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FEDERAL

R E SERVE

BAr~K

KANSAS

CITY

community

investment
AFFAIRS

DEPARTM ENT

ummer 1996

. - .
. _
-.. .:, . -.,

- ·,

:·:-: _·:_,-: ~-

~-~

~--

-. A Resource Guide to

Financing Housing and
omic Development

Commun i ty

Reinvestme n t

Doing the Undoable Deals:
A Resource Guide to Financing Housing
and Economic Development

a--._.

A Map for the Maze .................................... 2
A guide to finding your way through the maze of financial enhancements can help "undoable" deals get done in a changing environment.

a--i_►

Development Finance: Doing the Undoable Deals .......... 3
Many projects that are viewed as ineligible for financing may actually
be bankable-provided the parties involved take advantage of available
financial and managerial assistance programs .

...,.....,.. Development Resources ............................... 13
Financial enhancements for housing and commercial development,
with a description of each type of program.
Tax Credits ..........................................
Rent Supplements .....................................
Tax Abatements .......................................
Interest Rate Subsidies .............. : ..................
Equity Grants ........................................
Loan Guarantees ......................................
Subordinated Mortgages ................................
Technical Assistance ...................................
Maturity-Linked Funding ...............................
Secondary Markets ....................................
Additional Resources ...................................

15
19
27
31
37
41
51
55
63
67
75

...,.....,.. Contacts for Enhancements ............................ 77
...,....,_ Agency and Program Index ............................ 79
- ....-► Thank you ........................................... 80
1

Spe ci al

Iss u e

We encourage you to add regional, state and
local programs to the guide. As federal programs change, you will be able to replace
pages with updated summaries from the computer Bulletin Board or Internet pages of the
Federal Reserve Bank of Kansas City. Our
descriptions of current programs are brief: the
intent is to provide just enough information
for you to tell if an enhancement might be a
potential fit for your project. If it sounds

he project almost works-but not quite.

1 996

With just a few more dollars, a new business can get started or an existing one
can expand, new housing can be built or older
housing can be renovated. It may be a business owner who is looking for a way to make
a deal work, or community leaders looking for
ways to provide new jobs, additional goods
and services, or more affordable housing. The
bottom line is, the dollars or the collateral or
the expertise aren't quite there, and other
alternatives are needed to make the
"undoable" deal work.

... the process of partners working
together to make undoable deals work
is likely to change little.
promising, additional information is available
from the sources listed in the "contacts" section
of the resource guide. We've tried to err on the
side of brevity rather than length-we'd rather
encourage you to check further into too many
possibilities than too few.
The appropriate role of government in relation to community economic development will
continue to be considered and reconsidered. We
will have changes in leadership, changes in priorities, and changes in enhancement
programs.
What will not change is the necessity of
analyzing financing gaps in projects and finding alternatives for filling those gaps. New tools
for development and new partnerships may be
forged, but the process of partners working
together to make undoable deals work is likely
to change little. We think the framework provided in this guide will be useful to those partners well into the 21st century.

... we offer a map for finding your
way through the maze ...
In this guide, we offer a map for finding
your way through the maze of those alternatives. A sampling of federal financial and
technical enhancements is included, but those
programs-both public and private-will
change as our communities change and our
beliefs evolve regarding how to best balance
individual and society responsibilities. What
is needed is a method to locate possibilities,
not just a listing of currently available programs.

... programs .... will change as our
communities change an.d our beliefs
evolve regarding how to best balance
individual an.d society responsibilities.
Gap financing that was formerly available
through federal programs may instead be
available through a state or local government,
through nonprofit agencies or privately funded
foundations--or not at all. Some projects that
were doable in the past may not get done in
the future. Other "undoable" deals will get
done, however, by partners who have found
creative new ways to make projects work.
What will not change is the need for community leaders, lenders and development
resource people to form partnerships and work
together to improve their communities.
2

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Communit y
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Re i n v e s t m e n t
-

ty businesses to housing low-income individuals.
Many of the federal agencies providing this
assistance are well known·: the Small Business
Administration (SBA), Rural Development
(RD), and the Department of Housing and
Urban Development (ffiJD). The state and local
government programs, along with the philanthropic programs, are less familiar but are
often as supportive as the federal programs.
The process of using these program enhancements to make undoable deals bankable is
termed development finance.

enders are facing increasing pressure
to participate in community and economic development projects. Part of the pressure is
in response to Community Reinvestment Act
(CRA) responsibilities. But the interest often
goes beyond that. Like other community members, lenders too are adversely affected by
urban decay, economic disinvestment, and the
lack of a diversified economy. The problems
are often easy to identify. The difficulty is in
finding widely acceptable solutions. A frequent suggestion is to undertake more community and economic development projects.
This is the question facing lenders: Is it good
business?

Article Objectives
This article has two objectives:
1. To examine the structuring of development finance deals.
2. To address the problems associated with
institutionalizing development finance
lending.
In both cases, the prevalent issues are the
same as in conventional lending. Standard
credit analysis principles guide the structuring
of individual deals; overhead costs and interest
rate risk considerations guide the decision to
institutionalize the activity.

NO TERM FOR MARGINAL
PROJECTS
The financial literature is replete with
terms describing different types of
financing--consumer finance, real estate
finance, and commercial lending to name just a
few. There is no term, however, that describes
the financing of marginal projects and borrowers.
Deals with insufficient or too uncertain
cash flows, too little collateral, not enough management experience, or that pose excessive
interest rate risk or overhead costs are simply
not done. For most lenders, their obligations to
protect depositors' funds and earn profits for
shareholders preclude excessive risk taking and
inadequate profit-margins. Indeed, these tenets
of lending are basic, and lenders and their regulators pursue them vigorously.

THE DEVELOPMENT FINANCE
PROCESS
The starting point to understanding
development finance lending is not the alphabet/numbers soup of government and philanthropic programs--CDBG, HUD, NHS, EDA,
LISC, UDAG, GNMA, SBA, 221(d)(2), 235,
504,312, and so forth. These programs are the
caulking that fill the financial and managerial
gaps in individual projects and mitigate the
internal costs and risks associated with development finance lending. They are resources
that can make deals work, but only after a
thorough project analysis.
The critical issues and decisions associated
with development finance lending are easily
understood when analyzed sequentially (see
Figure 1). The upper portion of the figure
addresses credit issues associated with structuring individual projects. The lower portion
addresses internal or organizational issues
associated with development finance lending.
The project analysis section of Figure 1
(the upper portion) begins with credit analy-

Agencies Providing Assistance
Despite these perceived difficulties, many
"undoable deals" may be "doable" because of
their eligibility for financial and managerial
assistance. Various government and philanthropic entities provide assistance to projects
that aid economically disadvantaged individuals
and communities. The basis for that assistance
ranges from job creation and support for minori3

DEVELOPMENT FINANCE: ENHANCEMENT APPLICATION PROCESS
Project Analysis

Cash Flow
Sufficiency

>--

PROJECT
DEVELOPMENT

Project
Proposal

Enhancement Analysis

Gap Analysis

Project / Lender Analysis

Unacceptable:

Project
Gaps

IAcceptable I

-1

Cash Flow
Predictability

~ ---

1 • TAX CREDITS

3 • TAX ABATEMENTS

Reduce Expenses

4 · INTEREST RATE SUBSIDIES

5 • Equity (GRANTS)

!Proper Loan Structuring

Increase Lender
Compensation

PROJECT/LENDER
MATCH

H
H

Management
Ability

High Transaction
Costs

_I Strengthen Collateral
I
Coverage

6 • LOAN GUARANTEES

Higher Loan Rata

I Enhancement
I Conditions

New Cash Flow
Projection ,_
(New Proposal)

6 - LOAN GUARANTEES

junacceptable:

lntem8J

I Provide Management
Assistance
I

Reduce Transaction
Costs ·

{

Shift Transaction
Costs

Enhancements identified by all capital letters refer to government sponsored programs.
Enhancements with lower case letters denote private sector initiatives.

I
I

Manage Interest
Rate Risk

(GRANTS)

!s1aHTrai~t1on

Gaps

Interest Rate
Risk

8 • TECH.NICAL ASSISTANCE

IAcceptableI

11 GOVERNMENT INCOME &EXPENSE ENHANCEMENTS

Stabilize Cash Flows

5·

I Analysis
Lender

I Enhancement
Benefits

7 • SUBORDINATED MORTGAGE

Collateral
Adequacy

2 • RENT SUPPLEMENTS

,
►I

Viability
Analysis

Increase Revenue

Project Redefinition

I I

lestablshed Commumy Organizations
IConsoltialCOCs

9 • MATURITY-LINKED FUNDING

ISecaldaly-

I
Reduce
~
1Transaction Costs

I
I

Financing
Flexibility

I Enhancement
I Conditions

Acceptable

~ L..j

Unacceptable

Community

Re i n v e s t m e n t
-

sis. Development finance projects are treated
like any other project the lender considers
and are subject to the same underwriting criteria. Projects that initially pass the credit
test without enhancements are eligible for
conventional financing. By definition, development finance projects will fail the test until
enhancements are used.
For projects that fail the credit analysis,
weaknesses or gaps are identified and matched
with appropriate enhancements. Since the
enhancements usually produce additional
financial support, the project cash flows change.
This change requires another credit analysis.
Projects often cycle through this process
several times to obtain the optimal combination
of enhancements. It is a discovery process
which the Hungarian chemist, Albert con
Scent-Gyorgyi, once described as "seeing what
everybody has seen and thinking what nobody
has thought." If the project can be made creditworthy, however, there is no guarantee it will
be funded by a lender. Much depends on the
lender's motivations and business interests.
Lenders who occasionally participate in
such deals for community service reasons will
likely fund the project. Conversely, lenders who
make the activity a routine business must
address internal costs (see the lower portion of
Figure 1). Here again, the process involves
identifying gaps and addressing them with
enhancements.
The following sections explore the credit
and institutional analyses individually.

-------

the effective gross rent. This deduction gives an
expected cash flow that is_available for operating expenses and debt service.

Figure 2. Credit Analysis Example
GROSS RENT
- Vacancy contingency
EFFECTIVE GROSS RENT (EGR)
- Expenses
• Operating Expenses, Utilities,
Management
• Property Taxes
• Insurance
• Maintenance/Repairs
• Replacement Reserve
NET OPERATING INCOME (NOI)
- Debt Service (DS) (Principal and Interest)
CASH FLOW (CF)

Debt Coverage =

NOI

Loan to Value =

Principal Amount Borrowed
Market Value of Collateral

Cash Flow Rate =

CF
Owner's Equity Investment

Operating Expenses and
Net Operating Income
Operating expenses must be met first.
These expenses include the daily costs of operations, utilities, and management; property
taxes; insurance; maintenance and repairs;
and a reserve for replacing capital items.
Deducting operating expenses from effective
gross rent leaves net operating income.
Net operating income is the primary source
of loan repayment. A measure often used to
evaluate this source is the debt coverage ratio:
net operating income divided by debt service
expense. Projects with a value greater than 1.0
can service debt from operations.
For example, a ratio value of 1.25 means
that expected net operating income exceeds
debt service expenses by 25 percent. This 25
percent provides a margin of error in case
income and expenses do not meet projections.

CREDIT ANALYSIS ISSUES
The credit analysis part of the development finance process focuses on protecting the lender's funds. Lenders, in
contrast to equity investors, demand a high
probability of repayment and use the credit
analysis process to obtain that assurance.
Projects that pass a variety of credit tests are
financed; those that do not are not financed.
A brief illustration of the credit analysis
process for a nonprofit organization can be
derived from the fixed asset financing example
presented in Figure 2. Gross rent, based on projected rental rates, represents the maximum
possible income from the project. From that, a
vacancy contingency is deducted to determine
5

Special

Issue

1996

sis depicted here, must be considered and may
be cause for denial.

