The continued strong performance of affordable housing as an asset group looks set to draw in additional deep-pocket insurance companies because of a recent change in investment rules.

In June, the National Association of Insurance Commissioners (NAIC) changed its risk-based capital (RBC) rule to significantly reduce the amount of capital reserves that life insurers need for low-income housing tax credit (LIHTC) investments. The amount will drop from about 15% to 0.14% (for guaranteed investments) or 2.6% (for unguaranteed investments) and is effective in 2004. The change was made after pressure from the community investment arms of insurers (including MassMutual Financial Group; Prudential Financial, Inc.; AEGON USA Realty Advisors, Inc.; and John Hancock Realty Advisors [JHRA]) and from some regulators to have the RBC rule reflect the relative safety of these investments.

The RBC reserve is the percentage of an investment that must be kept available in liquid assets in case an investment goes bad. NAIC’s large RBC drop from 15% to 0.14%, for example, is hailed by insurers as a long-overdue recognition that tax-credit housing investment is a unique asset class that has proven itself over the past 15 years as a sound and safe investment.

Insurance industry experts interviewed by Affordable Housing Finance would not name specific companies that might enter the LIHTC market as a result of the NAIC change, nor would they guess how many insurers who already invest might increase their activity. With only a few exceptions, however, they strongly believed that this would bring in some life insurance companies that had told their investment advisers or other insurers that they have been holding back because of the RBC issue.

“What it’ll do is keep the insurance companies a very active participant in affordable housing,” said Joe Foss, founder and owner of Foss and Co., a San Francisco-based tax credit adviser that includes insurance companies among its clientele. He said he knew of two insurers who told him that they were waiting for the NAIC rules change before they would invest in LIHTCs.

The partnerships in which the insurers invest cannot include more than 50% of debt, Foss added: “That puts the onus on the syndicator to set up a partnership in which there are a lot of 9% deals and not a lot of 4% deals.”

Life insurers show the most interest

The insurance industry is a major component of the LIHTC investment world, although individual insurance companies vary widely in the level of activity in this sector.

The biggest buyers of the credits are the government-sponsored entities Fannie Mae and Freddie Mac, which together account for about 30% of the credits, estimated David Kunhardt, vice president of community investments at AEGON USA Realty Advisors. Kunhardt, who served as president of the Affordable Housing Investors Council in 2003, said the banking industry was in second place with another 30% or so, followed closely by insurers. Miscellaneous investors made up the remainder.

“Insurance companies are generally in the position to handle a long-term investment, so to buy into an investment that has a 15-year holding period works really well because they like the stability and they tend to have fairly stable tax liability over that period,” said Rick Floreani, senior manager with Ernst & Young’s Affordable Housing Services, which recently released a study on the performance of LIHTC investments (see Affordable Housing Finance, August 2004, page 6). “Other types of companies, such as high-tech and biotech companies, if they have tax liability at all, it tends not to be very predictable.”

Foss, state regulators and others cited anecdotal evidence that insurance companies are ready to emerge from the sidelines to invest in LIHTCs after the RBC change. But some insurance companies have been unimpressed with recent yields, according to David Abromowitz, director of the real estate group at the Boston law firm Goulston & Storrs. “The question is, will the substantial improvement in the risk-based capital standards overcome the continuing decline in yields?” he said.

Insurers tend to invest in a wide range of LIHTC projects in various regions, though they have less interest in assisted-living developments because of the complicated service component.

Life insurance companies have steadier and more reliable income levels than property and casualty insurance companies, so life insurers are in a better position to reap the 10-year revenue stream from federal credits. That is why NAIC changed the rules for life insurers in June; changes for other insurance types may follow.

“They need more buyers in the market,” said Florence Zeman, senior vice president at Moody’s Investors Service. She said Moody’s believes LIHTCs are solid investments with good performance and minimal losses, but they are too complicated for some investors. “It’s easier to buy Treasuries,” she said.

Insurers differ greatly in their LIHTC involvement

AEGON USA Realty Advisors’ LIHTC investment target for 2004 is $200 million, up from $76 million in 2003. Kunhardt said the RBC reduction could help AEGON expand its tax credit investments. “I expect our 2005 target to be higher than $200 million – perhaps as much as $300 million,” said Kunhardt. AEGON is the real estate arm of the AEGON USA Insurance Group, which includes a handful of companies that have invested more than $1.1 billion in LIHTC partnerships in the past 15 years.

