Mr. Chairman and Members of the Committee: Thank you for inviting me to testify on the very important matter of reforms to the multifamily housing programs and specifically on S. 513 and the Administration's bill, which was introduced by Chairman D'Amato as S. 853. I request that my entire statement be included in the record.

I am pleased to accept this opportunity to testify on legislation regarding the nation's stock of federally assisted, privately owned housing. I believe that solving the systemic problems facing the FHA-insured and subsidized portfolio is one of the highest priorities for the Department. We must work in a bi-partisan fashion to address the long-standing problems facing the multifamily housing inventory.

If we work together, we can enact historic legislation this year. We need a strong bill that preserves affordable housing for the benefit of low- and moderate-income residents, treats project owners fairly, and protects the taxpayers. Failure to design appropriate and responsible mechanisms for how these reforms are carried out could cost the taxpayers billions of dollars and expose residents and communities to the loss of vitally needed affordable housing.

Let me begin by reviewing the status of and lessons learned under the FY 1996 and 1997 mark-to-market Demonstration Programs and then proceed to a discussion of proposed new legislation.

The lessons learned from implementing the two Congressionally authorized demonstrations should be applied to any bill that addresses this complex problem.

Substantial progress has been made during the past year with regard to the 1996 and 1997 Demonstration Programs.

Of the 35 projects accepted into the 1996 Demonstration Program:

• 5 projects have closed;

• 6 owners are no longer interested;

• 12 projects are in active negotiations; and

• 12 projects are on hold because the owners must seek approval of the local and state agencies that financed the FHA-insured mortgages.

To date, owners of 75 eligible projects have chosen to participate in the FY 1997 Demonstration Program -- a participation rate of about 50 percent. Due diligence is under way for all of these projects and preliminary restructuring negotiations are in progress for many of these. Additional projects will be added to the 1997 Demonstration Program over the next four months as contracts expire.

With regard to the FY 1997 Demonstration Program, we have developed or completed the following:

• Published eligibility guidelines for projects entering the program;

• Developed a financial model to quantify the savings or cost of potential loan restructure scenarios;

• Implemented a field tracking system for all project, credit subsidy and loan-related information to evaluate and control the program;

• Developed industry-benchmarked due diligence procedures for analyzing market and property conditions.

• Trained personnel from 10 field offices who will be assisting HUD headquarters in the Demonstration Program

• Selected 43 local and state Housing Finance Agencies as designees;

• Issued guidance for State and local housing finance agencies regarding their roles as designees on a fee for service basis.

Working with local and state housing finance agencies and nonprofits is a key part of the Demonstration program.

The Demonstration legislation provides the Department with the authority to enter into agreements with local and state housing finance agencies, nonprofits, and for-profits to carry out project restructurings on behalf of the Department. We focused first on local and state housing finance agencies. After a number of discussions with interested agencies, we published a notice requesting that interested agencies indicate their interest and qualifications by February 15, 1997. Forty-five days later we selected 43 local and state housing finance agencies for participation. We asked those agencies to provide us with management plans detailing how they would carry out project restructurings.

To date, we have received management plans from the States of Ohio, Virginia, and Massachusetts, and from the City of Chicago. We have concluded discussions with Ohio and Massachusetts on their management plans, and have requested additional information from the other two public agencies and are waiting for responses. The State of Ohio has the largest number of projects eligible for the demonstration this year.

In addition to local or state housing finance agencies, HUD is seeking partnership arrangements with non-profit organizations, in which designees assume some or all of HUD's risk of restructuring. In exchange, designees will receive a share of the savings to the FHA insurance fund resulting from restructuring. The objective of this approach is to explore ways to significantly reduce HUD's administrative role while reducing claims to the FHA insurance fund.

Lessons learned from the Demonstration include the need to address the owners' concerns about timing, the tax consequences of restructuring, and the safe harbor provided by rents maintained at 120 percent of FMR.

