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Panelists: LIHTC Equity Market Needs Stability

Published by Jennifer Hill on Monday, November 1, 2010

Journal cover November 2010   Download PDF

Tax credit syndicators and lenders, concerned about what they see as potentially unsustainable equity prices, put the low-income housing tax credit (LIHTC) equity market’s current state into historical context and discussed the effect of new investors on the market during sessions at the Novogradac & Company affordable housing tax credit conference in San Francisco, Calif. on September 30. Novogradac & Company partners George Littlejohn and Rob Thesman each moderated a panel that explored the twists and turns that the equity market has taken during the past few years and mapped out their predictions for 2011.

Putting Things into Context
Littlejohn and Thesman kicked off their sessions by asking panelists to compare current market trends with those of 2009. Virtually all the panelists agreed that the 2009 market and the current one are as different as night and day. The market reached its peak in 2006 and 2007, with prices that hovered around 90 cents and a total equity volume of more than $10 billion, said Tom Dixon, Boston Capital’s vice president, origination.

Citi Community Capital’s equity volume was down dramatically in 2009, according to Leila Ahmadifar, director of LIHTC investments. She said that like many investors last year, her bank was forced to take a brief credit-buying hiatus. Lender Merchant Capital found itself in a similar situation, last year closing deals of approximately $75 million; that’s in contrast with the more than $200 million in transactions it anticipates closing before the end of 2010, said senior vice president John McAlister. Looking ahead to next year, McAlister expects to close approximately $300 million in equity transactions.
“2009 began as a product-rich, capital-restrained year and it’s turned around 180 degrees,” said Raoul Moore, Enterprise Community Investment’s senior vice president. “We’re a product-short, capital-rich environment these days.” Enterprise closed around $300 million in equity transactions last year, a figure Moore believes was the firm’s lowest volume ever. Before the end of this year, Enterprise will likely close $585 million for 72 deals. “It’s heated up considerably in a short period of time,” he said.

New Investors Explained
The arrival or re-entry of investors from outside the financial services realm, including insurance agencies, major retailers like Home Depot, and tech firms, bolstered this year’s market upswing. Insurance companies have made up the bulk of the most recent investor wave, said Boston Financial Investment Management CEO Greg Judge.

“Tax credits aren’t as sexy [as other investments] because they don’t have huge growth, but they also don’t have huge downsides,” Judge said. He worries, however, that many of the new entrants may bow out when yields start falling. “They’re getting 10 percent yields now,” he said, “but will they still be in the market when they’re getting 7 and 8 [percent]?” When that happens, Judge expects a core group to remain in the market, noting that the some of the more opportunistic companies have stated their intention to pull out of the market when yields drop below 10 percent.

On the other hand, companies investing in LIHTCs for the first time must spend a great deal of time and energy to learn about the market, so they may be reluctant to leave. “They don’t want it to be a one-shot deal,” Dixon said, adding that in his experience the vetting process with new investors is intense. “We had investors in our office for what seemed like days on end,” he said.

The bottom line brings new investors to the table, but high yields aren’t necessarily the only incentive, argued Russell Ginise, RBC Capital Markets’ director of investor relations. For instance, he said, insurance companies often seek out investments in states where they do business or have exposure to premium taxes.

Panelists said the investor base might expand even further if regulatory measures like Community Reinvestment Act (CRA) reform or allowing the effective-yield method for non-guaranteed transactions are realized. Ginise said the ability to manage the impact of losses on pre-tax earnings using the effective yield method would open up the market substantially. But Judge pointed out that while the ability to use the effective yield method would have a major impact on most public companies, its effects on insurers would be muted due to the type of accounting they use. As far as sheer numbers of investors go, Dixon said CRA reform would provide the biggest bang for the buck.

Pricing Peril
In fact, banks’ CRA obligations are creating an artificial market where prices in hot CRA markets like Los Angeles and New York have skyrocketed to more than 90 cents for some transactions, Ginise said. “I don’t think it’s sustainable for an industry, but it’s where we are now,” he added. Dixon said that the pricing gap between deals in those areas and rural deals is as much as 25 cents.

“Pricing’s gone up much more rapidly than I would have suspected,” Ginise said. While the higher pricing may be useful for getting deals funded in the short-term, he expressed concern about what it could mean for the future. “We’re moving toward a softening of terms and no one on the investor side likes it,” he said. After the wild swings the market has experienced, the industry needs balance to ensure its long-term health, and Ginise believes CRA reform could lead to a stable market.

“We’re all going after the same deals,” Ahmadifar said of transactions in primary CRA markets, noting that there are only a limited number of deals in those areas. Even though Citi has large CRA needs, she said the bank has become price-sensitive in response to accelerated pricing and has temporarily pulled back in certain markets.

If this trend of rising credit prices and falling yields continues, it could cause new investors to exit the market just as quickly as they entered. “It’s a little too hot right now,” said Moore, who watched pricing increase between 12 and 20 cents and yields drop from the 10 to 15 percent range to between 5.5 and 9 percent in a year’s time. “I worry that we’ll end up in the same spot, if not worse off, than we were last year.” He said in a follow-up interview that it’s critical for non-CRA investors to stay in the market to fill the void left by government-sponsored entities and avoid a greater concentration of capital in CRA markets.

To a lesser extent, developers should also be mindful of rapidly climbing LIHTC prices, said Judge, who said he received more calls last year from developers during a six-month period than he has in the past 20 years. “Don’t be greedy,” he cautioned. “We have to remember what we went through [last year] and feel fortunate that things are working out.”

In Some Areas, a Developer’s Market
Panelists advised developers seeking equity to call on their relationships with syndicators as soon as they begin working on a potential LIHTC project. “Syndicators can tell you if investors are frowning on this or embracing that,” Dixon said, adding that syndicators are generally not averse to working on transactions at early stages because it allows them to queue up deals and plan their business.

On the acquisition side, Ginise said next year is still an uncertainty. “I’m not sure we’re going to get enough deals.” Judge agreed that no one has a big pipeline going into 2011, noting that because the market is flush with capital, most projects with an allocation are under contract quickly.

Moore said industry participants will have a better idea of the direction the market is taking by the first and second quarters of next year, when some banks’ CRA cycles start over and they reassess their tax credit appetites. “As deals start queuing up and housing finance agencies are allocating more credits again, we’ll see if we get some equilibrium in the marketplace,” he said.

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