As the banking industry continues to struggle through the recession, access to construction capital isn't getting any easier.

Many long-dormant low-income housing tax credit (LIHTC) deals are ramping up again courtesy of the Tax Credit Assistance Program (TCAP) and credit exchange program. But this wave of new construction deals will have to scour the market a little harder to find the debt to break ground.

While the largest banks have been bolstered by federal bailout funds, equity raising efforts, and asset sales, many smaller local and regional banks are still struggling with balance sheets tainted by bad commercial real estate loans. The Federal Deposit Insurance Corp. (FDIC) said in late August that its watch list of troubled banks now numbers 416, up from 305 in March. In the second quarter, 111 lenders were added to the list, swelling the list to a 15-year high.

“We'll start seeing a flurry between now and the end of the year, but the problem is, how much can the banking infrastructure absorb, and how quickly can they get stuff done?” asks Phil Melton, senior vice president at Charlotte, N.C.- based lender Grandbridge Real Estate Capital, a subsidiary of BB&T Bank. “There's only so much capacity.”

BB&T Bank acquired Montgomery, Ala.-based Colonial BancGroup in August after Colonial, which was an active lender of condo construction deals in South Florida, became the largest of the 83 bank failures this year. The dwindling number of banks will only make it more difficult for the affordable housing industry to find tax credit investors, not to mention construction debt.

“With continued bank consolidation and all the failures, you lose some banks that would normally do Community Reinvestment Act stuff,” Melton says. “And people don't want to look at doing a lot of new construction at the moment.”

Most of the large financial institutions such as PNC are bundling their services, providing construction financing on deals for which it also provides LIHTC equity. “There are not that many institutions willing to do it,” says Thomas Booher, an executive vice president at Pittsburgh-based PNC MultiFamily Capital. “We are still doing that business, but very selectively both from a market and sponsorship standpoint.”

Last year, Citi Community Capital lent about $800 million in construction financing to tax credit deals, but the pace slowed dramatically in the first half of the year. In August, Citi closed on a $1 billion proprietary fund, split equally between equity funds and debt financing for tax credit deals.

The only game in town?

Some commercial banks are offering construction loans in the high 5 percent range, and while mini-perm executions are being priced as low as 7 percent, finding a CRA-motivated bank with an appetite for new construction is difficult.

Many developers are turning to the Federal Housing Administration (FHA), whose Sec. 221(d)(4) program, which blends a construction loan with a permanent loan, featured a 6.5 percent allin rate in early September.

CWCapital is working on one 9 percent deal through the Sec. 221(d)(4) program, as well as two bond deals, including one in western Atlanta that has applied for TCAP funds. The company is using the FHA as opposed to going with a forward commitment from Fannie Mae or Freddie Mac on the bond deals.

“There's a limited amount of commercial banks providing the interim letters of credit that you need with the Fannie and Freddie executions,” says Frank Baldasare, a senior vice president focused on affordable housing for Boston-based CWCapital. “So we're using FHA insurance to credit-enhance the bonds.”

But the favorable rates and terms of the program—it's nonrecourse and offers a 1.11x debt-service coverage ratio and 40-year amortizations—are offset by the agency's often lengthy process