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Lender Memo 02-06

VIEWS: 11 PAGES: 11

									                                                                       MEMORANDUM

Date:           September 13, 2002

To:             DUS Lenders

From:           Randy Berdine

Subject:        Lender Memo 02-06: Changes to Underwriting Guidelines




     This Lender Memo supersedes Lender Memo 02-03.
     This Lender Memo makes changes to Underwriting Guidelines, including:
        -   Further clarification of definition of Net Rental Income
        -   Change in definition of Recently Stabilized Properties and Maximum
            Economic Vacancy
        -   Change in Deferred Maintenance limits
        -   Increase in maximum variances in NOI permitted in Valuation
        -   Establishment of “Delegated Waivers” for:
            -   Estimating Underwritten Net Rental Income
            -   30-year amortization
            -   Application of SRCU and SRCU guideline parameters
        -   Documentation procedures for Delegated Waiver authority



The purpose of this Lender Memo is to announce underwriting changes to be made to
the DUS Guide. This memo supersedes Lender Memo 02-03, dated April 25, 2002 and
will replace or enhance current DUS Guide standards . This memorandum applies to all
DUS conventional loans under $20 million. For purposes of this Lender Memo, the term
“DUS Conventional Loans” does not include the following product types:

   Seniors Housing
   Multifamily Affordable Housing
   Manufactured Housing Communities
   Forwards
   Moderate Rehabilitation
   Student Housing Pilot
   Bond Credit Enhancements
   Large Loans

In order to provide the DUS Lenders greater flexibility without adversely affecting credit
quality, Fannie Mae is implementing a delegated waiver methodology outlined below. In
certain instances, the Lender will have the authority to use a waiver, a ”Delegated
Waiver”, subject to documentation requirements. In addition, the following will also
occur:

1. An expeditious process to verify reasonable Lender use of delegated waiver
   authority will be established.

2. A modified remedy structure to address imprudent use of delegation authority will be
   implemented.

The following highlights the specific changes to be made to the DUS Guide's property
specific, financial underwriting policies and practices:

1. Development of Net Rental Income

As currently published, the DUS Guide does not use Net Rental Income (NRI) in its
underwriting guidelines for calculating the Base Loan Amount. Beginning on the
Effective Date noted below, the calculation of NRI must be performed in addition to the
estimate of Residential Rental Income to be performed pursuant to Chapter 4 of Part III
of the DUS Guide. NRI must be calculated as follows:

                     Gross Potential Rent (GPR) (the rent roll of actual rents in place)
PLUS                 Market rents on vacant units
PLUS                 to the extent deducted as an expense, the rents for other non-
                     revenue units (including model units) and actual rent from
                     employee units
LESS                 Economic Vacancy, consisting of:
                             Physical vacancy loss
                             Rent loss from concessions granted to tenants at any
                                time during the current lease term, and
                             Rent loss from bad debts or write-offs


In most cases, the average cash collected from the most recent 3 months (defined as
the 3 months preceding underwriting) annualized (plus amounts deducted as expenses
from employee and non-revenue units) should be the maximum that is used to
underwrite annual NRI. The Lender must insure that the prior 3 months are not based
upon seasonal income, e.g. student housing, or include premium income that is not
allowed per Chapter 4 of Part III of the DUS Guide.

To support the underwritten NRI, the Lender must:
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   analyze the cash receipts from the prior 3, 6 and 12-month periods (accounting for
    each of the above categories to the extent possible from borrower records) to
    determine trend or momentum; and

   carefully analyze whether the GPR and NRI are sustainable for the foreseeable
    future.

For properties with downward trending cash collections: For properties whose
cash receipts from the prior 3, 6 or 12-month periods exhibit downward trends, the
Lender must determine that the downward trend is temporary and can be reasonably
underwritten. The Lender should generally use Special Risk Category Underwriting
(SRCU) unless there are significant mitigating circumstances. See Section 9 below for
changes in SRCU. Should the Lender choose not to use SRCU, the Lender may
employ a Delegated Waiver (“Delegated Waiver - SRCU”), subject to the requirements
in Section 9 of this memorandum.

For properties that do not exhibit downward trending cash collections: Due to
specific circumstances, the Lender may determine that the average cash collected from
the most recent 3 months does not accurately reflect the performance of the property.
In this case, the Lender may elect to use a Delegated Waiver for the calculation of NRI
(“Delegated Waiver – NRI”), subject to the requirements in Section 9 of this
memorandum.

