Community development ; Housing - Finance ; Real estate investment trusts

Judd S. Levy

Kenya Purnell

English

Research Papers in Economics

FEDERAL RESERVE BANK OF SAN FRANCISCO
Community Development INVESTMENT REVIEW 57
Case Study: The Community Development Trust 
Taps Wall Street Investors
Judd S. Levy and Kenya Purnell
The Community Development Trust
T
he Community Development Trust (CDT) is the country’s only real estate invest-
ment trust (REIT) devoted solely to providing debt and equity capital for financing 
community development projects. CDT was created in 1998 by the Local Initia-
tives Support Corporation (LISC), a national nonprofit community development 
intermediary, and 17 socially motivated institutional investors. As a private, mission-driven 
REIT, CDT operates much like a mutual fund, combining the capital of institutional inves-
tors to acquire or provide financing for affordable housing. In line with our mission, all CDT 
investments must satisfy Community Reinvestment Act (CRA) requirements. Through our 
debt-and-equity financing programs, CDT invests: (1) long-term debt capital by purchasing 
smaller, fixed-rate multifamily mortgages from community lenders; and (2) equity capital 
either in cash or by providing a tax-advantaged transition for existing properties to a new set 
of owners committed to long-term affordability.
CDT’s initial effort to meet its mission was the introduction of the debt program, which 
focused on creating a secondary market for smaller (under $3 million) Low Income Housing 
Tax Credit (LIHTC) loans. CDT’s equity capital was insufficient to fund and retain the 
whole loans created under the program. As a solution, CDT sought out institutional inves-
tors to purchase a 90 percent senior interest in each loan with CDT holding a 10 percent 
subordinate interest. In this way, every $1 million of CDT’s equity capital would finance 
$10 million in loans. CDT entered into a participation agreement with a socially motivated 
pension fund, the General Board of Pensions and Health Benefits of the United Methodist 
Church (the Board). Under this agreement, the Board agreed to purchase a senior interest 
in each mortgage loan subject to certain underwriting criteria, and CDT agreed to retain the 
subordinate interest. 
The initial commitment from the Board was for a $30 million facility. By 2004, as the 
program became more successful, the Board had increased the facility to $100 million. CDT 
had fifteen active originators around the country and volume was increasing to the point 
that additional capacity beyond the existing $100 million was needed. 
CDT approached the Board with a proposal to repurchase a portion of the Board’s senior 
interests and then combine them with the CDT-retained subordinate interests. CDT would 
then securitize the whole loans for sale in the open market. CDT also included several 
whole loans that it had not yet syndicated. In aggregate, the pool totaled $44.9 million 
and consisted of thirty-one affordable multifamily housing mortgages and more than two 
thousand units of affordable housing. CDT swapped the mortgages for an equal amount FEDERAL RESERVE BANK OF SAN FRANCISCO
Community Development INVESTMENT REVIEW 58
of Fannie Mae Mortgage-Backed Securities (MBS). The MBSs were then sold to JPMorgan 
Chase (JPMC). 
The loans had an average balance of $1.4 million and were secured by properties in 
eight states. The majority of the loans were on properties having LIHTCs. By repurchasing 
the senior interests CDT had previously sold to the Board, CDT was able to increase its 
program capacity with the Board and at the same time demonstrate its ability to securitize 
the previously illiquid senior interests. According to David Zellner, Chief Investment Officer 
of the Methodists Pensions and Health Benefits Board, “This transaction was a terrific way 
to illustrate the high quality of the affordable housing mortgage portfolio that we have been 
purchasing from CDT.”
The transaction provided several advantages to the Board and to CDT. First, the Board’s 
ability to sell its senior interests at market prices validated the underlying value of the 
senior interests. Second, a securitization provided liquidity to CDT by freeing up capital 
committed to its existing subordinate pieces. Furthermore, under the securitization, CDT’s 
credit enhancement was reduced to a level below the level provided to the Board. Finally, 
the Board agreed that the repurchase of the seasoned senior interests would allow CDT to 
deliver new senior interests on a dollar-for-dollar basis, thus increasing the capacity of the 
facility with the Board.
Evaluating the Options
CDT had to evaluate several alternatives for structuring the securitization transaction.
Senior Investor Facility
The first alternative CDT considered was to deliver senior interests on the mortgages 
through an existing participation facility with another large institutional investor. This struc-
ture was similar to the senior/subordinate agreement in place with the Board. However, 
each senior interest would be sold on a stand-alone basis and consequently CDT would not 
capture the value generated from pooling the mortgages. Furthermore, the facility limited 
the senior investor to a par purchase price. The mortgage loans were well seasoned with an 
excellent credit history and all were originated in a much higher interest-rate environment; 
thus, the pool was worth well above par. 
Real Estate Mortgage Investment Conduit (REMIC)
The second option was to pool the mortgages and issue securities via a REMIC with 
