7/28/09 OCCD Summer Quarterly Meeting 38 Structuring Assistance, cont. Enforcement Affordability period HOME minimums: 5-15 yrs principle residency Deed restrictions or notes/mortgages? Resale/recapture: five options Recapture: what/when recaptured on Voluntary sale, involuntary sale, subletting/non-compliance Program income requirements

39. Underwriting NSP Rental Projects

40. 7/28/09 OCCD Summer Quarterly Meeting 40 Market Issues Targeted range of renters Define minimum income required for affordability Rental units to meet @5% @ 50% AMI? Areas of Greatest Need (AGNs) Concentration of units/activities Rents NSP affordable rents Market competitiveness (over time)

41. 7/28/09 OCCD Summer Quarterly Meeting 41 Market, cont. Trends/impact of �shadow market� Long-term value/marketability Concentration of investment to overcome neg. factors Neighborhood advantages: transportation/access to�

42. 7/28/09 OCCD Summer Quarterly Meeting 42 Borrower Issues Owner/developer experience/capacity to own Developer equity/liquidity Portfolio & contingent liabilities Professional management

43. 7/28/09 OCCD Summer Quarterly Meeting 43 Project Issues Have any/all project deficiencies that caused or contributed to foreclosure been identified? Costs Acquisition cost Relocation? Codes/rehab standards/property standards Completion risks

44. 7/28/09 OCCD Summer Quarterly Meeting 44 Project, cont. Feasibility Reasonable �affordable� rents Realistic vacancy/collection loss Operating expenses reasonable Debt coverage ratio Reasonable, not excessive cash flow Level of capital subsidy required to serve < 50% AMI Sustainability: next slide

45. 7/28/09 OCCD Summer Quarterly Meeting 45 Sustainability: Rental Projects Long-term pro forma & crossover point Improvements beyond minimum: Energy efficiency & maximum useful life �Competitive� rents Realistic vacancy (after new car smell is gone) Adequate management & prev maintenance Funded reserves Cushion

46. 7/28/09 OCCD Summer Quarterly Meeting 46 Structuring the Assistance Calculation of the fundable gap Sustainability for affordability period Program compliance requirements Occupancy requirements (LMMI) Marketing Affordability (rents) Improvements/property standards

47. 7/28/09 OCCD Summer Quarterly Meeting 47 Structuring Assistance, cont. Investment terms Terms of capital advances Repayment - cash flow loan? Enforcement Affordability period or term: HOME 5 � 20 yrs Legal documents/mechanism: HOME deed covenant Occupancy reporting/monitoring requirements Property standards?

48. Underwriting Land Banking Activities

49. 7/28/09 OCCD Summer Quarterly Meeting 49 Land Banking Market: impact of banked property Borrower: Ability to maintain/provide interim/develop long-term Project: Interim use/protection: adequate security/ management/ maintenance; also interim occupant URA notices Long-term use strategy (within 10 yrs.)

50. Wrap Up

51. 7/28/09 OCCD Summer Quarterly Meeting 51 8 Principles for NSP Underwriting Costs are reasonable, necessary, allocable, documentable Fees/profit are reasonable All sources are identified & committed NSP assistance amount is appropriate (given all public sources) to achieve affordability

52. 7/28/09 OCCD Summer Quarterly Meeting 52 Project is ready to proceed within program deadlines Project is feasible & sustainable for affordability period Concentration of investments will help stabilize target area Investment terms protect the public investment for affordability period

53. 7/28/09 OCCD Summer Quarterly Meeting 53 Risk Assessment Market Affordability, demand, AGN impacts (two-way) Borrower Developer/owner capacity, buyer Project Completion/readiness Viability/sustainability Interaction of risks

54. 7/28/09 OCCD Summer Quarterly Meeting 54 Addressing Sustainability Starting points: �Longest feasible term� Impacting AGNs Addressing problems that led to foreclosure Techniques: Cushion affordability (not minimum assistance) Provide for reserves & post-closing cash Extend useful life of improvements Address energy efficiency Support with management/maintenance or counseling

55. 7/28/09 OCCD Summer Quarterly Meeting 55 Investment Decisions Determine appropriate amount of assistance Reasonable & necessary Specify all compliance requirements Impose affordability period requirements Create enforcement mechanism & reporting

56. 7/28/09 OCCD Summer Quarterly Meeting 56 Wrap Up Evaluation: additional guidance needed MLFranke@aol.com