As access to financing sources continues to challenge the development of new projects, the federal New Markets Tax Credit (“NMTC”) Program is becoming increasingly attractive. The NMTC Program provides incentives for financial institutions to provide unconventional and below-market financing for various projects, businesses and nonprofits located in “low-income communities,” which are liberally defined to include roughly 40 percent of the United States and most central business districts.
Financial institutions can participate in the NMTC Program in the following ways:
- as an investor
- as a lender
- as a community development entity (“CDE”)
Within the Treasury Department, the Community Development Financial Institutions Fund (“CDFI Fund”) and the Internal Revenue Service (“IRS”) jointly administer the NMTC Program. The NMTC process works as follows: The CDFI Fund allocates NMTCs to CDEs, which, in turn, offer the NMTCs to investors in return for equity capital.
What are the benefits to a financial institution?
Each NMTC financing is for a period of seven years.
As an investor or a CDE, financial institutions receive after-tax returns of 7%–12% (which includes a tax credit equal to 39% on their investment recognized over seven years) as well as credit under the Community Reinvestment Act of 1977 (“CRA Credit”).
As a lender, financial institutions receive market-rate interest only for seven years, with the principal paid off or refinanced after seven years in addition to CRA Credit.
As an investor, CDE, or leverage lender, a financial institution is able to provide financing to projects and borrowers who cannot otherwise receive financing in the traditional credit market. The NMTC Program is able to convert the investor and lender financing into non-conventional forms of financing which include: equity, equity-equivalent financing, below-market interest rate loans, debt with equity features (i.e., debt with royalties, debt with warrants or convertible debt), subordinated debt, lower than standard origination fees, longer than standard period of interest-only loan payments, higher than standard loan to value ratio, longer than standard amortization period, more flexible borrower credit standards, nontraditional forms of collateral, lower than standard debt service coverage ratio, and loan loss reserve requirements that are less than standard.
What kind of projects can be financed?
Qualifying projects are those that do not otherwise receive traditional financing and are located in low-income communities. Examples of projects that have been financed with NMTC proceeds include the revitalization of downtown areas centered on renovations or construction of office buildings, infrastructure improvements, commercial and retail buildings, shopping centers, mixed-use projects, for-sale affordable housing, workforce housing, transitional housing, hotels, arts centers, theaters, charter schools, hospitals, assisted-living facilities, nursing homes, college campuses, high-tech and biotech facilities, homeless shelters, and facilities to assist in educating the homeless.
How can a financial institution take advantage of the NMTC program?
Each year, applications for NMTC allocations are due in March and the awards are announced the following October. Financial institutions have the best chance of receiving an award of NMTCs. A financial institution can apply for an allocation of NMTCs by organizing a wholly-owned CDE and qualifying it as a “CDE,” and having such CDE apply for an allocation of NMTCs. To be categorized as a CDE, an applicant CDE merely needs to have its principal purpose be to serve or otherwise benefit low-income persons and/or low-income communities, and have either a governing board or advisory board; the membership of which includes at least 20% who represent low-income communities. The qualification is not competitive, is based on objective criteria, and there is no application fee.
A qualified CDE can apply for up to $125 million of NMTC allocation. The dollar amount of the allocation is a “permission slip” that permits the CDE to receive private investor dollars—or dollars from its own financial institution which is its sole member—up to the allocation amount (that is the amount on which the NMTCs are then calculated). The amount awarded will depend on the financial institution’s dollar amounts of raising and deploying capital (or facilitation thereof) over the past five years, as well as how well the application can support that the amount awarded can be deployed within two years as a practical matter. The application is scored based on 100 points (25 points to each of business strategy, community impact, management capability, and investor strategy), plus 10 bonus points (five if its sole member does use the NMTCs itself and five if none of the projects will be owned by the financial institutions).
Although the NMTC allocation application is competitive, a CDE wholly-owned by a financial institution is in an excellent position to receive an allocation of NMTCs if:
- the financial institution has a long and substantial track record of providing financing to borrowers in low-income communities; and
- the financial institution can provide its unique funding programs as part of its application.
This year the total amount of awards has increased from $3.5 billion to $5 billion (i.e., statistically better chance to receive an award) and fewer banks are applying for NMTCs this year (e.g., due to the market changes) so there is less competition (i.e., again statistically better chance to receive an award).
There is no application fee for applying for an allocation of NMTCs and an applicant receives CRA credit just for applying.
Alternatively, or in addition, to applying for NMTCs through its wholly-owned CDE, a financial institution can seek out NMTC financing in which to participate in its service area. This can be done by contacting CDEs who have NMTC awards with service areas that overlap the service area of the financial institution, as well as working with attorneys, consultants and accountants who regularly work with NMTC market participants and who can identify projects in the financial institution’s service area for proposed investment or lending.