CDT retaining the below investment grade interest. Some REMICs are entities that own 
pools of mortgages used for collateral to issue Commercial Mortgage Backed Securities 
(CMBS). Assets held by REMICs must comply with IRS regulations, and all securities issued 
by non-GSE (Government Sponsored Enterprise) REMICs must have a rating assigned from 
at least one of the nationally recognized rating agencies. Post issuance, the rating agencies 
are required, at a minimum, to monitor asset performance annually. However, on average, rating assignments carry a $100,000 upfront fee and a $15,000 annual surveillance charge. In 
addition, legal fees and other transaction costs can be substantial. The cost of a rated transac-
tion relative to the small size of the pool was likely to result in an inefficient execution. The 
minimum size for a REMIC transaction is generally at least $100 million.
Guaranteed Mortgage-Backed Securities (MBS)
The third option was to pool the mortgages and issue securities credit enhanced by a 
GSE to a broker dealer. Broker dealers have access to a wider variety of investors in the 
capital markets and may elect to include the CDT securities in a much larger securitization. 
The GSE guarantee would allow CDT to issue AAA-rated securities without going through 
the rating-agency process. The AAA rating would result in a higher price for the securities 
and alleviate investor uncertainty regarding affordable housing mortgages. In exchange for 
the GSE’s credit enhancement, CDT would provide a collateralized first-loss guarantee. The 
first-loss guarantee could be secured by cash, by retaining a percentage of the securities, or 
by providing a payment guarantee backed by a letter of credit. This obligation would remain 
constant for the life of the securities and would not decline as the underlying mortgages 
amortize.
However, the MBS option presented challenging corporate finance, tax, and accounting 
issues specific to CDT’s REIT status. Some of the major issues included: (1) selling the loans 
and foregoing the future income stream of principal and interest payments; (2) assessing the 
financial and administrative costs to provide CDT’s first-loss guarantee; and (3) managing 
the potential gain/loss on sale and any tax implications. 
Transaction Overview
CDT chose the MBS route. The primary reasons were costs and time. Under the MBS 
structure, we did not need to incur the costs of securing a rating from one of the independent 
rating agencies. Our legal costs were also substantially less than under the REMIC structure. 
At the time we were considering the securitization, the ten-year U.S. Treasury was trading at 
a level that would generate substantial value from the securitization. Any significant increase 
in the U.S. Treasury yield would eliminate much of the economic value of the transaction. A 
prolonged process would expose CDT to this risk, whereas the MBS execution appeared to 
have significant benefits in terms of coming to market quickly.
CDT swapped the mortgages for an equal amount of Fannie Mae Guaranteed Mort-
gage-Backed Securities (Securities) and then sold the Securities to JPMC. The portfolio was 
separated into nine smaller pools as required by Fannie Mae’s Mortgage-Backed Securities 
program. Securities were exchanged on a per pool basis; thus, CDT received a total of nine 
Securities. 
FEDERAL RESERVE BANK OF SAN FRANCISCO
Community Development INVESTMENT REVIEW 59Fannie Mae Pool Stratification
Interest	Basis	– 30/360 vs. A/360
Amortization	– based on fully amortizing vs. balloon mortgage
Unique	Call	Protection	–  non  yield  maintenance  or  defeasance,  fully  prepayable   
    without penalty, declining prepayment premium
Maturity	– loan terms of 30 or more years
Coupon	Variance	–	for any given pool, the spread between the highest and lowest   
  coupon may not exceed 200 bps
Rhoda Newman, senior account executive of Fannie Mae, said, “CDT’s first securitiza-
tion with Fannie Mae was a milestone. It helped to achieve Fannie Mae’s continued goal to 
support affordable housing and CDT’s goal to expand program activity. With Fannie Mae 
and CDT’s common commitment to affordable housing, we view this as a model for future 
securitized transactions.”
For a more efficient capital market execution, JPMC worked with Fannie Mae to exchange 
the securities into a single bond, FNGT 2004. The bond was divided into two tranches (Class 
A and an I/O class) and sold to four institutional investors (a bank and three insurance 
companies).
Although the entire pool of loans was sold to Fannie Mae, CDT is still responsible for 
ongoing asset management of the securitized loans. Because of the ongoing asset manage-
ment and administrative costs of managing the transaction, CDT will receive an annual 
administration fee. An annual fee is also payable to CDT to compensate for the credit 
enhancement it provided. These amounts were determined by using comparable fees charged 
in similar transactions. 
Key Portfolio Characteristics
The high DCRs and the seasoned nature of the loans, along with the duration and 
geographical and borrower diversification of the pool, resulted in a subordination level or 
guaranty obligation substantially less than the average CDT-retained subordination interests 
on individually syndicated loans. The reduced subordination level illustrates the benefits of 
completing a pooled transaction. To back its credit enhancement, CDT provided a letter of 
credit to Fannie Mae.
The participation of experienced, quality business partners, coupled with the proficiency 
of CDT’s employees, virtually eliminated the need to engage outside consultants. However, 
