BIG Competition.

Both Fannie Mae and Freddie Mac have boosted their activity in the apartment lending markets. Pushed by affordable-housing goals set by HUD, the two secondary market giants are approaching a 40 percent market share.

In the multifamily lending industry, it's hard to find someone who takes a neutral position on the growing role the two dominant government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, are playing in the market.

Those companies that have become frequent originators through the GSEs' automated underwriting networks say Fannie and Freddie bring real benefits by their consistent presence in the apartment lending markets. These lenders salute the active role the two are playing.

Then, there are other players that grudgingly give the two GSEs their respect, but keep a wary eye on the competition, which they feel has become extremely aggressive in the marketplace.

Fannie Mae's Delegated Underwriting and Servicing (DUS) program and Freddie Mac,s Program Plus(r) have grown so important to the multifamily lending industry that some of the biggest lenders now must consider the "Prudential Mortgage Paradigm." That is, do they maintain an independent course of action or go out and acquire an existing DUS or Program Plus lender?

The paradigm was defined by Newark, New Jersey-based Prudential Mortgage Capital Co. LLC which, last year, in a $138 million deal, bought The WMF Group Ltd., Vienna, Virginia, a top-five Fannie Mae DUS lender--thus instantly becoming a DUS lender. Another similar transaction occurred in 1999, when Lend Lease Real Estate Investments Inc., New York, bought Dallas-based AMRESCO Capital Ltd., an originator of loans for Fannie Mae and Freddie Mac.

"Last year, 50 percent of the Freddie Mac Program Plus lenders changed hands, many through consolidation," says Shekar Narasimhan, a managing director of agency and funds management at Prudential Mortgage. "Also, 25 percent of Fannie Mae DUS lenders changed hands, and they were to some of the largest lenders in the country--Prudential, Lend Lease, KeyCorp and Washington Mutual."

Those lenders that haven't become part of the GSE distribution system are left but one primary option: choose their financing areas carefully so as not to compete directly against the GSEs.

"The competition we are seeing from the agencies, both on price and proceeds, has really forced us to try and pick our spots where we want to be competitive. We have decided to just be very high-quality and really compete on that price level," says Joseph Franzetti, a director with Salomon Smith Barney, New York, which has a conduit program that lends on multifamily properties.

There is a third option that sometimes comes as a response to this narrowing of strategic business opportunities. Not many have chosen this route. The option is to become one of Fannie Mae's and Freddie Mac's more committed industry critics--a group that is becoming more organized and more strident all the time.

It's easier to find those people who are not entirely happy with the direction of the GSEs or what is perceived to be their anticompetitive zeal, because the most strident among them now have joined a group called FM Watch. FM Watch has its own Web site (www.fmwatch.org), and has taken to calling for stronger regulatory containment of the GSEs, however, they are focused primarily on the single-family lending market.

Washington, D.C.-based FM Watch represents a coalition of financial services- and housing-related trade associations working with affordable-housing and consumer advocates, taxpayers and financial institutions. The objective of the organization is solely to monitor the activities of Fannie Mae and Freddie Mac with an eye out for mission creep--or going beyond the activities authorized in the GSE's charters.

Lending credibility to the group's work is the involvement of some widely respected financial services companies including GE Capital Services, Chase Manhattan Corporation and Wells Fargo & Co.

One of the tenets of FM Watch's mission is to not allow the GSEs to move beyond their unique charters into markets and services already served by the private sector. While FM Watch does not focus on multifamily lending per se, according to statements posted on its Web site it is critical of the automated underwriting networks, which are as important to the GSEs' growth in multifamily as they are in single-family.

FM Watch views the underwriting networks as anticompetitive, or as FM Watch Chairman Gerald Friedman stated in an ABA Banking Journal article, "Fannie's Desktop Underwriter[R] and Freddie Mac's Loan Prospector[R] are monsters in disguise."

Basically, FM Watch charges in a pronouncement on its Web site that Fannie Mae and Freddie Mac are "squeezing out competitors and creating a monopoly."

Whether the GSEs are viewed as too aggressive or simply responding to a marketplace that needs their programs, the two companies have attracted adherents as well as critics.

Government birthrights

Originally called the Federal National Mortgage Association, Fannie Mae was created by Congress in 1938 to bolster the housing industry in the wake of the Great Depression. Fannie Mae started out as part of the Federal Housing Administration (FHA), but in 1968 it became a private company. Today, the Washington, D.C.-based company ranks as the country's 26th largest corporation, with $37 billion in sales, according to Fannie Mae. It still operates under a congressional charter, and Congress has exerted pressure on Fannie Mae to increase its affordable-housing efforts.

