Worsening Credit, Financial Crises Compound Problems for LIHTC Market
By Caitlin Jones & A. J. Johnson
8 min read
The worsening credit crisis from late September into October has created new difficulties for the already battered low-income housing tax credit (LIHTC) market.
“On the lending side of the equation for all [LIHTC] deals…the real problem is liquidity,” said multifamily mortgage lender Cathy Pharis, of Deutsche Bank Berkshire Mortgage, Inc., Bethesda, MD, on 10/14/08 at a Washington, DC conference of the National Leased Housing Association. She spoke on a panel with LIHTC syndicator Mark Sween, of The Richman Group, based in Greenwich, CT, who said liquidity is also the biggest issue today on the equity side for LIHTC deals.
“Pricing for equity is down and construction loan rates are up, at best,” added Washington, DC attorney Scott Fireison, a partner in the law firm Pepper Hamilton LLP.
Sween said the drastic curtailment since last November in new LIHTC investment by Fannie Mae, Freddie Mac, and some major financial institutions has resulted in a much smaller pot of equity available for new credit projects, and has depressed credit prices to developers while significantly boosting yields to investors. He noted the typical after-tax yield to investors last November was around 5.4%. “Today,” he said, “that pricing is at about 8, and in all likelihood one would expect it to rise.”
Major LIHTC investors still active have their pick of new LIHTC product to invest in, and some are ramping up their volume. Noted corporate investor Patrick Nash, of JPMorgan Capital Corporation, “We’ve been active in “˜08 and have plans to be active in “˜09 as well.” He expected the firm, a consistent investor in LIHTCs since 1994, to set an annual volume record in 2008 from investments in housing credit deals directly, and through proprietary funds and multi-investor funds managed by syndicators.
Growing Turmoil, Volatility
The LIHTC market was rocked in September and October by the global financial and credit crisis, which triggered volatility in financial markets and featured the collapse, federal rescue, or hurried sale of Bear Stearns, Lehman Bros., Merrill Lynch, Wachovia, Washington Mutual, and American International Group, and the conversion of investment banks Goldman Sachs and Morgan Stanley to commercial banks. Many of these firms had ties in one or more ways to the LIHTC market – as investors, lenders, etc.
Compounding the problems for the LIHTC market was a “freeze” in the credit markets in late September and early October, during which banks became reluctant to make loans to each other or new loans generally. This freeze and market volatility appeared to subside somewhat, largely due to the enactment of the financial rescue law and various steps by Treasury and the Fed to try to shore up the financial system and restore market and consumer confidence.
Debt Situation
But liquidity is still a problem for LIHTC projects.
“A lot of the traditional mortgage investors [for loans on affordable rental housing projects] are just sitting on the sidelines,” said Pharis, whose firm originates HUD-insured, Fannie Mae, and Freddie Mac loans for affordable multifamily projects. This has constricted the supply of funds for new multifamily loans, especially construction lending, indicated Pharis, who noted Deutsche Bank is still originating mortgages for multifamily projects, including those with LIHTCs.
She said Fannie Mae and Freddie Mac are “still very active and still doing well” – confirmed by those companies’ officials at an October convention in California – and that multifamily mortgages insured by the U.S. Department of Housing and Urban Development (HUD) are being made. But Pharis noted there’s no interest any more by investors in HUD “insurance upon completion” LIHTC deals; that it’s getting very difficult to get waivers for Fannie and Freddie deals; that certain fees (e.g., guaranty, servicing) have increased; and that pricing for liquidity facilities – purchased to hedge risk on variable-rate demand bonds – “has gone through the roof.” She noted, “There is no market for floating-rate bonds right now.”
Pharis also reported that spreads over key index rates used to determine interest rates on new multifamily mortgages and on tax-exempt housing bonds have widened, thereby boosting borrowing costs.
The use of tax-exempt short-term variable-rate bonds paired with the purchase of a “swap” to convert the interest rate to a synthetic fixed rate has been a popular way in recent years to finance many LIHTC projects because of the reduced borrowing rate. These bonds typically have weekly adjustment of interest rates that occur when the bonds are “remarketed” to investors, and have a liquidity facility that can be drawn on to buy the remarketed bonds if no others are interested.
