After a reserved first quarter, low-income housing tax credit (LIHTC) investors are looking toward the rest of the year.
Major investors remain in the market after being jolted by the prospect of tax reform late last year. They say they’re committed to buying housing credits in the months ahead, but they’re going to be cautious.
“Like many other investors, we’re looking more carefully at the possibility and consequences of reductions in corporate marginal rates,” says Michael Lavine, executive vice president and head of the tax credit equity team at Wells Fargo. “Otherwise, our approach in terms of underwriting and structuring transactions and the quality of the sponsors we prefer to work with has not changed significantly.”
One of the industry’s largest investors, Wells Fargo reported investing $2.2 billion in LIHTC equity in 2016.
“We’re working diligently to achieve a similar level of production in 2017,” says Lavine. “The temporary market disruption due to heightened concerns about tax reform has slowed our first-quarter closings, but we’re optimistic about prospects for the remainder of the year.”
Even though tax reform may be a year or more away, it triggered major shifts in the industry as LIHTC investors pulled back after the November election. With Donald Trump in the White House and Republicans in control of the House and Senate, the odds of an overhaul of the tax laws appear to have shot up. Trump has called for slashing the business-tax rate from 35% to 15%, and members of Congress will likely be eying a rate in the 20% to 25% range.
“Last year, there was a collision of events,” says Beth Stohr, director of LIHTC investments at U.S. Bancorp Community Development Corp.
The LIHTC market was extremely strong throughout 2016. Investments were receiving record-high pricing—pricing that might not have been sustainable, from an investor’s point of view. Then, in November, came the uncertainty created by the possibility of tax reform. Investors were already feeling they were paying at the top of the market, and now they were hit with another level of uncertainty.
“The market felt more of a pullback than it might have had we been in a different place in the market cycle,” Stohr says.
The first quarter is typically a slower time for closings. “But the strong 2016 market resulted in a very high number of 2016 allocations that still needed to close,” Stohr says. “Those investments were very much impacted by the uncertainty in the market around tax reform as prices adjusted and gaps in project financing were created. The pricing adjustments created uncertainty as to where the market would be for 2017 allocations.”
With the recapitalization of the 2016 investments well under way, the focus in the second quarter will turn to 2017, according to investors.
“You’ll begin to see more activity. More states will allocate their credits, and investors will have their investment plans,” Stohr says.
It’s important to note that plans will likely evolve throughout the year, according to Stohr.
“U.S. Bank never stopped investing,” she says. “The support and approach around the investment hasn’t changed. But we have adjusted our view on valuing tax losses. It’s the losses that really get devalued by lowering the tax rate.
“We started out offering a couple of tax-rate options and adding in ‘adjusters’ as appropriate as we bid on investments,” Stohr says. “At this point, we’re streamlining our approach by using a rate at a level where you don’t have to complicate it with an adjuster so it’s simpler for everyone involved.”
Fewer adjusters expected
Others agree that adjusters may be less common in the second half of the year as long as there are no big market events.
“You were seeing a 25% tax rate—and sometimes higher—being underwritten to, with a built-in downward adjuster to a 20% tax rate,” says Jennifer Seamons, senior vice president with KeyBank’s Community Development Lending and Investment team. “Across the board, we’re seeing that the downward adjuster is disappearing. For the most part, many investors aren’t offering an upward adjuster either, so, for ease and simplicity, they’re underwriting straight to a specific tax rate, with no upward or downward adjuster. I think that makes developers more comfortable. They’re not taking any of the downside risk should tax reform push rates below 25%.”
KeyBank is working to increase its LIHTC volume this year after investing just over $200 million in housing credits in 2016. “We have an extensive platform that brings together our balance-sheet capabilities, tax credit equity, and permanent-loan offerings,” Seamons says. “We’re continuing to develop and drive that strategy.”
The market conditions have caused funding gaps in deals, so KeyBank is trying to help fill those gaps with creative solutions, such as bridge loans, according to Seamons.
Bank of America Merrill Lynch, another major LIHTC investor, also remains in the market, according to Maria Barry, community development banking executive at BofA.
“We fulfilled all of our commitments in 2016 and closed over 20 deals as planned during the last seven weeks of the year,” she says, adding that the bank has a strong 2017 pipeline.
So far this year, the market has probably been the most unsettled it’s been since 2009, according to Brian Coffee, affordable housing executive at Regions Bank, which invests in 15 states.
“You have some banks honoring old term sheets, so you may hear of a deal in the Midwest still closing at $1.10, and then you hear of other deals that are being repriced for, maybe, 90 cents,” Coffee says. “It’s hard to draw firm conclusions, because you still have deals from 2016 that are being closed [at 2016 prices] and others being repriced.”
Like the other investors, Coffee says his bank is still in the market. Regions hopes to close approximately $300 million in direct investments this year, a slight increase from 2016. Last year, Regions also acquired First Sterling Financial, a longtime national LIHTC syndicator.
“We’re looking at deals,” Coffee says. “I think there’s still a fair return for the bank and a fair transaction for our developers.”
A positive is that people are being more thoughtful, according to Coffee. He says some deals are back to having a higher level of deficit reserves, and some may have underwriting that’s at a 1.20x instead of a 1.15x debt-service coverage ratio.
Banks make up a big portion of the LIHTC investor base. Many look to the housing credit as a way to meet their Community Reinvestment Act (CRA) obligations, and those requirements remain in place. Industry leaders aren’t expecting to see CRA reform efforts anytime soon.
Since the market shake-up, developers have been pushing to keep deals moving and working to fill gaps.
“More so than ever, developers and state housing agencies are going to have to get out a little earlier and have more frequent talks with investors and syndicators,” Stohr says. “I think pricing will continue to evolve over the year. It may adjust both up and down this year based upon progress (or not) around tax reform.”
Developers need to keep in real-time touch with both the state housing agencies and the investor–syndicator, adds Stohr.