Affordable housing developers have been looking to tax-exempt bonds to help them escape hotly competitive 9% low-income housing tax credit rounds. While Fannie Mae and Freddie Mac continue to slug it out to grab a bigger share of the credit enhancement market, commercial banks compete to offer letters of credit (LOCs) as a tool for keeping their clients engaged with them.
“If a client insists on using a letter of credit – where they might be using Fannie or Freddie to buy the permanent loan – we still want that client and that business,” said Gerry Thole, U.S. Bank’s senior vice president and manager of community lending. Although he sees a growing number of clients choosing privately placed, unrated bonds and skipping the entire credit enhancement process, he noted that developers benefit by having many choices.
For example, California-based Mid-Peninsula Housing Coalition is relying heavily on tax-exempt bond financing to help it revitalize its healthy-but-aging portfolio, convert more of its market-rate units to affordable units, and free up equity funds for further acquisitions and activities. Mid-Peninsula has been primarily using private-activity tax-exempt bonds credit enhanced with LOCs.
“We’ve just found that, for us, in terms of the interest rate you can get, the terms you can get, and the conditions of approval, it has been easiest to go with an LOC,” said Terese McNamee, Mid-Peninsula’s vice president of finance and asset management.
Mid-Peninsula’s portfolio includes more than 70 properties and about 5,000 units. (It also manages about 1,000 units for other owners.) A lot of its properties are 30 or 40 years old, “and even [though] well-maintained, you still have some major components that need to be addressed,” said McNamee.
In 2005, Mid-Peninsula refinanced two properties using tax-exempt bond financing backed with LOCs from Union Bank of California. Timberwood, a 286-unit family complex in San Jose, underwent an $18 million refinancing. About $3 million was spent to rehab the property and about $15 million went to pay off existing debt. The developer used the transaction to enable it to rehabilitate the property, increase the number of units leased at affordable rents, and – on a portfolio basis – leverage the increased value of its wholly owned properties it has held for a long time to give it financial resources for expansion, said McNamee.
The goals were similar for Mid-Peninsula’s Monte Vista Terrace, a 150-unit seniors housing development in Mountain View, Calif. The only difference was that Monte Vista’s units were already 100% leased at affordable rates. The $13 million bond issuance, backed by an LOC, was used to pay off the existing Federal Housing Administration-insured mortgage and fund almost $2 million in rehab.
Other borrowers have been attracted to private placements of tax-exempt bonds, as more developers have heard of the cost and time savings that can come with this transaction (see Affordable Housing Finance, March 2005, page 25). Unlike a bond that is publicly sold, a private placement involves a lender buying the bond and holding onto it, so it does not need to get third-party underwriting, credit enhancement, and a lot of additional attorneys involved in the process.
Demand for LOCs
With many developers escaping the 9% tax credit competition and instead pursuing tax-exempt bonds, Joyce Moskovitz, senior vice president of community development for Bank of America (BofA), has seen continued strong interest over the past five years in customers seeking short-term LOCs – from customers new to bonds as well as customers who pursue both 4% and 9% credits. Short-term LOCs cover only the construction period, while long-term LOCs cover the permanent loan. BofA does offer long-term LOCs, but not as a regular product; the bank considers it depending on a transaction-by-transaction basis.
Many banks, on the other hand, have a great deal of experience with long-term financing and holding of real estate. “We are still offering long-term letters of credit,” said Jim Mather, vice president of Union Bank of California. “For us, it’s basically a real estate loan.”
LOCs can still be fairly expensive, but the prices have been steady for the past few years, according to Shaun Carrick, a principal at the East Coast law firm of Miles & Stockbridge, P.C. LOCs require an origination fee (typically 75 to 100 basis points, according to lenders) and an annual fee, which can range from 90 to 125 basis points.
U.S. Bank also provides long-term LOCs, but they may be waning in popularity. In 2005, U.S. Bank closed between $1.2 billion and $1.3 billion in housing debt deals, and about half of it was in private placements. “Three or four years ago, private placements would only have been about 20% of the total,” said U.S. Bank’s Thole. “We’ve done probably half as many letters of credit as we did” several years ago.
Many conventional banks offer short-term LOCs, but Thole notes that “there are many players in this who just choose not to do long-term lending.” He said banks have different corporate philosophies and varying approaches toward meeting their Community Reinvestment Act (CRA) responsibilities; some earn CRA points through multifamily housing, others, such as Wells Fargo, do so through single-family home mortgages.
