Whither LIHTC Part 2

Posted: December 5th, 2008 | Author: mfguide | Filed under: Investment, LIHTC, News | 6 Comments »

The National Affordable Housing Management Association (NAHMA) issued a 2-page ‘white paper’ this week, “Stabilizing and Restarting the Residential Tax Credit Marketplace”, which was sent to various Congressional chairmen and ranking members.

I can’t find the document on their website, which seems an odd restriction for building legislative report.

The report identifies several challenges to the Low Income Housing Tax Credit program (LIHTC) that are familiar to regular readers. These dangers include:

1. Inability to close deals in the pipeline.

2. The reduction in credit value (from mid-80 cents per dollar to low 70 cents per dollar) requires increased equity contribution from the developer.

3. A small market made 40% smaller by the absence of Fannie and Freddie.

4. Banks and other tax credit holding institutions have no offsetting gains and experience a 10% reduction in value [Note: the tax credit period runs 10 years per project] each year the credits go unused.

5. No investors want or need tax credits, harming rural areas in particular.

6. State agencies rely on new projects and fees to fund operations and in some cases, provide general funding opportunities.

7. A sustained drought [Note: unspecified but MFG thinks 2+ years] will lead to a loss of expertise, investor interest, and professional infrastructure.

Most importantly, there is a risk that very little affordable housing will be built before 2012. If you assume that the financial institutions that drove the tax credit market for 10+ years will not show income before 2010, their current losses should carry forward well into the first part of the next decade. When combined with the long lead time to design and apply for tax credits, the lack of new product will be acute.

Unfortunately, most of the solutions proposed by NAHMA address supply rather than demand. The abject lack of demand is the crux of the problem and why lenders, syndicators, and developers are being crushed.

1. Provide either government guarantees or backstopping to unfreeze the current market in Tax Credits. As noted above, tax credits’ values depreciate over time. With the current lack of earnings in most sectors of the economy, those credits that are trading are priced at deep discounts. With the imbalance in supply and demand, there needs to be some modification to the use of credits that will preserve an orderly market.

[Note: There seem to be 2 goals here. One is a Federal backstop that would undermine existing guaranteed funds that are enhanced in some way. Secondly, NAHMA does not offer a solution to the 'imbalance'.]

2. Use existing enacted Federal Housing Administration lending programs to provide low interest “bridge” financing to permit new development to continue in markets with significant needs for more workforce and rural housing. FHA insured financing can be used where the loans are structured to permit new and rehabilitated developments and provide an option to use Tax Credits to take out the loan within one or two five-year terms. Initial loans could be structured as five-year financing with one renewal and no lock-ins that would permit earlier conversion if market conditions permit. These loans should be underwritten and administered through the State Tax Credit Agencies. The bridge financing would be designed to allow the properties to move to full Tax Credit status easily. This could occur either during the loan period or at the end of the loan period. The implementation of these bridge loans and subsequent Tax Credit compliance should begin either at the point of conversion from the bridge loan or year six, whichever occurs first, with a ten-year compliance period. Regulatory and compliance policies and procedures should be revised to allow investors assurance on tax credit compliance as the bridge loan converts.

[Note: Many deals have blown up because either the syndicator could not take or lay off the credits or, in some cases, the bank has refused to close. The problem is that most of the deals are underwritten aggressively so that there's not much room for FHA to make a credit-worthy decision. Now if we considered the FHA to be more of a 'soft second' lender, that would not be a problem.]

3. Address current tax and Securities and Exchange Commission regulatory policy to stabilize the book values, pricing and price volatility of Tax Credits. With the bulk of purchasers facing uncertainty in how purchases of new Tax Credits would be valued, the market is illiquid, and purchasers are risk averse. Greater certainty in subsequent valuation is needed.

[Note: I don't understand this proposal at all. Tax credits only have value to an investor to the extent they offset gains elsewhere. They have a defined benefit period and cannot be carried forward. Under Mark to Market principles, unused credits (for current or future years) should be valued at their current market price. The problem is there's no demand for the tax credits, not that there is uncertainty about valuation.]

4. Review current tax and regulatory policy with an eye to improve yield on Tax Credits. Policies should be developed that will allow the Federal Housing Finance Administration to place all “written down” and “written off” credits held by the GSE’s and other institutions in conservatorship with the Treasury, and allow the Treasury to hold the credits to maturity. This will prevent a “fire sale” in credits from undercutting the market. Methods to allow viable but unprofitable banks to place credits with the Treasury should be explored.

[Note: This is a good suggestion and should be enacted in concert with an increase in CRA requirements; eliminating the tax credits held by Fannie and Freddie and other institutions that accepted TARP funding would dramatically increase demand for tax credits to meet CRA regulations. If there is no demand for a product at any price, you must create demand by allowing it to fulfill other purposes. The traditional driver was CRA, but with so many CRA-subject companies combining or disappearing, that demand has slackened. Increasing CRA requirements for the survivors or eliminating old tax credits, would be one way to stimulate demand for fresh credits. Of course, what is not clear is what to do about the investments made in earlier tax credit rounds and whether that money is gone or must be returned by the developer or syndicator.]

5. A primary goal is to create new markets for Low Income Housing Tax Credits supporting affordable workforce housing, which continues to be in short supply in all major markets. Expanding the market in Tax Credits will permit expanded production both in the new construction and rehabilitation markets. Modifying current regulations to permit expansion in the market for Tax Credits is absolutely essential. 

[Note: Providing new and renovated affordable housing is the most important policy goal. It is not clear that the tax credit program can meet the demands for this product in the next 18-60 months. Ultimately what advocates of affordable housing want is more and better housing regardless of the funding source.]

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