Fannie and Freddie: Dangerously Off Message? Mission Drift (Seemingly) on Parade.

Well, Fannie and Freddie, bailed out, now have market capitalizations of $834MM and $381MM respectively; around $1.2 billion in total. 

Now, let’s keep that in mind as we read this Barron’s story:

The most prominent potential trouble spot is Stuyvesant Town and Peter Cooper Village, a giant complex with 56 buildings and more than 11,000 apartments along the East River. It was sold by longtime owner MetLife (ticker: MET) for $5.4 billion in 2006 to two prominent real-estate investors, privately held Tishman Speyer and BlackRock Realty Advisors. At the time, the sale was widely viewed as an extremely rich, top-of-the-market transaction. That view is being borne out.

[…]

[Rental] income at Stuyvesant Town/Peter Cooper Village last year fell to $108 million from $112 million in 2006, owing in part to slower-than-anticipated conversion of apartments to market rents. Rental income — rental revenue less expenses — covers just 35% of estimated annual interest costs of $300 million.

[…]

A pre-funded interest reserve of $400 million designed to tide over bondholders until the project could meet interest expenses is now down to about $175 million, meaning that Tishman Speyer and BlackRock may have to pony up more cash by 2010 or risk losing control of the 80-acre project and their large equity investment. When the new landlords arranged the financing in 2006, they projected that rental income would triple, to $336 million, by 2011. To reach that goal, rents would have to double from their current average around $1,800 a month — an unlikely scenario.

[…]

It’s touch to say what Stuyvesant Town/Peter Cooper Village is worth now, but it’s probably less than the $5.4 billion purchase price. If the complex were resold today, the buyers might not get enough to pay off the project’s $4.4 billion of debt, wiping out their equity of $1 billion and some $900 million of additional funds, including the $400 million interest reserve, that were contributed to the deal. 

(Emphasis mine.)

Ha! Wow! Okay, got that? $3 billion in debt could be in peril of not getting paid back fully, if Barron’s “perhaps” scenario comes to fruition. Okay, so what does this have to do with Fannie and Freddie? Well, for this answer, we need to examine something else. Look at this S.E.C. filing. Go to pages S-50–Stuyvesant town is in Loan Group 2. Now, look throughout the document and notice that Loan Group 2 backs the Class A-1A. What is this mysterious A-1A? It’s the class that is sold to Fannie and Freddie. Ouch. Here 66% is backed by Stuyvesant Town.

Obviously, as with any structured product, there are serious structural caveats to all of these basic interpretations. First, these classes have bonds subordinated to them. However, those bonds, being as this loan was rated “investment grade” (see here for an example from another securitization, although it’s in the Barron’s story and the S.E.C. filing as well) don’t take into account much, if any, of the principal cash from this loan–subordantion is, as an effect, lower.

And, further, what of this “conversion of apartments to market rents?” Curbed covers the whole situation in extreme detail… But, let’s look at this post in particular:

Tishman Speyer is using various law firms and private investigators to crack down on stabilization violators, but the crackdown has caught many innocent people in its vast net […]

[The New York Times ran a story] on Tishman Speyer’s crackdown on rent-stabilized tenants at Stuy Town, and the charges of harassment made by those tenants caught in the crossfire. Of the 800 stabilized leases denied renewal by Tishman Speyer since December 2006, about 40% of those cases were later dropped, and 30% resulted in the tenant vacating the apartment. The remaining cases have not been resolved yet. This means that, more often than not, Tishman Speyer has tried to kick out a rent-stabilized tenant who had every right to be there. Or, they just got lazy and didn’t follow up. Or, they felt bad and decided not to force the issue. Um, we’ll assume it’s mostly the first explanation.

(Emphasis theirs! [Except for the “theirs just before this”–you don’t see that ever!])

And what of the Times article they reference? Well, let’s read that too…

Stuyvesant Town and Peter Cooper Village are only the most recent examples of harassment complaints in scores of rent-regulated buildings that have been bought by international developers and private equity firms in recent years. Tenant advocates say that as those firms have sought to increase profits from those buildings, many have used aggressive tactics to dislodge rent-regulated tenants. The vacated apartments can then be rented to tenants at market rates.

The average monthly rent at Stuyvesant Town in 2006 was $1,241 for rent-stabilized units and $2,767 for market-rate units.

(Emphasis mine.)

Well, I see why they can’t make hit the targets set by their projections… 

So let’s review. Fannie and Freddie most likely (we’ll pretend there’s a chance that they didn’t, but there really isn’t) bought the debt that enabled two real estate firms to acquire, with a very agressively underwritten set of income assumptions, a $5.4 billion property (portfolio of buildings, technically two properties). This debt was, at the time, thought to be way too much (as noted by Barron’s). In order to meet these very aggressive projections these two firms engaged in a very aggressive campaign to convert apartments to market rates (a difference in rent of over a factor of 2). Note that aggressive, with respect to their actions, is my own intepretation.

Hmmmm… sounds odd, no? Well, now let’s see what Fannie has to say about their charter:

The Federal Housing Enterprises Financial Safety and Soundness Act (“FHEFSSA”) of 1992 modernized the regulatory oversight of Fannie Mae and Freddie Mac. […] [It] established HUD-imposed housing goals for financing of affordable housing and housing in central cities and other rural and underserved areas.

(Emphasis mine.)

Well, maybe they define that narrowly, right? Let’s see, looking into the FHEFSSA (wow!) of 1992: 

(7) the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation have an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families in a manner consistent with their overall public purposes, while maintaining a strong financial condition and a reasonable economic return; and

(Emphasis mine.)

Oh. Right. Not narrowly defined, really. Well, so I guess a reasonable interpretation (please correct me otherwise, bailed-out out G.S.E.’s) is that they worked against their charter? 

So, we have Fannie and Freddie, at the very least taking a very very loose interpretation of their charter, to buy debt to facilitate a private transaction that winds up decreasing affordable housing. That debt now sits on their books, it’s value likely impaired from a credit perspective, not just a technical mark-to-market perspective, and the notional value is larger than their current market capitalization. Also, keep in mind, they likely have levered it in some fashion, so it could easily be enough to wipe out the current equity value. Ow!

I’m glad I read that several-day-old Barron’s article and did some digging, otherwise I never would have put this together. Thank you Rupert Murdoch!

(FYI–I don’t own any stock or securities of either agency, except, of course, as a U.S. taxpayer whose funds are being used to prop them up…)

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Tags: Affordable Housing, debt, Fannie, Fannie Mae, FNM, FRE, Freddie, Freddie Mac, Housing, Rent, Stuyvesant Town, Underwriting

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