The Maryland Housing Fund

THE MARYLAND HOUSING FUND

ANNUAL REPORT: FISCAL YEAR 2006

A Report to the Maryland General Assembly

November, 2006

Maryland Department of Housing and Community Development

100 Community Place

Crownsville, Maryland21032-2023

(410) 514-7325

1- 800-756-0119, ext. 7325

Robert L. Ehrlich, Jr., Governor

Michael S. Steele, Lieutenant Governor

Shawn S. Karimian, Acting Secretary

The Maryland Department of Housing and Community Development (DHCD) pledges to foster the letter and spirit of the law for achieving equal housing opportunity in Maryland.

Table of Contents

TABLE OF CONTENTS1

EXECUTIVE SUMMARY2

1.0THE MHF INSURANCE PROGRAM4

2.0 MANAGEMENT’S PRESENTATION OF THE MHF PROGRAM4

2.1FINANCIAL STATEMENTS AND INFORMATION5

2.2OPERATING INCOME AND RESERVES5

2.3BALANCE SHEET DISCUSSION5

2.4DISCUSSION OF CHANGES IN NET ASSETS6

3.0DISCUSSION OF OPERATING CASH ACCOUNT6

3.1SELECTED ACTIVITY IN MHF’S OPERATING CASH ACCOUNT6

3.2LIQUIDITY7

3.3DISCUSSION OF LEVERAGE RATIOS7

3.4SELECTED INFORMATION ABOUT THE SINGLE FAMILY RESERVE RATIOS 8

3.5SELECTED INFORMATION ABOUT THE MULTI-FAMILY RESERVE RATIOS 9

4.0SINGLEFAMILY INFORMATION 9

4.1CERTAIN ADDITIONAL EXPECTED SINGLE FAMILY CLAIMS 9

4.2DISCUSSION OF SINGLE FAMILY OPERATIONS 9

4.3SINGLE FAMILY CLAIMS EXPERIENCE 10

4.4SINGLE FAMILY INSURANCE AGREEMENTS 10

4.5TERMS OF SINGLE FAMILY INSURANCE COVERAGE 10

5.0MULTI-FAMILY INFORMATION 12

5.1MULTI-FAMILY INSURANCE IN FORCE AND AVAILABLE RESERVES 12

5.2OUTSTANDING MULTI-FAMILY INSURANCE AS OF JUNE 30, 2006 12

5.3CERTAIN ADDITIONAL EXPECTED MULTI-FAMILY CLAIMS 13

5.4DISCUSSION OF MULTI-FAMILY OPERATIONS 13

5.5MHF’S RISK RATING OF THE MULTI-FAMILY PROJECTS AS OF JUNE 30, 2006 14

5.6MULTI-FAMILY CLAIMS EXPERIENCE 14

6.0ACTUARIAL STUDIES 17

7.0FHLMC REINSURANCE AGREEMENT 18

8.0STAFF 19

9.0ADDITIONAL INFORMATION 20

Appendix-Financial Statements and Independent Auditors’ Report MHF June 30, 2006 & 2005

EXECUTIVE SUMMARY

The Maryland Department of Housing and Community Development (DHCD), pursuant to its statutory requirements, is pleased to present the Maryland Housing Fund Fiscal Year 2006 Annual Report to the Maryland General Assembly. Additional information about the operations of the Maryland Housing Fund (MHF) for fiscal years 2006 and 2005 is also included.

MHF is a program within the Division of Credit Assurance, an operating division within DHCD. It is the oldest, and one of the largest, state-sponsored mortgage insurance funds in the United States. However, it is the only one of its peer programs to be operated within a line cabinet agency of state government. MHF provides mortgage insurance primarily for the Community Development Administration’s (Administration) tax exempt revenue bond mortgages. The Administration is a division within DHCD that issues revenue bonds to raise capital used to make below market interest rate mortgages. The Administration’s revenue bonds are typically rated by two credit rating agencies. The rating agencies continue to affirm the Administration’s “Double A” bond rating; and the Administration continues to be an active issuer of mortgage revenue bonds.

In early 1997, the Department suspended all new insurance activity of MHF (except for pool insurance on certain single family loans). Since that time, MHF has opened new, but limited, programs.

In 2002, the Department reopened a limited multi-family program of MHF insuring mortgage loans known as “SHOP” (Special Housing Opportunity Program) that finance or refinance the acquisition, construction, or rehabilitation of shared living and related facilities for the special needs population, which are owned by and sponsored by nonprofit organizations. In 2004, the Department expanded its MHF insurance program to authorize MHF insurance on a case by case basis for new multi-family loans financed by bonds, including loans with Credit Enhancement under the HUD Risk Sharing Program.

