Tax-Exempt Bonds and 4% Tax Credits

Mary Nash K. RusherHunton & Williams LLP(919) 899-3066mnrusher@hunton.com

Mark ShelburneNovogradac & Company LLP(919) 889-2596mark.shelburne@novoco.com

2015 North Carolina Affordable Housing Conference

October 29, 2015

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What are multifamily housing revenue bonds?

• Bond (debt) issued by a governmental entity (state, regional or local housing authority, county or city - the “Issuer”)

• Proceeds are loaned to private entity (typically a partnership or LLC - the “Borrower”)

• Borrower uses those dollars to acquire, construct and/or rehab and equip “multifamily residential rental housing”

• Bonds are “private activity bonds” or “exempt facility bonds” under Section 142 of the Code

Tax-exempt bonds issued under IRC Section 142 combined with the 4% tax credits under Section 42 are an alternative to traditional 9% tax credits•Section 42 provides an “automatic” 4% tax credit•50% or more of the project’s eligible costs must be financed with tax-exempt private activity bonds•Developer must submit an application to NCHFA for allocation of “volume cap” (i.e. permission to issue)•If NCHFA approves, the project sponsor/developer is not required to compete separately for tax credits

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• Each state is permitted to issue a limited amount of private activity bonds in each year (“volume cap”)

• Volume cap is divided among industrial development, student loan, single family, waste disposal and multifamily housing

• Currently far more supply than demand

• In NC, 2015 volume cap is more than $944 million

• Volume cap for housing allocated by the NC Federal Tax Reform Allocation Committee (“TRAC”)

• Use for multifamily housing is based on NCHFA recommendation

Benefits of tax-exempt bonds & 4% LIHTCs• No competition; resource goes largely unused• Tremendous need across the state• NC has extensive developer capacity – more than

60 groups involved in the 9% process annually• Difficult but certainly not impossible to make the

numbers work • Developers all understand LIHTCs, which is the

most difficult part

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Bond/4% Affordability Requirements

Bonds and tax credit rules require that at least 40% of the units be rented to households at <60% of AMI•As a practical matte most are 100% restricted•Tax rules permit as few as 20% to be leased to HHs at <50% AMI, with the remaining at 80% at market•Only one such project in N.C. (Charlotte)•An 80/20 project could be an option anywhere a market rate complex works

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Portfolio Transactions

• Portfolio transactions are a very specialized activity• Involve combining several properties in different

locations under one owner• Challenging, lots of moving parts• Very efficient outcome as compared to submitting

many 9% applications• NCHFA rather than a local authority is the issuer

since it has statewide jurisdiction

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Expected Bond Calendar for 2016, First Round (Draft QAP, same as 9%)

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• January 22 Deadline for submission of preliminary applications (noon)

• March 24 Notification of final site scores and initial evaluation of rehab projects

• May 13 Deadline for full application (12:00 noon)

• August, 2016 Notification of tax credit awards

• December 31, 2016 Deadline for closing transaction

NCHFA Review Criteria for Bond/4% Deals

Requirements essentially the same as the 9% pre-app

– site score, although no competition

– site thresholds still apply

– market study is the same

– need an option or contract on the real property

Other than the last item, a fairly small investment

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NCHFA Requirements• Meet all QAP standards unless indicated otherwise• Inducement resolution with the full application• All projects will carry out DHHS targeting• Rehabilitation applications must:

– Be placed in service date or before December 31, 1999– Require at least $10,000 per unit of rehabilitation– Not have an acquisition cost >60% of the total cost

• Qualify for experience with an out-of-state bond deal• Operating reserve must be the greater of $1,500/unit or four

months’ debt and operating• Developer fee same as for 9% other than max of $1,900,000

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Summary of initial steps for approval

• Apply to NCHFA for approval of volume cap• Identify an issuer – local housing authority (best

choice), regional housing authority, city or county• Issuer adopts preliminary (also called “inducement” or

“reimbursement”) resolution• Issuer agrees that it will issue bonds if all approvals are

obtained• Receive approval from NCHFA and allocation of

volume cap

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Summary of remaining steps

• Public hearing (“TEFRA” hearing) after 14 days’ published notice before Issuer or city/county

• Followed by approval resolution from city/county in which project is located

• If debt outstanding >5 years, Issuer adopts findings resolution to satisfy Local Government Commission (Treasurer); meets once a month

• Approval by town/city if a county or regional housing authority exercising jurisdiction there

• Final approval by Issuer

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Why does someone want to buy these bonds?

