The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 1 The ABCs of...

The ABCs of NMTCs: An Introduction to New Markets Tax Credits

© 2010 Fox Rothschild

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September 30, 2010Presented by

Jeffrey M. Hall, Esq.

and

Daniel V. Madrid, Esq.



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Objectives

What are NMTCs? When and how can they be used? Who are the parties to these transactions? How are these transactions structured? What are the common deal issues? How can we use knowledge about NMTCs to

help our clients?



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Road Map

Part I: Background Part II: Transactions Part III: Terminology Part IV: Deal Structure



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I. BACKGROUND

Community Renewal Tax Relief Act of 2000, 26 U.S.C. § 45D.

Other sources: Codified at Section 45D of the Internal Revenue Code. Tax regulations are in Section 1.45D-1 of the Treasury Regulations.

Purpose: Attract private investment to provide capital for specific types of for-profit and non-profit businesses in low-income, economically-distressed communities



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General Overview

The NMTC Program provides investors with credits against federal income tax in exchange for capital investments in businesses and commercial projects in low-income communities.

Qualified businesses benefit from the equity investments through additional equity capital.



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How NMTC program works



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NMTCs: What’s the big deal?

Because the NMTC projects are driven by government money, there is a certain “recession resistant” aspect so long as the NMTC program is extended by Congress

The NMTC program allows private developers to access public funds to make projects in low income communities feasible

The program’s flexible structure allows implementation in a wide variety of projects



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What’s in it for the investor?

NMTC Investor can claim a tax credit against income tax (but not AMT)

Credit can be claimed for a seven year period starting on the date the initial “Qualified Equity Investment” is made with the Community Development Entity, and continuing on each subsequent anniversary

The total tax credit is 39% of the QEI- 5% of the QEI is paid in Years 1-3- 6% of the QEI is paid in Years 4-7

Unused NMTCs can be carried back 1 year and forward 20 years.



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What’s in it for the developer?

Projects that pose too much credit risk may become feasible through the inclusion of NMTC investor equity in the capital stack

Developers typically pay interest-only loan payments during the 7-year compliance period with a balloon payment at the maturity

39% tax credit provides additional funds to capital stack making debt service less expensive



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What’s in it for the lender?

Credit under the Community Reinvestment Act (“CRA”) makes the deals particularly attractive to banks as a NMTC investor and/or leverage lender

Required loan amount is reduced by NMTC investor’s equity contribution

In addition to a pledge of membership or other capital interest, collateral can include personal guarantees and pledges of various state and local grants



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II. PROJECTS



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How we got started?

Isles Inc. - Mill One Project Redevelopment of 240,000 s.f. deteriorating

mill into a “sustainable urban village” Project will consist of business incubator, arts

hub, training center, residential lofts, neighborhood retail and headquarters for Isles operations

Located near Hamilton Township train station on the Northeast Corridor line



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Isles Inc. - Mill One



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The Salvation Army – Camden Kroc Center

Development of $55 million dollar state-of-the-art 125,000 s.f. Kroc Community Center in Camden, New Jersey on Harrison Avenue in Cramer Hill neighborhood

Project will provide community services, recreational programs, educational program and career counseling to Camden’s residents

Advised TSA on risks and benefits of NMTC financing



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TSA Kroc Center



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400 Market Street Associates

Wilmington, DE project with proposed NMTC financing component

Redevelopment of 400 Block of Market Street 20,000 s.f. project for creation of 14 apartment

lofts and 9,000 s.f. commercial retail space Restoration of original architecture and art-

deco façade prompted historic tax credits as part of deal structure



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Beneficial Bank – MacDade Darby Shopping Center

42,000 s.f. retail shopping center including Fresh Grocer food market, Popeye's Chicken and Dollar Tree in Darby Borough, Pennsylvania

Represented Beneficial Bank as leverage lender



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Future Project Involving NMTC

Greater Camden Partnership – HaddonAvenue Transit Village Located between Our Lady of Lourdes Medical

Center and the Ferry Avenue PATCO station Developer - Grapevine Development Mixed use project including 150,000 SF office

building, 90,000 SF retail with grocer anchor, structured parking and 250 units of workforce housing



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Takeaways

Opportunities for financing exist despite down economy

Public-private partnership will drive future development

NMTCs function as only one component of available public financing to assist clients in getting projects financed



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III. Terminology: Understanding the Jargon

NEED PICTURE HERE – IDEALLY SOMEONE LOOKING CONFUSED.



