Fannie Mae Not

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A shareholder applies to refinance her mortgage in a cooperative apartment building that has been embroiled in long-standing litigation that relates to a potentially substantial financial obligation – but one well within the ability of the cooperative and its shareholders to pay. In the past, lenders have accepted and approved new shareholder loans and approved refinancing of existing loans in the building, including a recent refinancing to the current borrower for another apartment in the same building. Under new guidelines from the Federal National Mortgage Association (Fannie Mae), the pending litigation makes the cooperative “ineligible” and the loan is denied.

A condominium unit-owner seeks to refinance. The unit-owner is told that banks will not lend in the building until litigation is settled – litigation that is against the sponsor, relates to conditions in only one unit, and, moreover, appears to be frivolous. Nonetheless, the loan is denied.

A prospective purchaser applies for financing in connection with the anticipated purchase of a cooperative apartment. The cooperative is a named defendant in a lawsuit brought by an existing shareholder alleging property damage and habitability issues following a water leak. The habitability issues have been resolved and the dispute concerns monetary damages. Although the cooperative is defended by its insurer, its policy will cover only the property damage claim. The loan is denied, although the litigation is settled months later for a relatively modest sum.

A condominium unit-owner applies to refinance his existing mortgage. The managing agent misinterprets a question on the condominium questionnaire, and his response triggers a “full review” of the condominium – not the borrower. The lending bank determines that the condominium’s bylaws, the form of which is fairly typical, do not meet the Fannie Mae criteria for a condominium project’s legal documents. The bank threatens to deny the loan and declare the building ineligible unless the bylaws are amended – a difficult and prolonged process that could never be accomplished within the unit-owner’s time constraints for obtaining financing.

These scenarios all happened to actual clients within the past year. And the lending climate promises to become increasingly inhospitable for the foreseeable future.

While local advocacy groups, politicians, legal professionals, and others have, at various times, approached Fannie Mae for clarification and petitioned for changes to the guidelines to bring them more in line with the realities of the New York City housing market, little change has been forthcoming. Recent rumblings in the cooperative-condominium community have erupted into an explosion of frustration as shareholders, unit-owners, and their prospective purchasers find themselves denied financing, regardless of the borrower’s creditworthiness or the financial health of the building. Fueling this brouhaha is Fannie Mae, a government-sponsored entity that, ironically, does not originate mortgages but buys them from lending institutions to hold the loans in investment portfolios or resell the loans to investors as mortgage-backed securities. Most mortgages are sold in the secondary market, and Fannie Mae is the nation’s single largest mortgage buyer. Thus, Fannie Mae’s underwriting guidelines, contained in its Selling Guide (www.efanniemae.com/sf/guides/ssg), increasingly serve as the industry standard.

In 2009, and presumably in reaction to the collapse of the mortgage-backed securities market and the ensuing outcry to reform the housing finance market, Fannie Mae substantially revised its guidelines and imposed more stringent underwriting requirements for the loans in its portfolio – not only as to the borrower, but as to the “project” – that is, the cooperative or condominium community. Although the revised guidelines have been in place for more than two years, lenders have only recently begun to adhere strictly to them.

As a result, where the lender is making the loan with an eye toward selling the debt to Fannie Mae, as is the case with most loans of $729,750 (as of this writing) or less, many loan applications that in the past might have been quickly approved and funded are routinely denied because of the failure of the cooperative or condominium to comply with some rule that Fannie Mae has promulgated – regardless of the creditworthiness of the applicant or the financial health of the cooperative or condominium.

While this rigorous approach is obviously employed by lenders to increase the likelihood that Fannie Mae will buy the loan, less clear is the threat that Fannie Mae can and will use the new loan as an opportunity to scrutinize prior loans in its portfolio bought from this particular lender to cull loans that do not meet the new guidelines and, as a consequence, require the lender to buy them back – a tactic that Fannie Mae has apparently been employing.

This pronounced change in the lending climate will invariably have an impact on property values, as well as the decisions and actions of the boards that are charged with maintaining the investments of the constituencies they serve, as we have seen in the opening examples.

Thus, at present, the Fannie Mae guidelines are here to stay, and it behooves a board to familiarize itself with the guidelines (as they apply to condominium and cooperative projects) and develop an understanding of how a board’s actions (or inactions) may collaterally affect the ability of its owners and shareholders to sell their units and obtain financing. While some of these guidelines were examined previously (“Under Scrutiny,”Habitat, June 2011), there are new issues that may prove even more troublesome.

Pending Litigation

Until December 2010, the Fannie Mae guidelines made ineligible any project that was involved in any litigation (other than a nonpayment or foreclosure proceeding), whether as a plaintiff or a defendant, and whether covered by insurance or not. Beginning this past December, the guidelines were relaxed – but not, it would appear, in a meaningful way. The new guidelines declare ineligible condominium and cooperative projects with pending litigation in which the homeowners’ association or the board is a party (again, whether as a plaintiff or defendant) or the sponsor or the developer is named as a party and that “relates to safety, structural soundness, habitability or functional use of the project.” So-called “minor matters” that do not affect the safety, structural soundness, habitability, or functional use of the building are exempt and, as per the guidelines, are defined as follows:

Non-monetary litigation involving neighbor disputes or rights of quiet enjoyment;

Litigation for which the claimed amount is known, the insurance carrier has agreed to provide the defense, and the amount is covered by the homeowners’ association’s or the co-op corporation’s insurance; or

Litigation in which the homeowners’ association or the co-op corporation is named as the plaintiff in a foreclosure action, or as a plaintiff for past-due homeowners’ association dues.