Fannie Mae maintains it is the nation's largest source of financing for home mortgages and the largest investor in multifamily mortgages. Last year, Fannie Mae's DUS product line financed $8.7 billion in multifamily business, according to the company.

Begun as the Federal Home Loan Mortgage Corporation, now officially known as Freddie Mac, this second housing GSE is much younger than Fannie Mae. It was launched in 1970 and today remains a congressionally chartered company that buys conventional residential mortgages from lenders, and then issues securities backed by the pools of loans. Today, McLean, Virginia-based Freddie Mac is also a shareholder-owned company, ranking as the country's 62nd largest with sales of $33 billion, according to Hoover's Online.

Since the introduction of the Freddie Mac Program Plus network of multifamily loan originators and servicers in 1993, Freddie Mac has provided financing for more than 7,200 multifamily properties totaling more than $29 billion. That volume represents more than 900,000 rental units across the country, a large portion of which is affordable to people whose income levels are at or below area median income--including newly established households, single-parent households, large family households at lower salaries and older Americans.

"Our business is purchasing multifamily mortgages that fit our credit and pricing parameters, and to the extent there are mortgages out there, we go after them," says Mitchell Kiffe, vice president of multifamily loan production with Freddie Mac. "If you look at Freddie Mac's multifamily assets owned as a percentage of mortgage debt outstanding, we have grown incrementally over the last few years.

After being out of the multifamily market in the early 1990S because of portfolio problems, Freddie Mac has been active in the sector since 1993. Going back six years ago to 1995, annual multifamily investment volume was less than $2 billion, and that rose to a record in 1999 of $7.8 billion. Last year, volume slipped to $7.1 billion, according to Kiffe.

More than 90 percent of the units that Freddie Mac financed in 2000 were affordable to low-income to moderate-income renters, says Kiffe.

In 2000, Fannie Mae's overall multifamily loan production reached $13.5 billion, and that included a new production high of $7.8 billion from its DUS network, says Wendell Johns, Fannie Mae's vice president for multifamily affordable housing. "Over 49 percent of the units we financed were of low-to moderate-income and, in addition, 31 percent were in underserved areas."

The heat is on

Fannie Mae's overall production was quite substantial, but Johns says 92 percent of the financing it did was well within that low- to moderate-income definition that counts toward the mandated affordable-housing goals for the GSEs. "I don't understand the criticism," he says. "May be on a particular transaction, the people who are voicing the criticism of Fannie Mae lost on the deal."

All the talk of affordable housing and financing for low income projects is just a smoke screen, says one FM Watch member who doesn't want to be identified since the person represents large companies on single-family issues. "You really have to ask yourself as you look at their activities in the multifamily area: What does their participation mean to actual renters? And the answer is, nothing--developers get a little bit more money [and] the deals help the GSEs meet affordable-housing goals, but it does not accomplish any affordable housing. What does the GSEs' participation mean to somebody who is low-income and needs rent subsidized? It doesn't mean anything. There is zero cost savings to renters."

Both Kiffe and Johns can point to clearly defined Department of Housing and Urban Development (HUD) definitions as to what should be "affordable" housing, but since both GSEs can bridge into moderate-income housing, some questions have also been raised as to what they finance.

"A high-end apartment community in a very expensive area like Silicon Valley would qualify as affordable, because the mean income of that apartment community [in contrast to the surrounding wealthy neighborhood] would qualify it as affordable as defined by the GSE guidelines, even though it is high-end," says Brian Stoffers, an executive managing director and chief operating officer for Houston-based L.J. Melody & Co.

"Depending on how one wants to define it, you can justify a lot of things as affordable," says Salomon Smith Barney's Franzetti. "From [the GSEs'] point of view, the more liberal the interpretation, the more business they can get."

Last year, Salomon Smith Barney financed about $800 million of standard, fixed-rate conduit properties and $1.4 billion in floating-rate, and this year it expects to do about the same--maybe even 10 percent more multifamily, according to Franzetti.

Obviously, Salomon Smith Barney found a way to compete with the GSEs. Still, Franzetti says, "it is their pricing that is very, very attractive. You really have to want the asset, really have to think it is attractive within your pool to go after it."

