Over the next few months, approximately $3 billion in single-family residential mortgage revenue bonds will be issued by various states, county and city housing authorities. These bonds are tax exempt, and because Congress is writing a law restricting their issuance, they may be the last single-family bonds as we know them.
These bonds generally are rated single-A or double-A by the rating services and offer more yield to investors than comparable tax-exempts. Because the next few months will offer good buying opportunities, pertinent aspects of these complex issues will be pointed out.
The bonds are issued to finance mortgages on single-family dwellings. Generally, an authority sells the bonds and turns the proceeds over to lending institutions, which then make low-interest mortgage loans to specified (as to income and cost of housing) borrowers. The borrowers' repayment of the principal and interest on the mortgages constitutes the security on the bonds purchased by investors.
This repayment of principal and interest (cash flow) goes to pay off the bonds at maturity (debt service). Consequently it is very important first that the quality of the mortgages portfolio be maintained and, second, that a steady cash-flow stream is available to pay off maturing bonds.
One key factor, therefore, is having a competent program administrator to see that the lending institutions are adhering to standards and to keep tight control on the cash flow.
Another key factor is prepayments of mortgages, especially if interest rates decline sharply. Certain authorities can relend the money in other mortgages or invest in Treasury securities. This flexibility is important to ensure the steady cash flow for debt service.
Mortgages may be insured by the FHA or VA. This government insurance helps the issuer obtain a good rating, but delays in settling claims can be lengthy and can affect the cash flow. Private insurance covers a smaller percentage of the mortgages, but their collection of claims is much quicker and their lending standards are higher, which leads to fewer defaults and delinquency payments. Thus cash flow is usually better.
Next, various types of reserves are capitalized from the sale of the bond issue and set up to aid in the debt-service payment in case the cash flow is insufficient. Usually a capital reserve fund and a mortgage reserve fund are established in all issues. Only the percentage set aside in each varies from issue to issue. These reserve funds may be invested to generate more income for the program.
Also important is the genuine need for the mortgage money in a particular area. This will be found in an economically viable area that is progressing and not stagnant.
Lastly, although there are many types of issuers of single-family residential mortgage revenue bonds -- namely counties, cities and states -- your best bet will be to stay with the state housing agencies. This is true because of the state governments who in no way want any of their debt-issuing bodies to develop a bad credit reputation.
This is not to say that city and county single-family residential mortgage revenue bonds aren't viable. However, they are more complex, and some are poorly conceived both as to actual need and structure.
If you look at these bonds, especially those issued by cities and counties, check with the salesman to ensure that the typical security requirements are structured in the bond.
Certain brokerage firms such as E. F. Hutton, and Prescott, Ball and Turben make studies on various issues of these bonds available through their sales force.