Ginnie Mae, Fannie Mae, And Freddie Mac ... - Standard & Poor's

June 26, 2007Criteria | Governments | U.S. Public Finance:Ginnie Mae, Fannie Mae, AndFreddie Mac Multifamily SecuritiesPrimary Credit Analyst:Wendy Dolber, New York (1) 212-438-7994; wendy_dolber@standardandpoors.comSecondary Credit Analyst:Karen Flores, San Francisco (1) 415-371-5018; karen_flores@standardandpoors.comTable Of ContentsMBS ProgramsDirect-Pay FacilitiesStandby Credit FacilitiesGinnie Mae ProgramsMBS Cash Flowswww.standardandpoors.com/ratingsdirect 1973338 | 300129047

Criteria | Governments | U.S. Public Finance:Ginnie Mae, Fannie Mae, And Freddie MacMultifamily Securities(Editor's Note: This criteria article originally was published on June 26, 2007. We're republishing this articlefollowing our periodic review completed on Oct. 18, 2011. The following replaces criteria published on Aug. 29,2006. This article has been partially amended and superceded by Revised Methodology For Certain FederalGovernment-Enhanced Housing Transactions, published May 12, 2010.)Standard & Poor's Ratings Services rates multifamily housing transactions supported by mortgages guaranteed byGinnie Mae and Government Sponsored Enterprises (GSEs), such as Fannie Mae and Freddie Mac. In thesestructures, Ginnie Mae, Fannie Mae, or Freddie Mac issue and deliver to the trustee an MBS in exchange for themortgage loan. Over the past few years, however, Fannie Mae and Freddie Mac have typically provided theirsupport in the form of standby and direct-pay credit facilities rather than MBS. Ginnie Mae continues to issue MBSin the form of permanent loan certificates (PLCs) or construction loan certificates (CLCs) that convert to PLCs forsubstantial rehabilitation or new construction projects. Mortgage payments on the MBS, or payments from thecredit facilities, are the principal source of credit protection for the bonds and pay debt service and all programexpenses.MBS ProgramsGinnie Mae, Fannie Mae, and Freddie Mac are obligated to make payments under the certificate or credit facility tothe trustee, regardless of whether payments are actually made on the underlying mortgage loans or bonds. GinnieMae and Fannie Mae guarantee the timely remittance of principal and interest on the MBS and credit facilities.Freddie Mac only guarantees timely payment of interest and ultimate payment of principal on MBS, with theexception of the Freddie Mac Gold program. Generally, Freddie Mac guarantees that principal on the participationcertificate will be received within approximately one year of the scheduled due dates. Standard & Poor's considerswhether this one-year lag in principal is addressed through funding of a reserve in the issue or lagging all bondmaturities by one year. Other alternatives may be discussed on a case-by-case basis.From a rating perspective, Freddie Mac and Fannie Mae programs are very similar in many respects to the GinnieMae programs outlined below, and the criteria should be used when structuring Freddie Mac and Fannie Maetransactions. With regard to payment receipt dates, Freddie Mac MBS are assumed to be received on the 20th of themonth (the 16th if book entry form) and Fannie Mae securities on the 25th of the month. In Ginnie Mae programs,payments are assumed to be received on the 20th of the month, although Ginnie Mae pays on the 15th. Standard &Poor's generally assumes an additional five-day lag in the cash flows for Ginnie Mae MBS, because MBS paymentsare not made directly by Ginnie Mae. This is not the case for Fannie Mae and Freddie Mac, whose payments aremade directly. There is an additional 30-day payment receipt delay at the onset of all Freddie Mac programs, andStandard & Poor's considers how this is addressed in the indenture and in the cash flows. (Note: Standard & Poor'sdefines a lag as a delay in payment that is in addition to the normal arrearage—the time period encompassed fromthe date of origination until the first scheduled payment.)www.standardandpoors.com/ratingsdirect 2973338 | 300129047