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A world of acronyms

LIC “Low Income Communities” QALICB “Qualified Active Low Income

Community Business” CDE “Community Development Entity” CDFI Fund “Community Development Financial

Institution” Fund of the US Department of Treasury

QEI “Qualified Equity Investment” QLICI “Qualified Low Income Community

Investment”



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Parties that fill in the gaps

The “Leverage Lender” The “Investment Fund” The “Investor”



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What qualifies as a Low Income Community (“LIC”)?

A census tract in which: the poverty rate is at least 20%; or the median family income does not exceed 80%

of the greater of statewide median family income or the metropolitan area median family income; or

additional areas including certain high migration rural areas, projects that serve targeted populations, and certain zones designated as Empowerment Zones by the Federal Government.



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LIC’s in Pennsylvania and New Jersey

City of Philadelphia – 90% qualifies. Other parts of Pennsylvania

- Norristown, PA- Chester, PA- Downingtown, PA

New Jersey- Urban Areas: Camden, Trenton, Newark, New

Brunswick, Atlantic City

Stamford, CT



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Qualified Active Low Income Community Business (“QALICB”)

When does an business enterprise qualify as a QALICB?

at least 50% of the total gross income is derived from the active conduct of a qualified business within any LICs;

a substantial portion (40%) of the use of the tangible property of such entity is

within any LICs;

a substantial portion (40%) of the services performed for the entity by its employees is performed in any LICs;

less than 5% of the average of the aggregate unadjusted basis of the property of the entity is attributable to certain collectibles; and

less than 5% of the average of the aggregate unadjusted basis of the property of the entity is attributable to certain nonqualified financial property.



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Examples of QALICB’s

an operating business located in a LIC; a business that develops or rehabilitates

commercial, industrial, retail and mixed-use real estate projects in a LIC;

a non-profit that develops or rehabilitates community facilities, such as charter schools or health care centers, in a LIC; and

a business that develops or rehabilitates for-sale housing units located in LICs.



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Prohibited businesses

“Sin” businesses: massage parlors, hot tub facilities, tanning salons, liquor stores

Golf courses and country clubs Businesses that purchase and hold

unimproved real estate Businesses that rent residential property Banks



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What is a Community Development Entity (“CDE”)

CDEs are an essential component to a NMTC transaction

CDEs are the pass-through entity through which NMTCs are allocated to an investor

CDEs can be for profit or non-profit and can be structured as limited liability companies, limited partnerships or corporations



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How is a CDE established?

CDE must be certified through CDFI Fund

Competitive application process- CDE must file an application with the CDFI

Fund - A CDE that is awarded credits enter into an

allocation agreement with the CDFI Fund.



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Prior Year Allocations

2002: $2.5 billion dollar aggregate award for 2001 and 2002

2004: $3.5 billion dollar aggregate award for 2003 and 2004

2005: $2 billion dollar award 2006: $4.1 billion dollar award 2007: $3.9 billion dollar award, $400 million of which

was specifically allocated for investments in Louisiana, Mississippi and Alabama that were affected by Hurricane Katrina.



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Recent Round of Allocations

The American Recovery and Reinvestment Act of 2009 allocated $5 Billion in NMTCs for 2008 and $5 Billion of NMTCs for 2009

Most Recent Application Cycle- $5 billion dollars of allocation authority pending

congressional approval- 250 applications filed- Requesting total of $23 billion dollars (nearly 5 times

the available amount)



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Qualifications for a CDE

A CDE must be legally established entity and a domestic

corporation or partnership for Federal tax purposes;

have a primary mission of serving or providing investment capital to LICs or Low-Income Persons; and

establish accountability to LICs through representation on its governing or advisory boards.



