While construction financing remains relatively affordable, fewer deals are penciling out these days, and underwriting standards continue to tighten.

The healthier regional banks are still in the game. And many large banks, such as Wells Fargo/Wachovia, U.S. Bank, and Bank of America are still actively lending, but their loans are being driven mostly by Community Reinvestment Act (CRA) needs.

Construction lenders are proceeding very cautiously these days, serving only their biggest and best clients. The most viable new construction deals this year include developments in which the lender is also the equity investor, a way of keeping the deal pipeline flowing and helping their best customers.

For those who can find it, construction financing is still affordable, thanks to the low London Interbank Offered Rate (LIBOR), the benchmark upon which most construction loans are based. With LIBOR at less than 1 percent, many banks are offering spreads of about 400 basis points, but the all-in rate is usually higher than the spread would suggest.

Union Bank is quoting new construction deals in the 5 percent to 5.5 percent range. Like many lenders, Union Bank has instituted interest-rate floors on its deals, usually around 5 percent. So, borrowers are really paying the rate of the underwriting floor in many cases, as opposed to an all-in rate of the benchmark rate plus the lender's spread.

“It's something we've been doing over the last year as the interest rate markets have gone pretty wild,” says Jim Mather, a senior vice president and regional manager at Union Bank.

Union Bank closed $400 million in construction loans in 2007 and about $175 million last year. The company would've done more last year but was working on five new construction deals where the equity investor backed out. Union Bank hopes that a better second half will lead to $100 million in construction financing this year.

Underwriting standards continue to tighten on affordable housing deals. Most new construction affordable housing loans will be underwritten today closer to a 1.20x to 1.25x debt-service coverage ratio (DSCR), a stark contrast to the 1.10x DSCR seen a year or two ago.

And while affordable housing deals often featured more than 80 percent loan-to-value (LTV) ratios in the past, that standard now is closer to 70 percent or 75 percent. The strongest deals by the biggest and best sponsors can still get 1.15 DSCRs and approach 80 percent LTV ratios, but the majority of borrowers can expect tighter credit standards.

Like Union Bank, PNC still has some appetite to lend off its books, but the near-term economic outlook is difficult to understand. That uncertainty combined with the short-term nature of construction loans has led to tighter underwriting standards.

“If you're making a construction loan today and you're trying to figure out LTV, but no properties are being sold, what do you use for a cap rate?” says Keeley Kirkendall, an executive vice president at PNC MultiFamily Finance. “As the future unknown grows, the cushion required to deal with that is going to grow.”

Keep the pipeline flowing

Construction lenders are focusing on keeping their key customers happy. PNC typically lends about $150 million in construction financing annually, though the outlook for 2009 is much murkier. The lender has closed on just two construction loans this year as of mid-April, both for deals in which it was the equity investor.

Likewise, the only construction loan that Union Bank closed this year was a deal in which it agreed to be the tax credit investor and debt provider. That deal involved the rehab of a 361-unit seniors development by EAH Housing for which Union Bank had agreed to buy the tax-exempt bonds about a year ago. But when the original equity investor backed out, Union Bank agreed to buy the tax credits as well, mainly driven by its close relationship with EAH.

The Community Preservation Corp. (CPC), a nonprofit lender concentrating on New York, New Jersey, and Connecticut, is sponsored by about 80 different lenders in its network, mostly banks but including some life insurance companies.

CPC has a revolving line of credit from one of its member banks from which it makes construction loans for affordable housing developments. The organization typically prices its loans using LIBOR and a spread of about 380 basis points but has recently moved to using interest-rate floors like its for-profit brethren.

“LIBOR has dropped pretty low, and we've been using a floor more recently to stay liquid,” says Bruce Dale, CPC's senior vice president and a regional director for the Bronx and Manhattan offices. “The floor floats depending on how our organization perceives the market for the moment.”

CPC now uses a floor of 6 percent for any new construction or rehab loans it issues, up from the 5 percent floor it featured up until fall 2008.

CPC's typical construction loans go up to 80 percent LTV, and the organization usually features DSCRs of between 1.25x and 1.30x. Last year, CPC issued about $750 million in construction financing for new developments and rehabs, but the outlook for 2009 is considerably lower.

Any discussion on the affordable housing debt markets inevitably comes back to the tax credit market. And many lenders believe that the second half will be rosier. The tax credit provisions of the economic stimulus package should begin to show a positive effect, as housing finance agencies work toward clarifying their allocation plans and the investment community readjusts.

“We're all waiting for the investing market to determine where it's going to be and for the public sector to allocate out its dollars,” says Kirkendall.