CDT did work closely with its independent auditors and outside legal counsel to address 
corporate accounting and legal issues.
1  Class A—senior tranche in which cash flow from principal and interest payments on the underlying mortgage 
loans are used to pay Class A note holders. I/O—(interest only) note holders repaid only from interest payments of 
the underlying mortgage loans.
Community Development INVESTMENT REVIEW 60
FEDERAL RESERVE BANK OF SAN FRANCISCOCollateral Characteristics  
Initial	Balance          $44,918,184
Number	of	Pools          9
Number	of	Loans	         31 
Weighted	Average	Coupon          7.92% 
Weighted	Average	DCR	         1.24x 
Weighted	Average	LTV		        72.7% 
Weighted	Average	Remaining	Maturity	(months)	         203 
Weighted	Average	Remaining	Amortization	(months)	         293 
Weighted	Average	Seasoning	(months)	         30 
Expected	Weighted	Average	Life	(years)          13.31
Geographic Distribution
Texas          25%
Pennsylvania          23%
California          22%
Wisconsin          11%
South	Carolina          5%
Connecticut          5%
Louisiana          4%
Tennessee          3%
Ohio          2%
  Asset Affordability         As % of UPB
LIHTC       88%
Non-LIHTC/Other	affordable	program        12%
FEDERAL RESERVE BANK OF SAN FRANCISCO
Community Development INVESTMENT REVIEW 61The Securitization Process
The securitization was one of CDT’s most complex fixed-income transactions to date. 
Despite the complexity, CDT was able to complete the entire process within ninety days. 
This is a significant achievement for a first-time issuer. The chart below summarizes the 
process step-by-step.
Midland Loan Services, Inc. (MLS), a Fannie Mae approved servicer, was the current 
servicer for a large portion of the loans in the portfolio. Fannie Mae’s agreement stipulated 
that the entire mortgage pool be serviced by a Fannie Mae–approved servicer. As a result, 
CDT transferred all of the non-MLS servicing rights to MLS. This step was specific to this 
transaction and unnecessary for most newly originated CMBS deals.
Due Diligence
The aggressive time line was achieved largely because of the quality of information and 
CDT’s rapid response time in providing the required due diligence items to Fannie Mae and 
JPMC.
Sample List of Required Due Diligence Documentation
  Promissory Note           Legal Opinion
  Deed of Trust/Mortgage           Partnership/Operating Agreements 
  Title                 Inspection Reports 
  Survey           Environmental Reports 
  Endorsements          Property Financials 
  Assignment Documents    Rent Rolls
  Reserve Agreements           Loan Agreements 
  Management Agreement           Regulatory Agreements 
  Certificate of Borrower   Appraisal/Market Study 
CDT submitted much of the material electronically. Individual loan files were indexed and 
scanned into portable document format (PDF) and then transferred to compact disks. Rather 
than sift through stacks of hard copies, the electronic format made the review, retrieval, and 
forwarding of information much more manageable. Through this strategy, the due diligence 
time frame was reduced by at least three to six weeks. 
CDT- 
Information  
Gathering
Fannie Mae 
Due  
Diligence
Modeling &  
Structural 
Analysis
Auditing/ 
Data  
Verification
Prospectus 
& Servicing 
Document 
Preparation
Pricing 
Issuance
Community Development INVESTMENT REVIEW 62
FEDERAL RESERVE BANK OF SAN FRANCISCOConclusion
The transaction was a milestone for CDT as well as for the entire community develop-
ment industry.
CDT Community Development Finance Industry
  Increased forward commitment 
  capacity with the Fund        
  Created a model for future  
  securitized transactions
  Reduced credit and interest rate 
   exposure by selling subordinate  
  interests and warehoused  
  whole loans
  Validated that smaller LIHTC whole  
  loans could be securitized as AAA    
  securities and sold for a premium
  Created an income stream to cover  
  ongoing administrative expenses and  
  guarantee fees
  Illustrates the value of high quality  
  affordable housing mortgages
The fixed costs associated with MBS issuance will continue to provide challenges to 
the community development finance industry. These extremely high costs can be a barrier 
to entering the MBS market, and intermediaries often lack the ability to generate the loan 
volume needed for an efficient execution. The industry will continue to look to GSEs 
to design new programs and develop innovative strategies such as the Fannie Mae MBS 
program. The MBS market has slowly expanded to include community development assets, 
and CDT looks forward to continuing to work with experienced partners such as Fannie Mae 
and JPMorgan Chase to create liquidity for community development finance investments.
Judd Levy is the founder, President, and CEO of CDT, and has been a leader in affordable housing 
for thirty years, including serving as Deputy Director at the New Jersey Mortgage Finance Agency and 
heading Merrill Lynch’s Housing Finance Department for ten years.
Kenya Purnell  is an acquisitions associate in CDT’s Equity department. Prior to joining CDT in 
2003, Ms. Purnell was an investment banking analyst with the Fixed Income Capital Markets team 
at JPMorgan Chase.
FEDERAL RESERVE BANK OF SAN FRANCISCO
Community Development INVESTMENT REVIEW 63

Case study: The Community Development Trust taps Wall Street investors

http://www.frbsf.org/publications/community/review/062006/levy.pdf

Case study: The Community Development Trust taps Wall Street investors

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