We have learned a good deal from the Demonstration:

• We have found that owners typically have chosen to move slowly at all stages of potential restructuring;

• The restructurings take longer to consummate than originally planned;

• About half of eligible properties in FY 1997 have chosen to accept rents at 120 percent of the Fair Market Rents rather than participate in the Demonstration -- indicating a preference to wait for legislative initiatives that Congress may consider relative to future expiring Section 8 contracts and tax relief for the impact of debt restructuring;

• Some owners also have opted to wait based on their expectation that local market rents will rise;

• Because owners have been reluctant to participate without fully understanding all aspects of their exposure, we find that 180 days is not sufficient time for the entire restructuring process; and

• The due diligence procedures of appraisal, market analysis and physical needs inspection are time consuming, and account for approximately 60 of the 180 day clock.

The universe of properties eligible to participate in FY 1997 includes insured properties with contract rents above 120 percent of the Fair Market Rent. At the beginning of the fiscal year, we believed that this universe would number approximately 330 contracts. In fact, we found that owners of properties with rents below 130 percent of the FMRs often found little incentive to participate in the demonstration. They were able, instead, to tighten their belts and accept the rent reduction, while waiting to see what the rules would be next year.

It is clear from the experience we have gained from the Demonstration Program so far that many owners are waiting and watching to see what will ultimately happen with regard to the proposals that are now before the Congress.

The Administration's bill builds upon the lessons learned from the demonstration as well as on the provisions in S. 513.

I would now like to turn to the Mark-to-Market provisions of the Administration's Housing 2020: The Multifamily Housing Reform, Consolidation, and Enforcement Act of 1997. This bill was introduced in the Senate by Chairman D'Amato as S. and in the House by Chairman Lazio and Congressman Kennedy as H.R. 1433.

In an era of shrinking governmental resources, we cannot afford to continue to subsidize projects with rents in excess of market rents. Yet, as those over-market rental subsidies are reduced, many projects with FHA-insured mortgages supported by above-market rents will default, sending the bill for those defaults to the American taxpayer. Both the Administration's bill and S. 513 address this fundamental problem. Both bills also address the fact that the impact for tenants and communities could also be severe, as those projects able to survive in market conditions may be lost as affordable housing, while others will be abandoned and will blight communities.

The Administration's bill provides authority to HUD to operate a mark-to-market program to protect the financial interest of the taxpayer by simultaneously reducing over- subsidized Section 8 contracts and writing down the FHA-insured debt. The legislation would allow HUD to act quickly to reduce over-market subsidies, restructure project financing, provide funds for rehabilitation needs and protect tenants -- rather than wait passively while costs mount and conditions worsen.

The bill includes tax legislation to ensure that adverse tax consequences do not deter owners from participating in mark-to- market. In exchange for favorable tax treatment, owners would preserve units at rents affordable to low-income families.

The Administration's bill and S. 513 share a number of key elements designed to protect residents and communities while also reducing budget costs.

• reducing over-subsidized rents to market levels

• using designees to assist HUD in restructuring mortgages

• addressing the need to also rehabilitate deteriorated properties in the process of debt restructuring.

• facilitating the voluntary transfer of ownership of a portion of this stock to resident organizations and nonprofits.

• The new bill is a more balanced approach. The bill now includes the authority to provide project based assistance in special cases, such as where tenant based assistance would be difficult to use or where the project houses predominantly or primarily elderly and/or disabled families.

• The bill reflects historic cooperation between Treasury and HUD. The bill contains a well-targeted tax proposal to encourage proactive restructuring, which we believe is the key to making the process feasible.

• The bill is more flexible. All types of financing, including insured financing, are permitted. In addition, the bill provides a number of ways to rehabilitate projects where needed.

Contracts should be renewed at current levels on projects that are financially vulnerable.

For mark-to-market projects, rents on restructured projects would not exceed market rents. For all other projects that are not eligible for mark-to-market, contract renewals in FY 1998 in general would be consistent with FY 1997 provisions. That is, they would be renewed at current rents, not to exceed 120 percent of FMR, except that projects can be renewed at current rents above 120 percent of FMR if:

• the project's primary financing or mortgage insurance is provided by a state government and the mortgage is not insured by FHA;

• the project is a Section 202 or a Section 515, Rural Housing Service project; or

• the project is eligible for mark-to-market but would not be financially viable at market rents, even with a complete write-off of the FHA-insured debt.

