Lower taxes would be boon for banks. Except in affordable housing
The prospect of a lower corporate rate resulting from looming tax reform discussions may be a blessing for the industry, but it could be bittersweet for one particular group of bankers.
The Trump administration is said to support a reduction in the corporate tax rate from 35% to 15%. On the one hand, lower taxes are appealing but, on the other, for commercial banks that invest in the affordable housing market, it is a downright scary prospect. These banks have traditionally relied on tax deductions to make their investments in affordable housing financially viable. The simple math is that deductions taken from a 35% tax rate are far more valuable than those taken from a 15% rate.
The affordable housing market was created by the Tax Reform Act signed into law by President Ronald Reagan in 1986. The law established low-income housing tax credits, or LIHTC, which provide investors with a one-for-one tax credit for every dollar they invest in affordable housing. Additionally, and key to the investment, the program also gave investors an avenue to take deductions against their corporate tax bills.
Banking regulators have encouraged banks over the years to consider LIHTC as a potential investment. They offer a competitive rate of return and, as the Office of the Comptroller of the Currency noted in a 2014 report, LIHTC-financed projects can help banks gain credit on Community Reinvestment Act exams. Banks can get CRA consideration either through direct lending or by investing in a project or a specially focused investment fund.
“National, regional, and community banks have made important investments in their communities using LIHTC,” the OCC report said. “By investing in or lending to LIHTC-financed projects, banks have met the needs of their customers and communities. In the process, banks have earned competitive rates of return and favorable CRA consideration.”
With significant commercial bank participation, the LIHTC program has been a resounding success. It has led to the construction of more than 2.4 million low-income housing units, created hundreds of thousands of jobs and improved neighborhoods in literally every state in the nation.
At the same time, the need for affordable housing has not abated. A record 21.3 million households were identified as “cost-burdened” in 2014 by Harvard University’s Joint Center for Housing Studies, which means they paid more than 30% of their income in rent. More than half of these households faced even more difficult circumstances, paying more than 50% of their income in rent.
The LIHTC program helps meet this challenge by granting tax credits to projects in which developers agree to solely lease housing units to households earning 60% or less than the median income in a local metropolitan area. Developers are also required to charge affordable rent, as determined by the government, for an extended period.
Under these rent-restricted conditions, project financial margins are almost always extremely tight. For example, in projects that receive the most generous tax credits, developers are only allowed to rent to households earning 50% or less than the area median income. Therefore, if the median is $50,000, the project can only serve people making $25,000 or less. The rent is also capped at 30% of income, which means a family of four making $25,000 pays just $625 a month in rent with a portion of that amount earmarked as a utility allowance. If the allowance is $100, the developer gets $525 a month, barely enough to cover operating expenses.
Developers almost always face funding gaps when they are putting together projects. The potential reduction in the tax rate threatens to make the gaps even wider and harder to close. In recent negotiations, investors, who are largely commercial banks, are showing justifiable caution. If they think tax cuts will be modest, they have offered to pay $0.95 a credit, down from $1.06 eight or nine months ago. If they think the corporate tax rate will really be cut to 15%, they are lowering their offers even further or are requiring “adjusters,” including putting some of their investment dollars into escrow, which could be taken back if rates are cut deeply. The overall market has slowed considerably.
LIHTC investments have proven to be an extremely valuable way for commercial banks to help meet the credit needs of their communities. But just like any other investor, they need to receive a reasonable return on investment in order to continue participating in the market.
Given all of the benefits of the LIHTC program, including millions of affordable homes and hundreds of thousands of jobs, this is a program that is well worth saving. We strongly urge Congress to make the LIHTC tax credits worth more, if the corporate tax rate is cut.
Government programs are not always successful, but this one is worth keeping.