GSE Tug-Of-War Stalls Reform

By Britton Costa, Associate Director – REITs, Fitch Ratings

At the onset of 2013, Fitch was patiently bearish on the role the GSEs would play in multi-family REIT credit. That is, Fitch expected a continued reduction in originations and a receding balance sheet, but it was patient due to D.C.’s reputation for enacting legislation protractedly and the glacial pace by which the portfolios would run off if left untouched.

For the first few months, Fitch’s expectations were largely coming to fruition. Multi-family mortgages held or backed by the GSEs increased by only $310 million in the first quarter of 2014, versus $3.7 billion in the first quarter of the previous year. Furthermore, bipartisan legislation was gaining traction. Fast forward to today, and momentum has stalled if not reversed. Draft bills have so far failed to generate the requisite support from senior-ranking senators. Moreover, FHFA Director Melvin Watt has deemphasized some of his predecessor’s goals, notably the 10 percent annual reduction in multi-family originations.

As Fitch approaches the end of 2014, the landscape reminds us of a four-way tug-of-war, with the GSEs as the flag at the center. Given the strength of the competing interests, Fitch doesn’t see the flag moving anytime soon. To the north and south are differing opinions on the scale, scope and structure of the entities, including balancing social and housing goals with taxpayer risk. And to the east and west are differing opinions on timing. Presumably, both Republicans and Democrats would prefer to address the GSEs after the mid-term elections (and potentially the 2016 presidential election). While the status quo of remaining in conservatorship is more palatable politically, given the GSEs’ recent profitability (note accounting profits may differ from sustainable cash profits), preferred stock holders have become much more vocal as dividends to the Treasury have exceeded draws from the Treasury (but are not considered repayments) and could try to litigate further to forestall the implementation of future reform.

While Fitch does not expect meaningful change for the foreseeable future, the importance of the countercyclical contingent liquidity provided by the GSEs (and demonstrated during 2008-2013) cannot be understated. Should the secured debt market for multi-family more closely resemble that of commercial real estate generally, credit metrics for rated multi-family REITs would need to improve, all else being equal, at the same rating.