HUD's bill would protect the most financially fragile projects--those that cannot survive at market rents, even if all debt is written off--until we learn more about the best ways to protect those projects. These projects are found in rural communities where market rents are lower than the rents needed to operate these projects. They are also found in inner-city neighborhoods where, because of the need to pay higher operating costs for increased security and because of the characteristics of their tenants, projects have operating costs higher than market rents for unsubsidized projects. S.513 does not protect these projects, but instead would require that they be included in a restructuring program.

Section 8 assistance must provide for resident choice and while also protecting the most vulnerable residents.

HUD's bill would continue project-based assistance where the project is more than 90 percent occupied by elderly and/or disabled families. Project-based contracts would also be continued where the use of tenant-based assistance would be difficult because of tight market conditions, for example, communities with low vacancy rates.

We estimate that over 50 percent of projects would continue with project-based assistance. Residents of the other projects would be provided tenant-based assistance as a level that would allow residents to remain in their current units.

The Senate bill would provide for project-based assistance on all projects that are restructured, regardless of whether it was needed or not. We believe that tenant-based assistance must be part of any proposal that addresses this problem. The Administration's bill protects vulnerable tenants, but allows other residents the right to exercise choice in where they live. Coupled with the requirements for tax amortization in our bill, this approach would expand the supply of affordable housing at a time when it is badly needed.

Efficient tax provisions must be included, so that owner concerns are addressed while protecting taxpayers and providing for long-term affordability.

As you are aware, owners whose debt is restructured face significant tax consequences as a result. These tax consequences are a formidable barrier to the voluntary participation of owners in a mortgage restructuring program prior to the expiration of their over-market Section 8 contracts. HUD and Treasury have worked together to craft a tax proposal that addresses the legitimate concerns of owners about the impact of debt restructuring while also protecting the taxpayers.

In the Administration's bill, taxes owed as a result of a restructuring transaction -- that is, from debt forgiveness -- would be amortized over a period of up to 10 years, rather than being due immediately. Incentives would also be provided to owners who sell projects to nonprofits.

In exchange for favorable tax treatment, owners would agree to maintain 40 percent of the project's units at rents affordable to families who earn 60 percent of the median income or less. These affordability restrictions match the eligibility requirements for the Low Income Housing Tax Credit. In order to ensure that the owner can provide these affordable units without endangering the project's financial stability, FHA will write-off or forgive sufficient debt to reflect the reduced income from those units.

The Senate bill lacks a similar comprehensive tax provision, but instead provides for the bifurcation of the FHA-insured mortgage into a performing, first mortgage, and a nonperforming second mortgage repaid only after the first mortgage is repaid. The nonperforming second mortgage would accrue interest at the Applicable Federal Rate. Over time, the second mortgage would balloon in size to double, triple, quadruple its original amount, because of the accrual of interest.

The second-mortgage provision of S. 513 poses a significant risk to the future viability of restructured projects. Accruing second mortgages would grow so large that the owner has no hope of repaying it, and would consume all of the project's equity. The owner would then have no financial inventive to maintain the property, exposing the taxpayers and residents to the dangers of severely dilapidated properties.

In addition, the Department of Treasury notes that the second-mortgage provision of S. 513 poses a very serious problem for the owners from a tax perspective. The bifurcation of the mortgage will result in an immediate tax liability for the owners if the second mortgage is not respected as valid indebtedness for tax purposes. In light of the terms of the second mortgage and the expectation that the owners would have no hope of repaying it, the second mortgage would most likely not be respected as valid indebtedness. As a result, the restructuring provision of S. 513 would effectively create immediate taxable income for the owners in an amount equal to the second mortgage. In short, while this provision purports to address owners' tax problems, it is unworkable--thus defeating the larger purpose of the legislation.

Restructuring must be done with a range of tools, so that it can be accomplished in a way that protects taxpayers and residents.

The Administration's bill would authorize a range of tools to restructure a project so that it would be financially viable, including the complete or partial write-off of the FHA-insured mortgage. The owner could choose whether or not to retain FHA insurance on the restructured mortgage.