Collateral
If cash flow fails to service debt, lenders
seek a secondary source of repayment in the
form of collateral-typically the asset being
financed. Loan-to-value ratios are a common
collateral measure, comparing the value of the
property to the loan against it. These ratios
are usually less than 80 percent and vary
according to the nature of the collateral.
Acceptable ratios are lower with specialized properties such as single-use manufacturing facilities and with properties in disadvantaged locations. Whatever the property, the
appropriate measure of its value is its market
value, not the amount invested. In the case of
many community development projects, collateral value is considerably less than the construction cost simply because of the property's
location.

... knowledge of the community and
the local economy are essential to
making sound lending decisions.
If the project passes the credit tests, it can
be funded with conventional resources.
However, if it fails the credit tests, a decision
must be made about pursuing credit enhancements. This decision will depend on the project's eligibility for credit assistance and the
willingness of the project sponsor to expend
the effort to undertake further analysis.
Assuming the decision is to proceed with further analysis, the next task is to identify project gaps and enhancements.
GAP AND ENHANCEMENT
ANALYSIS

Ownership Incentive
Another factor lenders consider in evaluating a project is ownership incentive. Even if a
project produces sufficient cash flow to service
debt, owners should get a sufficient return on
their investment to ensure their continued
interest.
A common measure of ownership incentive
is the cash flow rate: cash flow divided by the
owner's investment. With many development
finance projects, these rates are far below the
typical 15-20 percent minimums often required
by investors. However, this deficiency need not
pose problems. Equity investors in development finance projects are often satisfied with
other incentives such as tax benefits or even
the fulfillment of community service objectives.
These commonly used ratios often form the
basis for the credit analysis box depicted in
Figure 1.
While credit decisions are largely financial
in nature, other factors are also important.
Perhaps most important is the borrower's
character. An honest, committed borrower
with the knowledge and experience to succeed
with a project is essential. Also, knowledge of
the community and the local economy are
essential to making sound lending decisions. If
a project involves the leasing of commercial
space, the creditworthiness of the lessors is
also important. Factors such as these, while
not specifically addressed in the credit analy-

Lenders and investors have numerous
reasons for not funding projects-such
as sales projections are weak, overhead is too
high, management experience is lacking, collateral is insufficient, and the business is too
new. These deficiencies can be broadly classified as return, risk, and management gaps.
Each represents a sound basis for not supporting a project.

Return Gaps
Low return is perhaps the most common
project deficiency. Simply stated, income does
not exceed operating expenses by a wide
enough margin to justify either debt or equity
funding. In terms of the credit analysis ratios
previously mentioned, the debt coverage and
cash flow ratios are too low or perhaps less
than one. A variety of enhancements are available to augment return by increasing project
income or lowering expenses.
Today, income supplements fall into two
basic categories: rent subsidies and tax credits.
The Section 8 housing certificate and voucher
programs administered by the U. S. Department of Housing and Urban Development are
the nation's rent subsidy programs. Under
these programs, HUD helps low-income households obtain adequate housing by issuing certificates or vouchers for the difference between
6

Community

Reinvestment

ty and maturity the funds lent to the defined
borrower(s). However, they do not serve as col- ·
lateral to offset credit risks.
When commercial lenders participate in a
deal at market rates, borrowers can still benefit through blended rate financing. Housing
and community development agencies often
have pools of funds (perhaps from CDBG loan
repayments) that can be lent at low rates.
When combined with market rate financing
from commercial lenders, the financing package produces blended, below market rates.
In some cases, the lower cost funds also
take a second position to the commercial
lender. This position gives the commercial
lender a higher claim on cash flow to service its
loan and on collateral should the project fail.
Like interest rate subsidies, most equity
grants reduce debt service costs because they
offset some of the need for borrowing. Cities
often own vacant land and buildings, particularly in lower income areas, that can be the
starting point for housing or business development projects. Urban homesteading programs
are a common example of equity grants for
housing. Under these programs qualified, lowincome home buyers can buy homes for a nominal amount provided they meet residency and
property rehabilitation requirements.

the cost of adequate housing in the market
area and the renter's ability to pay. These payments thus enhance the landlord's revenues.
Unlike rent subsidies that enhance operating revenues, tax credits do not alter a project's financial statements. However, they are
integral to the financial analysis of a project
because they produce important returns to
investors that emulate project income supplements.
At the federal level, tax credits exist for
low-income housing and the preservation of
historic buildings. Both allow investors to
obtain federal tax credits for contributions of
goods, services, and cash to approved organizations, including venture capital funds.

Expense Reduction Measures
A more common avenue for augmenting
return is by reducing expenses. A wide range
of programs are available.
Local governments often use real estate
tax abatements to attract business development. Tax abatements are usually negotiated
and therefore vary from project to project and
city to city. The tax abatements reduce operating expenses and augment cash flow available
for debt service and equity holders. Tax increment financing is another form of tax abatement that uses taxes for property improvements.
Interest rate subsidies increase the cash
flow to market rate lenders and equity holders
by lowering debt service costs. This, in turn,
enhances project viability. The subsidies come
in several forms depending on their source of
funding. Local bond issues produce below mar;Icet rate funds because of their tax-exempt status or the creditworthiness of the issuers.
These funds are used for housing and business
development. Another form of interest rate
subsidy is a direct rate buydown whereby a
_ third party helps make interest payments.
Community Development Block Grant
(CDBG) funds are often used for this purpose.
Compensating balances can be used to
reduce interest expense and enhance project
cash flow. For example, government units may
deposit funds with a lending institution at low
or zero interest rates provided the lending
institution passes the lower rates on to borrowers. The deposits usually match in quanti-

... many nontraditional equity
sources ... seek benefits other than
a high return on investment.
Individuals and corporations are often in a
similar position to make property grants as a
result of plant closings or tenants moving.
Property grants may also carry with them tax
benefits. Whatever the motivation, property
grants enhance project equity and lessen the
need for borrowing.
In addition to property grants, cash grants
are sometimes available from public agencies or
foundations to reduce loan principal or to help
make down payments. In the case of home purchase loans, the loan down payment subsidies
are often repayable upon sale of the property.
There are also many nontraditional equity
sources that seek benefits other than a high
return on investment. Since the 1986 tax law
reform, corporations are the only entities that
can offset earned income with "passive" losses.
7

Specia l

I ss u e

1996

RISK GAPS

This tax benefit has made them prime candidates for syndication efforts.
Corporate and foundation grants to project sponsors are also popular, as are investments by national and local community development organizations. Community
Development Corporations (CDCs) are equity
investment vehicles for national banks, state
member banks, and for bank holding companies. The Local Initiatives Support
Corporation (LISC), an affiliate of the Ford
Foundation, is a nationally based organization that relies on corporate investments for
funding. It helps pay front-end development
costs for projects in target cities.
In a somewhat different way, "sweat equity" is also a nontraditional source of equity. It
represents an investment from the borrower
in the form of personal labor. In some
instances, it may be used toward a down payment. This equity addresses a major financing
problem for many home buyers who can qualify for monthly payments but lack the savings
to make a down payment. Sweat equity is
often a component in home improvement or
purchase loans in low-income neighborhoods.
A conventional technique often used to
lessen the debt service burden is to extend
debt maturities. This extension reduces periodic principal payments and lowers the overall
debt service burden. The practice can be risky
because it prolongs the lender's exposure to
credit risk. Although extending debt maturities does not involv.e direct subsidies, the decision may depend on the existence of other subsidies that give the lender better access to
cash flow or recourse to collateral. For example, a charitable foundation equity holder
seeking benefits other than cash returns may
provide a measure of comfort to the lender.
A final means of reducing operating
expenses is the use of small business incubators. Incubators allow small businesses to
share common facilities and office personnel
including secretarial and bookkeeping services and conference room space. Many incubator tenants can access technical expertise
from nearby colleges and universities; some
have affiliations with technology-based industries. Sharing these services with other small
businesses can reduce many operating
expenses.

Cash Flow Risk
While low return problems relate to a
project's expected level of income or cash
flow, cash flow risk relates to the certainty or
uncertainty of the cash flow. If a project's cash
flow were certain, the decisions to invest and
lend would be easy. But since it is not, lenders
must carefully weigh their exposure.
One means of addressing cash flow risk is
to stabilize income and expenses. The various
· income and expense subsidies that address the
low return problems often act as stabilizers. For
example, low-income housing projects that have
rental rates below market rates often have long
waiting lists of qualified renters. This list
ensures low vacancy rates and stabilizes rental
income. Similarly, tax abatements or fixed-rate
financing stabilize expenses and cash flow.

If a project's cash flow were certain,
the decisions to invest and lend
would be easy.
Another option for addressing cash flow risk
is to risk-price loans. This can be as simple as
charging higher rates on loans that are riskier
or as sophisticated as using loan guarantees
(see discussion below) to insure and sell loans
on the secondary market. The sale of guaranteed loans on the secondary market offers a
substantial profit potential because the lender
reaps the benefit of converting a loan with traditional market risk into a less risky instrument backed by the insurer.
SBA loans, for example, can be made at
rates of up to 2 3/4 percent over prime. When
these are sold on the secondary market to yield
slightly over the Treasury Bill rate, they bring
a substantial premium. Of course, only the
guaranteed portion can be sold in this manner.

Collateral Risk
If cash flow fails to materialize, lenders look
to collateral as a secondary source of repayment; it provides a fallback. Several options are
available to strengthen collateral on develo1r
ment finance projects.
Use of subordinated financing or "soft" second mortgages is a direct way to enhance collateral. A government or community develop8

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Community

Re i n v e s t m e n t

ment organization lends part of the needed
funds and agrees to take a second position to
the first mortgage lender on the collateral.
Since the subordinated mortgages often carry
a below market rate, the borrower gets a
blended or below market rate on the entire
financing package.
Loan guarantees enhance collateral by
guaranteeing its value. This is done by insuring a portion-usually 75-100 percent-of the
loan against default. The Federal Housing
Administration (FHA) and the Veterans
Administration (VA) are major federal insurers of home mortgages while the Small
Business Administration insures small business loans.
In addition, many state and local loan
guarantee programs encourage various housing and business development projects. These
programs often take the form of collateralized
deposits kept by the insurer at the lending
institution. Funding usually comes from
grants, such as CDBG funds.
The benefits of loan guarantees extend
beyond the collateral issue. There is an active
market for the guaranteed portion of loans
backed by nationally recognized insurers. This
gives lenders the option of selling guaranteed
loans to raise funds for additional lending. It
also raises lenders' loan limits, since the guaranteed portion of loans does not count against
regulatory lending limits. Even when guaranteed loans are held in the lender's portfolio,
they enhance liquidity because they are readily marketable.
Finally, collateral positions can be
strengthened through increased use of equity
financing. This lowers the need for financing
and strengthens loan to value ratios.

management consultants. The benefits of incubators were discussed previously. In addition to
those benefits, there is often an additional benefit to the tenants who can learn from their fellow
entrepreneurs' solutions to similar problems.
Management consultants are helpful for
technical problems as well as general management problems. The SBA, through its
Service Core of Retired Executives (SCORE),
provides experienced management consultants to small businesses. Also, many colleges
have small business development centers that
provide business and technical assistance.
Return, risk, and management enhancements bring constraints along with subsidies.
These constraints include job creation
requirements and housing disadvantaged people. All the constraints must be satisfied.
When several programs are used, the constraints of each must be compatible with the
original project as well as with the constraints of the other programs.
In the end, the enhancements will produce new project cash flows that must be
reanalyzed in the credit analysis process. If
the project remains uncreditworthy, it can be
analyzed again, and other program enhancements added. However, the project must
eventually pass the credit analysis test to
have a chance for approval.

