The Federal Deposit Insurance Corporation (“FDIC”) has publicly disclosed that it plans to sell $33 billion of mortgage facilities generally in two tranches. A total of 14 loan pools are being offered in 12 Joint Venture (“JV”) transactions open to all bidders and 2 all cash outright sales to FDIC insured institutions. The FDIC further stated that in the JV sales, the agency will retain a majority ownership stake in the JV. The FDIC will keep control of the JVs, and buyers will act as managing partners, in charge of servicing and ultimately the disposition of the loans by workout or sale. The pools will apparently include approximately $15 billion of mortgages secured by rent-stabilized apartment buildings. However, the exact composition of the pools and the overlap of rent stabilized and “market rate” collateralized buildings in the pools are not known at this time.
The FDIC’s announcement also cited its “statutory obligation … to maximize the preservation of the availability and affordability” of homes for low and moderate-income tenants, which suggests that JV partners may have limited options regarding disposition of the loans and the underlying building collateral. It has been reported that an FDIC spokesperson said the FDIC’s majority stake would not prevent a JV partner from “using any disposition strategy appropriate for the asset, including foreclosure.” However, the FDIC press release also noted that buyers will be subject to the terms of a JV operating agreement, the form and substance of which has not yet been publicly disclosed.
Bifurcating the loans based on whether the underlying collateral is “rent-stabilized” or “market rate” is an apparent admission by the FDIC that loans secured by rent-stabilized apartment buildings have materially reduced market valuations. The FDIC seems to have decided to put the rent-stabilized collateralized loans into one sale basket and thereby maximize the cash sales price for “market rate” collateralized loans. On its face, that seems to be a rational marketing strategy as it recognizes that the Housing Stability and Tenant Protection Act of 2019 (“HSTPA”) eliminated virtually all avenues to increase rent-stabilized building rent rolls, apart from the annual New York City Rent Guidelines Board (“RGB”) rent increase orders. Those annual RGB orders permit a specified annual percentage rent increase for vacancy and renewal leases. There is widespread acknowledgment that the annual RGB percentage rent increases trail actual operating expense increases, with the result that rent stabilized building operating margins will continuously narrow. The FDIC’s marketing plan suggests that the HSTPA is having this effect, and in response, the FDIC appears to have opted to largely segregate the rent-stabilized building collateralized loans.
Segregating the rent-stabilized loan pools and proposing JV interests may address the current risk profile of those loans, but there are additional pending rent regulation issues which could compound the HSTPA’s effects and further complicate assessing loan pool valuations as part of the bidding process. In June 2023, the NYS legislature passed additional punitive rent regulation bills (S2943B/A4047B and S2980C/A6216B; “the Bills”) which would modify the statutes that govern rent stabilized apartment rents. The Bills have not yet been delivered to Governor Hochul for signature. To date, the Governor has not publicly stated whether, if the Bills are sent to her desk, she would sign or veto them. Even if the Bills are vetoed, there are technically veto-proof supermajorities in the State Assembly and Senate which can override the Governor’s veto; however, a supermajority did not vote for either of the Bills. Moreover, DHCR’s proposed amendments to the Rent Stabilization Code (DHCR’s rent regulations) seek to impose similar draconian rent reduction risks even without the statutory changes in the Bills. The pending Rent Stabilization Code amendments and Legislature Bills would enact significant changes that could materially reduce rents by deeming virtually any mistaken rent calculation a “fraud” and, as a consequence, impose harsh — and permanent — rent reduction penalties. If these Bills and/or the proposed Rent Stabilization Code amendments become law and create further risk that is difficult to quantify, bidders may be confronted with rent-stabilized building collateralized loans which defy valuation at any reliable price.
Additionally, the FDIC’s decision to bifurcate the loan pools order to enhance the sales price of the “market rate” loans may be mere semantics, describing distinctions without legal differences. While we do not yet know the loans which make up the 14 pools in the two tranches, the buildings which have been designated as “market rate” may in fact contain apartments that were made subject to rent stabilization jurisdiction by the Emergency Tenant Protection Act of 1974 or by virtue of the receipt of tax benefits such as Real Property Tax Law Section 421-a. Those “market rate” apartments rely on having been deregulated from rent stabilization jurisdiction as specified by the governing statutes. Ultimately, the burden of proof is on the property owner/borrower to prove that the apartments have been lawfully deregulated and are no longer subject to rent stabilization; the FDIC’s designation of “market rate” and “rent stabilized” buildings does not change their true regulatory status under New York law. The HSTPA and pending statutory amendments in the Bills impose the same qualitative risks to proving the exempt status of the “market rate” apartments as they do establish the legal rents for rent-stabilized apartments. Put simply, “market rate” apartments are only truly market rate when the owner proves their exempt status based on permanent deregulation.
Comprehensively assessing all of these rent regulation issues in formulating a loan pool bid is critical. For example, the loans have passed through FDIC’s seizure of Signature Bank, and even if there are future FDIC sanctioned foreclosures of the collateralized buildings, those events may not constitute an exemption from the rent stabilization coverage based on authorities such as the New York State Court of Appeals decision in Fed. Home Loan Mortgage Corp. v. New York State Div. of Housing and Comm. Renewal, 87 N.Y.2d 325, 662 N.E.2d 773, 639 N.Y.S.2d 293 (1995).
Careful examination of the facts and circumstances of the collateralized building rent rolls and all due diligence materials that Signature Bank accumulated in making the loans is critical to bidders making informed decisions. We at Rosenberg & Estis, P.C. are available to advise and assist your bid analysis by applying our rent regulation expertise that has been successfully developed over decades of real-world experience.
If you have any questions, please feel free to contact your trusted Rosenberg & Estis, P.C. attorney or Zachary J. Rothken, Head of the firm’s Administrative Law Department, or Nicholas Kamillatos, Member with the Administrative Law Department, who authored the above.