The U.S. Department of the Treasury’s Community Development Financial Institutions Fund (CDFI Fund) released today its 2012 Notice of Allocation Availability (NOAA) which officially opens the 2012 round of competition under the New Markets Tax Credit Program (NMTC Program). $5 billion in New Markets Tax Credit authority will be allocated by the CDFI Fund in the 2012 round, pending Congressional authorization. The CDFI Fund also announced September 12, 2012 as the deadline for the submission of an application for New Markets Tax Credit authority and October 31, 2012 as the deadline for issuance by prior allocatees of New Markets Tax Credit authority of qualified equity investments in the amounts required in the NOAA.
“Fairway” Financing – an alternative to the New Markets Tax Credit Program
Since the inception of the Federal New Markets Tax Credit program, the industry has evolved from the traditional phase of understanding how to use the program, to the tax credit investors driving the transaction, to most recently the community development entities with allocation controlling the benefits of the program. As a result of the scarcity of New Markets Tax Credit allocation, the historic equity benefit generated to the sponsors of projects has slowly diminshed. In contrast during the recent Duane Morris Real Estate and Finance Reception the guest speaker Bill Hankowsky described the extremely favorable terms of market rate financing for those borrowers in the “fairway”, e.g. meet the current underwriting criteria of conventional lenders. As a result, there is a diminishing gap between the cost of New Markets Tax credit subsidized financing and market rate financing for those sponsors who are in the “fairway”. Sponsors should consider whether they fall within the “fairway” of conventional financing when developing the capital stack of a project.
Forbearance Agreements in Renewable Energy Financing Transactions
With the expiration of the legislation which provided the 1603 grant in lieu of the energy investment tax credit, renewable energy developers must now “sell” the investment tax credit to a tax credit investor. Recapture of the investment tax credit to a tax credit investor occurs if the energy property is foreclosed by a lender during the 5 year tax credit compliance period. As a result, tax credit investors routinely require a lender to forbear exercising its rights against a borrower during the 5 year tax credit compliance period to avoid recapture of the investment tax credit. Obviously forbearance is contrary to the goals of a lender which wants the right to exercise any and all remedies in the event of a default by the owner of the energy property. As a result of the stress between the positions of the tax credit investor and the lender a variety of alternatives to absolute forbearance have evolved. These alternatives include limiting forbearance to solely the energy property, providing the lender with a security interest in the equity interests of the borrower and permitting the lender to exercise its pledge of the equity interests of the borrower, and the exercise of rights against the energy property only in the event of a major default and after notice and an opportunity to cure to the tax credit investor as well as providing the tax credit investor with a purchase right of the energy property. The syndication of the energy investment tax credit to the tax credit investor creates a conflict between the interests of the investor and the lender which can only be resolved by a negotiated forbearance agreement between the parties.
Third Circuit Hears Oral Argument in the Historic Boardwalk Case
On June 25th in Philadelphia Pennsylvania a three judge panel of the Third Circuit Court of Appeals heard oral argument on the appeal by the Internal Revenue Service of the Tax Court decision in the Historic Boardwalk case. The Tax Court had upheld the allocation of a Federal Historic tax credit to the tax credit investor member. One of the primary issues on appeal is whether the tax credit investor member had risk in the transaction. The Service argued that the tax credit investor was not at risk in the transaction and consequently was not a “partner” in the Historic Boardwalk investment entity and entitled to the allocation of the Federal historic tax credit. While it is clearly the intent of Congress that the Federal historic tax credit serve as an incentive for the rehabilitation of historic buildings, there is very little guidance on how the tax credit can be syndicated to investors. The historic tax credit industry has developed a structure in which the investor is a “partner” in the ownership entity, receives a preferential return, and is bought out of the investment entity through a put/call agreement after the expiration of the tax credit compliance period. The decision of the Court of Appeals may affect the structure of the syndication of future historic tax credit transactions.