Several sources noted it has become difficult to find buyers for such bonds in recent weeks, for various reasons, and that those successfully remarketed have often been remarketed at much higher interest rates.
Investment and merchant banker John Rucker III, of Merchant Capital, Montgomery, AL, told the Tax Credit Advisor on 10/10/08 he was still working on a few Freddie Mac and Fannie Mae credit enhanced variable-rate tax-exempt bond deals with a rate swap for LIHITC projects, trying to rush them to market. “On most of these deals…we’re having trouble with our construction lenders,” he said. “Because in a Freddie Mac or a Fannie Mae scenario, you need a construction lender or a bank letter of credit, and that’s causing some of these deals to be challenged.” He said some banks are still willing to provide letters, but only under terms borrowers “are concerned about,” such as extra guarantees not required in the past.
Sources said especially challenged are variable-rate bond deals with regional bank letters of credit (LOC), or outstanding variable-rate bond issues that have interest rate caps or swaps from Lehman Brothers. Rucker said his firm has been “shoring” up some variable-rate bond deals by trying to replace the regional bank LOC with a Federal Home Loan Bank guarantee.
Rucker said there’s no market currently for fixed-rate tax-exempt multifamily bond issues.
Austin, TX lender Ginger McGuire, of Lancaster Pollard, noted it’s become difficult to originate new USDA Section 515 guaranteed multifamily mortgages because the Applicable Federal Rate (AFR) – the interest rate on the first $1.5 million of loan amount – has fallen so low (4.23% in October). The result, she said, is few investors want to buy the low-yield Ginnie Mae or Fannie Mae securities that would be produced from packaging such 538 loans. “We’re working on some creative solutions now and trying to come up with a fix for that situation,” said McGuire. She noted her firm is still accepting applications for 538 loans, originating various HUD-insured multifamily mortgages, but has had a “number” of loan closings postponed.
Boston CPA John Mackey, of Reznick Group, an accounting and consulting firm, said finding debt for LIHTC projects in many cases has become “as big a problem” as finding equity. “It’s not that you have to solve one problem on the equity side; it’s that you have to solve both problems often.” He added, “If you can get the permanent under normal terms, you can generally get the construction, but you may have to look harder.”
Developer Experiences
LIHTC developers reported various levels of difficulty in the current market.
“We have four projects that we’re seeking both historic and low-income credits on,” said Garrison Hassenflu, of Kansas City, MO-based Garrison Development Company. “We have one where we have the debt lined up, but not equity,” he noted. “And then we have three where we have to line up the debt and equity.” The projects are in: Pittsburg, KS (49 units); Coffeyville, KS (40); Omaha, NE (105); and Fargo, ND (36).
Hassenflu said his “real struggle” has been finding equity, more than debt. He noted his firm has obtained equity exclusively from syndicators in the past, but is now seeking out more bank community development corporations to try to place the equity directly with them. Hassenflu said debt traditionally has come from conventional mortgages from local banks, with some use of national banks and tax-exempt financing. He said he’d approached a few banks recently for debt, but “once again, unless they have CRA needs, and with all the turmoil in the market and uncertainty, they haven’t been aggressive in providing us any commitment letters.”
Rob McCready, of St. Paul-MN based MetroPlains, LLC, now developing multiple LIHTC projects in six Midwestern states, said “the choices have narrowed” in number of potential equity sources for a new project, but that his firm hasn’t had difficulty in finding debt. But he noted that, in general, construction lenders are “being more conservative in making the money available.” Of his firm’s two current LIHTC projects in the financing stage, both in Wisconsin with credit awards, McCready said one will use a conventional permanent mortgage with 30-year amortization period; the other, just equity and gap financing and no permanent debt.
McCready noted deals today must meet various stricter parameters to interest syndicators: developer experience; conservative underwriting for sources/uses and operating budget; simple deal structure; CRA need; and deal size. On the debt side, he said lenders now require equity closings prior to funding.
