Developers are injecting new blood into long-neglected downtown areas of some U.S. cities by renovating historic buildings — and banks are reaping a financial windfall as a result.

Approvals for federal historic tax credits have surged since 2011, as development projects revitalize sections of cities like Buffalo, N.Y., and Detroit, turning once-vacant factories, churches and office towers into modern apartments, hotels and office space.

Total approved projects in 2013 increased 26% to $6.73 billion,  from a year earlier, according to the National Park Service, which administers the historic tax credit program along with the Internal Revenue Service.

The tax credits have produced direct financial benefits to some banks. Two Buffalo banks, Evans Bancorp (EVBN) and First Niagara Financial Group (FNFG), said historic tax credits helped their bottom lines in the past 12 months.

Other banks have gotten in on the action, too. TD Bank provided loans to the $38.5 million restoration of the 1873-vintage Quaker City Dye Works building in Philadelphia into office space for nonprofits and apartments for public school teachers. JPMorgan Chase (JPM) and U.S. Bancorp (USB) have also recently financed historic projects.

The boom in historic tax credit financing comes after overconcentration in construction loans doomed many community banks during the financial crisis. Only recently has commercial real estate lending, and to a lesser extent construction loans, rebounded.

But historic redevelopment has been especially active in Buffalo, which is populated with scores of old, historically significant buildings. Its downtown area is resurgent after having been stuck in an economic slump for decades.

Now, private developers are scrambling to use a combination of federal and New York state historic tax credits to rehab many of Buffalo's structures, says Jim Rykowski, vice president of commercial lending at Evans.

"I've been active in the tax credit world for 25 years and there are more players interested in it now and more developers than ever," Rykowski says.

"It's cool to live downtown again and developers are putting their money there," he says.

In recent years, the $837 million-asset Evans Bank has helped revitalize several Buffalo properties. Those include the renovation of the Horsefeathers building, a formerly vacant warehouse built in 1896, into a high-end restaurant and loft apartments, and the conversion of a 1904 building designed by America's first professional woman architect into a boutique hotel called the Hotel @ the Lafayette.

Banks make use of several different tax credit programs when making loans to the rehabilitation of old buildings, including low-income housing credits and the New Markets program. But the federal historic tax credit program, which applies to 20% of qualified expenses, is the most efficient to use, Rykowski says.

"The application process is the shortest and the benefit is immediate," Rykowski says.

The historic tax credit program, established in 1976, requires periodic congressional reauthorization. Existing projects that have already been granted the credits would continue to receive the benefit even if the program were ever to be ended.

A New York state program often piggybacked onto the federal tax credit can boost the tax credit to up to 40% of a project's cost, says Ruth Pierpont, deputy commissioner for historic preservation at the state's Office of Parks, Recreation and Historic Preservation.

Banks, of course, get something in the bargain. Evans Bancorp saw its income tax rate almost chopped in half through the use of historic tax credits. Its 2013 effective tax rate was 18%, compared to 31.5% in 2012. Evans' income tax expense fell to $1.7 million in 2013, from $3.7 million for 2012.

First Niagara, whose headquarters is located in a former Larkin Co. warehouse built in 1911, lowered its effective tax rate to 19.6% in the first quarter, from 29.7% in the fourth quarter of 2013, through the use of historic tax credits. First Niagara expects its effective tax rate to remain at the lower level through the rest of the year, says Gregory Norwood, chief financial officer.

First Niagara has financed several Buffalo historic projects, including the $18 million renovation of the Foundry Lofts into residences and offices; and the $41 million rehab of the former Tishman Building into a Hilton Garden Inn, apartments and office space.

Not everything is rosy, says Patrick Robertson, executive director at the Historic Tax Credit Coalition. Many states offer no tax credit to partner with the federal program. And proposed changes to the federal program could remove many of the benefits that make projects financially feasible.

But for now, the program is serving its purpose of fostering historic preservation and giving banks a boost in the process. In fact, without the federal and state historic tax credits, many redevelopments of historic buildings would never happen, Rykowski says.

"[The tax credits] make these projects possible because they fill the gap from a budgetary need," Rykowski says.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.