As vice president of investments for Birmingham, Alabama-based Protective Life Corporation, Mike Prior focuses his efforts on anchored retail properties rather than multifamily. The problem with multifamily, Prior says, is that it would be very difficult to find an immediate-funding apartment project to which Protective Life could compete with Fannie Mae on a rate standpoint. "Unfortunately, economics favor doing business with Fannie Mae. And you could probably add Freddie Mac to that," he says.

As of the first quarter, Prior says, "Fannie Mae provides quotes in the high 6 percent range. I'm in the mid- to high-7 percent range. I would not be competing with them because basically their rates are so much lower than mine." There would be other complications as well. Statutorily, Protective is limited to 75 percent loan-to-value (LTV), while Fannie Mae and Freddie Mac can provide 80 percent financing. Also, Protective provides a 25-year loan maturation, while the agencies can go to 30 years.

Part of the problem is the GSEs are under a lot of pressure to meet affordable-housing objectives, and this has sent them rushing pell-mell into the multifamily market.

"When you look at where Freddie Mac and Fannie Mae are with the new affordable-housing goals, they are going to be much more aggressive in trying to originate multifamily loans through their lenders. They need a lot of loans," says Michael Petrie, president of P/R Mortgage & Investment Corporation, Indianapolis.

Stacey Berger, executive vice president with Kansas City, Missouri-based Midland Loan Services Inc., definitely concurs with Petrie. "You have to look at why it is the GSEs are so aggressive with respect to multifamily, and the primary reason is that HUD has mandated affordable-housing goals to them. The only way the GSEs can hit those targets is through multifamily investments. I understand and sympathize with investment lenders' inability to compete, but again, you really need to get to the root of the problem. They are so aggressive because they need to get to affordable-housing targets."

Right now, the market share of the GSEs has grown, Petrie adds, but they do not as yet dominate the market. Petrie's guess is that together Fannie Mae and Freddie Mac are still not yet at 50 percent of the total market, with life companies, banks and savings banks taking up the rest.

Petrie is also chairman of the Mortgage Bankers Association of America's (MBA's) Commercial Real Estate/Multifamily Finance Board of Governors (COMBOG), which has a few issues with the agencies-particularly in regard to keeping them out of primary markets.

"The agencies heard loud and clear that there was some concern that they were going direct to our borrowers, and they made strong verbal commitments that they will not- so we will take them at their word and they will continue to look to their lenders to provide the product they need to meet their goals," says Petrie.

According to Petrie, the issue with mortgage bankers is that they want to deal with the customer. "The mortgage bankers believe the customers are their clients; that they should work with the customer in every aspect of the mortgage loan transaction and the GSEs provide a function to purchase a loan and provide liquidity. The mortgage banker's job is to deal directly with the customer and provide all the services necessary to close that loan."

The separation between primary and secondary markets becomes blurred with the advances in technology, Petrie says. "Through technology you can step through the lender right to the borrower. That is what we are struggling with now. We are trying to deal with this issue head-on with the GSEs."

Protective's Prior served as last year's COMBOG chairman, and during his term of office "felt obligated to help determine whether or not Fannie Mae and Freddie Mac represented a threat to the non-GSE sector of multifamily finance," he says. "The jury is still out on that question."

Prior does say he recently met with the GSEs and they both expressed a desire to work more with the members of the MBA rather than "create a confrontational environment."

To the defense

"There are a lot of sour grapes in the industry," says Howard Levine, president of ARCS Commercial Mortgage Co. LP, Calabasas Hills, California. "The people that are upset with Fannie or Freddie are the life insurance companies and the traditional mortgage bankers that have historically relied on life insurance companies for their source of funds."

ARCS, which has a loan portfolio exceeding $6.2 billion, specializes in multifamily lending, and about 95 percent of its business is through Fannie Mae and Freddie Mac. Last year, the company did record business and expects to have another banner year in 2001.

"The products and programs the GSEs offer are superior to what the life insurance companies have offered," says Levine. "In addition, there is really a need for Fannie and Freddie to consistently be in the marketplace. As most everyone knows, life insurance companies come and go. When times get tight, they pull out. The same is true with savings and loans [S&Ls]."

The life insurance companies and the banks are raising the same issues in multifamily housing that they have in single-family housing, Levine says. "If Fannie Mae was not on the scene, the banks and life insurers would have bigger margins and a business to themselves."