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• Interest received is exempt from income tax• In NC, the LGC requires bonds must have credit

enhancement, be sold to a financial institution, or have an investment grade rating

• HUD insured mortgage with Ginnie Mae Certificates• Can be privately placed• May be purchased by a single institutional investor,

which may also be the tax credit investor• Banks get Community Reinvestment Act credit

Two Primary Structures: Long-Term Bonds

• Remain in place at least for the full tax credit period• Rents must cover the debt service• Often require some sort of credit enhancement (i.e.

Fannie Mae, HUD guaranty) or• A number of banks now will do privately placed long

term debt (SunTrust, Bank of America, CitiBank) or• Freddie Mac also has a long term product

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STRUCTURE – LONG-TERM TAX-EXEMPT MULTIFAMILY HOUSING BONDS

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BOND HOLDERSOR PURCHASER

TAX CREDITINVESTOR

[INDENTURE TRUSTEE]

AUTHORITY

DEVELOPER/BORROWER

PROJECT

CONSTRUCTION FUND

RESTRICTIVE COVENANTS

FILED AT CLOSING

Purchase Price($$)

($$)

Note Assigned

Loan Agreement& Note

Upfront IssuanceFee

LimitedPartnership

Interest

SellsBonds

$$

UNDERWRITER

($$)

TaxCredits

Revenues

$$

Bonds

• Bonds are outstanding only during construction

• Bonds and HUD 221(d)(4)/223(f)/Fannie Mae loan are outstanding simultaneously

• Construction draws on HUD or Fannie Mae loan deposited to a cash collateral account; corresponding amount of bonds used to pay actual costs

• Result is >50% of basis is constructed with bond proceeds

• Bondholders have no interest in the Project but are 100% cash secured; result is lower rate for short-term debt

• Bondholders have cash collateral; almost no risk16

Two Primary Structures: Short Bonds

STRUCTURE – SHORT-TERM TAX-EXEMPT MULTIFAMILY HOUSING BONDS

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UNDERWRITER

Release corresponding amount of

bond proceeds

BOND HOLDERSOR PURCHASER

TAX CREDITINVESTOR

INDENTURE TRUSTEE OR ESCROW AGENT

AUTHORITY

DEVELOPER/BORROWER

PROJECT

CONSTRUCTION FUND

RESTRICTIVE COVENANTS

FILED AT CLOSING

BOND PROCEED

S

Note Assigned

SellsBonds

$$

Purchase Price($$)

MORTGAGE SERVICER FOR HUD/FANNIE MAE

CASH COLLATERA

L FUND

Disbursement Request

Advance Funds

At end of construction, cash pays off bonds

TaxCredits

Upfront IssuanceFee

Loan Agreement& Note

LimitedPartnership

Interest

Revenues

$$

Bonds

Who are the players in a bond deal?• Issuer – governmental unit that issues bonds

• Very important to identify issuer early in the process• In NC the local housing authority is the first choice;

cities and counties can also act as housing authorities• Purchaser – institution that purchases bonds• Underwriter – for publicly offered bonds, the investment

banking firm that structures the deal and finds buyers• Trustee – bonds are issued under a trust indenture;

the trustee holds proceeds pending disbursement for construction and collects payments for bondholders

• Credit Enhancer – provides financial guarantee for bonds/project; makes bonds ratable/marketable

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Who are the players in a bond deal? (cont’d)

• Bond Counsel – oversees entire process and issues opinion that bonds are tax-exempt

• Underwriter’s Counsel – prepares disclosure document to sell bonds to the market place – “Official Statement”

• Borrower’s Counsel – looks out for Borrower’s interest; generally does real estate, tax credits, and opinion (sometimes roles split between >1 firm)

• Issuer’s Counsel – represents the bond issuer• Rating Agency – will issue ratings for the bonds based

on credit enhancement; makes bonds more marketable

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QUESTIONS?

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Mary Nash K. RusherHunton & Williams LLP(919) 899-3066mnrusher@hunton.com

Mark ShelburneNovogradac & Company LLP(919) 889-2596mark.shelburne@novoco.com