The Bond Volume Cap Dilemma

7 min read

Some states find creative solutions 

Last June, attorney Wade Norris reported in these pages on the increasing demand for tax-exempt, multifamily bonds throughout the United States and  noting that several states were burning through volume cap. Norris predicted that historical excess of bond volume would quickly become shortage in additional states. While New York (which has fully utilized its volume cap for years), Massachusetts, Connecticut, New Jersey, Minnesota, and Utah were on the list back in June, we can now add states like Colorado, Tennessee, Oregon and Florida to the list as well.

While many states are approaching, or have reached volume cap limitations, they have done so for different reasons and as such have come up with different ideas for making the best of a suddenly limited resource. New Jersey has experienced a spike in utilization partly due to pairing 4 percent bond projects with Hurricane Sandy funds. Florida has a large number of 9 percent projects reaching the end of their life cycles. California and Massachusetts have large numbers of HUD properties in need of rehab causing constraints on the bond program. Overshadowing all of these state-specific conditions was the nation-wide market conditions of 2016: low interest rates and strong tax credit pricing, resulting in an attractive market for 4 percent LIHTC/bond financed multifamily development.

The Laboratory of the States
For the state of New York, utilizing 100 percent of bond cap is old hat. One explanation is New York’s strong CRA demand. Another is the state’s significant menu of soft funds. Governor Cuomo has made affordable housing a priority and $2 billion of the state budget has been designated for affordable, supportive, and senior housing over the next five years, (pending an anticipated memorandum of agreement between the legislature and governor’s office). These funds play an integral role in gap financing for the multifamily bond program. Marian Zucker, President of Finance and Development at New York’s HFA, explains that these funds also direct bonds to deserving projects due to the requirements that come with them. “We end up having a very policy-driven pipeline.”

The Agency received $150M this year towards Supportive Housing Opportunity Program (SHOP) funds, which finance projects with a supportive housing aspect. Two years ago, Governor Cuomo put a program in place for funds for middle income (up to 130 percent AMI). “It’s very common for the agency to prioritize the financing of projects that meet a range of policy goals, such as providing housing for particular populations,” says Zucker.

Massachusetts, in similar fashion, provides soft funds which have aided in utilizing multifamily volume cap. Karen Kelleher, Deputy Director at MassHousing, adds that her agency has moved money from single-family to multifamily because “there’s more bang for the buck on the multifamily side,” and notes that they are able to manage single-family lending well without using volume cap (as long as rates remain relatively low).

Not all states have a former HUD Secretary as their governor, as New York does, and many state agencies cannot prioritize multifamily at the expense of single- family since single-family is a common revenue generator for them. In Minnesota, revenue gained from home mortgage loans funds the agency’s Affordable Housing Fund – a fund which finances grants and deferred loans for affordable housing activities across the agency. So diverting all bonds from single-family would be counterproductive.

From 2011-2014, Minnesota’s use of multifamily bonds never exceeded $186 million in a single year. That number jumped to $313 million and $400 million in 2015 and 2016, respectively. Suddenly, the un-used balance of state housing pool went from roughly $150 million for the last few years to a dramatic $4 million of unused volume cap in 2016.

In response, Minnesota proposed several policy changes to ensure the bond program served the state’s policy needs on the multifamily side. Changes included increasing the minimum score required to qualify, meeting at least one of the state’s priority policies and maintain affordability for a minimum of 30 years. But unlike the example of New York, the higher requirements Minnesota proposed placing on the multifamily bond program were not tied to additional funds. Serving people with incomes below 60 percent is a noble pursuit, but a costly one as well.

The agency received roughly 60 comment letters on the proposed changes, including one from NH&RA. The fear was that increased requirements and costs upon developers could lead to dramatically less use of tax exempt bonds for multifamily, turning a high-demand commodity into an inefficient market where volume cap goes underutilized. In light of the comments, and potentially different market conditions soon to come, Minnesota has decided to extend the comment period and is hosting several stakeholder conversations in order to come to a solution that will materialize in early 2017.

When multifamily bonds become scarce, advocates and state HFAs could consider the following strategies:

  1. Allocate more to multifamily from other uses
    Politically speaking, this might not be an easy task. You could be competing with attractive political causes, like student loans. Emphasize that multifamily private activity bonds, unlike any other, leverage additional federal subsidy in the form of the 4 percent LIHTC.
  1. Implement an effective carryforward program
    Excess volume can be shifted from one purpose to another during the first year of allocation. Once that year passes, the volume can only be used as carryforward for the designated purpose. Tennessee, an example of a state HFA primarily focused on single family, has put in place the temporary fix of shifting current single-family volume towards multifamily. The balancing act here is to determine future need of the use you are taking from to determine if carryforward from past years can make up for the gap.
  1. Maximize efficiency of the 50 percent test
    The 50 percent test dictates that any project receiving 4 percent credits must be funded with at least 50 percent bonds and a typical deal may utilize bonds to fund 60 percent of the project. One tact Minnesota has taken (and several other states including New York and Massachusetts stress this as well) is to limit bonds to 52 percent or 53 percent of funding per project. The few extra percentage points provide a cushion and the limit ensures more bond volume to go around.
  1. Recycle bonds
    The advent of the short-term cash back bond structure (typical with FHA and rural development loans) creates an opportunity to recycle volume cap when the bonds are redeemed. New York, for example, recycles bonds, as has Minnesota in the past. Limitations here include using the recycled amount within six months, no more than a 34-year maturity and recycled bonds do not generate 4 percent credits. In a rising interest rate environment, this may be a more attractive opportunity for market-rate and mixed-income developers.

Federal Legislative Solutions
Every state is allocated a yearly amount of private-activity bond volume – the greater of $300 million or $100 per citizen. Even when particular states reach their volume cap limit, on a national basis, the country only utilizes roughly one-third of all volume cap. One potential legislative solution is to move to a national pool model – where excess volume cap from low-demand states can be transferred to high-demand states.

Multifamily bonds are unique from all other tax-exempt bonds in that they are able to utilize an additional subsidy – the 4 percent LIHTC – as long as a minimum of 50 percent of the project is funded with bonds. In light of this, another potential solution involves reducing the 50 percent test to 40 percent stretching the bonds a state has allocated for multifamily.

There is the possibility that these solutions will become a moot point over the next several months: as rates increase and tax reform looms, the perfect market conditions for multifamily bonds dwindles. But history repeats itself and 2016 was not the first time America has seen such high demand in the bond market. In the 1990s, demand for multifamily bond volume outstripped supply in many states. If demand for multifamily bond volume falls, it will no doubt rise again, and states that handled the 2016 bond shortage efficiently will be prepared strategically when faced with this problem in the future.