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HUD Using More Partial Payment of Insurance Claims to Deal with Troubled Loans

Housing Client Alert

Authors: Sheldon L. Schreiberg, Scott E. Fireison and Gerald H. Salzman

6/26/2009

HUD-FHA insured multifamily loans are experiencing a new boom era as other sources of multifamily loans have virtually dried up, with the exception of those sold to Fannie Mae and Freddie Mac and very specialized affordable programs. The quality of HUD-FHA borrowers has strengthened as strong entrepreneurs seek alternatives to conduits and banks. At the same time as the workload of our lender clients grows because of this boom, we are seeing more use of Partial Payment of Claims (PPC) to deal with troubled HUD-FHA multifamily loans. We discussed this phenomenon at a recent conference, as described in the May issue of Tax Credit Advisor and, now, in this Alert. We believe that the PPC process requires some tweaking to be a more effective tool for preservation and to provide significant savings to the HUD-FHA insurance funds. It is not surprising that denial of PPCs has generally resulted in project failure and full HUD-FHA claim payments.

An abridged explanation: PPCs have been used for more than 15 years to avoid HUD payment of the full mortgage insurance claim for financially troubled projects. Rather than full claim payment, (i) an insured loan is re-sized to a sustainable level, (ii) the insured mortgagee receives payment on a partial claim and retains the balance as an insured loan, and (iii) HUD, in recognition of its partial insurance payment, receives a second mortgage in the amount of the payment made to the mortgagee. (HUD second loans are payable upon the earlier of maturity of the remaining insured loan or the sale or refinancing of the property.) HUD requires applications from owners and lenders seeking a PPC to be reviewed by both field office and headquarters in a complex application process. In our experience and from information from lenders, we believe that, notwithstanding headquarters and field office review of the same material for a project, the results of the reviews are very often opposite, i.e., the field offices more often support PPC approvals while headquarters takes a more conservative view of the viability of the proposal and the property’s long-term outlook. In addition, HUD recently has asked at least one borrower to share with it some future equity appreciation.

After having worked through multiple PPC engagements, we have come to know that HUD has relied upon two PPC Handbook criteria to deny many PPC requests: (i) the PPC amount is limited to three times an owner’s cash contribution after final endorsement, and (ii) the PPC cannot exceed 50 percent of the outstanding loan amount. We believe that neither of these criteria have much to do with whether a given project is sustainable under new market conditions and that the first of these criteria has served to eliminate from PPC preservation many projects owned by competent owners.

HUD is now reviewing this program. We are offering suggestions for modifications and will continue to alert you as changes in criteria and processing are made.

Please feel free to contact Sheldon L. Schreiberg, Scott E. Fireison, or Gerald H. Salzman with questions or comments.

The material in this publication is based on laws, court decisions, administrative rulings and congressional materials, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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