Criteria | Governments | U.S. Public Finance: Ginnie Mae, Fannie Mae, And Freddie Mac Multifamily SecuritiesDirect-Pay FacilitiesFannie Mae and Freddie Mac provide credit and liquidity support for fixed and floating-rate bonds. Fannie Mae andFreddie Mac cover for preference and stay provisions provided under the U.S. Bankruptcy code for funds paid bynon-rated sources. These floating-rate transactions usually have a seven-day variable rate, where bondholders havethe option to tender bonds upon seven days' notice. The GSEs are obligated to make payments under their respectivefacilities to the trustee in the event that the mortgage payment has not been received by a certain date. Additionally,the GSEs are obligated to cover the purchase price of tendered bonds in the event of a failed remarketing. With thisbond structure, Fannie Mae or Freddie Mac pay the bond debt service directly as if it were the mortgage loan, muchlike a direct-pay LOC. Although not an LOC, this facility is similar to a bond LOC transaction. In this instance, thetrustee draws monthly on the facility and uses the funds to pay debt service on the bonds. Cash flows areunnecessary because payments are received by the trustee prior to debt service payment dates.Fannie Mae has modified its direct-pay facility to include a bifurcation of credit and liquidity expiration dates sothat the liquidity support provided under the enhancement expires 10 years after the effective date of the agreement.This change introduces the possibility for a tender option to occur without the necessary liquidity support in placeto pay the purchase price of bonds. To avoid this structural risk, Standard & Poor's considers whether liquidityevents such as mandatory or optional tenders are scheduled to precede the termination of the liquidity portion of thedirect-pay instrument.Fannie Mae and Freddie Mac direct-pay structures may include a mandatory tender upon substitution of analternate credit facility without rating maintenance. This substitution could be problematic in the fixed-rate mode ifthe liquidity support has expired. To resolve this issue, the documents typically:• Limit substitution to the variable-rate modes;• Provide that the credit facility portion or a liquidity facility portion will be available to back the tender;• Indicate that credit facility expiration leads to a redemption; or• Indicate that substitution can only occur if remarketing proceeds equal to the full purchase price of the bonds areto be on hand for the substitution to occur, otherwise the credit facility will remain in effect or there will be aredemption of the bonds if the credit facility is scheduled to expire.These suggestions resolve Standard & Poor's liquidity concerns that could negatively affect bondholders. Standard& Poor's will continue to evaluate the direct-pay structure and legal documents to see how this issue is addressed.Standby Credit FacilitiesFannie Mae and Freddie Mac provide another type of credit enhancement on bond issues in the form of a standbycredit facility. In this structure, the GSE is obligated to make payments to the trustee in the amount of the mortgagepayment once the payment is a specified number of days delinquent. Since the GSE agreement does not coverinvestment earnings, Standard & Poor's looks to see if all revenues are invested in investments rated as high as thebonds. In addition, Standard & Poor's considers whether payment of trustee fees are provided for in a no-defaultand post-default situation. Similar to the cash flows indicated for MBS as described below, standby credit facilitytransactions typically include cash flows run with a lag to take into account the timing of the GSE's payment to thetrustee, as well as the regular payment lag on the underlying project mortgage.www.standardandpoors.com/ratingsdirect 3973338 | 300129047

Criteria | Governments | U.S. Public Finance: Ginnie Mae, Fannie Mae, And Freddie Mac Multifamily Securitiesaccruing bonds. Standard & Poor's looks to the cash flows to demonstrate sufficient asset coverage during this timeframe.Concerning optional prepayments, the prepayment penalty on the mortgage needs to be seasoned 91 days to avoidrecapture as a preferential payment. Ginnie Mae may not cover the premium portion to be paid on the bonds in theevent that it would be obligated to pass through the prepayment. This seasoning problem can be eliminated throughan issue-specific letter from Ginnie Mae stating that it will guarantee the premium portion of the payment on themortgage. Standard & Poor's reviews the trust indenture to see that notice of redemption on all prepayments are notto be made until the premium is seasoned.Additionally, Standard & Poor's looks to see whether prepayment terms on the bonds match the prepayment termson the mortgage (this avoids the mortgagor making a prepayment that cannot be used immediately to call bonds)and whether redemptions resulting from prepayments provide that the resulting decrease in debt service on thebonds is proportional, as nearly as is practicable, to the decrease in the payments on the Ginnie Mae securitiesduring such period (this method ensures that even if a curtailment occurs instead of a ratable reduction of futuremortgage payments, debt service will still be met, as it will be structured around the prepaid mortgage terms).Standard & Poor's also looks to see whether the trust indenture states that the Ginnie Mae MBS is to be held by thetrustee or in the trustee's name by the Federal Reserve and that the trustee has a first perfected security interest inthe MBS.MBS Cash FlowsAs a general matter, Standard & Poor's uses worst-case assumptions when reviewing cash flows for this program.For construction financing programs, Standard & Poor's looks to see that the worst case indicates the leastfavorable time from a revenue-generating standpoint for drawing on the acquisition fund to acquire the MBS. Forexample, if the acquisition fund investment agreement earns less than the MBS, Standard & Poor's considerswhether the acquisition scenario assumes delivery on the latest possible date provided under the indenture. For eachday that the MBS is not acquired, more negative arbitrage is created. The maximum amount of this shortfall istypically covered in one of the following ways:• Providing an unsecured LOC or cash;• Selling the bonds at a premium; or• Using another ratable credit enhancement.Standard & Poor's reviews the acquisition section of the indenture and the financing agreement to see whether themethod employed is defined clearly.In addition, Standard & Poor's reviews the submitted cash flow simulations to see that they are run usingappropriate lags, have sufficient excess assets to cover for reinvestment risk, and include all fees paid from revenuesor interest income. Standard & Poor's will review financing documents to check that fees are capped or fullysubordinate to debt service. If fees are expressed as a fixed dollar amount and not as a percentage reduced over time,Standard & Poor's typically requests a 90% immediate prepayment run. This is to ensure that the fixed fees couldbe paid in the event of a large prepayment. Alternatively, the fees specified in the legal documents can be ratablyreduced with any prepayments. Expenses for MBS include Ginnie Mae, Fannie Mae, or Freddie Mac fees and lenderfees.www.standardandpoors.com/ratingsdirect 5973338 | 300129047

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