Recently stabilized properties (defined as properties with less than 12 months of
stabilized operating history) must also adhere to the methodology in this section and
are subject to the following conditions:

   While 90% physical occupancy for 90 days still applies (or 85% as outlined Part III,
    Section 202.01 of the DUS Guide), the property’s actual total economic vacancy
    cannot exceed 15% for the same 90 days. In addition, the 90 day trend for
    economic vacancy must be decreasing.           Lenders are required to include
                                                                                      th
    concessions occurring during any time of the lease term (e.g. free rent in the 12
    month of a 12-month lease) in its economic vacancy estimate.

   To exclude or decrease the effect of lease up concessions, the Lender must
    demonstrate that:

       recently signed leases have lower or no concessions; and

       stabilized competitors are either not offering concessions or offering concessions
        at a lower rate (the expectation that concessions will decrease due to lack of new
        construction alone is not acceptable).

None of these tests are currently required for conversions of existing Fannie Mae
Forward Commitments. Future changes will be implemented to correlate the process
used for Forward Commitments to these tests.


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2.       Rent Rolling

Until further notice, use of Rent Rolling to determine GPR as outlined in Option 1 of
Paragraph 2 of Section 403.02 of Part III can be used only with a waiver approved by
Fannie Mae.

3.       Commercial Lease Rollover Costs

Lenders may be required to reserve for potential cash flow shortfalls from leasing costs
at lease rollover. There are several steps to determine if reserves will need to be
collected.

    The first step is to remove all commercial income from the underwritten NOI.

        If the reduced NOI results in a Debt Service Coverage (DSC) that is greater than
         1.10, then reserves are not required.

        If the reduced NOI results in a DSC that is lower than 1.10, then the Lender must
         perform the following calculations:

            An estimate must be calculated for leasing commissions and tenant
             improvement costs for all commercial leases that expire during the term of
             the loan and for a period of two (2) years after the balloon date. The Lender
             must estimate the annual escrow required to cover these costs. All
             assumptions must be clearly described in the underwriter’s narrative.

             In the ordinary course of business, some commercial tenants may utilize
             short-term leases with frequent renewals as opposed to long-term leases. In
             order to substantiate appropriate reserves for these tenants, the analyses
             must document actual leasing commissions and tenant improvements and
             historical renewal percentages to demonstrate the high probability of lease
             renewals.

            The Lender must subtract this escrow from its Underwritten NOI, which
             includes the commercial income, to determine the effect upon underwritten
             DSC.

            If the reduced NOI results in a DSC below 1.10, the Lender has two options:

                   Structure and fund an initial deposit along with annual deposits to
                    increase the DSC to 1.10, or

                   Decrease the loan amount to increase DSC to 1.10.




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4.      Amortization

In most cases, 30-year amortization should not be used for properties that exhibit
deferred maintenance in excess of 4% of the Underwriting Value for refinance
transactions and 6% of the Underwriting Value for acquisition transactions unless:

    the deferred maintenance is escrowed at 150% of the estimated repair amount
     (125% if there are acceptable bids),

    the loan is 75% LTV or less, and

    the DSC is 1.30 or greater

A Lender may allow 30-year amortization by using a Delegated Waiver (“Delegated
Waiver - Amortization”), subject to the requirements in Section 9 of this memorandum.

“Deferred maintenance” is defined as the immediate repairs and Year One
recommended replacement costs (excluding routine unit turnover cost) pursuant to the
final Physical Needs Assessment (PNA).

5.      Expenses

Expenses must be underwritten pursuant to Section 403.05 of Part III of the DUS Guide
with the following requirements relating to specific expenses:

A.      Insurance

        Insurance expense must be underwritten using the following guidelines:

           Insurance policies with a bona fide written quote from a reputable broker for a
            new 12-month policy may be underwritten at the quoted expense; or

           Insurance policies with less than 6 months remaining term must be
            underwritten at no less than 110% of the current expense.

           In no event can the expense be less than a commercially reasonable amount
            under the current guidelines.

B.      Taxes

           To the extent possible, the Lender must gather tax information from
            comparable properties within the same taxing jurisdiction to determine
            whether the current assessed value is below competitors. The Lender should
            use this comparable data to develop a ratio of assessed value to market
            value. If the comparable properties show a ratio of assessed value to market
            value greater than the ratio of the subject’s assessed value to market value,
            the tax expense must be increased by a like amount.


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         At a minimum, the estimated tax expense must be underwritten at 103% of
          the current tax expense.

