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Combining Tax Exempt, Short-Term Bonds with Taxable GNMA Sale for Affordable Apartment Financings

12th Annual Southeast Mortgagee Advisory Council (SMAC) Conference Hilton Head Marriott Resort and Spa, Hilton Head, SC May 29 – 31, 2013. Combining Tax Exempt, Short-Term Bonds with Taxable GNMA Sale for Affordable Apartment Financings.

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Combining Tax Exempt, Short-Term Bonds with Taxable GNMA Sale for Affordable Apartment Financings

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  1. 12th Annual Southeast Mortgagee Advisory Council (SMAC) Conference Hilton Head Marriott Resort and Spa, Hilton Head, SC May 29 – 31, 2013 Combining Tax Exempt, Short-Term Bonds with Taxable GNMA Sale for Affordable Apartment Financings

  2. Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  3. From 2000 – 2008, the United States has produced about 230,000 units of new multifamily rental housing per year. If one estimates rehabilitated units at 50,000 – 150,000*, perhaps total production of 300,000 to 400,000 units per year • Volume fell precipitously post 2008 – 90,000 new units in 2009; 100,000 in 2010; 180,000 in 2011 from 230,000/ year average • Cumulative deficit in new rental units 2009 – 2011 of 330,000 units – a major current driver of new rental unit demand ________________________________ * Housing for All Americans 2007-2008, Affordable Housing Finance Magazine, citing NCSHA data Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  4. ADDITIONAL HUGE DRIVERS OF MULTIFAMILY RENTAL HOUSING DEMAND • Post WWII Baby Boom “Echo” generation entering with force and seeking housing • Continued Net Immigration (immigrants rent for 10 years before buying) • Severe tightening in lending standards for single-family home loans post 2008 – U.S. home ownership 69%  65% Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  5. ABOUT ONE THIRD OF ABOVE IS AFFORDABLE RENTAL HOUSING(60% AMI OR LESS) Two Major Programs of Above – Both Involve Low Income Housing Tax Credits (“LIHTC”): • 9% LIHTC - about 70,000 units/ year at peak • 4% LIHTC combined with Low Rate Tax Exempt Bonds – about 60,000 units/ year at peak Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  6. LOW INCOME HOUSING TAX CREDITS (“LIHTC”) • What is a “tax credit?” • A tax credit entitles the holder to offset the check he or she would otherwise have to write the federal (or state) government for income taxes owed in a given year dollar-for-dollar, up to the amount of the tax credits he or she holds. • Better than a tax deduction, which is worth only 30 or 40¢ per dollar, since deductions only lower your income. If you are in a 35% tax bracket, a $1.00 deduction is worth 35¢; it saves you 35¢ in taxes you would otherwise pay. A dollar of tax credits is worth a dollar because it directly offsets a dollar of taxes you owe and would otherwise have to pay. Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  7. How Does Low Income Housing Tax Credit Equity work? • Section 42 of IRC permits investors in qualified projects to claim an annual credit against federal income tax for a 10-year period after the project is placed in service • Amount of credit which can be taken each year is a specified percentage (e.g., approximately 9% or approximately 4%) of the “qualified basis” of the affordable units • “Qualified Basis” is roughly speaking, total development cost less land and commercial Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  8. 9% LIHTC PROGRAM • Can sell 9% tax credits for about 65% of Total Development Cost • Very popular program, but very little volume versus demand • Results in small loan size; unattractive for FHA execution Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  9. TAX EXEMPT BONDS PLUS 4% LIHTC PROGRAM • Must obtain private activity bond volume allocation, but much easier to get than 4% LIHTC allocation • Can sell 4% tax credits for about 25% - 30% of Total Development Cost: • While loan size a bit smaller than for market rate project, still quite substantial • Increasingly important part of US Housing stock – perhaps one of every six apartments or more Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  10. SINCE 2008 – UNIQUE OPPORTUNITY TO FINANCE AFFORDABLE HOUSING BY COMBINING TAX EXEMPT BONDS + 4% LIHTC WITH FHA INSURANCE OR GSE CREDIT • Results from fact that since financial crisis in 2008, U.S. Government backed debt has traded at yields dramatically lower than all other long-term debt instruments, including even tax exempt municipal bonds. Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  11. SINCE 2008 – EXTREMELY LOW RATES ON U.S. TREASURY BACKED DEBT ISSUES 30-Year MMD (Tax Exempt) Versus 10-Year Constant Maturity Treasury (Taxable) Early 2008 – Taxable US Government Securities Rates Fall Below Tax Exempt Municipal Rates ~400 bps ~127 bps Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  12. COMBINING LONG TERM TAXABLE LOANS WITH SHORT-TERM TAX-EXEMPT BONDS AND 4% LIHTC VS • Traditional Long-Term Tax Exempt Bond Financing: • 18 - 40 Year Bond Coupon is 3.50% or higher. • After 3rd party fees and overides are added, all-in borrowing rates are 5.0% or higher. • New Construction/Sub Rehab Bond Financings also require a significant amount of Negative Arbitrage (~5 - 10% of Loan Amount)  Advantages of Taxable Executions: • ~0.50 - 1.50% lower permanent borrowing rate: resulting in additional loan proceeds on a debt service constrained loan and/or increased ongoing project cashflow. • New Construction/Sub Rehab deals: dramatic reduction in negative arbitrage deposits • Since 2008 taxable FHA/GNMAs Market, have delivered extremely low rate pricing: • FHA/GNMA: 223(f)/221(d) GNMA sales currently provide 3.5% - 4.0% all-in borrowing rate with no negative arbitrage and 35-40 year amortizations. • Fannie/Freddie loans with no “construction” period (i.e. immediately funded transactions w/ mod-light rehab) currently provide 4.0% - 4.5% all in borrowing rate with 30-35 year amortizations. Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  13. 4% LIHTC 50% TEST With today’s low taxable loan rates, why not just borrow funds in the taxable market? Reason: Under Section 42, in order to qualify for the full value of the 4% Low Income Housing Tax Credits, at least 50% of aggregate basis of the building and land must be financed from tax exempt bond proceeds. However, these tax exempt bonds only need to remain outstandinguntil the Project’s “placed-in-service” date. Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  14. LONG TERM TAX EXEMPT BONDS Traditional Long Term Tax Exempt Bond Execution: 6 5 4 3 1 2 18-40 Year Bonds Trustee Bond Purchaser Bond Proceeds Bond Proceeds MBS Draw Request Borrower FHA/GSE Lender Loan Funding Problem: High Mortgage Rate (and large Negative Arbitrage deposit for New Construction or Substantial Rehab transaction) Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  15. COMBINED TAXABLE LOAN WITH TAX EXEMPT BONDS Bond Payoff (after Project is placed in service) Trustee ~2-Yr Bonds 8 2 1 6 5 7 4 3 Escrow Account Bond Proceeds Account MBS Proceeds Bond Purchaser MBS Purchaser Bond Proceeds Bond Proceeds Sale of Taxable MBS Borrower Draw Request FHA/GSE Lender Loan Funding Benefits: Qualifies for 4% LIHTC; Low Mortgage Rate (and minimal negative arbitrage deposit for new construction or substantial rehab transaction) Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  16. EXAMPLE COMPARISON FOR FHA/GNMA TRANSACTION Result 1.65% ML Rate Savings (~12% additional loan proceeds on debt service constrained loan) Estimated Negative Arbitrage Savings for New Construction / Substantial Rehabilitation Transactions: (1) $7 million sized on 50% test ($13 million total costs) Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  17. EXAMPLE SOURCES AND USES (1) $7 million sized on 50% test ($13 million total costs) Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  18. TWO SAMPLE TRANSACTIONS 223(f) Pilot Program Acq./ Rehab Deal ¹Actual rates MAY VARY GREATLY based on deal size, project location, type of loan, market conditions and many other factors. Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  19. TWO SAMPLE TRANSACTIONS 221(d)(4) New Construction ² Makes Paper Tax-Exempt Money Market Fund Eligible; dramatically lowers coupon. Borrower and 4% LIHTC investor must get comfortable with remarketing risk; but risk very low. ³Additional deposit of capitalized interest in bankruptcy remote funds required if Bonds not called on 1st optional call date. Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  20. RESULTS OF STRUCTURE Net Results – Borrower: • 50 - 150 basis points of savings in permanent borrowing rate, resulting in a lower cost of capital over the life of the loan • Increased Loan Proceeds and/ or • Increased Cash Flow • Full syndication value of 4% LIHTC equity on affordable units achieved • For New Construction or Substantial Rehab Transactions, Negative Arbitrage deposit is significantly reduced Net Results – IRS: • Often results in fewer Tax Exempt Bond proceeds needed to fund Qualified Project Costs– $1.0 million less in example compared to the traditional long-term tax exempt bond issue • No arbitrage “artifice or device” -all Tax Exempt Bond Proceeds (and replacement proceeds) invested at far below tax exempt bond yield • No “over issuance” of bonds or “overburdening” of market – only Tax Exempt Bonds to meet 50% test, and outstanding 2 years versus 18+ years Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  21. Other Related Questions/Issues Bond Amount > Taxable Loan Amount: Other sources of funds (i.e. Equity, Subordinate loan, etc.) needed to cover the differential. Timing of funding is crucial Additional Rating Agency requirements on publically offered transactions Bridging Equity: Limited collateral available for bridge financing Publically Offered vs. Privately Placed: Timing; Cost; Issuer requirements Bond Interest &Third Party (Bond Related) Fees Typically escrowed at closing with Trustee for full term of Bonds Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

  22. CONCLUSION • All major bond counsel firms with whom we have worked have issued or agreed to issue unqualified approving opinions on deals using this type of cash collateralized structure for numerous tax exempt multi-family housing bond issues • Documents and rating agency criteria are well developed • This structure has become a THE WAY to finance affordable housing projects with FHA insurance and also works with other GSE executions • Unlikely that market conditions will change in next 12-18 months to favor traditional long-term tax exempt bond structure Eichner Norris & Neumann PLLC Merchant Capital L.L.C.

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