Affordable housing deals have long enjoyed more favorable underwriting than their market-rate brethren. The large amount of equity in 9 percent tax credit deals and the presence of deep-pocketed investors and syndicators gave lenders a certain peace of mind, leading to high loan-to-value (LTV) ratios and low debt service coverage ratios (DSCR).

Those days may be coming to an end as lenders experience a crisis of confidence. For the first time in recent memory, syndicators struggled with their own finances, and some equity investors began to turn their backs and walk away from troubled projects in 2009. In short, the underwriting on affordable deals is beginning to look a lot like conventional market-rate underwriting, as lenders cast a jaundiced eye on the equity side of the equation.

“It may be a sea change. What’s happening is a reconsideration of what the proper underwriting criteria should be,” says Hal Kuykendall, a managing director at Citi Community Capital, the community development arm of the New York-based bank. “It’s not going to return to that kind of aggressive underwriting unless people believe that LIHTC investors and syndicators will be there to support deals that get in trouble.”

Most lenders are now underwriting tax-credit deals to a 1.20x DSCR and 80 percent LTV, as opposed to the 1.15x DSCR and 90 percent LTV ratio that had been the standard. This is especially true for deals that use TCEP funds: Since the funds come directly from the HFA, there’s no syndicator in the deal. That absence has led to requests from lenders for higher reserves as a safeguard against any potential shortfalls.

“The lessons of this year will cause underwriting standards to continue to tighten in the foreseeable future,” says Steven Fayne, a managing director at Citi Community Capital.

But there’s one lender that never really changes: The Federal Housing Administration (FHA) currently offers the best products on the market right now for new and existing affordable housing deals.

Construction Outlook

Construction capital remains elusive, and it doesn’t look to get much better in 2010. The strongest borrowers in major markets can still access construction funds based on longstanding relationships and the Community Reinvestment Act (CRA) needs of banks. But the majority of borrowers will have a much tougher time in 2010.

The spreads on construction loans from banks have doubled over the last 18 months to as much as 500 basis points (bps) over the benchmark LIBOR rate. And since most banks have very little appetite for new balance-sheet executions, that trend isn’t expected to reverse any time soon.

Though the government-sponsored enterprises (GSEs) have been a much-needed source of liquidity throughout the credit crisis, not all executions are created equally. Rates on forward commitments from the GSEs rose steadily throughout the year, and unfunded forward commitments were pricing between 8.5 percent and 9.5 percent as of late October.

The best bet for construction financing continues to be the FHA. The FHA’s Sec. 221(d)(4) program, a blended construction/permanent loan, was offering rates in the high-6 percent range as of late October. Plus, you don’t need a bank credit facility on an FHA deal as you would need on a GSE forward.

But the program’s unbeatable terms—it’s nonrecourse and includes 40-year amortizations, 90 percent loan-to-cost, and 1.11x DSCR—are tempered by the time-consuming process of dealing with the agency. And as the FHA gets inundated with more loan requests, questions remain about how much capacity the agency will be able to take on next year.

Four Percent Deals

Four percent LIHTC deals are headed for another tough year in 2010.

Investors heavily favored 9 percent deals in 2009, and there’s no indication that next year will be any different. Outside of large coastal metro areas, where CRA needs are highest, tax-exempt bond deals will have a hard time in 2010, many predict. 

With the private placement market effectively frozen, the best execution for a bond credit enhancement in 2009 was Freddie Mac’s variable-rate execution with a swap. Fannie Mae exited the variable-rate bond credit enhancement market in late 2008, and there’s little hope of a return engagement.

While Freddie is expected to remain in the variable-rate market next year, the company adopted stricter underwriting standards and much higher liquidity and guarantee fees as 2009 wore on. As a result, fixed-rate bond credit enhancements from the GSEs became more competitive in the fourth quarter of 2009, and the all-in rates on both executions were nearly running neck and neck in late October.

“The other thing we’ve seen on the bond debt side is an absolute rebirth of FHA financing,” says Wade Norris, a partner at Eichner & Norris, a Washington, D.C.-based law firm specializing in tax-exempt bond finance. “Fannie and Freddie liquidity charges have gone to the moon, and they’ve tightened their underwriting standards. But HUD has not changed a thing.”

The fee stack on an FHA deal is about 70 bps, compared to more than 200 bps for the GSEs. “And you don’t have any re-underwriting on your loan after you finish construction,” Norris says. In the past, FHA loans comprised about 5 percent of the deals Eichner & Norris worked on, but in 2009 it was about 40 percent.

Immediate Fundings

As the first wave of LIHTC deals start to come through their compliance period, many lenders are busy doing refinances of old or expiring use deals.

In contrast to new construction financing, rates on immediate fundings were stable throughout 2009 and are expected to remain that way through next year. The GSEs were offering rates close to 6 percent, while the FHA’s Sec. 223(f) program was coming in closer to 5.75 percent.

The FHA also offers longer amortizations and higher LTV ratios than the GSEs. This is especially true in pre-review markets, such as Florida, where the GSEs are much more selective. In hard hit markets, immediate fundings from the GSEs could offer just 65 percent LTV, maxing out at 75 percent, while the FHA will go up to 85 percent LTV as long as you’re not taking cash out (and up to 80 percent, if you are).