Avoiding Bank Liability in Low-Income Housing Tax Credits

The federal low-income housing tax credit program is an opportunity for banks to do well and do good at the same time – a nice parlay for an industry that is routinely pilloried in the media as cold and heartless. Lenders can both finance the construction and rehabilitation of low-income affordable rental housing and purchase credits generated by such projects at discounts that reduce their tax liability on a dollar-for-dollar basis.

More low-income housing gets built. Banks earn interest and fee income, and pay less in taxes to the benefit of the bottom line and their shareholders. Sounds like a win-win-win-win, right?

As Oscar Wilde once said, no good deed goes unpunished.

Recent news reports have described, in somewhat overheated terms, probes into the practices of banks that have purchased low-income housing tax credits (LIHTCs). There is, of course, nothing intrinsically wrong with a deposit institution buying LIHTCs. What federal agencies – including the Internal Revenue Service, the Federal Housing Finance Agency and the U.S. Department of Housing and Urban Development – are looking into is whether banks received favorable terms on the purchase of such credits (i.e., a steeper discount than otherwise available in the market) in exchange for consideration to real estate developers.

That consideration could take several forms: more favorable interest rates, lower fees, more lenient underwriting requirements. Why, one might ask, does the government care about business terms negotiated between two private parties? The hook is that, if regulators’ suspicions are correct, less low-income housing has been built than anticipated for the volume of of LIHTCs authorized by the IRS.

Two banks have thus far been investigated, but not yet charged, for such practices. How can your institution avoid similar regulatory scrutiny?

As with all contracts with customers, make sure that the terms offered are the product of arm’s-length negotiations, and not a quid-pro-quo for other business. This is a central theme of safety-and-soundness regulation across banking agencies.