• HUD would establish procedures to ensure that local governments, tenants, and the holder of the insured mortgage receive timely notice of the owner's participation in the restructuring process.

• Third parties would be authorized to carry out the restructuring and HUD could use designees by delegation, contract, cooperative agreement, or other arrangement. The designees could be state and local housing agencies and non-profit or for-profit entities.

• The Secretary would establish procedures to encourage the sale or transfer of a project, or the transfer of the management of a project, to tenant organizations, community-based nonprofits, and public agencies.

The Administration's bill authorizes State and local housing agencies and non-profit and for-profit groups to be designees. The designees may be reimbursed and may work separately or in conjunction with one another. These designees will be accountable to the Secretary of HUD and will be selected based on capacity.

S. 513 provides HUD with the authority to contract with designees, but would limit HUD to using only designees that are local and state housing finance agencies and would constrain HUD's ability to choose qualified designees. It would also severely constrain HUD's ability to provide adequate oversight to ensure that taxpayers are protected as local and state agencies act on HUD's behalf.

I would like to quote from a letter written by HUD's Inspector General on this issue. She wrote on June 25, 1996 to the Subcommittee to convey her comments on a Senate discussion paper on a strategy for addressing this portfolio, including the primary reliance on local and state housing finance agencies to carry out restructurings. The Inspector General wrote: "While there are many well performing SHFA's [state housing finance agencies] and other similar public and non-profit entities, there is reason to doubt whether there would be sufficient such entities that are qualified, able, or interested in taking on the responsibility of restructuring HUD's portfolio. There is also reason to doubt whether these entities would ensure that the best financial choices are made on behalf of the Federal government, without close oversight."

This portfolio has significant repair needs, which, if left untended, pose an enormous liability for taxpayers, residents, and communities.

With regard to rehabilitation, the Administration's bill would finance needed repairs through a number of means. Owners would have to apply project reserves and residual receipts to rehabilitation. Rehabilitation costs could also be funded as part of restructuring, through refinancing or write-down of the existing debt or, when required, grants from the FHA insurance fund. In addition, Interest Reduction Payments could be continued on restructured or refinanced 236 projects to pay for rehabilitation.

The Senate bill recognizes the need for rehabilitation of this portfolio, but does not include the use of Interest Reduction Payments to fund rehabilitation, a worthwhile use of that funding when it is no longer needed to support the restructured mortgage. S. 513 limits rehabilitation to $5,000 per unit, a number which will be too low for many projects. Although we support the need to exercise prudence and cost control over any decisions about rehabilitation, we believe that a higher rehab cost cap might be considered in light of the actual physical condition of this portfolio.

Any legislation must be implemented quickly.

The Senate's bill would require the use of negotiated rulemaking to develop regulations for the program. Negotiated rulemaking could potentially lead to gridlock on the development and implementation of regulations. Projects will expire while HUD attempts to reach consensus with affected parties. We believe that the Department should use notice-and-comment rulemaking to develop regulations for the program, which will provide all interested parties with the opportunity to comment on the program regulations.

Bankruptcy reform is an important part of efforts to restructure multifamily housing.

Both the Administration's bill and S. 513 include provisions that would strengthen the Department's ability to take actions against bad owners. S. 513 does not include an important provision, however, that would amend the Bankruptcy Code governing the powers of a bankruptcy court.

These changes would allow HUD to proceed in a timely manner with foreclosure actions and to take all necessary and appropriate measures to protect the property, the FHA insurance fund, or the residents of HUD-insured or HUD-assisted multifamily housing projects from the potentially adverse impact of mortgagor bankruptcies. Bankruptcy reform will help the portfolio restructuring process by minimizing delaying tactics by negligent owners of assisted housing.

It is time to work together to pass a bill.

The Administration's bill and S. 513 are in many respects very close; but, clearly, substantial work remains for us to produce a successful bill. Let us make a commitment to resolve the remaining issues in a way that protects taxpayers, residents, and communities. With bipartisan effort, we can pass a bill that will put a significant portion of the FHA-insured and Section-8- subsidized portfolio on a much sounder footing for the difficult years ahead. I invite you to work with me to achieve that.

Content Archived: January 20, 2009