Ever since Congress made the housing tax credit a permanent part of the tax code in the early 1990s, institutions have rushed headlong into this niche investment.

Snapping up billions in low-income housing tax credits, big lenders have recognized the twin benefits of reducing their federal income taxes on a dollar-for-dollar basis while fulfilling, in part, their building requirements under the Community Reinvestment Act.

However, many of these investors seem to have forgotten that real estate - the bugaboo of so many commercial lenders - is the underlying asset and that all the risks inherent in real estate (construction, lease-up, interest rates, operations, etc.) persist with tax credit properties.

These transactions must also navigate myriad compliance and reporting requirements of the Internal Revenue Service and state housing agencies.

Attractive yields, CRA pressure, and a remarkable track record have apparently lulled some institutions into a false sense of security regarding these tax-advantaged investments. Sophisticated lenders who carefully monitor other types of real estate exposure are among the chief offenders.

Also, as banks consolidate through mergers and acquisitions, inherited tax credit investments often fall through the cracks; files get lost, tax benefits are missed, and underlying assets go unsupervised for long periods.

Granted, affordable housing is a niche investment, making up only a small portion of an institution's mortgage or investment portfolio. Banks and others with equity portfolios exceeding $250 million typically either employ specialized tax credit management people to oversee these investments or invest indirectly in syndicated tax credit funds.

But tax credit investments can be a minefield of financial risks and public relations headaches when things don't go as planned.

Congress created the housing tax credit in 1986 to stimulate private-sector investment in the construction and rehabilitation of affordable housing. Since then, the low-income housing tax credit has been responsible for the creation of nearly one million housing units.

Initially, the tax credit was a wild card, requiring annual reauthorization by Congress. This uncertainty kept many institutions on the sidelines, leaving the credits largely to individuals investing through syndicated limited partnerships.

However, Congress made the credit permanent in 1993, and the investor makeup quickly changed. Institutions now supply about 75% of the roughly $4 billion raised annually for affordable housing. Committed industry participants include many of the largest national lending institutions, including Bank of America Corp., Wells Fargo & Co., U.S. Bancorp, Bank One Corp., and PNC Financial Services Group Inc.

Though these institutions acquire and manage broad portfolios of tax credit investments, not all banking companies have committed sufficient resources to manage these sophisticated transactions.

Banks invest in the low-income housing tax credit primarily to get a steady stream of tax benefits, typically over a term of 10 years. And their faith in the program has largely been rewarded: Tax credit projects have performed well, with few significant defaults or losses.

Because tax credit investments involve the real estate, tax, community development, and investment areas of a bank, they rarely fit neatly into its organizational structure and, therefore, sometimes do not get the appropriate management resources.

The typical result is undermanaged portfolios. Construction, lease-up, and compliance may be ignored. Periodic tenant qualification, partnership compliance, fiscal and operational review, project inspections, property management, and periodic portfolio reporting may also be overlooked.

Many banks breathe a sigh of relief when projects are built and leased, sometimes assuming no news from the property is good news. However, significant compliance problems can be hidden in affordable-housing transactions, only to be uncovered during an IRS or state agency audit, at which point remedies may be out of reach.

Make no mistake: The financial impact of ineffective asset management is real. Construction and lease-up delays can delay benefit delivery and/or force premature funding of capital contributions. Either can result in substantially reduced yields for investors.

A reduction in the qualified basis within the 15-year tax credit compliance period may ultimately prompt tax credit recapture, requiring the investor to return one-third of the tax credits taken, plus interest on the recaptured amount. If a property is threatened with foreclosure, investors may have to commit additional money to preserve their investment, significantly reducing its yield.

All of this highlights the need for vigilant oversight of tax credit properties. A few banks recognize they simply cannot devote the necessary resources to monitoring these portfolios and have begun to enlist qualified third-party asset managers. Typically these are national syndication firms with a track record of managing large, complex tax credit portfolios.

An effective asset manager will demonstrate commitments to enhanced technology, experienced people, and the capital resources to be around for the entire 15 years of the tax credit compliance period.

Low-income housing tax credits have proven a relatively safe, predictable investment for institutions seeking to meet their social and CRA commitments while sustaining shareholder returns and fiduciary expectations. Experienced third-party asset management simply assures investors they will get what they bargained for.

Mr. Galvin is general counsel and Mr. Chiles is vice president at Columbia Housing, a low-income housing tax credit syndicator based in Portland, Ore., and wholly owned by PNC Financial Services Group.

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