In June, 2005, the Department opened a program of MHF to insure 40-year single family mortgage loans being purchased by the Administration.

In June, 2006 the Department authorized the expenditure of up to $1 million of the Revitalization Reserves to provide credit enhancement to a loan program that is sponsored by a nonprofit corporation, which is intended to stabilize and strengthen property values in targeted areas of the City of Baltimore.

MHF’s audited financial statements for fiscal year 2006 show a continuation of positive performance. There is continued improvement of the loan portfolio due to increased recovery rates on Real Estate Owned (REO), reduced single family delinquencies, and the continued health of the multi-family portfolio, which still shows no MHF insured loans in financial or physical default. Fiscal Year 2006 showed a net income of $6.7 million, as compared to $5.5 million for Fiscal Year 2005, both primarily due to allowance reductions in both the single family and multi-family portfolios.

The audited financial statements for Fiscal Year 2006 are attached as an appendix to this report. MHF reports its financial condition on a consolidated basis, combining operational results for Multi-Family, Single Family, Revitalization, and Home and Energy mortgage insurance programs. Insurance claims are payable only from each program’s respective reserves, MHF operating funds, and Unallocated Reserves. Other funds, assets, or reserves of MHF that may be described in the financial statements, as well as the general financial resources of the Administration, DHCD or the State of Maryland, are not available to pay claims resulting from the insurance obligations of MHF. As of June 30, 2006, MHF had primary insurance commitments on mortgages for approximately $147.6 million and $126.1 million, respectively, under its single family and multi-family insurance programs. In addition to the primary insurance, MHF has $203.5 million in outstanding single family pool insurance coverage.

MHF's insurance obligations extend only to the mortgages it insures and not to the underlying bond obligations of the Administration orother local issuers. DHCD is required to file official statements and other reports with the Nationally Recognized Municipal SecuritiesInformation Repository (NRMSIR) pursuant to undertakings to comply with Rule 15c2-12 of the Securities and Exchanges Commission. Potential purchasers or sellers of the Administration's bonds should refer to such information with this report (including more recent informationabout MHF). For additional information on the operations of MHF, please contact:

George Eaton, Director

Maryland Housing Fund

Maryland Department of Housing and Community Development

100 Community Place

Crownsville, Maryland21032-2023

(410) 514 - 7348

1.0 THE MHF INSURANCE PROGRAM

The following describes the mortgage insurance programs administered by the MHF pursuant to Section 3-201 through 3-208 of the Housing and Community Development Article of the Annotated Code of Maryland, as amended (the "MHF Statute"), and is qualified in its entirety by reference to such statute and the regulations thereunder (the “MHF Regulations”).

MHF was created in 1971 as a special insurance fund of the State of Maryland and is a programin the Division of Credit Assurance of the Department (the “Division”). MHF is authorized to insure mortgage loans, including mortgage loans for multi-family developments financed by public agencies such as the Administration and to provide primary and pool insurance for single family mortgage loans. MHF insures against certain monetary losses incurred as a result of nonpayment of principal, interest or other sums agreed to be paid and certain other events of default under the terms of any insured mortgage loan but does not insure against property losses, including without limitation, title risk, risks of defective construction or casualty, or any other reduction in project value due to insurable risk or force majeure, casualty or title loss.

In early 1997, the Department suspended all new insurance activity of MHF (except for pool insurance for certain single family loans), partly as a result of concerns expressed by Moody’s during 1996 and 1997. The Department responded to the concerns and took appropriate steps. Since that time, MHF has opened new programs.

In 2002, the Department re-opened a limited program of MHF insuring mortgage loans known as “SHOP” (Special Housing Opportunity Program) that finance or refinance the acquisition, construction or rehabilitation of shared living and related facilities for the special needs population which are owned by and sponsored by nonprofit organizations. Moody’s advised the Administration that such a re-opened program, implemented in the limited manner proposed by the Administration, would not affect the Moody’s rating on the Administration’s Bonds.