Management Gaps
Management is a final project-related concern in all small business ventures. It is often
of special concern in real estate development
projects where the developer is a not-for-profit
developer. Business ventures require a
breadth of expertise and a wide variety of
management services ranging from the development of business plans to accounting and
secretarial services.
To address management gaps, two significant resources are available: incubators and

Two Basic Problems Precluding Funding
Two basic problems may preclude a lender
from funding a creditworthy development
finance project:
1. High transaction costs associated with
assembling, analyzing, or monitoring the
credit.
2. Long-term funding risks.
The former is an overhead issue concerned
with recovering the often extensive costs associated with development finance projects. As is
evident from the section describing the credit

INSTITUTIONAL ANALYSIS
ISSUES
Successful completion of the credit analysis process does not assure project
financing. The lower portion of Figure 1 depicts
the institutional issues that must be addressed
before the funding decision is made.

Special

Issue

1996

ing credit needs and products. Depending on
their purpose and expertise, they may assist
with marketing, project development, or even
credit screening of potential borrowers.
Another approach to shifting transaction
costs is to form a community development corporation or CDC. Banking regulations permit
their formation as national bank, state member
bank, and bank holding company subsidiaries.
While they have latitude to engage in a wide
variety of activities from real estate development to property management, a major benefit
can be reaped by absorbing transaction costs.

analysis process, lenders must have a high
level of expertise and spend a significant
amount of time to assemble and manage deals
while juggling a maze of government and private program restrictions.

... lenders must have a high level
of expertise and spend a significant
amount of time t o assemble and
manage deals while juggling a maze
of government and private program
restrictions.
When combined with a modest volume of
activity, this often translates into excessive
overhead. However, a variety of cost reduction
and cost shifting efforts can mitigate the transaction cost burden for the lender and make the
activity profitable. The latter issue, interest
rate risk management, is familiar to most
lenders and is also eligible for a variety of
enhancements.

... the ag, ncies offering program
enhancem~nts are g enerally willing
to assist p rogram users.
Most CDCs are formed as not-for-profits so
they can use funds from government and philanthropic sources to structure deals. This lets
the lender's organization control the deal while
others help underwrite it. If the deal is bankable, then the CDC's affiliate bank can participate as a lender without incurring excessive
transaction costs.

Tran saction Cost Gaps
Cost reduction efforts for organizations funding development finance projects generally
focus on two areas: staff training and organizational structuring. In the area of staff training,
knowledge of the development finance process
is essential. The Federal Reserve System
through its Community Affairs programs has
been an active participant in training efforts,
largely through the sponsorship of seminars
explaining available -p rogram enhancements.
Also, the agencies offering program enhancements are generally willing to assist program
users. In recent years, many of those agencies
have undertaken efforts to reduce the paperwork
and make their programs more user friendly.
Organizational structuring _is also critical to
controlling transaction costs. By focusing community development lending activities in a
single department or with a specialized group of
people, lenders can take advantage of knowledge and experience developed from the activity.
In addition to undertaking efforts to minimize transaction costs, lenders can shift some
of those costs to others. One popular means is
to establish working relationships with community organizations such as not-for-profit development companies and neighborhood organizations. These groups are often helpful in defin-

Maturity Gaps
The funding risk issue is a function of credit
maturity. Many development finance credits,
whether business or housing related, are longer
maturity credits--including financing for plant,
equipment, and home purchase. Banks generally lack longer term funding sources and are not
willing to fund long-term loans with short-term
deposits. The risk of paying more for their
funds than they get is too great. Several options
are available for dealing with this issue.
A direct means of addressing interest rate
risk is to match sources of funds with uses so
that both are of the same maturity. Many state
and local government entities, foundations, corporations and pension funds are willing to commit long-term deposits to lending institutions
contingent on their making similar term loans
to specified borrowers.
Usually the depositor is not at risk if the
loan defaults. These arrangements do not
absolve lenders of credit risk. Furthermore, if
the borrower repays the loan early or defaults
and the deposit is not withdrawn until its original maturity, the lender also bears some inter10

Commun i ty

Re i n v e s t m e n t
-

est rate risk. State linked-deposit programs are
a typical example of matched funding. In some
instances, the deposits are made at below market rates provided the favorable rates are
passed on to the borrower.
The secondary market is another alternative
for minimizing interest rate risk. Because of
various government loan insurance programs,
insured loans can be frequently sold on the
secondary market. This limits interest rate
risk to the short time period needed to package
the loans for sale. Even this risk can be minimized using futures market hedges.
When the secondary market is not available----usually because the loans have nonstandard terms or they do not meet insurer standards-private placements may be an option.
State and local governments, foundations, and
others often have loan purchase programs
funded by local bond issues, churches, and
other sources.
For example, the Colorado Housing and
Finance Authority will purchase the guaranteed portion of an SBA loan with fixed rates
on the guaranteed portion. The lender funds
the unguaranteed portion at a variable rate.
This solves the lender's interest rate risk
exposure, and since up to 90% of the loan carries a fixed rate, the borrower also has little
interest rate risk exposure.
Other programs also offer an outlet for
loans that do not comply with national loan
packaging standards. For example,
Neighborhood Housing Services of America
will purchase noncomplying home improvement and rehabilitation loans in Neighborhood
Housing Services (NHS) neighborhoods.
Like the credit enhancements, the institutional enhancements produce a variety of
financial benefits and constraints. Again, the
constraints must be carefully addressed.
Ideally, the benefits will be significant enough
to overcome the obstacles to funding and managing creditworthy development finance projects. For an occasional deal, the institutional
issues may not be that important. For the
lender interested in pursuing development
finance as a line of business, they are critical.
Two observations about the process depicted in Figure 1 deserve special attention. First,
the existence of government and philanthropic
enhancements in development finance deals is

not a sign of weakness. The enhancements are
an integral part of the deals.
Second, profits and risks should be balanced. Credit weaknesses are not tolerable
and lenders should get competitive returns. If
a project cannot pass conventional credit tests,
it should not be funded. Similarly, lenders
should not routinely fund development finance
projects if they cannot cover their transaction
costs and manage the interest rate risks associated with the business.

OBSERVATIONS
AND CONCLUSIONS
Any discussion of the development
finance process would be incomplete
without mentioning the people involved.
Structuring and funding development finance
deals is a partnership effort involving
bankers, assistance program administrators,
community leaders, and project sponsors
among others. While the parties often have
different agendas and may even be competitors, they are all integral to the deal, and all
must agree on a project's viability. They are, in
many respects, like a loan review committee;
each member has veto power over the deal.

While the success of individual deals
is never guaranteed, the partnership
nature of the effort and the veto
power of each partner improve the
chances of success.
Development finance is doing "undoable
deals." It is making some projects work that
would not work without enhancements. While
the success of individual deals is never guaranteed, the partnership nature of the effort
and the veto power of each partner improve
the chances of success. No one wins if a deal
fails, and the deal is made stronger when each
party adheres to its investment standards. For
lenders, this means lending for a profit and
prudently managing their risks as they would
for any other type of loan.
-Larry G. Meeker
Copyright 1990 by Robert Morris Associates. Reprinted
with permission from the Journal of Commercial
Lending July 1990. .

Development
Resources--

Federal Reserve Bank of Kansas City

June 1996

Tax Credits
Description ..................................................... 16
Historic Preservation Tax Credits ................................. 17
Low-Income Housing Tax Credits .................................. 18
Other:

Federal Reserve Bank of Kansas City

June 1996

Tax Credits
Tax credits increase a project's cash flow by reducing tax obligations of equity
investors, developers and/or owners of development or rehabilitation projects.

Criteria
Projects receiving tax credits must:
• create or retain jobs;
• stimulate investment in eligible real property, improvements,
machinery or equipment;
a

preserve historic buildings;

• create low-income housing; and/or
■

provide other designated public benefits.

Uses
Ill

Tax credits are most commonly used for historic preservation, low-income
housing, jobs and capital investment.

Tax credits can serve as equity in real estate development projects because
they produce a stable source of project-related revenue and may be sold to
limited partners for cash.

Tax credits are often used in designated improvement areas such as enterprise
zones, where they can be used with other enhancements.

Tax credits may encourage investment in property with limited marketability
due to historic designation constraints or neighborhood characteristics.

Structure

Tax credits are authorized and monitored by federal, state, or
local governments.

Programs are administered either directly by government or through
a quasi-governmental organization.

•

Tax credits are rationed by rules and/or negotiation, depending upon
the crediting authority.

Federal Reserve Bank of Kansas City

June 1996

HISTORIC PRESERVATION TAX CREDITS
National Park Service, U.S. Department of the Interior
This program provides tax credits for rehabilitation of historic structures to
property owners and long-term lessees.

Eligibility
Rehabilitation must be certified as having preserved and enhanced the historic
character of the property. Requirements include:
•

a certified historic structure, i.e. a building individually listed in the
National Register of Historic Places or a building that contributes to
a historic district that is either listed in the register or locally
designated and certified by the National Park Service;

•

a certified rehabilitation of a certified historic structure where the
work meets the Secretary of the Interior's Standards for Rehabilitation;

•

a depreciable building, i.e., one used in trade or business or held for the
production of income and not an owner-occupied residence;

substantial allowable rehabilitation expenses, i.e., they must exceed the
greater of the adjusted basis of the building or $5,000; and

1111

completion of the rehabilitation within two years, or five years
if a project is phased.

Program
a

111!1

Credits equal a maximum of 20 percent of allowable costs for the
rehabilitation of certified historic buildings for commercial, industrial
and rental residential purposes, or 10 percent credit for rehabilitation
for non-residential purposes of structures built before 1936.
The straight-line depreciation period for residential property is 27.5 years;
for non-residential property, the period is 31.5 years.
Applications are submitted to the state office of historic preservation and
reviewed by the National Park Service.

Contact
State Historic Preservation Office or
National Park Service

Federal Reserve Bank of Kansas City

June 1996

LOW-INCOME HOUSING TAX CREDITS
Low-Income Housing Tax Credits provide a dollar-for-dollar credit that reduces
federal income tax liability for developers or limited partner investors in
low-income rental housing.

Eligibility
Ill

Developers constructing or rehabilitating low-income housing may apply for
credits for themselves or for limited partner investors.

Ill

A project must set aside a minimum of 20 percent of the units for households
earning 50 percent or less of the area median income or a minimum of 40
percent of the units for households earning 60 percent or less of the area
median income.

■

The proposed property must entail new construction, acquisition and/or
substantial rehabilitation.

Program
ll

States administer the program and award the credits based on housing plans
submitted by developers in a competitive applications process.

Qualified new construction and substantial rehabilitation costs earn credits at
a rate of approximately -9 percent each year for a ten-year period, or 4 percent
per year if tax-exempt bonds or other federal subsidies are used.

Contact
State Housing or Economic Development Office

Federal Reserve Bank of Kansas City

June 1996

Rent Supplements
Description . ..................................................... 20
HOME Investment Partnership Program ............................ 21
Rental Housing Certificate Program ................................ 22
Rental Housing Voucher Program . ................................. 23
Rural Housing Vouchers .......................................... 24
Rural Mutual and Self-Help Housing ............................... 25
Other:

Federal Reserve Bank of Kansas City

June 1996

Rent Supplements
Rent supplement programs pay to a property owner or developer the difference
between the amount a low-income tenant pays for rent and the market or contract
rent amount.

Criteria

Properties must provide affordable housing and must meet requirements
for space and bedroom configuration.

Use
Ill

Rent supplements improve cash flow by increasing development project
revenue.

Structure
Iii

Rent supplements may be in the following forms :
111

certificates are property-based payments to property owners for the
difference between what low-income renters pay and the market rate;

111

housing vouchers are provided to tenants for use in paying rent
on their choice of qualified housing, and

• subsidies to property owners compensate for costs of property
rehabilitation and management.
R

Rent cannot exceed 30 percent of a tenant's gross monthly income.