Consequently, anything from a simple slip-and-fall matter where the amount sued for is not specified (as is often the case) to a construction defects claim against the sponsor can have implications beyond the underlying merits of the lawsuit.

Litigation thus contributes yet another layer of complication to the decisions of a board, which now must balance its fiduciary obligation to maintain the property and protect the interests of the condominium or cooperative owners against the ability of those owners to borrow money and sell their units.

Thus, where a board is considering a lawsuit against the project’s developer or sponsor, it should further consider the impact of the litigation on the ability of owners to borrow money and sell their apartments. Moreover, while a board is generally free to discontinue any lawsuit it has initiated (or not initiate the action in the first place), it cannot control the course of an action in which it is a named defendant, even a frivolous one.

Governing Documents

The governing documents of the condominium or cooperative must conform to the Fannie Mae legal document requirements found in the guidelines, or the building will be deemed “ineligible” and unit-owners and prospective purchasers will have difficulty securing funding. While many of the issues do not affect cooperatives, since the recognition agreement with the lender can cover the “deficiencies,” condominiums do not have a comparable mechanism.

Of particular note for condominiums is the requirement that the bylaws provide that each mortgagee or the guarantor of the mortgage receive timely written notice of any condemnation or casualty loss, any 60-day delinquency in the payment of assessments or charges by the unit-owner, and the lapse or cancellation of the condominium’s insurance policy. In addition, any amendments to the bylaws (or the other governing documents) of a material adverse nature to mortgagees must be agreed to by mortgagees who represent at least 51 percent of the votes of the units that are subject to mortgages.

If these provisions appear unfamiliar, it is because most condominiums’ bylaws do not contain them. Moreover, as every board is well aware, the process to amend a condominium’s bylaws can be a protracted and costly one, with no guarantee of success.

And, while the situation relating to cooperatives is somewhat simpler, the cooperative’s documents must require notice to lenders of a large increase in monthly charges as well as any material changes in insurance or fidelity coverage, the rules relating to leasing of units, or voting rights, which might well include a change from cumulative to straight voting. Finally, they must provide that if the lender acquires a unit, it cannot be prohibited from subletting for up to three years, a right that is clearly inconsistent with the strong policy of many cooperatives to ensure the maximum amount of owner occupancy, often by limiting subletting to one-year terms, and then, in each instance, only with board approval.

Other Issues

While these are the most troubling requirements from the perspective of legal counsel, other perplexing issues to be found in the Fannie Mae guidelines include:

Balloon Mortgages. According to Fannie Mae, if the cooperative’s underlying mortgage is a balloon mortgage and it has less than three years to maturity, the project is ineligible. Moreover, because of substantial prepayment penalties, it rarely makes financial sense for a board to refinance the underlying mortgage until the cooperative is within six to eighteen months of the maturity date. Consequently, the board may be faced with a difficult dilemma: refinance when it will cost too much to do so, or let individual shareholders and their prospective purchasers face denials on loan applications.

Sponsor Issue. The guidelines touch upon many issues relating to sponsors. If the sponsor has a lease for the parking facilities, the project is ineligible. If the sponsor has reserved the right to rent rather than sell units, that, too, renders the project ineligible.

Tax Abatements. If the project is the recipient of any tax abatement that will terminate within the next three years, the project is ineligible. As New York’s co-op and condo tax abatement is currently set to expire in 2012, this could potentially render every project ineligible. So far, we have not seen this raised as an issue, but in this lending climate, anything is possible.

What Can You Do?

So, what is a beleaguered board to do? Fannie Mae asserts that its guidelines are neither draconian nor untenable, as any individual requirement may be waived in an appropriate case. But Fannie Mae views the lenders as its clients and will not deal directly with a cooperative or condominium board, the entities most familiar with the particular (or extenuating) circumstances present in an individual building. Each board must rely on the lending bank to invest an adequate amount of time and resources in first learning about the particular circumstances of its building and then persuasively and accurately presenting the issues to Fannie Mae so as to obtain a waiver. Thus, at the first hint of a problem, the borrower’s attorney should work with both the lender’s counsel and the board’s attorney to coordinate information and initiate a waiver application.

While financing remains available to most owners and buyers who require it – whether through portfolio lenders, private banks, or e-banks – the future appears less promising. One grim portent is found in the sweeping Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which requires the federal government to develop regulations for so-called “Qualified Residential Mortgages.” As a result, many boards may find themselves juggling two competing mandates: to effectively manage their buildings while, at the same time, preserving Fannie Mae eligibility and the marketability of their properties.