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HomeMy WebLinkAboutMINUTES - 03061990 - 2.4 (2) ay TO: BOARD OF SUPERVISORS FROM: Harvey E. Bragdon _ . ,,.., Director of Community Development = :, C tra ' Jr DATE: March 6, 1990 0 .s �`C� y.... CourYty SUBJECT: Financing of Multi-Family Housing Projects Owned >� coot i by Non-Profit Organizations or Governmental Entities. SPECIFIC REQUEST(.S) OR RECOMMENDATIONS(S) & BACKGROUND AND JUSTIFICATION RECOMMENDATIONS Accept Report and recommendation from the Director of Community Development on the Prospective Financing of Apartment Projects with Tax Exempt Bonds to be owned by Non-Profit Organizations or Governmental Entities; and refer said Report to the Internal Operation Committee for discussion and recommendation. FISCAL IMPACT None BACKGROUND/REASONS FOR RECOMMENDATIONS Consistent with Board of Supervisors Policy and Direction, . the County of Contra Costa has been among the more active issuers of Multi Family Mortgage Revenue Bonds in the State of California, and for that matter in the Country. Qualified 501(c) ( 3) Non-Profit Financing, and Governmental Bond Financing of Multi Family Projects represent new opportunities for financing affordable rental housing. I am recommending that the Community Development Director be directed to pursue the establishment of a tax exempt financing program for non-profit organizations and for 100% government owned rental apartment projects. In -1986 the Congress passed and the President signed into law the Tax Reform Act. With respect to tax-exempt financing, the Tax-Reform Act generally resulted in additional restrictions or limitations on the ability of local government to finance its activities through the sale of Tax-Exempt Bonds. Two exceptions to this generalization could affect Multi-Family Housing Fina cing in Contra Costa County. These are: CONTINUED ON ATTACHMENT: X YES SIGNATURE- RECOMMENDATION OF COUNTY ADMINISTRATOR RECOMMEND OF tbr COMMITTEE APPROVE OTHER SIGNATURE(S) : ACTION OF BOARD ON March 6, 1990 APPROVED AS RECOMMENDED x OTHER VOTE OF SUPERVISORS I HEREBY CERTIFY THAT THIS IS A xUNANIMOUS (ABSENT IV ) TRUE AND CORRECT COPY OF AN AYES: NOES: ACTION TAKEN AND ENTERED ON THE ABSENT: ABSTAIN: MINUTES OF THE BOARD OF SUPERVISORS ON THE DATE SHOWN. cc: Community Development ATTESTED 4, /990 CAO PHIL BATCHELOR, CLERK OF Auditor-Controller THE BOARD OF SUPERVISORS County Counsel AND COUNTY ADMINISTRATOR Dept. of Social Services Community Services BY DEPUTY Veterans Health Services County Housing Authority 1. Qualified 501 (c) ( 3 ) Bonds or tax-exempt obligations issued to finance activities of Tax-Exempt Non-Profit Organizations; 2. Governmental Bonds, or tax exempt obligations issued to finance multi family projects which are owned by a Governmental Entity or by certain entities on behalf of a Governmental Unit (a Non-Profit Subsidiary or authority of the local government) . The County has been approached by parties interested in pursuing these rental housing finance alternatives. Attachment A specifically discusses Tax-Exempt Multi Family Housing Financing for a Qualified 501(c) ( 3 ) Organization. Attachment B is a summary of a Governmental Bond Financing Proposal which is currently being reviewed by County and Housing Authority staff. The programatic benefits to financing apartment projects through either of the above mechanisms are as follows: 1. Such bonds are not subject to the uniform volume cap that greatly restricts the ability of local government to finance privately owned apartment projects. 2. Greater flexibility by the local issuer to structure housing affordability terms. (Federal Law restrictions on Multi Family Financing of privately owned projects do not generally exist for 501(c) ( 3 ) and governmental bond financed projects) . 3 . Qualified Projects owned by non-profits and governmental entities tend to maintain their public purpose (affordability, etc. ) for much longer periods of time. Qualified 501(c) ( 3 ) and Governmental Bond Financing of Multi Family Projects present four policy issues that need to be discussed: 1. Generally projects work best from both a financial and social standpoint as mixed income projects where most of the units are rented at market rates with a portion (generally 20% to 49%) being available for low and moderate income households at affordable rents. The policy issue of whether the County should enter into financing arrangements for projects that would compete with the private sector is one that has not been previously addressed by the Board of Supervisors; 2. Should the County impose minimum public purpose standards for such financing (e.g. , minimum percentage of units affordable, affordable rent levels, affordability term, ' priority for General Assistance individuals and AFDC families, etc. ) or should a more flexible approach be used. 3. The County has generally required that Tax-Exempt Multi Family Housing Bonds carry an investment grade rating which generally means the presence of a credit enhancement, or third party guarantee that principal and interest will be paid to the bond holders (a discussion of credit enhancement techniques is included as Attachment C).. These standards may be