      Please note that there are special rules for California and other applicable
      jurisdictions. For refinance transactions in the State of California and other
      jurisdictions with similar laws restricting the frequency of property
      reassessments, which may result in significant differences between the current
      real estate taxes and the real estate taxes based on a sale or transfer, the
      Lender must use an alternate approach to underwriting real estate taxes. In
      these cases, the Lender must use the higher of the following:

         The real estate tax based on the property’s assessed value multiplied by the
          current millage rate, appropriately trended; or

         The real estate tax based on the loan amount multiplied by the current
          millage rate.

      In using this approach, however, the Lender should be careful to consider any
      known or contemplated sales, transfers or other events that could trigger a
      reassessment and subsequent increase in real estate taxes. In these cases, the
      Lender should underwrite the real estate tax based on the expected increased
      amount.

C.    Replacement Reserves

      The allowance for Replacement Reserves utilized in underwriting must be equal
      to or greater than:

         The calculated average annual funding of the Replacement Reserve over the
          12-year schedule as determined by the Lender pursuant to Section 310.03 of
          Part III of the DUS Guide. The funding must ensure that there are no
          negative balances on the schedule for all 12 years. If a Lender structures
          (and collects) an initial deposit into its reserve funding calculation that results
          in a lower annual funding, the lower annual funding should be used;

         The first year's total funding of the Replacement Reserve as determined by
          the Lender; or

         $200 per unit per annum or $150 per unit per annum if the property was
          completed in the past 3 years.

The replacement reserves utilized in the Lender’s determination of the prospects for
refinancing the Mortgage at the end of the Mortgage term must be based upon the
actual Replacement Reserve Agreement.

6.    Replacement Reserves Funding

Full funding of replacement reserves is required for properties that exhibit deferred
maintenance (as defined in Paragraph 4 above) in excess of 4% of the Underwriting
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Value for refinance transactions and 6% of the Underwriting Value for acquisition
transactions.

    Lenders may follow the existing waiver of replacement reserves outlined in Part III,
     Chapter 3, Section 310.05 if special circumstances exist, e.g. the property is being
     acquired by a reputable borrower with proven experience in managing this type of
     renovation. In this case, the Lender must document the inspection (with pictures) of
     other properties in the borrower’s portfolio.

7.      Valuation

A.      For all acquisitions except 1031 tax exchange and non-arms’ length acquisitions:

        If the underwritten NOI for DSC divided by the capitalization rate for Underwriting
        Value results in:

           a value equal to 80-90% of the Underwriting Value, the Lender must provide
            substantiation for the difference.

           a value that is less than 80% of the Underwriting Value, a waiver from Fannie
            Mae must be obtained prior to closing the transaction.

B.      For all other types of loans including 1031 tax exchange and non-arms’ length
        acquisitions:

        If the underwritten NOI for DSC divided by the capitalization rate for Underwriting
        Value results in:

           a value of 85-90% of the Underwriting Value, the Lender must provide
            substantiation for the difference; or

           a value that is less than 85% of the Underwriting Value, a waiver from Fannie
            Mae must be obtained prior to closing the transaction.

If a Lender has applied SRCU standards to develop its Underwritten NOI, the pre-SRCU NOI should be
used for the valuation test.

8.      SRCU

The requirements of SRCU underwriting are modified such that the Lender may use a
Delegated Waiver to waive one of the three underwriting requirements concerning 1)
increased debt service coverage, 2) decreased loan to value percentage, or 3)
increased underwritten economic vacancy percentage (“Delegated Waiver – SRCU
Provision”). Such action is subject to the requirements of Section 9 of this
memorandum.

Please note that this option applies only to DUS Conventional Loans as defined in this
memorandum.


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9.       Use of Delegated Waivers

Use of Delegated Waivers are subject to the following requirements:

     The Lender must identify the loan as possessing one or more Delegated Waivers by
      type (e.g. Delegated Waiver – NRI) as defined in Sections 1, 4 and/or 8 of this
      memorandum.
     The Lender must provide, in the underwriting narrative, a detailed, written
      justification of the specific circumstances that support each Delegated Waiver.

Justification should include a specific analysis of risk and mitigating factors, including
property characteristics, market conditions, and any consultation with third parties or
Fannie Mae personnel.

