Uncertainty of Execution

AFFORDABLE HOUSING FINANCE • February 2009

Lenders expect a tough year ahead as debt grows pricier

BY JERRY ASCIERTO

Fannie Mae and Freddie Mac lenders usually end the year with a flourish, processing deals hand over fist. But as 2008 came to a close, fewer affordable housing loans were closing.

The government-sponsored enterprises (GSEs) began 2008 as fountains of liquidity in an arid multifamily environment. As the year wore on, though, more and more affordable housing deals dried up: A depressed low-income housing tax credit (LIHTC) market, higher debt prices, and a lack of available gap financing scuttled plans left and right.

The debt outlook for 2009 hinges on the LIHTC equity market, which collapsed once the GSEs stopped investing. Industry experts predict that about 40 percent of all 2008-allocated LIHTCs have been or will be returned to state housing finance agencies as project feasibility suffers.

Much depends on federal legislation in 2009. Not only will President Barack Obama’s administration grapple with the futures of Fannie and Freddie, but it will also be under pressure to make changes to the LIHTC program that would attract more investors. “Tax credit prices are down, financing spreads are up, and soft money is more difficult to come by,” says Don Giffen, CEO of PNC MultiFamily Capital. “In the absence of legislation, it’s going to be an extraordinarily difficult year for affordable housing.”

Liquidity timidity

Debt prices from the GSEs shot up in 2008, and they will likely continue to tighten underwriting standards in 2009.

Permanent loans for 9 percent LIHTC deals should be readily available from the GSEs throughout 2009, albeit at higher prices. Pricing rose slowly but steadily throughout 2008, and by the end of the year, immediate fundings were being quoted in the high-6 percent range, while unfunded forward commitments were at least 100 basis points higher.

The outlook is much less clear on 4 percent transactions. Investor interest in tax-exempt bond deals has waned considerably, and the GSEs’ appetite for bond credit enhancements has been unpredictable. Fannie dropped out of the liquidity market for variable-rate bonds in 2008. And while Freddie stayed in the game, it raised prices, grew much more conservative, and rethought its role in the market as 2008 came to a close.

The long-term fixed-rate bond market was also stalled at the end of 2008. “Nine percent deals are going to drive the bus, but 4 percent deals are going to be very difficult to get done,” says Phil Melton, a senior vice president with Grandbridge Real Estate Capital, which placed 19th on AFFORDABLE HOUSING FINANCE’s list of top affordable housing lenders this year.

On conventional loans, the GSEs were offering 10-year deals in the 6 to 6.5 percent range in mid-December, though debt-service coverage ratios were at a minimum 1.25x, and loan-to-value ratios were straddling 70 percent.

Construction financing will also be difficult to procure in 2009. Many banks are minimizing their real estate exposure, and those lenders still active say that project feasibility concerns will reduce demand next year.

The underlying fundamentals of the affordable housing industry remain strong, but construction lenders will take a harder look at the financial viability of development teams and their investors in 2009. “From a construction lender’s standpoint, the risk that’s entered the market has really been on the risk of who the counterparties are and has nothing to do with the fundamental viability of the underlying project,” says Jim Francis, a senior vice president at Union Bank.

Consolidations galore

Citi Community Capital tops AFFORDABLE HOUSING FINANCE’s list for the second straight year. Citi distanced itself from No. 2 lender Bank of America by more than $200 million in 2007, thanks in large part to its acquisition of last year’s No. 3-ranked lender, Capmark’s Affordable Housing Debt group (click here for more on Citi).

In the No. 4 slot, U.S. Bank processed more than $1 billion in affordable housing debt financing in 2007 for the fourth straight year (click here for more on U.S. Bank).

A few regional lenders also topped this year’s rankings. The New York City Housing Development Corp. (NYCHDC) doled out more than $1 billion in 2007 and was well ahead of that pace by midyear 2008. The Community Preservation Corp., which lends to preservation deals in New York, New Jersey, and Connecticut, entered the rankings for the first time, originating $559 million in 2007 and surpassing that amount by mid-2008.

Union Bank is shedding its “regional lender” label, with aggressive expansion in the Pacific Northwest and the East Coast (click here for more on Union Bank).

A rash of bank failures accelerated the banking industry’s consolidation trend. In all, 25 U.S. banks failed in 2008, and this game of high-stakes musical chairs will continue, as more failures are expected in the first half of 2009.

PNC rocketed up the rankings by eight slots to No. 7, thanks in large part to its acquisition of ARCS Commercial Mortgage in 2007. PNC should continue to climb in next year’s list: The company acquired National City Corp. for $5.6 billion in October. The deal is significant for the affordable housing industry because Red Mortgage Capital is a subsidiary of National City. Red, ranked No. 17 for the second year in a row, will bolster PNC’s reach once the acquisition is finalized (click here for more on PNC).

Wells Fargo acquired Wachovia, whose affordable housing debt group was the No. 4 lender last year and the No. 5 lender this year, for $12.7 billion in October. The acquisition should signifi cantly boost Wells Fargo’s geographic footprint and capacity for affordable housing deals, catapulting the company to the Top Five on next year’s list.

The problems in the banking sector have created opportunities for those that have best weathered the credit crisis. Grandbridge Real Estate Capital continues to build out its affordable expertise, leveraging the footprint of its parent company, BB&T Bank, to expand. The company was created in 2007 when BB&T acquired Collateral Real Estate and combined it with Laureate Capital.

“We want to continue to expand our scope of business with top-tier developers that we’re now getting opportunities with, as some of the other big players are not doing as much as they had previously,” says Grandbridge’s Melton.

The biggest lenders, such as Citi and Bank of America, anticipate more opportunities as a result of the reduced competitive landscape. “Some lenders that are teetering right now are not going to make it, and we’ll be the beneficiary of that unfortunate activity,” says Steven Fayne, a managing director at Citi.

On the horizon

The affordable housing industry has been bolstered by the Obama administration’s pick of Shaun Donovan as Department of Housing and Urban Development (HUD) secretary, a signal that multifamily housing will be a priority. When Donovan assumes the mantle at HUD, he will give up his post as chair of NYCHDC, this year’s No. 3 lender.

Marc Jahr, president of NYCHDC, applauded the appointment and, like many in the affordable housing industry, is excited to see what Donovan will bring to HUD. Hopes are high that an energized and skilled HUD leadership team will renew the Federal Housing Administration while making affordable multifamily production a priority.

But tax credit pricing and a debt market that has seen unprecedented volatility over the last year are the 800-pound gorillas in the room. “If we don’t see improvements in the tax credit market, if we don’t see the increased availability of liquidity and capital, then 2009 is going to be a tough year,” says Jahr, formerly a director for Citi.