Affordable Housing Finance

TAX CREDIT EQUITY

Buyer’s Market

AFFORDABLE HOUSING FINANCE • February 2009

LIHTC investors weigh the year ahead

BY DONNA KIMURA

All eyes will be on low-income housing tax credit (LIHTC) investors in 2009. They will hold tremendous influence on what happens in the industry after several prime buyers retreated last year, leaving a huge void in available capital. Some estimate that what has been an $8 billion market fell to about half that size in 2008, which means a significant number of deals may not get done.

That’s distressing because the need for affordable housing is growing and will continue to grow as unemployment rises and the economy stumbles.

The remaining investors have been getting their choice of deals and seeing their yields rise. In December, one investor reported returns in the 9 percent range. Another cautioned that citing one number for yields is too simplistic these days and that returns range widely, at least 200 basis points, between high-demand metros and some secondary and tertiary markets.

Those interviewed said they invested either more in 2008 or at least a similar amount as they did the prior year because of the increased opportunities that emerged in the market. Several reported closing more direct investment deals. With recent mergers and expansions, some banks may also be looking at some new territories to invest in.

Bank of America

Bank of America (BofA) was consistently in the LIHTC market in 2008 and continued to be one of the nation’s largest investors. It expected to finish the year with about $1 billion in new housing tax credit investments.

The bank will remain a market leader in 2009 but has not set any investment goals, says Brian Tracey, tax credit investments executive.

It has invested largely where it has Community Reinvestment Act (CRA) obligations, including California, Florida, Texas, and major cities in the Northeast. BofA’s recent acquisition of LaSalle Bank will also likely mean that it will be looking at more deals in the Chicago area, says Tracey.

He adds that the bank’s LIHTC investments are “client focused,” meaning that many deals are with developers it has worked with in the past. In addition to investing in tax credits, the bank often provides construction or permanent loans.

BofA’s LIHTC portfolio is approximately $6 billion, with more than 4,000 affordable housing developments.

“We’ve always had a very disciplined approach,” Tracey says. “This particular class of assets has a strong history of performance. There is a very low rate of defaults and foreclosures.”

Tracey did not report any big changes to how the bank will underwrite deals in 2009. It will continue to adhere to its established underwriting policies and guidelines, with a focus on developer’s capacity, experience, and financial strength, he says.

Union Bank

The role of regional banks in the LIHTC market may take on increased importance in the coming year after several national investors have retreated.

San Francisco-based Union Bank has been an LIHTC investor for about 15 years. It invested roughly $200 million in 19 projects in 2008, keeping pace with its 2007 levels, says Jim Francis, senior vice president. The recent deals were strong on green features, and many involved the rehabilitation of project-based Sec. 8 developments.

Seventeen of the 19 deals were on a direct-investment basis, primarily with nonprofit housing developers. Union Bank has been largely a direct investor for the last three years.

The bank, previously called Union Bank of California, announced a name change in December to reflect its recent growth. The company operates primarily in California but has branches in Washington and Oregon. As a result, most of its LIHTC investments have been in California, but the firm will look at some deals outside of the state. Francis says he will continue to look for deals in markets with high needs and projects that have strong cash flow. Spiking unemployment rates will also mean that he will be paying attention to property vacancies.

The emergence of regional bank investors will depend on several factors, including their anticipated tax positions, according to Francis. In order to use the tax credits, investors must have profits and tax liability. Another question will be whether a company has the infrastructure in place to take on the role of a LIHTC investor.

JPMorgan Capital Corp. had its best year in terms of production in 2008. The firm exceeded its expectations when more opportunities became available as a result of fewer investors in the market, according to Managing Director Pat Nash. He declined to state how much the firm invested in 2008, but it has become one of the nation’s largest investors.

The majority of JPMorgan’s investments are done on a private-label basis, where it is the sole investor in a fund. The company, which has been drawn to deals in major markets, also participates in a discreet number of direct investments and multi-investor funds.

JPMorgan expects to continue to be an important investor in the new year. Although it has been a national tax credit investor, the recent purchase of Washington Mutual, which has a big presence in the West, will enlarge its footprint, says Bill Pelletier, who manages the firm’s proprietary and direct investment products. Washington Mutual has invested in tax credits in the past but was out of the market in 2008, according to Nash, whose group will oversee WaMu’s significant portfolio.

Nash says he will invest cautiously in 2009 for several reasons. With fewer investors these days, JPMorgan Capital is in a position to separate the strongest LIHTC deals from weaker ones. “We want to make sure that we spend time on the deals that work,” says Nash, who is in line to be president of the Affordable Housing Investors Council this year. “We will make sure they are well structured and well underwritten [to withstand] strains on operations due to the economy.”

The overall economy continues to be a big concern, according to Pelletier. As a result, he will be keeping a close watch on how different regional markets are doing in these stressful times. “Some locales may be more challenged than others,” he says.

The struggling economy also means that the health of the different tax credit partners, including developers and syndicators, becomes an increased concern.

U.S. Bancorp CDC

“My sense is that the investors who are in the market are investing more but not enough to make up the gap created by those who have left,” says Beth Stohr, president of U.S. Bancorp Community Development Corp. (CDC).

U.S. Bancorp CDC invested more in 2008 than the year before, largely because it increased its direct investment activities while still participating in a few multi-investor funds. The bank’s direct investments grew by roughly 50 percent from the prior year.

Stohr expects her group to remain an active investor in 2009. She hopes the investment volume will be about the same as the past year. The bank invests in its CRA footprint, which stretches across 24 states. “It continues to be a strong product,” she says. U.S. Bank has invested close to $3 billion in LIHTCs over the years.

Stohr says her team will not change the way it has looked at deals, but there will be an even greater focus on deal sustainability and mitigating any issues.

Key CDC

Key Community Development Corp., a subsidiary of KeyBank, increased its LIHTC investment by approximately 10 percent in 2008 from the year before.

The group hopes to see additional growth this year, but Key’s investment activities will depend on finding the right projects, says Senior Vice President Roz Ciulla.

“We do not have a mandate that we must do X amount or cannot do more than a certain amount,” she says.

Key has traditionally been a direct investor, according to Ciulla. Like other investors, she credits her group’s increased investment activities in 2008 to more opportunities. The group also increased its staffing.

The Cleveland-based company has a 13-state footprint and invests primarily where it has a retail bank presence. “Those are the markets we know,” Ciulla says. “We have lending groups in the major markets, and we know the communities.”

Key likes to have a “full banking relationship” with developers of its LIHTC projects, meaning that it prefers to be the construction lender as well as the tax credit investor when possible. It also means deposit accounts.

Ciulla says her concerns going into the new year are in line with those of other investors, with the state of the economy high on the list. As a result, asset management will be important, as will ensuring that partners will be able to ride out the economic downturns.

One area that Key has emphasized is healthy project reserves. Ciulla says the amount of reserves depends on a project, but a good industry rule of thumb has been six months of operating expenses plus debt service on all mustpay debt.