That would not be a good thing for consumers, according to Levine. "Borrowers are much better served utilizing GSE financing, in that they can afford to rent their buildings at a lower cost than they could otherwise if they had gone to other funding sources," he says. "The ultimate beneficiaries are the tenants, who will get lower rents."

Chicago-based Aries Capital, a national commercial mortgage lender, is both a Wall Street conduit and a licensed Fannie Mae- and HUD-approved multifamily lender. According to Neil Freeman, the company's president, Aries closed $215 million in loans last year--of which $50 million to $100 million was multifamily.

"The GSEs perform a productive purpose," says Freeman. "If you got rid of the GSEs it might be easier for private firms to compete, but I really view affordable housing as an important issue, and multifamily housing almost by definition is affordable housing. Most apartment tenants are at 80 percent or less of median income, although there are exceptions in the various luxury apartment complexes. By creating a more efficient lending market, the GSEs are good for the country."

Freeman, who has been in the commercial mortgage lending business a long time, remembers how important Fannie Mae was to the industry during the last recession. "In the early 1990s, the S&Ls were going out of the business, commercial banks were told by the government not to take any more commercial real estate loans and even Freddie Mac put [its] tail between [its] legs and went out of the business for a few years. But Fannie Mae never went out of the market. One of the things the GSEs do is soften the blow of different markets when times are tight for private capital," says Freeman.

Rodrigo Lopez, president of AmeriSphere Multifamily Finance LLC, and as of December 2000 a DUS lender, works out of Omaha, Nebraska. He says what he likes about the GSEs is the fact they have programs for rural areas and for small properties. "Fannie Mae, for example, rolled out last year a well-thought-out program to finance apartment properties with as little as five units," he says. "Very few life insurance companies have those kinds of programs for that type of affordable housing. They are difficult to finance unless the local banks do it."

L.J. Melody & Co. ranked as the No. 2 originator of multifamily loans for Freddie Mac in 2000. The company as a whole did $1.8 billion in multifamily financing last year, and of that $660 million was GSE financing, with the balance through conduits and life insurance companies, according to Stoffers.

"We are doing some big loans outside of the agencies," says Stoffers. "I would characterize those deals as a little more aggressive at pushing the dollars. And the life companies can outmaneuver the GSEs if the borrower has a requirement for very quick execution. I don't concede any advantage to the GSEs; each one of our sources works a very distinct market niche."

Stoffers does admit his company's activity levels with Freddie Mac are up substantially, but that, he says, is because the borrowing public for multifamily has become more familiar with the GSE process. "People are getting comfortable with them. It's kind of a natural progression. As they come up with good pricing and better processes, people will gravitate to them," says Stoffers.

Narasimhan was chairman and chief executive of The WMF Group before its purchase by Prudential Mortgage, and he stayed on with the new company. "What companies now are trying to do is broaden their lines and fill in product niches," he says.

Companies such as Prudential Mortgage and Cleveland-based KeyCorp, which bought Newport Mortgage Co., a Dallas-based Fannie Mae and Freddie Mac lender, are broadening their product lines. The thinking is that the best value is to offer financial solutions to customers across a very broad platform. Prudential Mortgage now boasts that it offers the borrower a better product lineup through an approach that involves a single point of contact, whether it be a Prudential loan, Fannie Mae DUS, conduit or mezzanine product.

"Life companies have found it more difficult to compete with the companies in the agency networks," says Narasimhan, "and Prudential's strategy is, if it wants to be competitive, if it wants to be in the market all the time, then let's become one of them. So, we do multifamily loans for our books, in conduits for securitization and for Fannie Mae through DUS."

According to Narasimhan, Fannie Mae and Freddie Mac together hold about 40 percent of the market. "People are concerned because [the GSEs] are growing their market share. Some of this fear of the GSEs is just paranoia, because they have seen what has happened on the single-family residential side, where the agencies hold 70 percent of the market."

While Narasimhan doesn't buy into the speculation that the GSEs have become more aggressive, he does agree that they are definitely more competitive. "The GSEs have learned to react faster, they have sustainable pricing advantages and are in the market every day. I know some of my colleagues find it interesting that they do not compete as well anymore. They were used to getting higher spreads. The GSEs make the market more efficient. Ask the multifamily borrower whether or not they would like to have an efficient secondary market that produces capital for them and is tightly priced." MB

Steve Bergsman is a freelance writer based in Mesa, Arizona.