A Tale of Two Bond Caps

7 min read

The Wide Discrepancy of Bond Cap Availability Across the Country 

Across the country, affordable housing developers are turning to private activity bonds (PABs) and four percent Low Income Housing Tax Credits (LIHTC or credit) to finance their affordable housing transactions since the nine percent LIHTC remains persistently oversubscribed. As demand for PABs and the accompanying four percent credit rises, numerous states are consistently hitting their annual multifamily PAB cap limit (California, Colorado, Connecticut, Georgia, Massachusetts, Minnesota, New Jersey, New York, Oregon and Tennessee) and others are rapidly approaching their multifamily PAB cap limitations (including the District of Columbia, Florida, Hawaii, New Mexico and Texas.)

This contrasts with the 14 states that issued less than ten percent of their volume cap in 2018: Alaska, Arkansas, Delaware, Kentucky, Louisiana, Mississippi, Missouri, New Hampshire, Ohio, Oklahoma, Pennsylvania, South Carolina, Vermont and West Virginia.

This bifurcated landscape means we must implement a dual-pronged policy approach to ensure we are stretching the bond cap as far as we can in oversubscribed states and increasing bond utilization in states that have latent federal money available to finance affordable housing.

National Solutions to Increase Availability of Bond Cap            
The Affordable Housing Credit Improvement Act (AHCIA) of 2019 includes provisions to expand PAB recycling and enact a minimum four percent credit rate.

In 2015, Congress permanently fixed the nine percent credit rate at nine percent but has yet to do so for the four percent credit. While enacting a minimum four percent credit rate has long-been a top priority for LIHTC advocates, it became even more urgent in May 2020 when it hit a record low of 3.08 percent.

The AHCIA would also give states one year to recycle bonds, as opposed to the current six-month time frame, and allow multifamily bonds to be converted to single-family bonds. In 2008, Congress authorized recycling of multifamily PABs so that states could use the proceeds from the repayments of those bonds to finance more affordable multifamily bond-financed housing. However, the recycled PABs do not generate additional four percent credits, thereby limiting their efficacy for multifamily developments. (See Housing USA)

Under current federal law, at least 50 percent of PABs/four percent LIHTC development’s aggregate basis must be financed with PABs in order to generate LIHTCs on the entire eligible basis of the project. The Internal Revenue Service (IRS) annually updates the amount of nine percent credits and PABs that each state receives based on population changes. Four percent credits, on the other hand, are only limited by the amount of PAB volume cap. By lowering the 50 percent test, states could further ration PAB volume cap and still leverage the LIHTC.

Several groups, including NH&RA, are developing additional proposals aimed at increasing the amount of bond cap, including: raising the PAB volume cap; an exemption for preservation of public housing through programs, such as Rental Assistance Demonstration (RAD), from the PAB cap; and an exemption for all multifamily housing from the PAB cap.

Solutions for Oversubscribed States
While federal law requires at least 50 percent of PAB/four percent LIHTC development’s aggregate basis be financed with PABs in order to generate LIHTCs on the project’s entire eligible basis, there is no upper limit to the amount of PABs that can be used in a transaction. Some states (including California, New York, Oregon and Tennessee) require developments to limit their bond usage to 55 to 60 percent of a project’s aggregate basis. Limiting volume cap requests to align with the 50 percent test, plus a modest cushion to accommodate unforeseen increases in costs, allows states to stretch a limited resource.

Housing credit allocating agencies can also remove caps that arbitrarily limit the amount of four percent credits a project and/or developer can receive each year. Allowing developers to claim all the credits they are eligible to receive should further limit the total PAB request, fill project gaps that might otherwise need to be filled by soft-resources and/or off-set the additional interest rate and transactional costs generated by having a taxable tail.

There are many uses for PABs, but only bonds used for multifamily housing generate another federal subsidy, the four percent LIHTC. Of course, it is not feasible that all PAB caps be allocated to multifamily housing – states must determine how to balance many competing priorities, budgetary considerations and mission-oriented goals. However, NH&RA maintains that given the need for affordable rental housing and the generation of the associated four percent LIHTC, to the extent possible, states should maximize PAB allocations for multifamily affordable housing.

The Tennessee Housing Development Agency (THDA) recently approved the use of a drawn-down facility for its single-family PABs, which has a similar impact as the multifamily recycling program. THDA temporarily refunds single-family bond repayments into short-term taxable notes and reinvests them. When new tax-exempt proceeds are needed, the notes under the draw down program may be refunded into the new tax-exempt bond issue, preserving the private activity volume cap used for the prior THDA bonds.

THDA also introduced a hybrid product that allows single-family loans to be funded with a blended taxable and tax-exempt product. Historically low borrowing rates make taxable products competitive with tax-exempt products.

Solutions for Undersubscribed States
Solutions for undersubscribed states focus on increasing demand for multifamily PABs by making deals more financially feasible. In many locations, market realities, such as low area median incomes and rents combined with remote project locations that make it difficult to secure labor and materials, will make it hard for deals to pencil out. But states and housing credit allocating agencies have significant policy levers at their disposal to support affordable housing in these areas, areas where it is often needed the most. States and housing credit allocating agencies should do everything they can to build demand for this latent federal resource that would otherwise expire unused. For example, to the extent that soft resources (e.g. HOME Funds and state Housing Trust Funds) are available they could be prioritized to support PAB financed transactions.

Housing credit allocating agencies can separate the Qualified Allocation Plan requirements for nine and four percent credits and limit four percent credit requirements to mandatory threshold items, like affordability requirements, project location and developer qualifications. Similarly, they can decouple the nine and four percent application deadlines. One of the most attractive features of the four percent credit is the speed of execution and relative certainty of the credit’s availability in undersubscribed states. A rolling application deadline enables developers to take advantage of this program’s defining feature.

Perhaps most importantly, housing credit allocating agencies should do all that they can to maximize eligible basis. Maximizing the amount of credits available to the project will reduce the overall amount of necessary debt leverage, making more projects viable as four percent credit/PAB projects. In this regard, there are a number of options available to states, including incentivizing development in Difficult to Development Areas and Qualified Census Tracts (both of which receive a 30 percent basis boost); differentiating total development costs and/or total per unit costs based on nine vs. four percent credits, location, density and parking, including all eligible basis in developer fee calculation; and eliminating fixed dollar amount or per unit limitation on developer fees. Maximizing developer fees is a proven and successful method of increasing eligible basis, raising additional LIHTC equity and generating more production through the PABs. In effect, progressive approaches to structuring developer fee policy can serve as an alternative to gap financing in a project, allowing housing credit allocating agencies to prioritize soft dollars for other needs.

Bond Execution
The importance of selecting the best bond execution for your deal cannot be overstated, and this holds true for states that are under- and oversubscribed for multifamily PABs. We urge states to not tie gap funding to a specific permanent loan product, as is often done to prioritize the state’s own lending product. Policies like this inhibit the ability of the developers to select the financial execution most suitable for a given project and their business model.

Kaitlyn Snyder is managing director of National Housing & Rehabilitation Association.