The Lender must exercise prudent business judgment when electing to use any
Delegated Waiver. Failure to justify the use of a Delegated Waiver for a loan may
result in a loan remedy and/or the revocation of the delegated waiver authority. In
addition, should the Lender have failed to properly mark the Folder III of the loan in
question (whether a physical file or an electronic submission) as outlined in Section 10
below, the severity of the loan remedy may be increased. The use of Delegated
Waivers is not permitted for the following product types:

     Seniors Housing
     Multifamily Affordable Housing
     Manufactured Housing Communities
     Forwards
     Moderate Rehabilitation
     Student Housing Pilot
     Bond Credit Enhancements
     Large Loans


10.      Documentation

A Lender is required to flag any loan possessing any Delegated Waiver. In preparing
the physical Folder III file, the outside cover of the file shall be marked in red in some
obvious manner. In addition, a form shall be inserted into the front of the contents of
the file delineating any Delegated Waiver by type (e.g. Delegated Waiver - NRI) and
noting on which page of the Narrative the Delegated Waiver is analyzed and/or
discussed. For those Lenders approved to submit Folder IIIs by electronic means, the
Lender will be required to affirmatively check the designated Delegated Waiver field
when creating an electronic folder for the loan. Any Folder III not appropriately marked
may be subject to an increased remedy.

Continued failure to adequately flag Folder IIIs with Delegated Waivers shall result in
the revocation of the Lender delegated waiver authority for a designated period of time
subject to the following schedule:

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For Loans with
Nominal Loan Risk Implications (i.e. Loans with no remedies imposed)
Occurrences within a 6-month period        Action
1 to 2 loans                               None
3 to 4 loans                               Written Warning
5 or more                                  Revocation for 3 months
Repeated offenses                          Indefinite Revocation

For Loans with
Moderate Loan Risk Implications (i.e. Loans imposed with the remedy of Watch
List)
Occurrences within a 6-month period        Action
1 loan                                     Written Warning
2 or more                                  Revocation for 3 months
Repeated offenses                          Indefinite Revocation

For Loans with
Severe Loan Risk Implications (i.e. Loans with additional remedies beyond Watch
List)
Occurrences within a 6-month period         Action
1 loan                                      Revocation for at least 3 months with
                                            reinstatement only by Fannie Mae
                                            approval
Repeated Offenses                           Indefinite Revocation

Effective Date

This Lender Memo is effective September 16, 2002 and does not apply to any loan that
has already been committed with Fannie Mae.

If you have any questions concerning these DUS Guide changes, please contact Randy
Berdine, Director, Multifamily Credit Management, at (202) 752-7923, Eric Barteldes,
Senior Risk Manager, Multifamily Credit Management, at (202) 752-5652, or call your
National Account Manager.




                                         9
                                   Lender Memos


All Lenders Memos except those listed below have been superseded by previous Guide
Updates. The Lender Memos listed below will be incorporated into the DUS SM Guide as
the applicable sections are updated.

• 97-12 (12/08/97) Refinance Enhancements

• 98-09 (05/14/98) Bond Premium Sales for Fixed-Rate Bond Credit Enhanced
                   Properties / Eligible Borrower Organizations

• 98-12 (06/02/98) New Choice Loan Refinance Guidelines; Structured DUS and
                   Rapid Refi Changes (ESP)

• 98-17 (07/23/98) Single Asset Seniors Housing Product Line

• 98-24 (11/17/98) Loan Limits

• 99-02 (03/18/99) DUS Bond Credit Enhancements - Reduction of Fannie Mae
                   Counsel Fees in DUS Variable Rate Transactions, Fannie Mae
                   Counsel Option for Real Estate Documentation, and Revised
                   Counsel Designation Form

• 99-05 (08/24/99) Live Pricing for Cash Commitments/MCODES Commitment
                   Procedures

• 00-01 (02/24/00) Mezzanine Equity

• 00-03 (05/09/00) Fannie Mae 5-50SM Streamlined Mortgage Loan Product

• 01-02 (01/16/01) Manufactured Housing Community Loans

• 01-05 (05/02/01) Modifications to Underwriting Guidelines for Seniors Housing
                   Product

• 01-06 (06/12/01) New Streamlined Loan Summary Tool

• 01-10 (07/18/01) Consolidation of the 5-50SM Streamlined Mortgage Loan Product
                   with the DUS Small Loan Product

• 01-12 (08/22/01) Revisions to Documents Published on Fannie Mae Multifamily Web
                   Site (#2)

• 01-13 (10/04/01) Quarterly DUS Lender Financial Information Submission

• 01-14 (10/04/01) 3MaxExpressSM Update

• 01-15 (11/27/01) Actual/360 Interest Accrual

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• 01-16 (12/11/01) Registration of DUS Loans

• 02-02 (01/08/02) 63-20/Public Entity Borrowers – Underwriting Guidelines for Tax-
                   exempt Bond Financings

• 02-04 (05/17/02) Seventh Multifamily Assured Schedule Payment TrustSM

• 02-05 (07/08/02) Change to Folder I Content and Folder II Delivery and Content

• 02-06 (09/13/02) Changes to Underwriting Guidelines




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