The Administration has been designated as a participant in HUD’s Risk-Sharing Program (the "Risk-Sharing Program") for multi-family loans. Under the Risk-Sharing Program, upon payment of a claim by FHA, the Administration would be responsible for reimbursement to FHA of up to 50% of such claim. The Administration expects that MHF would reimburse the Administration for its share of such losses. Subsequent to 1997, the Administration participated in the Risk-Sharing Program only in connection with the refinancing of loans currently insured by MHF where the Administration expected that risk-sharing will decrease the dollar amount of MHF’s insurance exposure with respect to such loans. In 2004, the Department expanded its MHF insurance program to authorize MHF insurance on a case-by-case basis for new loans financed by Bonds, including loans with Credit Enhancement under the Risk-Sharing Program. Moody’s advised the Administration that such a re-opened program, implemented in the limited manner proposed by the Administration, would not affect Moody’s rating on the Administration’s Bonds.

In June, 2005, the Department opened a program of MHF to insure 40-year single family mortgage loans being purchased by the Administration.

2.0 Management’s Presentation of the MHF Program

The following information is management’s presentation of the MHF Program.

2.1 Financial Statements and Information

Audited financial statements of MHF for the years ended June 30, 2006 and June 30, 2005 are included in the Appendix to this report– "FINANCIAL STATEMENTS OF THE MARYLAND HOUSING FUND." The financial statements for the fiscal years ended June 30, 2006 and June 30, 2005 have been audited by Reznick Group, P.C. As indicated in the report of the auditors, such financial statements have been prepared in conformity with accounting principles and the audits conducted in accordance with auditing standards generally accepted in the United States. The financial statements of MHF are reported on a consolidated basis combining results of operations for MHF’s MultiFamily, Single Family, Revitalization, and Home and Energy Mortgage Insurance Programs.

2.2 Operating Income and Reserves

MHF’s operating income from insurance premiums is used to pay operating expenses and also may be used to pay insurance claims.

MHF maintains five insurance reserves, which are separate from MHF’s operating funds. Four of the reserves cover specific categories of insurance: the Multi-Family Reserve, the Single Family Regular Program Reserve, the Revitalization Reserve, and the Home and Energy Loan Reserve. The investment earnings on each of the four specific reserves are credited to a fifth reserve, the Unallocated Reserve, which may be used to pay claims on all categories of insurance, may be transferred into any other reserve, or may be restricted for claims under a particular category. The Unallocated Reserve is available for any category of claims or for any other purpose consistent with contractual obligations with the Administration's bondholders.

The MHF Statute provides that any moneys of MHF that the Department creates as an identifiable insurance reserve may be used only in conformance with the terms and conditions creating that reserve. MHF Regulations provide that each reserve is maintained to pay claims arising from its respective category of insurance and may not be subject to claims arising from other categories of insurance (except for the Unallocated Reserve, and except for claims arising from single family regular and revitalization insurance issued before August 20, 1975, which claims are payable from all MHF insurance reserves). The reserves are held by the Office of the Treasurer of the State, which credits MHF with income on investment of reserves for the benefit of MHF.

MHF does not insure the Bonds, and the assets of MHF are not available to the Administration or the Trustee to satisfy obligations to holders of the Bonds. The obligation of MHF is limited to the payment of mortgage insurance claims as described herein. An insurance claim against MHF is payable from and limited to the applicable MHF reserve and does not constitute a general obligation of MHF, the Department, or the State.

2.3 Balance Sheet Discussion

During the fiscal year ended June 30, 2005, the overall equity increased from $86,361,339 at the close of June 30, 2004 to $91,884,940 at June 30, 2005. The increase of $5,523,601 is primarily due to allowance reductions in both the single family and multi-family portfolios. Duringfiscal year ended June 30, 2006, the overall equity increased from $91,884,940 at June 30, 2005to $98,559,409 at June 30, 2006. The increase of $6,674,469 is primarily due to an increase in the interest income on investments.

The Unrestricted Accumulated Deficit is a part of the overall equity. The Unrestricted Accumulated Deficit - which decreases when claims are paid from the insurance reserves - represents the cumulative net income (loss) of MHF since its inception less any investment income earned on the insurance reserves. When MHF’s insurance reserves are greater than its net assets, there will be an accumulated deficit in the equity section of the MHF Statement of Net Assets.

During the fiscal year ended June 30, 2005, the Unrestricted Accumulated Deficit decreased by an additional $3,323,723 to a deficit of $6,403,765 at the close of June 30, 2005. The $3,323,723 is a net gain of income from operating activities (income net of interest earned on investments held by the State Treasurer). During the fiscal year ended June 30, 2006, the Unrestricted Accumulated Deficit decreased from a deficit of $6,403,765 to a deficit of $3,829,079. This was due to a $2,574,686 netgain of income from operating activities (income net of interest earned on investments held by the State Treasurer).