Supplement amounts are based on the area median income and market rents.

Some rent supplement programs are structured for use in conjunction with
local government and private sector funds.

Federal Reserve Bank of Kansas City

June 1996

HOME INVESTMENT PARTNERSHIP PROGRAM
HOME Program, U.S. Department of Housing and Urban Development (HUD)
Federal funds are granted to local jurisdictions and are used in working with
private partners to leverage funds and expand the availability of affordable
housing through a broad range of innovative approaches.

Eligibility
Ii

Programs must develop or support safe, decent and sanitary affordable
housing for low- and very-low-income residents whose incomes fall at
or below 80 percent of the median income for the area.

"'I

Eligible uses of funds include tenant-based rental assistance, assistance
to home buyers, property acquisition, new construction, rehabilitation,
transitional housing, and capacity-building.

Jurisdictions receiving funding must have a HUD-approved Comprehensive
Housing Affordability Strategy (CHAS), or consolidated plan.

Jurisdictions must provide a 25 percent match of funds received for rental
assistance, housing rehabilitation and acquisition, and a 30 percent match
for new construction. Contiguous units of local government may form a
consortium to receive HOME funds.

Ill

Funds are allocated to participating jurisdictions through a formula based
on the jurisdiction's vacancy rate for low-income renters, the amount of
substandard housing, housing production costs, number of units needing
rehabilitation, number of families in poverty, and fiscal capacity.

Program

Model program areas include rental housing production, rental rehabilitation,
rehabilitation loans, sweat equity, home repair services grants, energy
efficiency conservation grants, and second mortgage assistance for
first-time home buyers.
Fifteen percent of funds are reserved for Community Housing Development
Organizations (CHDOs); 1 percent of funds appropriated are reserved for
Indian tribes.
Contact

State Office of Housing or U. S. Department of Housing and Urban Development

Federal Reserve Bank of Kansas City

June 1996

RENTAL HOUSING CERTIFICATE PROGRAM
U.S. Department of Housing and Urban Development (HUD), Section 8
Rent payments are made to property owners for the difference between rent paid
by a tenant and fair market rent.

Eligibility
II

Eligible families earn less than 80 percent of the area median income. Most
assistance is for very-low-income families earning less than 50 percent of the
area median income.

Iii

Any type of housing can be eligible as long as units are decent, safe and
sanitary.

Program
•

Eligible tenants receive a certificate from the Public Housing Authority (PHA)
stating the terms and conditions of their participation; they then find
appropriate housing.

Iii

HUD enters into contracts with local public housing agencies and Indian
housing agencies (IRAs) that administer the program. The PHA makes
assistance payments to private owners who lease their rental units to
assisted families.

Tenants pay 30 percent of their adjusted income toward rent.

Tenants may move to another property and keep their certificate.

Contact
Local Public Housing Authority or
U. S. Department of Housing and Urban Development

Federal Reserve Bank of Kansas City

June 1996

RENTAL HOUSING VOUCHER PROGRAM
U. S. Department of Housing and Urban Development (HUD), Section 8
Low-income families are assisted in housing rent payments through vouchers for
the difference between a percentage of their income and market-rate rents.

Eligibility
11

Eligible applicants are the very low-income tenants whose incomes do not
exceed 50 percent of the median income.

Preference is given to families who are occupying substandard housing, are
involuntarily displaced, or are paying more than half their income for rent.

Program
11

Low-income families receive rental vouchers and then locate suitable rental
units. Vouchers cover the difference between market rate rental and the
higher of 30 percent of the tenant's adjusted income or 10 percent of
gross income.

HUD enters into contracts with local public housing agencies (PHA.s) and
Indian housing agencies (IHA.s) that administer the program. The PHA
makes assistance payments to private owners who lease their rental units
to assisted families.

Rents are negotiated between the owner and the tenant. Vouchers permit
families to rent units beyond the fair market value, but the PHA may
disapprove a lease for rent that is not considered reasonable and is not
comparable to other rents in the area.

The total level of HUD's annual contribution to a voucher program is based
on review and approval of a housing authority's request for funding.

EID

Rental housing selected by the eligible families must meet the specifications
required by the program.

Contact
Local Public Housing Authority or
U. S. Department of Housing and Urban Development

Federal Reserve Bank of Kansas City

June 1996

RURAL HOUSING VOUCHERS
Rural Development (RD)
U . S. Department of Agriculture
Rural housing vouchers provide assistance to renters of rural housing.

Eligibility
Ill

Assistance is available for very-low-income families.

Program

Assistance is calculated using a payment standard based on the fair .market
rent established for the area.

m The monthly assistance payment for a family is the amount by which the
payment standard for the area exceeds 30 percent of the family's monthly
adjusted income.
II

The subsidy cannot exceed the difference between the actual rent for the
dwelling unit (including utilities) and 10 percent of the family's gross
monthly income.

Contact
Rural Development
U. S. Department of Agriculture

Federal Reserve Bank of Kansas City

June 1996

RURAL MUTUAL AND SELF-HELP HOUSING
Rural Development (RD)
V. S. Department of Agriculture
Financial assistance is available for individuals and families who participate in
mutual and self-help programs to build or rehabilitate rural homes.

Eligibility
II

Assistance is available for very-low-income families.

Program
II

Assistance is calculated using a payment standard based on the fair market
rent established for the area.

m The monthly assistance payment for a family is the amount by which the

payment standard for the area exceeds 30 percent of the family's monthly
adjusted income.
11

The subsidy cannot exceed the difference between the actual rent for the
dwelling unit (including utilities) and 10 percent of the family's gross
monthly income.

Contact
Rural Development
V . S. Department of Agriculture

Federal Reserve Bank of Kansas City

June 1996

Tax Abatements
Description . ..................................................... 28
Tax Increment Financing ......................................... 29
Other:

Federal Reserve Bank of Kansas City

June 1996

Tax Abatements
Tax abatements enhance cash flow on projects by reducing expenses through
abatement of local property taxes for a specified time.

Criteria
a

Tax abatement is often available in an area designated as blighted, such as
an urban renewal district or an enterprise zone.

Uses

This program is generally offered as a tool to promote new construction or
rehabilitation.

Structure
ID

The property tax on improvements to private development projects is
"forgiven" or abated up to 100 percent by local government.

The length of time of the tax abatement usually ranges from 10 to 25 years .

Property tax paid to the local taxing authority during the abatement period
is based on the property's assessed value before the project's expansion.

Federal Reserve Bank of Kansas City

June 1996

Tax Increment Financing
Tax increment financing (TIF) is authorized by some states as a tool for using a
portion of the increase in taxes generated by a new project to help finance
project-related costs.

Criteria
II

Criteria and eligibility vary from state to state.

State statutes usually require a TIF project area to be designated as a
blighted area or an enterprise zone.

Redevelopment plans using TIF often must be submitted to all affected local
tax jurisdictions and usually to a TIF commission. Jurisdictions such as a
county commission or a local school board may have the power to veto the use
of tax increment financing if they find it will adversely affect their operations.

Uses
II

Tax increment financing bonds can be used to purchase a site, construct a
building, fund demolition or rehabilitation of an existing building, and for
other permitted uses.

Contact
State Housing or Economic Development Office

Federal Reserve Bank of Kansas City

June 1996

Interest Rate Subsidies
Description . ..................................................... 32
Farm Labor Housing ..................... ; ....................... 33
Rural Home Improvement Loans, Repair Loans and Grants ........... 34
Rural Housing Loans ............................................. 35
Affordable Housing Program (AHP) ................................ 39
Community Development Block Grants ............................. 76
Community Investment Program (CIP) ............................. 65
HOME Investment Partnership Program ............................ 21
Other:

Federal Reserve Bank of Kansas City

June 1996

Interest Rate Subsidies
Interest rate subsidies typically use public dollars to reduce the cost of borrowing
for business or housing development.

Criteria
II

Projects that receive interest rate subsidies must demonstrate that jobs are
being created or retained or affordable housing for low- and moderate-income
households is being improved or produced.

Uses

Interest rate subsidies improve project cash flow by decreasing loan payments.

The final user or borrower pays a below-market interest rate on either one
loan or on a "blended rate" from multiple market-rate and subsidized loans.

Structure
Interest rate subsidies may take three forms: a direct cash grant to a lending
institution to write down the bank's interest rate on a business or housing
loan; a government-sponsored low interest loan subordinated·to a participating
commercial lender; or a lower than market rate loan to a qualified borrower
as a result of an advance or pass-through provision from a public entity, i.e.,
Federal Home Loan Bank or tax-exempt bond authorities.

Typical sources for interest subsidies are government programs such as Community Development Block Grant funds for cities and states, state maturitylinked funding programs, and economic development set-asides from state
treasuries. Proceeds from the sale of tax-exempt bonds issued through designated authorities and funds advanced to banks from a Federal Home Loan
Bank are also sources of funds with below-market rates.

Federal Reserve Bank of Kansas City

June 1996

FARM LABOR HOUSING
Rural Development (RD)
U. S. Department of Agriculture
This program authorizes loans to support the development of housing and facilities
for domestic farm labor.

Eligibility
11111

Farm owners or associations of farm owners, nonprofit organizations, Indian
tribes, and state or local agencies are eligible for loans.

m Applicants must generally be unable to provide housing from their own
resources, but must have sufficient operating capital to cover the costs of
property and liability insurance, fidelity premiums, equipment, and other
initial expenses.
■

Domestic farm workers must be citizens or have legal alien status and must
receive a substantial portion of their income in the handling of agricultural
commodities.

Retired or disabled persons who meet the definition of domestic farm workers
at the time of retirement or disability are also eligible.

Interest on loans must not exceed 1 percent per year.

Program
■

Loans to state and local government agencies and nonprofits can include up to
2 percent of the project development cost for initial operating expenses.

The term of loans cannot exceed 33 years.

Contact
Rural Development
U. S. Department of Agriculture

Federal Reserve Bank of Kansas City

June 1996

RURAL HOME IMPROVEMENT LOANS, REPAIR LOANS AND GRANTS
Rural Development (RD)
U. S. _Department of Agriculture
Loans and grants are available to rural homeowners for home repairs and
improvements.

Eligibility
Ii

Recipients must own and live in property on a farm, in the open country, on an
Indian reservation, or in towns with population of up to 10,000 or in eligible
towns of up to 20,000.

Recipients may not qualify for loans from commercial lenders.

Loans and grants may be used to bring houses up to minimum health and
safety standards.

Loans may also be used to make changes for the convenience of the residents,
such as adding a room or modernizing the house.

To receive a combination of grant and loan funds, an applicant must be 62
years or older and able to pay for only a part of the repairs; to receive grants,
applicants must be 62 years or older and unable to pay for aiiy repairs.

Program
11

Very low-income families can receive up to $5,000 in a loan, a combination
loan and grant, or a full grant to remove health hazards.

Loans up to $1,500 must be repaid within 10 years; between $1,500 and
$2,500 within 15 years; and loans over $2,500 within 20 years.

The interest rate on loans to very low-income borrowers is 1 percent.

Iii

Families with higher incomes can borrow up to $7,000, with interest rates
that are usually 1, 2 or 3 percent, based on the household's income.

Other home improvement loans are repayable in 33 years, with market
interest rates or "interest credits" depending on family size and income.

Contact
Rural Development
U. S. Department of Agriculture

Federal Reserve Bank of Kansas City

June 1996

RURAL HOUSING LOANS
Rural Development (RD)
U. S. Department of Agriculture
Guaranteed loans, direct loans and credit toward interest on loans are available
for housing in rural areas.

Eligibility
a

Loans are to be made for homes located either on a farm or in a designated
rural area.

Direct loans are made primarily to low- and very-low-income borrowers.

111

Repair and rehabilitation loans may be made to finance improvements to
existing dwellings.

•

Loans may be used for the purchase of a new manufactured home and lot,
and to finance acquisition of an existing home and lot.

