In some ways, 2016 couldn’t have been a better year to lend money to affordable housing developers.

When LIHTC prices fell last fall, Citi bought 49% of the tax credits for Copper Valley, an affordable seniors housing community in Puyallup, Wash., and brought in an equity partner to purchase the other 51%. The project, expected to have begun construction in February, will be identical to Copper Peak Apartments (above), a sister property in Longmont, Colo., by the same developer, Inland Group.
When LIHTC prices fell last fall, Citi bought 49% of the tax credits for Copper Valley, an affordable seniors housing community in Puyallup, Wash., and brought in an equity partner to purchase the other 51%. The project, expected to have begun construction in February, will be identical to Copper Peak Apartments (above), a sister property in Longmont, Colo., by the same developer, Inland Group.

The AHF Top 25 affordable housing lenders last year lent a total of $27 billion to affordable housing properties with formal income restrictions, including permanent and construction loans. That’s a big increase from the $22.9 billion in 2015 and the $18.7 billion in 2014.

The coffers are likely to be much barer this year, however. Interest rates were low in 2016 but are now beginning to rise. Similarly, though prices for federal low-income housing tax credits (LIHTCs) were high last year, they’ve fallen sharply since, putting pressure on deals. And construction costs had already begun to rise in 2016, particularly for labor, and are expected to rise further this year. Perhaps worst of all, it’s unclear where the capital markets will go from here.

Because of these new pressures, developers are likely to build fewer new affordable housing units this year, which means they’ll take out fewer loans.

“Last year was a record year for Citi,” says John Heppolette, co-head of Citi Community Capital. “There’s much more uncertainty ahead in 2017.”

Uncertainty and the election


The election of Donald Trump as president has scrambled the assumptions behind interest rates and LIHTC equity pricing. It now seems possible, or even probable, that Congress will pass a comprehensive reform of the federal tax code.

“There’s enough momentum in Congress … that it appears they’re going to get something in the manner of tax reform done,” says Tim Leonhard, managing director for JLL Capital Markets.

A lower corporate tax rate would reduce the value of LIHTCs, but no one knows what the new tax rate will be, or how much the tax credits should be worth.

“We’ve seen drops in LIHTC pricing of 8 to 18 cents for a dollar of tax credit,” says Heppolette.

For affordable housing lenders, uncertainty and falling prices have created an immediate challenge. Many borrowers now have large budget gaps.

Compounding the problem, interest rates have risen sharply since the election, particularly for permanent loans, as the financial markets respond to promises like a potential $1 trillion infrastructure program. All that government spending may finally lead to inflation and even higher interest rates.

Investors have responded by demanding higher yields on U.S. Treasury bonds. The yield on 10-year Treasury bonds rose roughly 75 basis points (bps) immediately after the election and was 2.45% in early February. That’s nearly 60 points higher than in October 2016.

Experts expect the Federal Reserve to continue to raise its benchmark short-term interest rates several times throughout 2017, perhaps by as much as 100 bps. Some of those increases are already priced into the yield on 10-year Treasury bonds, which is likely to rise another 30 bps or so by the end of the year.
Higher bond yields mean higher interest rates for affordable housing properties, and those higher interest rates translate to smaller loans.

“We size the loan to the cash flows,” says Heppolette. “It takes away about 7 points of loan proceeds.” For example, a property that could support a $20 million, 15-year loan last fall may now only be able to support $18.5 million in debt, he says.

“Lenders are coming under pressure to decrease their debt service coverage ratios, so that the loans can stay as large as possible,” says Dan Smith, senior vice president for the Community Lending Division at U.S. Bank. For now, however, most banks have resisted loosening their underwriting standards.

“People are scrambling a bit to close the gap,” says Ed Sigler, managing director at JPMorgan Chase. “Developers are having to defer their fees.”

Developers who have already fully deferred their fees may look for new sources of funding, like soft financing or further allocations of tax credits from housing agencies. “States have all become aware of the problem,” says Sigler.

Citi still on top


Lending a Helping Hand

Last fall, Inland Group was all set to close its financing for Copper Valley, a community of 220 apartments in Puyallup, Wash., affordable to low-income families. Work would start with a $25 million construction loan from Citi, which would be replaced, once the project was finished, with $19 million in permanent tax-exempt bond financing plus equity from the sale of 4% LIHTCs.

Then November happened: LIHTC prices fell sharply. An investor that had planned to pay $16 million for the LIHTCs walked away. “The syndicator lost their upper-tier investor and couldn’t close their financing,” says John Heppolette, co-head of Citi Community Capital.

Citi had only planned to provide the debt financing to the property. But with the deal in trouble, the bank stepped up to buy 49% of the LIHTCs for Copper Valley and brought in an equity partner to buy the other 51%. The LIHTC prices were lower, to reflect the new expectation that corporate tax rates would drop, but the deal was able to close. The developer, Inland Group, closed its financing gap by deferring its developer fee. “Citi really stepped up with the major financing needed to help this project come to life,” says Darin Davidson, president of Inland Group, based in Spokane, Wash.

Once again this year, Citi leads AHF’s list of the industry’s top 25 affordable housing lenders in 2016, having lent $5.75 billion to affordable housing properties last year. That’s nearly $2 billion more than the company’s closest competitor last year and over $1 billion more than it lent in 2015.

Affordable housing developers are likely to be less active in 2017. “There’s some element of sticker shock,” Heppolette says. “The amount of work and risk to build a project hasn’t changed, but returns will be lower. People may not be willing to jump in at these levels.”

