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CRE Finance World Autumn 2015
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thereby creating an incentive for the tax investor to exit at the
end of the recapture period.11 The Guidelines sought to eliminate
certain forms of developer guarantees including most notably a
guaranty of the tax credits themselves. The inability to obtain a
guaranty of the HTCs, as before, is expected to result in stricter
underwriting of transactions by tax investors. Guarantees may not
contain minimum net worth covenants. As a result, look for tax
investors to “piggyback” upon lender net worth requirements.
HTC Program Benefits to Lenders
Because HTCs are personal to the entity that originally claimed
them, HTCs are not part of the lender’s collateral. Although the
lender does not benefit directly from HTCs, it can still receive
significant indirect benefits from lending on an HTC project.
The tax investor’s very involvement in the transaction can be a
source of comfort to the lender in that the tax investor will add its
own underwriting and oversight requirements to the transaction.
The project will also require certification by the NPS and SHPO,
which provide another layer of oversight. Further, the Guidelines
now require that all fees payable to the developer and its affiliates
be reasonable.
The capital structure also will
benefit from the tax investor’s
involvement in the transaction.
The tax investor typically infuses
large amounts of funds prior
to construction reducing the
potential for the project ending
up “out of balance.” Moreover,
the tax investor’s equity must remain in the deal for at least five
years after completion of the renovations, helping to reduce the
loan-to-value ratio of the project and the need for other forms of
risky capital, such as mezzanine financing.
Issues for the Lenders On HTC Projects
A lender foreclosing on a project that has benefited from HTCs is
not subject to any state or federal restrictions specific to HTCs.
However, the prudent lender will still need to address certain issues
relating to HTCs. We have outlined below a few of the more salient
issues that lenders may face.
1. SNDA
If the master-lease structure is utilized, the relationship between the
tax investor and lender will be governed by an SNDA. The primary
effect of the HTC SNDA is to subordinate the master lease to the
lien of the mortgage in exchange for the lender’s agreement not
to terminate the lease following a foreclosure, a concession which
the tax investor will require in order to avoid a resulting recapture
event. In fact, the tax investor will often insist that the lender agree
not to terminate the master lease even if the master lessee is in
default under the master lease, a so-called “standstill” or “SNDA-
on-steroids” provision.
While the steroids provision at first glance appears objectionable
to the lender, agreeing to such a provision in exchange for a
concession from the tax investor may make strategic sense. For
example, in an SNDA with an office or retail space tenant, the
lender-post foreclosure-could be faced with a non-rent-paying
tenant. In this situation it is essential that the lender has the right
to terminate the lease and remove the tenant. However, with an
HTC master lessee, there is no real chance of the master lessee
committing a material default since the master lessee is merely a
pass through entity for the property’s real economics and because
the lender, in any event, will be able to foreclose on the developer’s
pledge of the managing member interest in the master lessee and
thereby cause the master lessee’s compliance with the master
lease.12 Regardless, the lender
should insist on the right to
terminate the master lease
once the recapture period
has expired.
For its part, the tax investor will
want to prohibit the transfer of
the property through foreclo-
sure (or deed-in-lieu of fore-
closure) to a disqualified transferee. Such a transfer could result
in a recapture event or loss of credit. The lender, meanwhile, will
want the freedom to foreclose and to further transfer the prop-
erty. A frequent compromise is to permit the lender to foreclose in
exchange for an agreement that any subsequent offer to purchase
the property made by a disqualified transferee will trigger a right of
first refusal for the tax investor.
The lender needs to obtain a release from any liability for the
developer’s obligations to the tax investor should the lender
foreclose on the developer’s pledge. If the tax investor insists
on its own right to remove the developer as managing partner of
the master lessee, the lender should limit such replacements to
cases involving the developer’s willful misconduct, fraud or other
malfeasance and require the tax investor to supply a replacement
managing partner with the requisite operating experience.
A Lender’s Guide To Funding Historic Tax Credit Projects
“With the safe harbor in place as a guide post, the
expectation is that the industry players will return
to the market. As the tax experts work through the
kinks in the Guidelines, and successful structuring
precedents are established, look for the market to
fully return unabated.”