Program
~

Homes must be modest in size, design and cost and not exceed the housing
needs of the applicant.

Ill

Loans terms may range from 10 to 38 years.

Interest credit provides a subsidy to very-low-income and low income
borrowers to reduce the effective rate on a home purchase.

Contact
Rural Development
U . S. Department of Agriculture

Federal Reserve Bank of Kansas City

June 1996

Equity Grants
Description ..................................................... 38
Affordable Housing Program (AHP) ................................ 39
Community Development Block Grants (CBDG) ..................... 76
HOME Investment Partnership Program ........................... 21
Other:

Federal Reserve Bank of Kansas City

June 1996

Equity Grants
Equity grants are made in the form of cash contributions, gifts or sale of property
at reduced cost.

Criteria
■

To be eligible for equity grants, projects must contribute to local housing
and commercial revitalization efforts.

•

Recipients may be required to meet other criteria, such as bringing property
up to code standards or selling or renting property at specified rates.

Uses
■

Equity grants strengthen collateral and improve project cash flow.

•

Uses vary among grantors, programs, and projects.

Structure
II

Equity grants are often used with other enhancements.

Grants are usually negotiated with the grantor.

Federal Reserve Bank of Kansas City

June 1996

AFFORDABLE HOUSING PROGRAM (AHP)
Federal Home Loan Banks (FHLB)
Federal Home Loan Banks make grants or loans to member institutions,
which then make funds available to borrowers for projects.

Eligibility
II

Lenders must be members of the Federal Home Loan Bank.

111

Projects may be for purchase, construction or rehabilitation of single-family
or multi-family affordable housing units.

Borrowers must be very low-, low- or moderate-income, with preference given
to projects that serve the greatest percentage of very low-income households.

Projects must support the priorities of the Federal Home Loan Bank.

Program
II

Grants are made for down payments, principal reduction or interest rate
buy-downs.

Loans with favorable terms are often structured to be forgiven if project
criteria is met.

Competition for funding is held in each of the ten Federal Home Loan Bank
Districts, and awards are made to lenders' who score the most points
according to FHLB criteria, objectives and priorities.

Iii

Priorities include projects that support owner-occupied affordable housing;
projects that will have at least 20 percent of their units occupied by very
low-income households; purchase or rehabilitation of housing owned by
government entities or nonprofit organizations; projects that empower
residents in ways that help meet critical urban or rural housing needs;
and projects that provide permanent housing for the homeless.

Objectives include projects that promote long-term retention of affordable
housing and community stability, projects that involve the community, and
innovative projects.

Contact
Federal Home Loan Bank

Federal Reserve Bank of Kansas City

June 1996

Loan Guarantees
Description...................................................... 42
Business and Industry Guaranteed Loans ........................... 43
Guaranteed Home Loans for Veterans .............................. 44
Home Mortgage Insurance Programs ............................... 45
Indian Housing Loan Guarantee Program ........................... 46
Indian Loan Guarantee Program ................................... 4 7
Rural Development Home Ownership Loans ......................... 48
SBA 7(a) Loan Guarantee Program ................................. 49
SBA Special Loan Programs ....................................... 50
HOME Investment Partnership Program ...... .' ..................... 21
Rural Housing Loans ............................................. 35
Other:

Federal Reserve Bank of Kansas City

June 1996

Loan Guarantees
Loan guarantee programs strengthen collateral by securing part of a loan against
default, often making the guaranteed portion of the loan eligible for sale in a
secondary market.

Criteria
lfi

Loan guarantee programs are established primarily to meet needs of a target
population or to encourage development that meets specified community
needs.

Uses
ll

Loan guarantee programs are offered by federal, state and local governments
to complement private financial institution lending.

A wide variety of uses of loans are supported by guarantee programs,
including fixed asset and working capital financing.

l!i

By making a loan eligible for sale in a secondary market, guarantees
enhance the liquidity of the lender.

Structure
ll

Funds for loan guarantees may come from a variety of both public and private
sources.

By insuring loans against default, loan guarantees help encourage financial
institutions to make loans on projects that are considered more risky than
conventional loans.

Federal guarantee programs are budgeted as part of agencies' annual
appropriations.

HUD Community Development Block Grants (CDBG) are the primary
source of loan guar~ntees in cities with populations of 50,000 or more.

States use CDBG funds or other state revenues to make loan guarantees
available in small towns and rural areas.

The guaranteed portion of a loan usually does not count against a bank's
legal lending limit.

Federal Reserve Bank of Kansas City

June 1996

BUSINESS AND INDUSTRY GUARANTEED LOANS
Rural Development (RD)
U. S. Department of Agriculture
Rural Development guarantees bank loans for financing business expansions,
job creation and job retention activities in rural areas.

Eligibility
•

Individuals, public and private organizations, and federally recognized Indian
tribal groups are eligible.

II!

Borrowers must have 20 to 25 percent tangible balance-sheet equity for new
businesses and 10 percent for existing businesses.

•

Borrowers must be in a rural area with population of 50,000 or less that has
high unemployment.

■

Loans can finance the acquisition of land, buildings, machinery and
equipment; working capital; debt refinancing; housing development sites;
processing and manufacturing facilities; pollution control projects; and site
development for housing for area employees.

Ill

Projects must demonstrate marketability, sufficient financial strength and
continuity of management.

Program
Ill

Participating banks apply directly to RD.

•

Maximum guarantees are 70 percent for loans over $5 million; 80 percent for
loans over $2 million but less than $5 million; and 90 percent for loans of $2
million or less. Loans of less than $750,000 are usually referred to the SBA.
Loan maturity is up to seven years for working capital, five to 15 years for
purchase of machinery and equipment, and up to 30 years for real property.

•

Rates may be fixed or variable and are determined between the lender and the
borrower. A 2 percent fee is charged on the guaranteed portion of the loan.

Contact
Local Bank or Rural Development
U . S. Department of Agriculture

Federal Reserve Bank of Kansas City

June 1996

GUARANTEED HOME LOANS FOR VETERANS
U.S. Department of Veteran Affairs (VA)
This program guarantees against loss by lenders for mortgage loans to eligible ·
veterans.

Eligibility
■

Loans can be used to purchase and/or improve a single-family house; purchase
a home or condominium in a VA-approved project; refinance an existing loan;
buy a mobile home and/or lot on which to place a mobile home; or for home
weatherization.

■

Veteran must have served at least 90 days active service in wartime or 181
continuous days in peacetime, unless an earlier discharge is attributable to
a service-connected disability. Veteran must not have been discharged
under other than honorable conditions.

■

World War I veterans are not eligible for the guarantee program. Reserve
active-duty training and active-duty training in the National Guard does not
qualify candidates unless they were called into regular active duty.

Program
■

Up to 50 percent of a loan is guaranteed, or a maximum of $45,000.

•

A down payment is not required by the VA if the purchase price is less than
the value of the property as determined by the VA. If the price is more than
the established value, the veteran must make up the difference.

•

Maximum loan maturity is 30 years plus 32 days.

11!1

Rates are negotiable with the lender. Rates are fixed for the life of the loan,
but loans may be refinanced for a lower rate.

Iii

Fees include a loan origination fee of 1 percent, a VA funding fee of 1 percent,
and closing costs. Discount points may not be paid in connection with VA •
financing.

•

Lender must apply to VA office for guarantee.

Contact
U.S. Department of Veterans Affairs

Federal Reserve Bank of Kansas City

June 1996

HOME MORTGAGE INSURANCE PROGRAMS
U. S. Department of Housing and Urban Development (HUD)
Federal Housing Administration (FHA)
The Federal Housing Administration (FHA) insures loans made by private lenders,
making lower interest rates or more favorable terms available to borrowers.

Eligibility
II

Loans must be made by banks, savings and loan associations, mortgage
companies, and other lending institutions that meet HUD/FHA requirements.

Ill

Prospective borrowers generally must meet cash requirements at closing,
must have good credit records, and must be able to make monthly mortgage
payments.

•

Loans may be for purchase, refinance and rehabilitation of homes, for
cooperative units, condominium units and manufactured housing.

Program
ll'I

A wide range of mortgage insurance programs are available, including
programs for low- and moderate-income borrowers, disaster victims, the
elderly, homes on Indian reservations and on Hawaiian Home Lands,
and experimental housing.

Ill

The level of insurance risk, mortgage limits, and types of mortgagors who
qualify vary from program to program.

Contact .
U.S. Department of Housing and Urban Development
Federal Housing Administration

Federal Reserve Bank of Kansas City

June 1996

INDIAN HOUSING LOAN GUARANTEE PROGRAM
U.S. Department of Housing and Urban Development, Section 184
This program guarantees loans for homes owned by Native Americans on trust
land or in Indian or Alaska Native areas.

Eligibility
II

The borrower must be an Indian who will occupy the home or an Indian
Housing Authority.

Loans may be used for the construction, acquisition or rehabilitation of oneto four-family dwellings located on trust land or in an Indian area.

Tribes must have foreclosure, eviction, and priority of lien procedures.

■

Lenders must be approved by the Secretary of Housing and Urban
Development, the Secretary of Agriculture, the Secretary of Veterans' Affairs,
or must be supervised, approved, regulated or insured by any agency of the
federal government.

Program
Ill

Loans may be guaranteed for up to 100 percent of the unpaid principal and
interest.

The term of loans is 30 years, with a fixed interest rate.

Borrowers pay a modest down payment amount and a 1 percent guarantee fee.

Qualified Mutual Help program participants can use the program to attain
home ownership.

Contact
U.S. Department of Housing and Urban Development

Federal Reserve Bank of Kansas City

June 1996

INDIAN LOAN GUARANTEE FUND
Bureau of Indian Affairs, Division of Financial Assistance
U.S. Department of the Interior
This fund guarantees business loans made by private lenders to Native Americans
and may provide interest subsidies.

Eligibility
11

Applicants must be a federally recognized tribe or Alaskan Native group; a
member of such a tribe or group; or an Indian-owned corporation, partnership
or cooperative association.

Funds may be used to finance Indian-owned commercial, industrial, or
business activities organized for profit, provided eligible Indian ownership
constitutes at least 51 percent of the business.

■

Loans must benefit the economy of an Indian reservation.

a Interest subsidies may be granted when a business is incurring losses.
Program

Individual guarantees are limited to $350,000; the maximum for tribes or
organizations is $5.5 million.

The borrower must have minimum equity of 20 percent of project funding in
cash or unencumbered assets to be used in the proposed business.

1111

Maturities may extend up to 30 years and vary with the use of funds and
repayment capacity of the borrower.

Interest rates are variable. The maximum interest rate for a 90 percent loan
guaranty is equal to 1.5 percent above the New York prime; the maximum for
an 80 percent loan guaranty is equal to 2.75 percent above the New York prime.

Ill

Interest subsidy amounts are based on the difference between the Treasury
interest rate for direct loans and the interest rate charged by the lender.
Subsidies are limited to the first three years of the loan.

Contact
Bureau of Indian Affairs

Federal Reserve Bank of Kansas City

June 1996

RURAL DEVELOPMENT HOME OWNERSHIP LOANS
Rural Development (RD)
U. S. Department of Agriculture
Guaranteed or direct loans are available in rural areas to finance homes and
building sites.

Eligibility
■

Eligible borrowers are very low-, low- or moderate-income persons or families.

•

Borrowers must be without decent, safe and sanitary housing.

■

Borrowers must be unable to obtain a loan with reasonable terms and
conditions from other sources.

■

Borrowers must have sufficient income to pay mortgage payments, insurance,
taxes, and living expenses. Persons with inadequate repayment ability may
obtain cosigners for the loan.

■

Loans may be used to buy, build, improve, repair or rehabilitate rural homes
and related facilities, and to provide adequate water and waste disposal
systems.