Citi is always looking for opportunities to lend to affordable housing properties. “There are more projects coming out of their compliance periods,” says Heppolette. “We’ve seen some conventional buyers with no intention to resyndicate just hold these properties as cash-flow investments with future upside.”

Wells Fargo plans to offer options


Though financing is more challenging nowadays, Wells Fargo plans to continue offering affordable housing developers its full suite of financing options.

“We really have every product you need for affordable housing,” says John Epstein, EVP of community lending and investment at Wells Fargo, No. 2 on this year’s AHF top lenders list.

Wells Fargo lent $3.78 billion to affordable housing properties in 2016, up from $3.02 billion in 2015.

The bank will probably lend less this year, though it will continue to be aggressive in competing to make deals.
“Until the tax rates are resolved, we anticipate volume to be down in 2017,” says Epstein.

Wells Fargo is also working to help its borrowers whose deals have been hurt by lower tax credit prices and higher interest rates.

“On the banking side, we can be more creative in how we structure a deal, timing how equity comes into the deal or finding effective bridge financing,” says Epstein.

BofA builds on RAD experience


Over the past two years, Bank of America Merrill Lynch has provided $2.2 billion in debt and equity financing to 29 projects that the San Francisco Housing Authority has taken through the federal Rental Assistance Demonstration program, including 227 Bay Street (above).
Over the past two years, Bank of America Merrill Lynch has provided $2.2 billion in debt and equity financing to 29 projects that the San Francisco Housing Authority has taken through the federal Rental Assistance Demonstration program, including 227 Bay Street (above).

Lenders are also seeking types of affordable housing deals that are likely to continue to be feasible despite changes in the financial markets.

For example, Bank of America Merrill Lynch is deeply invested in the federal Rental Assistance Demonstration (RAD) program, which allows housing authorities to bring new, private debt finance to public housing properties.

“RAD was a big part of our success in 2015 and 2016,” says Maria Barry, Bank of America Merrill Lynch community development banking executive.

Bank of America lent a total of $2.44 billion to affordable housing properties in 2016, slightly less than the $2.57 billion the bank lent in 2015, though much more than the $1.8 billion it lent in 2014. That makes the bank the third-largest U.S. affordable housing lender.

Over the past two years, BofA has provided $2.2 billion in debt and equity finance to projects the San Francisco Housing Authority brought through RAD.

RAD deals may be affected by lower equity prices and higher interest rates, but the program benefits from strong support from local housing officials—entities that might be able to provide soft financing to help make these deals work, even with rising interest rates and falling tax credit prices.

FHA lenders more prominent


Developers are also looking for loans through the Federal Housing Administration (FHA) to help fill gaps in their project budgets, particularly for developments financed with tax-exempt bond financing and 4% LIHTCs.

“Tax-exempt bond deals are just more sensitive to changes in the marketplace,” says Tracy Peters, senior managing director at RED Capital Markets.

FHA loans may provide some relief. “Borrowers can get more leverage and better terms out of the FHA,” says JLL’s Leonhard. “We’re going to use FHA financing much more aggressively in 2017.”

Lenders are also planning to make more loans through agency programs. “The Freddie Mac Tax-Exempt Loan program and the Fannie Mae Multifamily Tax Exempt Bond program will become more prevalent,” says Heppolette.

Many developers have avoided the FHA in the past because the process of originating a loan through the agency could take as long as nine months. The FHA is now much more timely—its loans often now close in six months—and borrowers in trouble have also become more tolerant.

“Developers and property sellers were not willing to wait around to get an FHA deal done,” says Leonhard. “Now, if I’m a seller, I’m going to give a developer more time.”

Top 25 Lenders of 2016

Company 2016 (in millions) 2015 (in millions)
1. Citi Community Capital $5,751.0 $4,644.0
2. Wells Fargo $3,780.6 $3,020.8
3. Bank of America Merrill Lynch $2,437.0 $2,573.0
4. JPMorgan Chase Bank $1,828.0 $1,406.0
5. KeyBank Real Estate Capital $1,400.0 $949.0
6. JLL Capital Markets $1,222.9 $1,130.0
7. Greystone Servicing Corp. $932.9 $582.4
8. Capital One $890.0 $864.0
9. Stifel, Nicolaus & Co. $872.0 $525.0
10. PNC Real Estate $860.8 $908.9
11. Berkadia $726.6 $722.2
12. U.S. Bank $719.0 N/A
13. Walker & Dunlop $622.4 $557.0
14. Pillar $586.5 $604.4
15. Rockport Mortgage Co. $578.6 $514.0
16. RBC Capital Markets $578.2 $462.7
17. Bellwether Enterprise $560.0 N/A
18. Red Capital Group $507.7 $553.8
19. P/R Mortgage & Investments $463.9 $470.9
20. Prudential $438.6 $565.6
21. Red Stone Tax Exempt Funding $334.4 $431.9
22. Berkeley Point Capital $320.0 N/A
23. CBRE Capital Markets $190.4 $338.8
24. Gershman Mortgage $179.0 N/A
25. Century Housing $143.5 $196.4

Totals include construction loans for affordable housing and permanent loans for 9% LIHTC projects, Sec. 8 housing, and bond credit enhancement.

Note: The Top 25 rankings reflect only those companies that provided Affordable Housing Finance with figures. If you'd like to be considered for next year's rankings, please contact Donna Kimura at dkimura@hanleywood.com.

Source: Affordable Housing Finance survey, January 2017