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Qualified Equity Investment (“QEI”)

To be “qualified” the equity investment must be- acquired solely for cash;- designated by the CDE as a QEI; and- used by the CDE to make QLICI.

An investor must make a qualified equity investment in a CDE.

The equity investment must occur within 5 years of a CDE entering into an allocation agreement with the CDFI Fund.



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Qualified Low Income Community Investment (“QLICI”)

An investment by a CDE that allows NMTCs to be generated

Typically takes the form of a CDE’s loan or equity investment in a QALICB

Can also less typically take the form of:- An equity investment in or loan to another CDE- Financial counseling or services to businesses and

residents in LICs- The purchase from another CDE of a QLICI loan

made by the CDE to a QALICB



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IV. Deal Structure



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Leverage vs. Non-Leverage Structure

A non-leverage structure involves only the investor, the CDE and the QALICB.

The investor provides funding directly to the CDE, which in turn makes QLICI in QALICB.

In the leverage structure, the investor equity and leverage loan are aggregated in a pass-through “investment fund” and distributed as a QEI.

The leverage structure allows an investor to receive NMTCs based on the aggregate QEI.



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Non-Leverage Structure

1. A NMTC Investor makes a QEI in a CDE

2. The CDE uses substantially all (85%) of the QEI

3. To make a QLICI (consisting of debt or equity) in a QALICB.



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Putting it in perspective



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Leverage Structure

Investor makes equity investment into an investment fund

Lender makes a “leverage loan” to investment fund

Investment fund makes QEI comprised of NMTC investor’s equity

and lender’s leverage loan into CDE.

CDE uses QEI to make QLICI in QALICB.

Investor receives NMTCs based on the investment fund’s QEI.



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How leverage loans are structured

Maturity date of 7 years with additional period to wind up transaction.

Investment fund makes interest-only payments during 7-year compliance period with balloon payment of principal due at maturity.

Collateral is a pledge of the investment fund’s equity interest in CDE.



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Example of Leverage Loan Deal Structure



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What happens once the deal is closed?

CDE makes a continuous QLICI into the QALICB.

QLICI can be in the form of a construction loan or equity.

QALICB and CDE must continuously keep up with IRS Regulations during 7-year period.

Leverage lender and CDE agree on forbearance on leverage loan and QLICI

Investor may receive distributions from project cash flow



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NMTC Recapture

At any time during the 7-year NMTC compliance period all previously-issued NMTCs may be recaptured

QLICIs must be continuously monitored to ensure that the QEIs remain in compliance with the NMTC regulations during the entire 7-year compliance period

NMTC investor may also have to pay interest at the IRS underpayment rate

NMTC investors typically require a guaranty from the borrower for losses due to recapture



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Events triggering recapture

Recapture can occur in any of the following circumstances:- The CDE ceases to be a CDE- The CDE ceases to use “substantially all” of

its cash for making a QLICI- An investor redeems an equity investment in

a CDE



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Winding Up the Transaction

Leverage loan is repaid or refinanced after expiration of interest-only period

Investment fund is unwound pursuant to put-call agreement:- Put: Investor can exercise “put option” requiring

QALICB entity to purchase investor’s interest in investment fund for agreed-to purchase price.

- Call: QALICB entity can exercise call mechanism requiring investor to sell entire equity interest in investment fund for agreed purchase price.



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Issues

Getting comfortable with the collateral Complicated deal structure – too many chefs in

the kitchen Tax expertise is a necessity for advising CDEs

or NMTC investors Transactional Fees: CDE fees, legal and

accounting fees Seven year lockout Potential for recapture



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Counseling a client on the potential use of NMTCs

Is the property located in a LIC? Does the proposed business (profit or non-

profit) qualify as a QALICB? Prepare your presentation (project description,

sources and uses, creditworthiness). Put together the team: CDE, investor, lender,

attorneys, accountants (for financial modeling) and consultants (for brokering deals).

Identify other available tax credit programs and sources of public financing.



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Contact Information

Jeffrey M. Hall, Esq.(609) 895-6755

[email protected]

Daniel V. Madrid, Esq.(609) 844-7413

[email protected]

The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 1 The ABCs of...

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Transcript of The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 1 The ABCs of...