■

Loans may be used to modernize homes by adding bathrooms, central heating,
modern kitchens and other improvements.

Ill

Under certain conditions, funds may be used to refinance debts on a home.

•

Houses must be located on sites where roads, water and waste disposal
systems meet RD requirements.

Program
Ill

Loans may be made for up to 100 percent of the RD-appraised value.

•

The maximum repayment period is 30 to 38 years.

When a borrower's financial position makes him/her eligible to borrow
through a commercial lender, the loan will be refinanced.

Contact
Rural Development
U. S. Department of Agriculture

Federal Reserve Bank of Kansas City

June 1996

SBA 7(a) LOAN GUARANTEE PROGRAM
U. S. Small Business Administration
The SBA 7(a) program guarantees repayment to private lenders of a portion of
conventional loans to small businesses.

Eligibility
•

Businesses must be operated for profit and must meet SBA size standards.

Ill

Loans must be for expansion, renovation, or construction of new facilities;
purchase of land, buildings, machinery, equipment, fixtures, leasehold
improvements, or inventory; or for working capital or debt refinancing.

•

Owner equity of 10 to 30 percent is required for existing businesses; 30 to
50 percent equity is preferred for companies in a start-up phase.

•

Businesses cannot be involved in speculation or investment in rental real
estate.

111

Applicants must show good character, management expertise and commitment,
and ability to repay the loan.

Program
•

The maximum amount of guarantees is $750,000, with an 80 percent guarantee
on loans of $100,000 or less, and 75 percent on loans over $100,000.

•

Lenders approved for the SBA Preferred Lenders Program may unilaterally
originate loans with a guarantee of up to 80 percent.

Loan maturity depends on ability to repay, but is generally five to seven years
for working capital and up to 25 years for real estate.

Ill

Interest rates are negotiable and may be fixed or variable. Loans under seven
years have a maximum rate of prime plus 2.25 percent; seven years or more,
maximum 2.75 percent over prime. Rates for loans under $50,000 may be
slightly higher.

Ill

The lender may retain the guaranteed portion of the loan or sell it in the secondary market.

Contact
Local Bank or U.S. Small Business Administration

Federal Reserve Bank of Kansas City

June 1996

SBA SPECIAL LOAN PROGRAMS
U. S. Small Business Administration
SBA offers a variety of special loan guarantee programs that are similar in
structure to the basic 7(a) Loan Guarantee program.
■

LOW DOCUMENTATION LOANS (LowDoc) provide financial assistance
to companies needing up to $100,000. A one-page application and high-speed
fax machine help SBA respond to applications in three to five working days.

SMALL GENERAL CONTRACTOR LOANS assist small construction firms
with short-term financing needs. Loan proceeds can be used to finance residential or commercial construction or rehabilitation of property for sale.
Proceeds cannot be used for real estate used for investment purposes.

■

SEASONAL LINE OF CREDIT GUARANTEES assist small businesses
with short-term needs during peak seasons.

•

ENERGY LOANS assist firms engaged in manufacturing, selling, installing,
servicing or developing specific energy measures.

■

EXPORT REVOLVING LINE OF CREDIT GUARANTEES provide
short-term financing for exporting firms that are at least one year old and
are developing or penetrating foreign markets.

■

INTERNATIONAL TRADE LOAN GUARANTEES are available in amounts
up to $1 million for the acquisition, construct ion, renovation, modernization,
improvement or expansion of facilities or equipment to be used in the United
States in the production of goods and services involved in international trade.

•

MINORITY PREQUALIFICATION LOANS are for up to $250,000 and are
available in select geographical pilot sites. The program helps eligible small
businesses access capital through the use of local, private-sector organizations.
Eligibility requirements include businesses that are at least 51 percent owned
and managed by a racial or ethnic minority person(s).

■

MICROLOAN PROGRAMS are administered through nonprofit intermediaries
selected and approved by SBA. Short-term loans of up to $25,000 are made to
small businesses for a variety of need8"'

Contact
U . S. Small Business Administration

Federal Reserve Bank of Kansas City

June 1996

Subordinated Mortgages
Description. ..................................................... 52
SBA 504 Certified Development Corporation Loan Program ........... 53
Affordable Housing Program (AHP) ................................ 39
Community Development Block Grants (CDBG) ...................... 76
HOME Investment Partnership Program . ........................... 21
Other:

Federal Reserve Bank of Kansas City

June 1996

Subordinated Mortgages
Subordinated mortgages are direct loans that are in a subordinated collateral
position to the primary lender.

Criteria
■

Subordinated mortgages are made available for projects that meet quantifiable
objectives such as housing low-income people, creating jobs through business
expansion, etc.

Requirements vary, but may include criteria such as a limit on the subordinated
mortgage in proportion to the total project cost, minimum equity investment,
rents that can be charged to tenants, etc.

Uses
■

Subordinated mortgages strengthen the collateral position of the first
mortgage lender.

Some subordinated mortgages are "near equity" and may be partially or
completely forgiven over time.

Structure
ll

Subordinated mortgages are often used with other enhancement programs.

111

Revolving loan funds generally operate as subordinated mortgages.

Subordinated mortgages often carry an interest rate subsidy.

Federal Reserve Bank of Kansas City

June 1996

SBA 504 CERTIFIED DEVELOPMENT COMPANY LOAN PROGRAM
U.S. Small Business Administration (SBA)
The SBA 504 program is a source of long term, subordinated mortgage funds that
makes loans with subsidized interest rates available for small business financing.

Eligibility
11

Loans must be made through SBA Certified Development Corporations
(CDCs).

Borrowers must operate as for-profit businesses and not exceed $6 million in
net worth and not have average net income over $2 million for the previous
two years. Equity must equal at least 10 percent of the amount of financing.
Loans must be for purchase of land, buildings, machinery, equipment, and
fixtures ; construction and renovation of commercial facilities; and projectrelated costs.

•

At least one job must be created for every $35,000 in SBA assistance unless
the project will produce a high community impact.

Program
fl

The 504 program is a subordinated mortgage program for permanent financing
for fixed-asset purchases. It also makes below-market interest rates available
to borrowers through the blending of interest rates.

For 100 percent SBA-backed debentures, the limit of the SBA portion on a
project is $750,000 to $1 million, or 40 percent of total project costs,
whichever is less. The minimum loan amount is $50,000.

Loan maturity is generally 10 to 20 years.

A typical financing structure consists of a loan from a private sector lender for
50 percent of project costs, a 40 percent debenture from the CDC that is 100
percent guaranteed by the SBA, and 10 percent equity.

Interest rates are based on five- and ten-year U.S. Treasury issues, plus an
increment above Treasury rate.

Contact
Local Bank or U. S. Small Business Administration

Federal Reserve Bank of Kansas City

June 19961

Technical Assistance
Description . ..................................................... 56
Administration for Native Americans Grant ......................... 57
BIA Management and Technical Assistance ......................... 58
Home Ownership Counseling Programs ............................ 59
Rural Self-Help Housing Technical Assistance ....................... 60
Service Corps of Retired Executives (SCORE) ....................... 61
Small Business Development Centers . .............................. 62
HOME Investment Partnership Program . ........................... 21
Other:

Federal Reserve Bank of Kansas City

June 1996

Technical Assistance
Technical assistance is available to help individuals, organizations, and businesses
develop management capacity or obtain technical services in conjunction with
development projects.

Criteria
II

Criteria are established by the provider of the technical assistance and
usually stipulate assistance for designated populations or for specific needs.

Technical assistance may be available to assist potential homeowners,
business owners, or nonprofit or for-profit developers in moving forward with
a project that will benefit the community.

•

Technical assistance may be a condition of a funding provider prior to the
recipient receiving financial assistance.

Uses
Technical assistance may include:
• free or low-cost legal and accounting services and advice;
• office support for tenants in an incubator project;
• assistance to small-business or minority contractors in preparing bid
documents and obtaining bonding for a construction project;
• assistance with marketing analysis, environmental impact assessment,
or other :pre-development costs;
lll'l

pre- or post-purchase homebuyer counseling;

111i

training to develop management skills.

Structure
II

Government may provide direct assistance, or may fund an agency or
organization to provide technical assistance to target audiences.

m Through a major company or business or civic council, the private sector may
"loan" executives to assist eligible recipients.

Federal Reserve Bank of Kansas City

June 1996

ADMINISTRATION FOR NATIVE AMERICANS GRANT
U.S. Department of Health and Human Services
Grants are available for technical assistance and training related to governance,
economic development, and social development.

Eligibility
The following entities are eligible for these grants:
m

federally recognized Indian tribes, consortia of Indian tribes,
incorporated non-federally recognized tribes;

incorporated non-profit, multi-purpose, community-based Indian
organizations;

111

Ill

urban Indian centers;
national or regional incorporated organizations with objectives specific
to the Native American community;
public and nonprofit agencies serving Native Hawaiians and Alaska
Natives.

Program
ml

Funding must be used for technical assistance and training to develop, conduct, and administer projects.

There is no set maximum or minimum grant amount; however, maximum program benefits are 80 percent of program cost.

Terms of grants may be single or multi-year.

ffli

Approximately $5 million in grants are distributed during three closings each
fiscal year, usually in February, May, and October. An announcement regarding the grant is usually made in the Federal Register in August.

Contact
Administration for Native Americans
U. S. Department of Health and Human Services

Federal Reserve Bank of Kansas City

June 1996

BIA MANAGEMENT AND TECHNICAL ASSISTANCE
Bureau of Indian Affairs, Division of Financial Assistance
U. S. Department of the Interior
Management and technical assistance is available to loan or grant applicants
before or concurrently with their requests for financial assistance.

Eligibility
m Funds must be used to aid in the preparation of application for funds,
and/or the administration of funds after they have been granted.
ll

Applicants must be a federally recognized Indian tribe or Alaskan Native
group; a member of such a tribe or group; or an Indian-owned corporation,
partnership or cooperative association.

Program
Ill

There is no set maximum amount and no set term.

BIA expects the project to be beyond the "idea stage."

Contact
Bureau of Indian Affairs
U.S. Department of the Interior

Federal Reserve Bank of Kansas City

June 1996

HOME OWNERSHIP COUNSELING PROGRAMS
Counseling is offered to educate potential home buyers about credit, home
ownership, and the loan application process.

Eligibility

Programs are designed for first-time low- and moderate-income borrowers,
but are usually open to any interested person.

Some lenders and some loan programs require buyers to complete a home
buyer's education course before they can receive a loan.

-~rogram
II

Home buyer education courses may be sponsored by community organizations,
lenders, churches or others.

Classes may be one-time sessions or may be held over a series of weeks.

Materials may be developed locally, purchased from the Federal National
Mortgage Association (Fannie Mae), or purchased through other sources.

Contact
Local Lenders or Community Organizations

Federal Reserve Bank of Kansas City

June 1996

RURAL SELF-HELP HOUSING TECHNICAL ASSISTANCE
Rural Development (RD)
U. S. Department of Agriculture
Loans and technical assistance are available through nonprofit organizations to
help groups of families build homes in rural areas.

Eligibility

Small groups of low-income families who cannot individually afford to build
modest houses by customary methods may qualify.

Iii

Each participating family must be able to repay a loan for the cash cost of the
house.

Loans may be used to pay for skilled labor and contract costs for work the
families are unable to perform.

Loans may be used to buy material, and if necessary, to buy and prepare
building sites.

•

Technical assistance funds may be used to hire personnel and pay office and
administrative expenses.

Ill

Technical assistance funds make equipment such as power tools available
to families participating in construction.

Technical assistance funds may be used for fees to train self-help group
Ill;embers in construction or for other needed professional services.

Program

m The self-help group decides how members will share labor and what parts of
the work need to be done by outside contractors.
•

Families must work a required number of hours to complete the houses, under
the guidance of a construction supervisor.