2.4 Discussion of Changes in Net Assets

During the fiscal year ended June 30, 2005, MHF reported a Change in Net Assets of $5,523,601. The improved performance for the period was primarily due to reductions in both the single and multi-family allowances. Investment earnings for the fiscal year ended June 30, 2005, in the amount of $2,199,878 flowed directly to the Unallocated Reserves.

During the fiscal year ended June 30, 2006, MHF reported a Change in Net Assets of $6,674,469. The improved performance for the period was primarily due to an increase in the interest income on investments. Investment earnings for the fiscal year ended June 30, 2006 in the amount of $4,099,783 flowed directly to the Unallocated Reserves.

As described below in "Single Family Information – Certain Additional Expected Single Family Claims" and "Multi-Family Information – Certain Additional Expected Multi-Family Claims," the Administration has notified MHF of defaults under insured mortgages that were expected to result in additional claims to MHF. Payment of these claims is not reflected in MHF’s Statement of Net Assets; however, MHF included provisions for these claims in its allowance for unpaid insurance losses.

3.0 Discussion of Operating Cash Account

3.1 Selected Activity in MHF’s Operating Cash Account

The following table is management’s presentation of activity in MHF’s operating cash account as of June 30, 2006.

Single Family / Multi-Family / Total
Premiums Collected (1) / $968,147 / $905,300 / $1,873,447
Operating Expenses Paid (2) / (1,157,190) / (1,735,784) / (2,892,974)
Premiums Net of Operating Expenses / (189,043) / (830,484) / (1,019,527)
Claims (3) / (2,244,200) / (26,213) / (2,270,413)
Recoveries (4) / 2,128,948 / 416,052 / 2,545,000
Net Claim Activity / (115,252) / 389,839 / 274,587
Other (5) / 2,555 / 8,485 / 11,040
Net Cash from Operating Activities / ($301,740) / ($432,160) / ($733,900)

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(1) Premiums collected as stated in the Statement of Cash Flows.

(2) Operating expenses include salaries and benefits, general and administrative, and intradepartmental expenses.

(3) Includes principal, interest, and supplemental expenses incurred on claims, and carrying costs on acquired properties.

(4) Includes proceeds collected on the sale of loans or acquired properties.

(5) Includes changes in other assets and liabilities such as mortgage receivables, notes payables and escrows.

During the fiscal year ended June 30, 2005, MHF’s net operating cash activity was $1,088,662 for Single Family and ($88,949) for Multi-Family. The change in Single Family and MultiFamily was primarily due to a decrease inclaims paid and decrease in recoveries received,respectively. During the fiscal year ended June 30, 2006, the net cash activity in MHF’s operating cash was ($301,740) for Single Family and ($432,160) for Multi-Family. The change in Single Family and Multi-Family was primarily due to adecrease in recoveries.

3.2 Liquidity

MHF’s primary uses of funds are to pay its operating expenses (direct and indirect) and to satisfy multi-family and single family claims under its insurance policies resulting from a loan default (payment or physical) by an insured borrower. In general, MHF’s insurance policies require MHF to pay claims to the lender, which includes the total principal outstanding, interest in arrears (through foreclosure), and other expenses associated with a failed real estate loan (e.g., foreclosure costs, negative escrows, etc.). MHF generally acquires a loan or property with the payment of the claim. The proceeds of the sale of this asset are deducted from the original claim to derive the net loss (or net gain) associated with the defaulted loan claim.

Besides these proceeds from the sale of assets acquired through the payment of claims, MHF’s primary sources of funds result from mortgage insurance premiums paid by the borrowers and investment earnings on funds in insurance reserves. These assets, together with the corpus of the reserves held by MHF, are available to pay insurance claims and related expenses. The available reserves are leveraged against insurance commitments outstanding. Calculations for the leverage ratios are shown in "Discussion of Leverage Ratios" below.

To manage MHF’s resources effectively from both a business and liquidity sense, the management of MHF has developed several claims paying strategies. For multi-family defaulted loans, MHF pays debt service claims after a loan has missed a total of six monthly payments. These claim payments represent any unpaid principal and interest due from the regular scheduled payment. While making these monthly payments, MHF, working with the Administration, attempts to workout the loan in order to minimize its loss. When the final workout of the loan is completed, MHF either pays a partial claim or pays the full claim. A workout may be accomplished through (a) refinancing of the loan after re-underwriting the debt to enable the project to meet debt service from net operating income or (b) payment of claims and resale of the asset to minimize the total size of the claim.