Risk Analysis and Workouts
Logan Place (NNEH). Portland, ME
The tax credit industry has evolved to use sophisticated tools to monitor and assess risk, and to communicate internally and with investors about potential or real problems. Syndicators must have comprehensive systems and well defined procedures to ensure consistency in risk analysis and reporting. Within the tax credit industry, certain standards for risk analysis and reporting are influenced by major institutional investors or their trade associations, such as the Affordable Housing Investors Council (AHIC). Many syndicators seek to integrate such standards to the degree that they are relevant, feasible and productive for syndicators to implement. Most syndicators prefer to use one integrated system for risk ratings and watch lists, but standardization of risk assessment does not currently exist among major investors. Hence, it is likely that some syndicators will continue to be challenged by the costs and inefficiency of maintaining multiple risk evaluation and reporting tools.
It is common practice to assign ratings to all lower tier partnerships, meant to synthesize quantitative and qualitative evaluation of investment risk at many levels appropriate to tax credit operating partnerships. Multiple categories are assessed, such as financial, sponsorship, physical, market, and ultimately aggregated into one overall rating. Similarly, ratings of individual assets can be analyzed to determine collective portfolio risk. Typically, syndicators start the rating process at the closing of a new investment and regularly update the ratings thereafter. During construction and lease-up, as well as for stabilized projects which fall short of projections, it is common for risk ratings to be conducted at least quarterly. Ratings for stable investments may be updated annually.
There are several templates in the tax credit industry used by syndicators and investors to assign risk ratings. Sources include the investors cited above, as well as other NASLEF and national syndicators. AHIC revised its rating guidelines in 2010, which may be posted to the AHIC website cited below. Typically there are unique ratings templates for each of the development and stabilized phases. The calculation of risk ratings requires inputs from analysis of the multiple aspects of investment partnerships, much of which have been previously discussed:
- Pace and budget of construction completion.
- Lease-up progress.
- Occupancy statistics.
- Financial results, both interim and annual audited statements.
- Tax returns.
- Physical inspections.
- Major casualty events.
- Compliance reviews.
- State HFA certifications & findings.
- Breach of contractual obligations.
Just as syndicators maintain risk ratings systems, they also generate regular periodic watch lists, typically on a quarterly schedule, to report on under-performing assets. Many follow or adapt their watch list criteria in conformity with AHIC standards. It should be noted that some investors ascribe to a policy of identifying all tax credit partnerships which in some way fall short of original or updated financial and performance projections, intending to have early warning of potential problems and avoid any “surprises”. On the other hand, investors frequently want to focus only on those investments most likely to deliver impaired investment return, particularly due to reduced tax credits or real estate failure. Syndicators must balance the desire of investors for inclusive “transparency” with the efficacy of narrowing attention to assets likely to lose investment benefits. Syndicators should follow consistent guidelines to categorize watch listed assets as effectively benign, chronic or of serious concern. Please see the AHIC website for its watch list criteria: Welcome to AHIC.org.
- Risk rating criteria which reflect current industry priorities.
- Development phase rating template.
- Stabilized Operations phase template.
- Updated ratings output — quarterly or annually.
- Summary analysis report of portfolio ratings.
- Watch list criteria.
- Watch list report quarterly.
- Classification of watch list by defined levels of investment impairment.
Syndicators must allocate experienced staff and have clear procedures to identify and resolve problem investments. Although threatened or actual impairment of investment return is the common trigger to most workouts, the nature of troubled assets can be complicated and unique. However, some common threads to successful resolution require advance procedural planning by syndicators and may include any of the following:
- Syndicator’s decision-making authority.
- Collaboration with external stakeholders having an interest in the asset.
- Collaboration with internal departments, such as Fund Accounting (upper tier impact).
- Professional guidance, particularly legal counsel and accounting.
- Property management consulting or engagement.
- Organizational subsidiary to act as replacement General Partner.
- Loan restructuring.
- Bankruptcy protection.
- Investor reporting.
Upper Tier Risk Analysis
It is common for executive staff, internal boards of directors and large tax credit investors to seek periodic analytical output from syndicators to assess the stability and long-term viability of their business operations, particularly in the absence of future development or acquisitions activities. Such “sustainability analysis” consists of financial projections typically over a rolling 15–year period to forecast corporate revenues and expenses to maintain Asset Management and Fund Accounting operations. Several templates for such analysis are in use by syndicators and AHIC makes available a suggested format.
Related to fund level risk evaluation is the assessment of availability and adequacy of upper tier reserves, capitalized by syndicators from fees earned upon the subscription and closing of new investment pools or funds (upper tier partnerships). Such reserves are usually intended to be held over the investing horizon of the fund, to be used for various purposes in conducting upper tier business. Acceptable uses of upper tier reserves at the syndicator’s discretion may include routine professional fees (such as annual audits) incurred by the syndicator, asset management fees to the syndicator, costs of workouts incurred by lower tier partnerships, and fund disposition expenses. The upper tier partnership documents typically specify expected creation and use of such reserves.
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