Ill

Families must attend pre-construction meetings and must agree to carry out
responsibilities of home ownership after housing is completed.

Contact
Rural Development
U. S. Department of Agriculture

Federal Reserve Bank of Kansas City

June 1996

SERVICE CORPS OF RETIRED EXECUTIVES (SCORE)
U.S. Small Business Association
SCORE volunteers work with small businesses to provide management
counseling and training.

Eligibility
ti

Almost any small independent business not dominant in its field can
get help from SCORE.

Program
Iii

SCORE volunteers help business owners and managers identify and
determine the causes of basic management problems and become better
managers.

Workshops are offered on a variety of topics to business owners and
prospective entrepreneurs.

Contact
Local U.S. Small Business Administration

Federal Reserve Bank of Kansas City

June 1996

SMALL BUSINESS DEVELOPMENT CENTERS (SBDC)
Small Business Development Centers are established through the resources of the
Small Business Administration and other public and private entities to offer assistance, information and training to small business owners.

Eligibility
II

Almost all small businesses are eligible for assistance.

Program
m Management and technical assistance, business information and training are
available through workshops or individualized consultations.

Contact
Local Small Business Development Center or
U . S. Small Business Administration

Federal Reserve Bank of Kansas City

June 1996

Maturity-Linked Funding
Description ..................................................... 64
Community Investment Program (CIP) ............................. 65
Federal Home Loan Bank Advanced Funds ......................... 66
Affordable Housing Program (AHP) ................................ 39
Other:

Federal Reserve Bank of Kansas City

June 1996

Maturity-Linked Funding
Funds are deposited in or loaned to a bank for a time matching the maturity of
the associated bank loan. Sometimes the bank pays a below market interest rate
on the funds and in turn will make its loans to eligible borrowers at below-market
interest rates.

Criteria
111

Banks using maturity-linked funding must meet program requirements such
as using the funds for housing or funding companies that create or retain jobs.

Ill

Eligible projects may include fixed assets and working capital for new, existing
and expanding businesses or for housing development. A business must be
located in, or moving to, the jurisdiction offering the program.

•

Deposits must be secured or collateralized by government debt securities,
treasuries, or other securities as specified. Other potential sources are
philanthropic, foundation or pension funds.

Uses

Maturity-linked funds provide an incentive for banks to provide longermaturity loans.
II

Uses include business expansion, working capital and home mortgages.

Structure
ll

Banks wishing to participate in linked funding programs must apply to the
sponsoring entity.
The interest paid by the lender is sometimes indexed several basis points
below the cost of funds on the market.

Rates are fixe_d for the linked funding period of the deposit.

m Terms vary from one to five years on most business financing programs and
up to 15 years with housing finance programs.

Federal Reserve Bank of Kansas City

June 1996

COMMUNITY INVESTMENT PROGRAM (CIP)
Federal Home Loan Banks (FHLB)
Federal Home Loan Banks advance funds to lenders to allow them to provide
maturity-linked and moderately subsidized loan assistance for eligible activities.

Eligibility
Lenders must be members of the Federal Home Loan Bank.
Funds may be for purchase, construction or rehabilitation of single family
or multi-family affordable housing units or for commercial and economic
development activities.
Fl

Household income of housing unit residents must be below 115 percent of the
area median.

lll'II

Commercial and economic development activities must be located in or benefit
low- or moderate-income neighborhoods.

Funds are awarded to lenders who score the most points according to FHLB
criteria, objectives and priorities.

Program
ffl

Advances provide funds to FHLB members at slightly reduced interest rates.

Maturities can range from one month to finance delays in closing reimbursements from state mortgage revenue bond programs to up to 20 years for
eligible housing and commercial projects.

Program objectives include promoting long-term retention of affordable
housing and community stability, community involvement, and innovation.

The price of advanced funds is based on the estimated cost to the FHLB of
consolidated obligations. Banks with an outstanding rating on Community
Reinvestment Act activities may receive a small discount on the cost of funds.

Contact
Federal Home Loan Bank

Federal Reserve Bank of Kansas City

June 1996

FEDERAL HOME LOAN BANK ADVANCED FUNDS
Federal Home Loan Bank System (FHLB)
Federal Home Loan Banks advance funds to member banks to ensure the availability of funds and mitigate risks associated with mortgage lending.

Eligiblity
II

Banks must be members and purchase stock in the Federal Home Loan
Bank system.

Banks must have a specified level of home mortgages in their portfolios to be
eligible for advances.

Funds must be used for activities related to residential housing finance.

Uses
11

Advances can help minimize banks' risk in interest rate variability by providing funds at a fixed interest rate for a fixed period of time.

Iii

Banks' basis risk, when funding is priced using a different benchmark than
the assets on which a loan is made, can be balanced by borrowing FHLB
funds through different funding programs.

Advances can help balance lenders' portfolios by diversifying the sources and
maturities of their funding base.

Structure
a

Twelve regional Federal Home Loan Banks make funds available to banks
in their regions.
Programs vary and may have flexible interest rates and terms negotiated
between the member bank and and the FHLB.

Contact
Federal Home Loan Bank

Federal Reserve Bank of Kansas City

June 1996

Secondary Markets
Description. ..................................................... 68
Farmer Mac I Pooled Loan Program . ............................... 69
Farmer Mac II Guarantee Program ................................. 70
Federal Home Loan Mortgage Corporation (Freddie Mac) ............. 71
Federal National Mortgage Association (Fannie Mae) ................. 72
Government National Mortgage Association (Ginnie Mae) . ............ 73
Other:

Federal Reserve Bank of Kans~s City

June 1996

Secondary Markets
Residential and business mortgages may be purchased from lenders by federallychartered, government-sponsored enterprises or by private secondary market
purchasers.

Criteria
Fl

Secondary market purchasers establish underwriting criteria for loans they
will buy; they may negotiate terms with a lender for loans that do not meet
their standard criteria.

Uses
111

The secondary market helps balance availability of funds for mortgages
throughout the country.

Purchase of mortgages in the secondary market gives lenders:
• increased liquidity of funds and access to capital;
11

additional options with underwriting criteria;

l!!i

decreased risk of lower profits because of interest rate changes;

e decreased risk of lower profits because of early payback of loans.

Structure
Secondary market purchases are structured in various ways:
a

Mortgage-backed securities represent shares in a pool of mortgages.
These are sold to individual investors, making additional capital
available for mortgages.

With mortgage-backed bonds, the mortgage originator or purchaser retains
ownership of tl~e mortgages, which are deposited with a trustee and used
as collateral for bonds issued to raise capital.

Mortgage securities are used as collateral for other transactions; the
security holder sells the mortgage security to an investor with an
agreement to repurchase the security after a specified period at a
specified interest rate.

Federal Reserve Bank of Kansas City

June 1996

_ _FARMER MAC I POOLED LOAN PROGRAM
Federal Agricultural Mortgage Corporation (Farmer Mac)
Farmer Mac provides a secondary market for agricultural real estate and rural
housing loans by allowing loans to be sold into loan pools that serve as collateral
for securities sold to the investing public .

. Eligibility . ·
• ·. Eligible uses include purchase of property used for the production of
agricultural commodities and consisting of at least five acres or producing
at least $5,000 in annual receipts.
•

Loans for rural housing must be in rural areas or communities of 2,500 or less,
must not have a purchase price of more than $109,200 (adjusted for inflation),
or be on no more than 10 acres ofland.

•

Loan originators must own and maintain a minimum amount of Farmer
Mac-issued shares of voting stock.

ffl

Poolers must be certified by Farmer Mac and meet requirements of the
program.

Program

The pooled deposits that provide a guarantee of repayment for investors
help manage the risk of interest rate changes.

·• ; Loan amounts cannot exceed 75 percent of the appraised value of the land
· .·. and dwelling, or 85 percent with private mortgage insurance.
El . :.

Amortization may be up to 30 years.

Rates are fixed through negotiation between the lender and borrower.

Equity is subject to the lender's criteria for the originated loan.

Contact
Federal Agricultural Mortgage Corporation

Federal Reserve Bank of Kansas City

June 1996

FARMER MAC II GUARANTEE PROGRAM
Federal Agricultural Mortgage Corporation (Farmer Mac)
Lenders may sell the guaranteed portions of Rural Development (RD) loans to
Farmer Mac, resulting in increased liquidity for lenders and reduced interest
rate risks associated with long-term, fixed-rate loans.

Eligibility
II

The guaranteed portion of Rural Development loans for farm ownership and
farm operating loans, which may be newly-originated or existing, can be sold
to Farmer Mac.

Loans in portfolio must have at least 12 months remaining term, have valid
assignable guarantees, be current and not delinquent in the previous 12
months, and not have an early payoff, delinquency, liquidation or default.

•

Lenders must follow RD standards and procedures for originating farm
ownership and operating loans.

Program
II

The ability to sell guaranteed portions of loans helps lenders -manage interest
rate risk.
Rates are fixed and are seven-year fully amortized or 20-year fully amortized
farm ownership loans with five- or 10-year resets.

11.'1!

Equity is subject to the lender's criteria.

m Maturities are the same as the prevailing lender's criteria for RD loans.
Contact
Federal Agricultural Mortgage Corporation

Federal Reserve Bank of Kansas City

June 1996

FEDERAL HOME LOAN MORTGAGE CORPORATION (FREDDIE MAC)
Freddie Mac purchases mortgages and resells them in the form of guaranteed
mortgage securities.

Eligibility
11

Loans must be originated by federally insured savings and loan associations,
other federally insured financial institutions, or HUD approved mortgage
bankers.

111

Loans cannot exceed 80 percent of the value of the property unless the seller
retains at least 10 percent participation in the mortgage; the amount in excess
of 80 percent is insured by an approved private mortgage insurer; or the seller
agrees to repurchase or replace the mortgage in case of default.

Loan-to-value ratios cannot exceed 95 percent for one-and two family properties
and 90 percent for three- and four-family properties.

Loans on single-family homes can be up to $207,000; for two-family homes up
to $264,750; for three-family homes up to $320,050; and for four-family homes,
up to $397,800.

Ill

Mortgages must meet credit, appraisal and underwriting criteria established
by Freddie Mac.

Ill

Loans insured by the Federal Housing Administration or guaranteed by the
Veterans Administration must be at least one year old before purchase.

Mortgage originators and servicers must be approved by Freddie Mac.

Program

Freddie Mac commits to purchase a variety of fixed-rate, adjustable-rate, and
graduated-payment first mortgages, which are usually converted to securities
and sold for cash in the form of participation certificates.
Rt.

Whole loans and participations of 50 to 95 percent are purchased on one- to
four-family properties, with 15- and 30-year terms.
Second·mortgages on single family homes and conventional mortgages on
multifamily properties with five or more units are purchased.

Contact

Federal Home Loan Mortgage Corporation
Federal Reserve Bank of Kansas City

June 1996

FEDERAL NATIONAL MORTGAGE ASSOCIATION (FANNIE MAE)
Fannie Mae is a publicly owned corporation, chartered by Congress, that invests
in mortgages originated by lenders.

Eligibility
Iii

Conventional, FHA-insured, or VA-guaranteed loans may be purchased,
ranging in value from up to $207,000 for single-family homes to up to
$397,800 on four-family homes.

Ill

Multifamily mortgages on conventionally-financed or FHA-insured projects
are also eligible for purchase.

Iii

If a conventional mortgage is for more than 80 percent of the value of the
property, private mortgage insurance is generally required on the portion of
the loan exceeding 75 percent of the value of the property.

Ill

If the borrower's down payment is less than 10 percent, housing expenses
should not exceed 25 percent of the borrower's monthly income, and housing
expenses and installment debt combined should not be above 33 percent.

Loan originators and servicers must be approved by Fannie Mae for each type
of loan they plan to sell to Fannie Mae.

