Ripple Effects Of Surfside Condo Collapse – FNMA And Freddie Mac Tighten Oversight Of “Deferred Maintenance” In Condos And Co-Ops
PART I – FINDING EVIDENCE OF “DEFERRED MAINTENANCE”
When you take out a personal mortgage or a co-op loan, your bank usually packages it with other mortgages and sells them in bulk to the Federal National Mortgage Association (“FNMA” or “Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac” or simply “Freddie”). (In this newsletter, we are calling both condo and co-op loans “mortgages.”) FNMA and Freddie Mac insure the payment of these packaged loans for the benefit of the institutions that buy them.
In response to the Surfside Condominium collapse in Florida, Fannie Mae and Freddie Mac issued Bulletins that required banks counting on FNMA and Freddie Mac insurance to look for “Deferred Maintenance” in the buildings in which the mortgaged unit is located. The results are affecting not just individual borrowers but also underlying loans to co-op and condo associations.
“Deferred Maintenance” is defined as “[conditions] severe enough to affect the safety, soundness, structural integrity, or habitability of the improvements;” or “[that] impedes the safe and sound functioning of one or more of the building’s major structural or mechanical elements, including but not limited to the foundation, roof, load bearing structures, electrical system, HVAC, or plumbing.” FNMA and Freddie Mac will not insure a loan in a building with significant Deferred Maintenance.
A. How FNMA/Freddie Mac Determine “Deferred Maintenance.” Lenders are instructed to obtain and review the following documents and information:
(i) “Addendum” to the Standard FNMA Questionnaire. FNMA and Freddie Mac customarily require banks to fill out a questionnaire with information about the community association in which the unit is located. They have added a “temporary” addendum to the questionnaire focusing on potential “Deferred Maintenance” in the building and the steps that a condo or co-op has taken to address it. A copy of the Addendum can be viewed here. The full questionnaire, including the Addendum, can be viewed HERE.
Lenders pass on this Questionnaire to managing agents, who charge to fill it out. Some managing agents, though, demand indemnification from the Association for their answers, since they are required to “certify” the answers.
(ii) Building Condition Reports: Up to five years of reports required to be filed by localities or the state. In New York, that could mean NYC Local Law 11 façade or gas pipe inspections, state-mandated garage inspection reports, engineering inspections that were performed by lenders before approving mortgage refinancings, or reserve fund studies. Freddie Mac states that the absence of a report will not protect an Association against a negative inference.
(iii) Minutes of Board Meetings. The last six months of Board meeting minutes.
(iv) Violation Searches. Building Department or Environmental Control Board records of outstanding violations.
(v) Special Assessments. The purpose of, percentage collected, and remaining installments of current and planned special assessments, and whether the assessments will have any impact on the financial stability, viability, condition, and marketability of the project.
(Freddie Mac adds that if the special assessment is related to safety, soundness, structural integrity, or habitability, all related repairs must be fully completed or the Project is not eligible.)
Initially, the appraiser hired by the bank is instructed to perform these reviews (which would double the prices of appraisals). But FNMA also states that “Lenders cannot rely solely on appraisals” to make their determination.
B. How Associations Can Address Lender Demands. If Associations refuse to provide information or to fill out the Addendum, they run the risk that FNMA and Freddie Mac will simply decline to insure loans in their buildings. FYI, these agencies keep a master list that lenders and mortgage brokers can refer to in order to review why loans may have been declined in the past.
Some banks make “portfolio” loans (hold them rather than packaging and reselling them). FNMA and Freddie also don’t insure “jumbo” or “non-conforming” loans, which currently includes loans exceeding $970,400 in NYC and some surrounding areas. But many lenders are now requiring borrowers to provide the same information, including filling out the Addendum (or the bank’s proprietary equivalent), as a condition of making any mortgage loan. Moreover, New York State is considering legislation that would expand the required reporting of building conditions to conform to what most other states already have. (More on that in Part II, “New FNMA and Freddie Mac Reserve Requirements; Preparing for Future Capital Repairs.”)
How can your Association prepare itself for this increased disclosure? We submit these suggestions on how to prepare your Association to respond to these new lender demands, particularly in conjunction with the reserve and capital planning issues to be discussed in Part II:
1. Sanitize and Conform Your Minutes. Appraisers will be reviewing your minutes for evidence of deferred maintenance and incipient physical condition issues. Boards should express their concerns in the minutes in a proactive or positive light. In other words, rather than stating, “Director Smith demanded that the Association fix the severe ongoing roof leaks since the warranty expired,” the minutes might state, “The Board discussed the advisability of planning for installation of a new roof as part of its overall repair and maintenance plans, and authorized management to engage an engineer to review roof conditions and to solicit proposals.”
Also, make sure your minutes are consistent with existing reports. It doesn’t look good if your Board appears simply to ignore a report that recommends replacement of a building component within a particular period.
2. Anticipate and Address the Results of Mandated Inspections. New York
City has tightened up its requirements for making prompt repairs after receiving “SWARMP” comments in Local Law 11 reports, but these may still unsettle potential lenders. Show that you’re dealing with them in some written record. Likewise, you do not want to see a garage inspection that states, “The mortar in the ceiling shows evidence of water penetration and has fallen in several places,” unless you plan to address it.
3. Review Current Violations. Many Lenders are asking for explanations of violations issued for failures to conduct regular elevator or boiler inspections (a common failing of service) companies, or to remove old “Stop Work” orders. Consider how your outstanding violations look from an institutional standpoint.
4. Explain Your Special Assessments (Possibly in the Minutes). Provide a basis for a special assessment that looks consistent with prudent capital planning as opposed to a desperate remedy to emergency conditions. (This will be explained in greater depth in Part II.)
The FNMA/Freddie Mac demands have received considerable pushback from community associations across the nation, including requests for a one-year deferral of enforcement. That has not happened. Meanwhile, banks are pushing ahead with their own inquiries and will make independent judgments. We still have to see how this plays out.
NEXT INSTALLMENT – “The Other Shoe Drops – Enhanced FNMA and Freddie Mac Reserve Requirements.” FNMA and Freddie did not stop with requiring banks to obtain more information about building conditions; they are also demanding that Associations establish “adequate” reserves and demonstrate that they have the financial capacity to deal with potentially hazardous conditions before another Surfside disaster. We will discuss the new guidelines in our next E-Blast and offer additional suggestions on how to cope with them.