It has been slightly over a year since HUD fully implemented LEAN processing for the Section 232 and related mortgage insurance programs for skilled nursing, assisted living and limited independent living projects. Under LEAN processing, applications for mortgage insurance follow a uniform exhibit and loan underwriting format that a) eliminates redundancies, b) utilizes conventionally-developed appraisals and market analyses, c) incorporates loan closing documents into the application, and c) is designed to be reviewed by a LEAN-trained underwriter in a relatively short period of time. The goal of LEAN processing is to review an application, issue a firm commitment for mortgage insurance, and close the loan within 40 days. How have things worked out so far?

1. LEAN processing produces a decidedly more conservative loan underwriting than HUD’s statutory and regulatory requirements require. Under LEAN, the recommended loan-to-value ratios (LTV) for all projects are 80% for for-profit borrowers and 85% for not-for-profit borrowers. There is an exception for new construction of assisted living projects, which requires a 75% LTV ratio for for-profit borrowers; not-for-profit borrowers are eligible for an 80% LTV. For a not-for-profit to qualify for the 80% or 85% LTV, it must demonstrate a successful operating track record, significant project operating and management experience, and a solid financial track record. By contrast, HUD’s Section 232 regulatory and statutory LTVs range from 90% to 95% for new construction projects and 85% to 90% for existing projects. In addition, LEAN’s recommended debt service coverage ratio (DSC) requirement is 1.45 for all property types. Section 232 regulatory and statutory DSC requirements are range from 1.17 to 1.05. LEAN processing presents a formidable barrier to underwriting to higher LTVs and lower DSCs: in order for a lender to justify a higher LTV or lower DSC, it has to show HUD good cause for the action and demonstrate how the additional risk of a higher loan or lower coverage ratio is mitigated.
2. There have been significant delays in LEAN processing as a result of staffing shortages and greater than anticipated number of applications for HUD-insured financing, which has been driven by the lack of alternatives in the capital marketplace. HUD is trying to increase its staffing, but we do not expect any material change in their personnel situation through the end of the fiscal year ending September 30, 2010.
3. To cope with the higher volume of work – as of March 26, 2010 there were 161 applications in the system and an additional 63 applications assigned to underwriters – LEAN applications are first placed into a “queue”, or holding pattern. As applications are assigned to an underwriter, the others behind move up the queue. However, HUD has created separate “express” lanes that are designed to move less-complicated and/or less-risky proposals more quickly through the queue and to require less time for underwriter review.
4. Through these lanes, HUD has effectively established a priority system; projects that reflect HUD’s current priorities will move through the LEAN system faster, and those that do not will encounter significant time delays. For example, applications for projects that are refinancing existing HUD-insured loans under the Section 223(a)(7) program, and applications for non-HUD projects being bought or refinanced under Section 232/223(f) that meet certain risk-assessment tests move the most quickly through the LEAN system – projects that qualify under the latter go to a designated “green lane” for expedited review, while Section 223(a)(7) projects have a dedicated team of underwriters. We recently closed a $17 million Section 223(a)(7) transaction where the application review and commitment issuance took approximately 30 days.
5. Farther down HUD’s priority list are a) Section 232/223(f) acquisition and refinancing applications that are not eligible for “green lane” consideration, b) Section 232 proposals involving new construction or substantial rehabilitation of existing properties where new units are being added, and c) proposals involving recapitalization of prior operating losses on existing HUD-insured projects or supplemental loan proposals involving renovations of or additions to an existing HUD-insured project. LEAN views new construction in the current economic climate, especially for assisted living projects, as very risky propositions. As of March 26, 2010, LEAN had rejected 27 out of 48 applications for new construction. However, new construction for a replacement facility or for “Medicaid-waiver” assisted living projects, while still down the priority list, are considered less risky, and subject to the underwriting limits described above, can be financed through LEAN.
6. Despite the processing delays and conservative underwriting, the LEAN program has been generally successful to date: through March 26, 2010 of HUD’s fiscal year beginning October 1, 2009, there were 95 LEAN closings, compared to 88 closings a year earlier. However, in a clear indication of HUD’s priorities, 66 of the closings were for Section 232/223(f) transactions and 28 closings were Section 223(a)(7) transactions. There has only been 1 closing for a new construction project this fiscal year.

Sims Mortgage Funding, Inc. has been focusing its origination efforts on projects that meet the higher priority levels. To see where your potential HUD-insured skilled nursing, assisted living and independent living financing may rank in the overall LEAN picture, or to find out more about HUD’s lower-risk, expedited review “green lane” requirements for Section 232/223(f) transactions, please contact Anthony Luzzi.