Program

m · Fannie Mae issues commitments to purchase a specified dollar amount of
loans from a lender.
II

Lenders pay fees to Fannie Mae, usually between 1/2 and 2 percent of the
amount of commitment.
Fannie Mae will purchase a wide variety of types of mortgages for purchase
and rehabilitation of different types of housing.

Contact
Federal National Mortgage Association

Federal Reserve Bank of Kansas City

June 1996

GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(GNMA/GINNIE MAE)
Ginnie Mae purchases mortgages generated by subsidized programs to support the
construction and purchase of low-income housing.

Eligibility
'11

Mortgages must be insured or guaranteed by the Federal Housing
Administration (FHA), Rural Development (RD), or the Veterans
Administration (VA).

Mortgages in Ginnie Mae mortgage-backed security pools must have interest
rates higher than the security rate.

Ill

Lenders must be approved by Ginnie Mae and must have a guaranty commitment from Ginnie Mae before issuing securities.

An issuer of Ginnie Mae securities must be an FHA-approved mortgagee and
must be approved by Ginnie Mae or Fannie Mae as a mortgage servicer.

Program
Iii

Ginnie Mae is part of the Department of Housing and Urban Development and
most of its programs are carried out under contract with the Federal National
Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage
Corporation (Freddie Mac).

Ginnie Mae can guarantee the timely payment of interest and principal on
securities issued by lenders.

Most Ginnie Mae securities are pass-through certificates representing interest
in a pool of mortgages for which the payment of interest and principal is
passed on to investors.

A GNMA pool of mortgage-backed securities must consist of the same types of
loans with the same interest rate.

A GNMA II program may include multiple-issuer jumbo pools and may have
interest rates that vary by up to 1 percent.

Contact
Government National Mortgage Association

Federal Reserve Bank of Kansas City

June 1996

Additional Resources
Community Development Block Grants (CDBG) . ..................... 76
Other:

Federal Reserve Bank of Kansas City

June 1996

COMMUNITY DEVELOPMENT BLOCK GRANTS (CDBG)
U. S. Department of Housing and Urban Development (HUD)
Community Development Block Grants are allocated to state and local
jurisdictions.
Eligibility
II

CDBG projects and activities must principally benefit low- and moderateincome persons, aid in the prevention or elimination of slums or blight, or
meet other urgent community needs.

Entitlement communities, states, small cities, Indian tribes, and special
purpose programs, including technical assistance, are eligible for block grants.

•

Spending is subject to federal regulations or state regulations under stateadministered programs.

1111

No less than 70 percent of the funds must be used for activities that benefit
low- and moderate-income persons over a period specified by the grantee, not
to exceed three years.

Program
Iii

Funds to entitlement areas are allocated using formulas that consider the
extent of poverty and extent of housing overcrowding.

Entitlement cities develop their own programs and funding priorities.

Activities that can be carried out with block grants include provision of public
facilities and improvements such as water and sewer, streets, and neighborhood
centers, arid assistance to profit-motivated businesses to help with economic
development activities.

Contact
Local government housing or economic development agency or
U. S. Department of Housing and Economic Development

Federal Reserve Bank of Kansas City

June 1996

Contacts
Administration for Native Americans
U.S. Department of Health and Human Services
348F Hubert H. Humphrey Building
200 Independence Ave., S.W.
Washington, D.C. 20201
(202) 690-7776
Internet: http://www.os.dhhs.gov
Bureau of Indian Affairs (BIA)
U . S. Department of the Interior
1849 C Street, N.W.
Washington, D.C. 20240
Fax: (202) 208-6334
Internet: http://www.usgs.doi/bureau-indian-affairs.html
Federal Agricultural Mortgage Corp. (Farmer Mac)
919 18th St. N.W., Suite 200
Washington, D.C. 20006
(800) 879-3276
Internet: jmh@macmail.ccmail.compuserve.com
Federal Home Loan Banks
Office of Finance
11921 Freedom Drive, Suite 1000
Reston, VA 22090
(703) 487-9500
Federal Home Loan Mortgage Corporation (Freddie Mac)
8200 Jones Branch Drive
McLean, VA 22102
(800) 373-3343
Federal National Mortgage Association (Fannie Mae)
3900 Wisconsin Avenue, N.W.
Washington, D.C. 20016-2899
(800) 732-6643
Internet: http://www.fanniemae.com
Government National Mortgage Association (Ginnie Mae)
T- U . S. Department of Housing and Urban Development
451 Seventh Street, S.W.
Washington, D.C. 20410
(202) 708-0926

Federal Reserve Bank of Kansas City

June 1996

Housing and Urban Development, U. S. Department of (HUD)
P - Public and Indian Housing
451 Seventh Street, S.W.
Washington, D.C. 20410
(202) 708-0980
Internet: gopher://gopher.hud.gov/11/hud. program.area.munus%7e/pih%7e
Interior, U. S. Department of
National Park Service
1849 C Street, N.W.
Washington, D.C. 20240
(202) 208-3171
Internet: http://www.usgs.doi.gov
Rural Development (RD)
U. S. Department of Agriculture
14th Street and Independence, S.W.
Washington, D.C. 20250
(202) 720-2791
Internet: http://www.rurdev.usda.gov
Small Business Administration, U. S. (SBA)
409 Third Street, S. W.
Washington, D.C. 20416
(800) 827-5722
Internet: http://www.sbaonline.sba.gov/int ro.html
Veterans Affairs, U. S. Department of (VA)
Veterans Benefits Administration
Washington, D.C. 20420
(202) 273-567 4
Internet: http://www.va.gov

Federal Reserve Bank of Kansas City

June 1996

Agency and Program Index
Administration for Native Americans Grant, 57
Fannie Mae (Federal National Mortgage Corporation), 72
Farmer Mac (Federal Agricultural Mortgage Corporation)
Farmer Mac I Pooled Loan Program, 69
Farmer Mac II Guarantee Program, 70
Federal Home Loan Banks
Affordable Housing Program (AHP), 39
Community Investment Program (CIP), 65
FHA Home Mortgage Insurance Programs (Federal Housing Administration), 45
Freddie Mac (Federal Home Loan Mortgage Corporation), 71
Ginnie Mae (Government National Mortgage Association), 73
HUD (U. S. Department of Housing and Urban Development)
Community Development Block Grants (CDBG), 76
HOME Investment Partnership Program, 21
Home Mortgage Insurance Programs, 45
Indian Housing Loan Guarantee Program, 46
Rental Housing Certificate Program, 22
Rental Housing Voucher Program, 23
Interior, U. S. Department of
Historic Preservation Tax Credits, 17
BIA Indian Loan Guarantee Program, 4 7
BIA Management and Technical Assistance, 58
Rural Development (formerly Rural Economic and Community
Development/Farmers Home Administration)
Business and Industry Guaranteed Loans, 43
Farm Labor Housing, 33
Rural Development Home Ownership Loans, 48
Rural Home Improvement Loans, Repair Loans and Grants, 34
Rural Housing Loans, 35
Rural Housing Vouchers, 24
Rural Mutual and Self-Help Housing, 25
Rural Self-Help Housing Technical Assistance, 60
SBA (U. S. Small Business Administration)
SBA 7(a) Loan Guarantee Program, 49
SBA Special Loan Programs, 50
SBA 504 Certified Development Company Loan Program, 53
Service Corps of Retired Executives, 61
SmaU Business Development Centers, 62
VA Guaranteed Home Loans (U. S. Department of Veterans Affairs), 44

Federal Reserve Bank of Kansas City

June 1996

Special

I ssue

1996

ject resources. To learn more about those
resources, contact the appropriate agencies for current, definitive program information. For information about workshops,
or for updated versions of the Resource
Guide via the Internet, contact the
Federal Reserve Bank of Kansas City.

The staff of the Community Affairs
Department of the Federal Reserve
Bank of Kansas City is appreciative
of the partners across its seven-state dis:trict and beyond whose involvement has
contributed to the creation of this
Resource Guide. People from banking and
community organizations, state and federal agencies, and local community development organizations have worked with us
to create similar resource guides for their
constituencies and to present workshops
on financing those difficult housing and
business deals-deals that are undoable
outside the context of local partnerships.
The themes and titles of the workshops
and resource guides-"Partnerships in
Housing," "Energizing Your Local
Economy," "Increasing Lending on Indian
Reservations," etc.-reflect both the partnership nature and the benefits of these
efforts.
We also thank the various federal
agencies that have provided information
about development enhancements; however, any inaccuracies are ours, not theirs.
We want to emphasize that this document
is designed to serve as a general guide
and framework, not as a final program
reference. Many programs are not included, and as this document goes to press,
legislation is pending that will change
how some of the federal programs we
have included will work. In addition, a
host of state and local enhancements further broaden project financing possibilities. We encourage you to add information
about these resources to this guide to
expand its usefulness in exploring financing options for your projects.
To use the guide, first identify the
nature of your project's resource gaps,
then look to the enhancement categories
pertinent to that gap to find potential pro-

Volume 4 Number 1

CommulPty Reinr,e•tment is
published twice a year by the
Community Affair,, Department
of the Federal Reserve Bank of
Kansas City, 925 Grand
Boulevard, Kansas City, Missouri
64198-0001, (800) 333-1010
Ext. 2890

The views expressed. are not necp
essarily those of the Federal
Reserve Bank of Kansas City or
the Federal Reserve System.

Telephone: (800) 333-1010
Ext. 2890
Fax: (816) 881-2252
Electronic Bulletin Board:
(800) 257-6701
Internet: http://www.kc.frb.org

John A. Wood
Assistant Vice President and
Community Affair,, Officer

Free subscriptione and additional
copies are available upon request.
Material may be reprinted or
abstracted provided Commumty
Reinve•tm.mt is credited.
Please provide the Community
Affair,, Department with a copy
of any publication in which .
material is reprinted.

Larry G. Meeker
Vice President and

Director of Community Affsirs

Sharon M. Blevins
Editor and
Community Affair,, Coordinator
Desktop Publishing:
Tune Lee

C u

111

Gap Analysis

R e

Enhancement Analysis

Increase Revenue

Cash Flow
Sufficiency

e s t m e n t

Reduce Expenses

I
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}.
I

I
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1 • TAX CREDITS
2 - RENT SUPPLEMENTS

3 - TAX ABATEMENTS

4 • INTEREST RATE SUBSIDIES

S - Equity (GRANTS)

!Proper Loan S1rucluring

Project

Gaps

-I

H
y

Cash Flow
Predictability

Collateral
Adequacy
Management
Ability

High Transaction
Costs

I
I

.j Stabilize Cash Flows
Increase Lender
Compensation

Reduce Transaction
Costs

Shift Transaction
Costs

I
-I

Manage Interest
Rate Risk

Internal

6 - LOAN GUARANTEES

!Higher Loan Rate

I
_ I Strengthen Collateral }+ I
·I
Coverage
I
_ I Provide Management
I
Assistance
HI

I
I

6 - LOAN GUARANTEES
5 - Equity (GRANTS)

8 · TECHNICAL ASSISTANCE

IStaff Trainir,wSpecializalion

Interest Rate
Risk

I
I

7 - SUBORDINATED MORTGAGE

1Es1ablished Community Organizations

I
I
I

9- MATURITY-LINKED FUNDING

ISecondaly Markets

Federal Reserve Bank of Kansas City
925 Grand Boulevard, Kansas City Missouri 64198 0001
Telephone: (800) 333-1010 Ext. 2890
Fax: (816) 881-2252 Electronic Bulletin Board: (800) 257-6701
Internet: http://www.kc.frb.org

·-

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IConsortia/CDCs

Gaps

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11 GOVERNMENT INCOME & EXPENSE ENHANCEMENTS

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Full text of Community Reinvestment (Federal Reserve Bank of Kansas City) : Community Reinvestment : Doing the Undoable Deals : A Resource Guide to Financing Housing and Economic Development

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