Another vigorous investor in tax credit housing is JHRA, which invests between $75 million and $125 million a year in LIHTCs (see JHRA profile, below).

Never a major LIHTC investor, Nebraska-based Mutual of Omaha Insurance Co. has averaged $7 million or $8 million a year since 1993. Its largest single-year investment was $10.8 million and the lowest was $1 million, according to Peter Newland, vice president of mortgage real estate investments at Mutual of Omaha.

The level of its investment has decreased in the past few years, but Newland said that some of Mutual of Omaha’s early credits have reached the end of their 10-year period, so the company will likely replace them with new credits in the near future. The NAIC change will play no role in his company’s LIHTC activity, Newland said.

The RBC change also will make no difference at American Family Insurance Group. It has never done LIHTC investments and is unlikely to change its mind. The income of the Madison, Wis.-based company is too variable to benefit from the credits, said Rick Schelthem, who works in American Family’s tax department.

Eight insurance companies with operations in California banded together in 1999 to form Impact Community Capital (ICC), which makes community investments on their behalf. ICC finances mortgage loans for affordable housing projects, pools them and turns them into rated commercial mortgage-backed securities. The “vast percentage” of the loans involve some level of federal LIHTCs, according to Dan Sheehy, president and CEO of ICC. “The loans that we are pooling and securitizing are loans that are more aggressively underwritten than those that would meet Fannie and Freddie standards,” he added.

John Hancock expects continued LIHTC appetite

Boston-based John Hancock Realty Advisors (JHRA) is looking for good tax-credit properties, but only projects with solid financial viability will interest this affiliate of the John Hancock Life Insurance Co.

JHRA, founded in 1995, is a direct investor in federal low-income housing tax credit (LIHTC) developments. It typically invests between $75 million and $125 million a year in LIHTCs, and the company’s leadership expects it to stay in that range for the near future. As of March 31, 2004, JHRA’s portfolio included $567 million in equity commitments for 128 affordable housing properties with a total of 14,033 units.

 “One of the most important things for us is that we look for good, experienced, well-capitalized partners,” said Cynthia Lacasse, JHRA president. JHRA wants general partners with minimum net worths of $2 million, though it may make an exception for a smaller deal or for a nonprofit developer. The general partner must agree to compensate JHRA for any shortfall in LIHTC benefit due to recapture or noncompliance.

JHRA is pleased to be able to help develop affordable housing in areas where it is needed, and when the project is in Boston, the satisfaction level is even higher, Lacasse said. But the company sees housing tax credits “first and foremost” as investments to be judged on the basis of the amount of return they provide JHRA and the amount of risk they pose, she added.

One project on JHRA’s home turf is the $17 million Amory Street Residences, which recently began construction. Located in the Jamaica Plain neighborhood of Boston, the site was previously used as a car wash and vehicle tow lot. John Hancock’s net equity in the project is $7.7 million.

Developed by consultant Housing Investments, Inc. (HII), and Urban Edge, a community development corporation, Amory will consist of a four-story nine-unit building, a four-story eight-unit building, and a six-story 47-unit building. All 64 units will serve tenants earning no more than 60% of the area median income, and six of those units will house formerly homeless families. Completion of the project is scheduled for winter 2005.

Though HII had not previously worked with Hancock, the two organizations were discussing several projects the consultant had in the works when Amory came up. “Clearly, for John Hancock this would be a particularly special project for them because it was in Boston,” said Holly Hart Muson, a HII project manager.

JHRA considers investments in a broad range of projects. It is open to developments in urban, suburban and rural locations in any state. They can be garden-style, mid-rise or high-rise buildings, and the financing can be for rehabilitation or new construction. JHRA will consider mixed-income and mixed-use projects in selected markets. There is no maximum tax credit amount, but there is a $200,000 minimum.

On April 28, 2004, Manulife Financial Corp. completed its acquisition of JHRA’s parent, John Hancock Financial Services, Inc. JHRA will draw on its experience in the field to run the LIHTC investment segment for the combined company, according to Joe Foss, founder and owner of Foss and Co., a San Francisco-based tax credit adviser.