difficult for Non-Profit Organizations or Governmental Entities to meet. The financial community is beginning to understand and accommodate such bonds, however, most projects will likely need some additional form of financial support, most likely public, in order to pass lender underwriting standards; and 4. If governmental bonds are to be used should the County the Housing Authority, or a non-profit subsidiary of either the County or Housing Authority have ownership interest. JK:krc sra4:A:multif .hp ATTACHMENT A Tax Exempt Multi-Family Housing Financing for Qualified 5O1(c)(3) Organizations The issuance of tax exempt bonds to finance the acquisition of existing rental properties or the new construction or substantial rehabilitation of rental properties by a qualified 501(c)(3) tax exempt charitable organization merely represents a slight twist on something that the County of Contra Costa has been active in for years. The 1986 tax reform act created a category of bonds called Qualified 501(c)(3) Bonds. Such bonds are obligations of a local government to finance activities of tax exempt non-profit organizations. Issuance of qualified 501(c)(3) bonds is an emerging area in the tax exempt financing world. Major advantages of this alternative (as contrasted with the heretofore more conventional "private activity bonds" where a profit motivated developer is owner of the finance project, rather than a non-profit organization) are as follows: 1. Qualified 501(c)(3) bonds are not subject to the state volume cap, which private activity bonds are; 2. Under some conditions a qualified 501(c)(3) project is not subject to low and moderate occupancy and continuous rental requirements 'that private activity bonds are. (This is an advantage only insofar as the locality is left with the flexibility of setting public purpose standards that would have to be met with the financing. ) 3. Qualified 501(c)(3) bonds may be used to purchase existing properties irrespective of whether substantial rehabilitation is completed or not. (Private activity bonds are limited to new construction or the substantial rehabilitation of existing structures. ) 4. Interest on qualified 501(c)(3) bonds are not subject to the alternative minimum tax giving them an interest rate advantage; and 5. Qualified 501(c)(3) bonds may be advance refunded which private activity bonds cannot be. The County of Contra Costa has been among the more active issuers of Multi-Family Mortgage Revenue Bonds in the State of California and for that matter in the entire country. The County has financed over 2,600 rental units with an aggregate financing in excess of $150 million. Cities in the County have probably financed another 1,000 units. These bonds have financed privately owned and operated multi-family projects, not projects owned and operated by qualified 501(c) (3) non-profit organizations. Primarily because of their exemption from the very restrictive volume cap for private activity bonds, the qualified 501(c)(3) mechanism is emerging as a useful mechanism for financing multi-family projects. A financing program for qualified 501(c)(3) non-profit organizations has several key advantages: 1. The interest rate on mortgage loans will be below the conventional market rate as of February 1990. The overall loan interest rate would be approximately 8 1/2 to 9 per cent; 2. The loan interest rate would be fixed for a long term (25 to 30 years) ; 3. All costs associated with new construction and acquisition/rehabilitation are generally eligible; 4. Up-front costs are reasonable and competitive when compared with other financing available to such organizations. Difficult projects for non-profit organizations tend to be of a smaller size. Because of this small project size and resultant financing needs, it is generally difficult for such projects to economically use bond financing. The solution to this problem is the pooling of numerous qualified 501(e)(3) projects into one program for purposes of financing. The major steps in structuring such a pooled financing is the identification of: 1. A credit enhancement provider (see Attachment C) and loan originator and servicer who will take the real estate risk. Such a party on a qualified 501(c)(3) non-profit bond issue must understand the underlying nature of non-profit organizations and projects with public policy goals as well as, various other public financing resources. 2. A bond purchaser(s) who will fully understand the bonds and their underlying security and will provide a competitive interest rate; and 3. Bankable qualified 501(c)(3) organizations and economical viable projects. SRA3/jb/taxexmpt.att . . I ATTACHMENT B Governmental Bonds When a project is to be owned by a governmental entity or by a designated Entity on behalf of a governmental unit (for example a non-profit subsidiary or authority of the local government) governmental bonds maybe issued to provide the financing by virtue of their governmental ownership the projects would not be subject to the various use and occupancy restrictions. Uniform volume cap requirements and other limitations of "Private Activity Bonds" . Governmentally owned projects may be operated by a private entity pursuant to