Capital Corner: HUD lenders, borrowers welcome updated handbook

In a groundbreaking move two years ago, the Department of Housing and Urban Development issued the first-ever handbook for the Section 232 Program, which insures HUD-approved lenders against financial loss from mortgage defaults on nursing homes and assisted living facilities. 

The handbook established uniform national standards for applying, underwriting, closing, managing and servicing mortgages insured or held pursuant to Section 232 of the National Housing Act. The handbook’s issuance marked a milestone for the seniors housing industry because up until that time the Section 232 program was using the Multifamily Accelerated Processing (MAP) handbook, which focuses on the apartment sector.

Now, HUD leadership is in the final stages of revising the Section 232 handbook after extensive collaboration with lenders in the program in addition to third-party appraisers, organizations like the Mortgage Bankers Association, environmental analysts, legal counsel and others.

Industry experts say the goal behind the proposed revisions is twofold: to better meet the needs of borrowers and lenders and to strengthen the overall portfolio
of properties in the mortgage insurance program that generated $2.7 billion in loan volume in fiscal 2015, down 35.7 percent from the prior year.

The proposed changes cover several areas, including partner buyouts and recapitalization of properties. More specifically, the updated handbook eliminates the two-year debt-seasoning requirement in certain instances.

High-quality, stable, cash-flowing projects that previously were subject to debt seasoning for two years would be immediately eligible to seek HUD financing under the proposed changes, according to Lancaster Pollard, the largest lender in the HUD Lean mortgage insurance program with $531 million in closed loans during fiscal 2015. This applies to immediate HUD refinancing of bridge loans used for recapitalizations up to a 70 percent loan-to-value (LTV) maximum.

The new rules would allow for the refinancing of loans held by the operator/lessee associated with the purchase of FF&E (furniture, fixtures and equipment), capital improvements and working capital for the facility, according to RED Capital Group. Under current HUD rules, debt incurred by an operating company that leases a facility is not eligible for refinancing. 

To gain more insight into the significance of the proposed changes, Seniors Housing Business spoke with Latoria Thompson, managing director at Chevy Chase, Md.-based Housing & Healthcare Finance, and Steve Kennedy, senior managing director at Lancaster Pollard, Columbus, Ohio.


Seniors Housing Business: Can you tell us when the handbook changes go into effect?

Thompson: The public comment period closed June 1. HUD is now reviewing the matter internally and at some point will be going to the Office of Management and Budget to vet those changes and issue the final handbook. The long and short of it is that no one knows exactly when that will happen, so no one is taking the risk of guessing when the final handbook will come out because there are two more reviews that effectively have to happen. 

However, HUD is accepting waiver requests to implement some of the changes prior to the final handbook coming out.


SHB: What’s the big takeaway for borrowers with regard to the handbook changes? Does it give them more flexibility, more loan options?

Thompson: I absolutely believe that the handbook changes will expand loan options for borrowers. There are three areas that everyone is focused on: the timing of when you can bring deals to HUD for partner buyouts and for recapitalized properties, and what property debt HUD will allow. Removing that two-year seasoning period for these areas really changes the game. Not every borrower will benefit, but there are enough borrowers that will benefit that I expect to see HUD’s deal volume increase significantly.


SHB: How does the elimination of the two-year debt seasoning rule make a
significant difference?

Kennedy: Let’s say that you have a property that is worth $10 million and has only has $5 million of debt on it. If the ownership group wants to leverage that property up to $7 million, pay off its existing $5 million debt and access additional leverage via its facility for an extra $2 million, it can do that today. It no longer has to wait for that debt to season for two years to take it to HUD. 

To be clear, in that scenario a couple of things have to happen. You first need to get a bridge loan for $7 million from a lender and then complete the application to HUD, process it and close the loan.

Obviously we’re in this environment with extremely low interest rates. If a borrower can close a loan and get into HUD within months rather than years, lock in a fixed rate and refinance the property up to 35 years on a non-recourse basis, that’s compelling. 


SHB: What other change to
the handbook strikes you as significant?

Kennedy: The second change that jumps out right away concerns the partnership buyout. Let’s say there is a skilled nursing facility owned by two people, and Person A wants to buy out Person B. Person A needs to raise debt capital to buy out Person B.  

In order for Person A to raise capital, it could leverage the skilled nursing facility. But if the use of those proceeds is to buy out Person B, it historically had to wait for two years before it could take the property to HUD for permanent financing. The interim debt didn’t become eligible debt until a two-year seasoning period. 

Now with these handbook changes, it becomes eligible debt right away. Person A no longer has to wait two years. Additionally, the skilled nursing facility is not subject to a 70 percent loan-to-value; it’s subject to an 80 percent loan-to-value. 

Now when you look at transactions where there are partner buyouts, HUD ultimately becomes an immediate option that wasn’t considered previously. That becomes important with regard to the intergenerational transfer of assets and the substitution of different partners that naturally occurs over the ownership life cycle. 


SHB: The 10-year Treasury yield has dipped to about 1.4 percent. What impact will the handbook changes and the ultra-low interest rates have on HUD lending for seniors housing?

Thompson: It’s going to be a dual-powered driver for more business for the HUD Lean 232 Program. The interest rates in and of themselves always drive borrowers to re-examine their refinancing opportunities, but these handbook changes now just give
it extra fuel. 


SHB: It used to be that HUD was considered the lender of last resort for some borrowers. Is that changing?

Kennedy: Absolutely. This is not a lender of last resort. HUD is not looking to build a portfolio or grow a portfolio of challenged assets. The HUD default rate, the delinquency rate, is very low. That is important for the sustainability of the program to keep the pricing of the program low, i.e. what owner-operators have to pay on an annual basis via the mortgage insurance premium. 

But it continues to meet a need. There is a need in the market for permanent financing for these properties that serve the senior population. It also keeps the cost of capital down for assets that have quite a bit of government-related revenue in the payer mix — Medicaid and Medicare. 

— Matt Valley