a management contract. Because direct ownership of a rental housing project may not be feasible or appropriate federal law does permit a governmental unit to establish a seperate entity to own and operate a housing project. This entity can take the form of a statutorily created authority, a non-profit corporation, or a subsidiary of a municipal corporation or authority. A project financed with governmental bonds may still utilize the participation of a private developer in a number of roles ranging from construction contractor, management or joint or partial ownership (although the latter would be very difficult and circumscribed by tax law) . Advantages of governmental bond financing of apartment projects are similar to those of qualified 501(c) (3) bonds (see Attachment A) . 'The bonds would be limited obligations of the governmental entity, i .e, secured by revenues pledged under the financing not by the general fund of the County. Such financings would likely include credit enhancements as well as other public financing. An example of a governmental bond structure that uses Redevelopment Agency 20% housing set aside as additional security is attached. County and Housing Authority Staff are currently evaluating this proposal . i I i JK:krc sra4:taxexmpt.att CREDIT ENHANCEMENT STRUCTURES Under its tax exempt financing program the County provides loans secured by a first deed of trust. A- fundamental requirement for financings is that the project have loan underwriting and credit enhancement from a third par- ty who bears the ultimate risk and responsibility of the loan. The County may consider unrated bonds on a case by case basis. 1. Credit Enhancement Techniques: Tax exempt bonds for multifamily hous- ing generally involve the use of credit enhancements. A credit en- hancement is an arrangement with a third party which provides more security to the bondholder for the timely payment of principal and interest on the bonds. In a simplistic sense, credit enhancements may be considered credit substitutes, and are employed to obtain the low- est rate with the highest credit rating at the lowest cost for the project financing. Credit enhancements take many diverse forms, and new forms of credit enhancements are continually appea.-- while existing credit enhancements are modified or eliminated. participants - banks, corporations, and insurance companies - are C tinually entering the business of providing them. Two basic alter, tive credit enhancement structures are, more fully described A. Direct Credit Enhancement Structures 1. Insurance Company Direct Guarantees Typically structured as a 50 - 50 joint venture, the guarantor takes the full real estate risk in exchange for equity and cash flow partic- ipation. Usually limited to larger developers, large and strong rent- al markets, and insurance companies that will provide a AA rating or higher for the bonds they guarantee. The insurance company guarantor will typically not charge up front points, but generally expects a to annual fee. Insurance companies do not generally take any construC7 tion period risk. Advantages o Low rate with joint venture position; and o Insurance company will offer equity infusion. Disadvantages 0 40-50% equity and cash flow given up; 0 May be conservative underwriting; 0 Don't take construction period risk; and 0 Developers generally not permitted to syndicate their share of the equity. 2. FHA Insurance/Co-Insurance This direct loan program is provided a federal guarantee under Section 221(d)(4) . Mortgage loan term is 40 years, and maybe repaid in full upon 30 day notice subject to a prepayment penalty. The maximum per- mitted amount of mortgage insurance depends on the amount of approved costs and estimated net income. FHA insurance will cover 904 of ap- proved costs, with the remainder provided by developer equity. The actual cash contribution may be reduced under the builder and sponsor risk allowance (BSPRA) , where the developer is also the builder. The additional 10% risk allowance coverage for up to 98 - 990 of approved costs. Calculations of net income may be conservative due to high va- cancy factors used in many market areas. Developer may be required to fund a debt service reserve, and pay 1.25 - 1.5 points for financing costs. An annual fee of 0.54 will be charged for the life of the loan. Page 2 Advantages 0 Low cost of credit enhancement 50 basis points per year; 0 40 year fixed rate mortgage and financing; 0 90% mortgage and financing available; and 0 Used for both construction and takeout financing. Disadvantages o HUD processing procedures and time (note that the co-insurance program simplifies and streamlines the processing) ; 0 Davis-Bacon wage requirements apply; and 0 State and locally mandated policies and requirements on rent lev- els may be difficult to approve. B. Indirect Credit Enhancement Structures I. Letters of Credit Irrevocable letters of credit are used frequently to guarantee payment of principal and interest on tax exempt bond issues. By borrowing funds on the debt rating of the letter of credit provider, a lower in- terest on the debt can be obtained. Letters of credit may be direct guarantees of the lenders completing the real estate ;review and under- writing, as a direct guaranty of said lender by a commercial bank, or as a collateral program in which the lender establishes collateral backing for the project loan in exchange for letter of credit backing. Letters of credit are flexible instruments and can be tailored to fit the needs of a develoFier and issuer. Use of the letter of credit may be structured under a standby agreement, where the letter of credit is drawn upon only if the developer (and therefore the issuer) is unable to make scheduled principal and interest payments,, or a direct pay letter of credit, where the letter of credit provider makes all sched- uled principal and interest payments and is repaid by the developer. Advantages 0 Relatively fast project review time, particularly if the lender has previous tax exempt financing experience; 0 Can be used for construction and takeout financing; 0 May use existing bank relationships; 0 A debt service reserve fund may not be necessary as part of the bond issue, thereby reducing costs; 0 Large number of potential providers including foreign as well as domestic banks; and 0 Developer can shop real estate underwriting criteria. Page 3 Disadvantaces 0 Letters of credit are generally for a maximum term of 10-12 years, therefore developer must be prepared to refinance; 0 If multiple parties are involved in the letter of credit agree- ment, there may be multiple real estate review and underwriting; 0 The experience and net worth of the developer may be a critical criteria for some lenders in particular projects. 2. Surety Bond Guaranteed Programs Using this structure the proceeds from the sale of tax exempt bonds are loaned to a lender who in turn makes a loan to a developer. An additional credit enhancement device other than the surety bond (let- ter of credit, etc. ) would have to be employed in order to comply with federal tax law. In exchange for the loan of the tax exempt bond pro- ceeds the lender provides a surety bond and such other enhancement which guarantees the lender's obligations to make payments. In con- sideration of the surety bond, the lender pays a fee to the surety company, and provides a conditional assignment of the first mortgage lien on the project and/or posts collateral in sufficient amounts. If the lender defaults, the surety company is responsible for debt. ser- vice on the bonds, assumes the lender's right, under the mortgage, and may liquidate any collateral pledged. Surety companies impose strin- gent criteria for underwriting a surety bond to a bank or savings and loan. Advantages o A debt service reserve fund may not be necessary as part of the bond issue, thereby reducing costs; o Aggressive real estate lenders may have potential use; and o Can readily be used to provide construction as, well as take out financing. Disadvantages 0 Some lenders may not have or wish to pledge the required collat- eral; 0 Surety bond terms of 10 - 12 years, therefore developer must be prepared to refinance; and 0 some lenders may not meet surety companies criteria (maximum as- set size, net worth-to-assets ratio, etc. ) 3-. Pledged Collateral Programs A lender can secure the developers loan from an issuer of Lax exempt bonds with collateral in the form of seasoned single family mortgages, U.S. government Securities, or GNMA or FHLMC securities. The rating on the bonds is determined by the degree of over collateralization and Page 4 the quality of the collateral. In the event of a lender default the collateral is liquidated, and the proceeds used to redeem bonds. An alternative is to structure a cash flow collateral program, in which a lender default does not trigger liquidation of collateral, but rather the collateral cash flow is used to pay debt service on remaining bonds. A second alternative involves the structuring of a collateral purchase agreement, in which a lender default could trigger a highly rated commercial bank or insurance company to purchase the collateral. Advantages o Simple and straight forward in concept; and o Theoretically allows any lender to be used. Disadvantages o Collateral requirements limit or eliminate many lenders; and o Revaluation and substitution of collateral is cumbersome and ex- pensive. Use of a collateral program may eliminate these recur- ring expenses. 4. Bond Insurance Bond insurance, the most common form of third party guarantees, permit an issuer to obtain a Aaa/AAA rating. Bond insurance is typically used in conjunction with one or more of the other types of credit enhance- ments. The actual rate advantage depends on the underlying creditworthiness of the project financing. The key question with bond insurance is whether the interest rate savings exceed the cost of the premiums. JK/mb a lrpt2/apendixb.rpt 2. Unrated Bonds/Escrow Bonds while most multifamily mortgage revenue bond issues are rated and in- clude a credit enhancement, occasionally a developer will propose the issuance of unrated bonds. Because such bonds are riskier - bondhold- ers are generally secured only by the real estate projects mortgage payments - they should be purchased only by sophisticated buyers who can afford the risk and are capable of analyzing the underlying secu- rity. 1 j i E