Finding New Markets Tax Credit Allocation in Strange Places
With the demand for New Markets Tax Credit allocation at a historical high, available New Markets Tax Credit allocation is appearing in strange places. The downturn in the economy has hurt not only conventionally financed projects but also projects financed through government subsidized programs including the Federal New Markets Tax Credit program. Upon the foreclosure of a New Markets Tax Credit subsidized loan, the community development entity lender is obligated to redeploy the proceeds from the foreclosure in a new “qualified low-income community investment” to a new “qualified active low-income community business”. The requirement that a community development entity lender redeploy the proceeds of a previously extended New Markets Tax Credit subsidized loan presents an opportunity to sponsors to “reuse” New Markets Tax Credit allocation for a project. The new loan must satisfy the flexible lending product requirements of community development entity but may not contain a forgivable B note or a 7 year maturity.
Twinning the New Markets Tax Credit
While the Federal New Markets Tax Credit Program and the Federal Low-Income Housing Tax Credit Program are mutually exclusive – the former available for non-residential property and the latter available for residential rental property – the New Markets Tax Credit may be combined with other federal tax credits such as the Historic tax credit and the Renewable Energy tax credit. In the twinning structure – which is distinct from each tax credit being generated by a separate investment – the equity which generates the Historic or Renewable Energy tax credit is contributed as a qualified equity investment by an investor in a community development entity with an allocation of Federal New Markets Tax Credit authority. The result of twinning is to generate a New Markets Tax Credit on the Historic or Renewable Energy tax credit equity. While the pricing of a twinned credit will be more than the Historic or Renewable Energy tax credit without the New Markets Tax credit enhancement, the benefit may not always be significant when you factor in: (a) added transactional costs as a result of the complexity of the transaction; (b) the payment of the customary fees to the community development entity based on the amount of the “qualified equity investment”; and (c) the limited market of investors for the twinned credit. In a nutshell, a financial analysis of the net benefit of twinning the credits should be performed before pursuing the twinning of two federal tax credits.
New Markets Tax Credit Allocation as Inexpensive Private Equity
While the demand for New Markets Tax Credit allocation is at a historical high the Duane Morris New Markets Tax Credit practice group has been successful in assisting clients identify allocation available from community development entities in which the benefit provided to the sponsor is in the form of a subordinate interest free loan in the amount of the net tax credit equity. This subordinate loan payable in 7 years and may be converted into an equity interest in the sponsor. While this form allocation may not be desirable to non-profit sponsors, the allocation provides for-profit sponsors with what is tantamount to inexpensive private equity. Projects which have the best opportunity to receive this form of New Markets Tax Credit allocation: (a) are located in non-metropolitan census tracts; (b) create significant permanent jobs: and/or (c) are supermarkets in a food desert.
Renewable Energy Opportunities in Puerto Rico and the Virgin Islands
Caribbean islands such as Puerto Rico and the U.S. Virgin Islands have historically been dependent upon imported energy for their energy needs. As a result electricity prices in these Caribbean islands are more than five times the average in the United States. The high cost of electricity makes renewable energy sources such as solar and winds a cost effective alternative. Duane Morris has been active in Puerto Rico and the Virgin Islands representing both governmental agencies as well as clients doing business in both Islands. With the recent dramatic decrease in the cost of solar technology and the availability of a renewable investment tax credit for both solar and wind projects, there should be execellent opportunities for the development renewable energy projects in both Puerto Rico and the Virgin Islands.
Release of 2012 NMTC Application to be Delayed by the CDFI Fund
The CDFI Fund had indicated that it would disseminate the 2012 NOAA and the New Markets Tax Credit allocation application absent the enactment of legislation to extend the Federal New Markets Tax Credit Program. It had been anticipated that the time table for the 2012 NOAA, and the distribution and return of the application for New Markets Tax Credit allocation would parallel the schedule employed by the CDFI Fund last year. However, the New Markets Tax Credit Coalition recently reported that the CDFI Fund advised it that release of the 2012 New Markets Tax Credit allocation application will not occur by the end of May as originally anticipated. Further, the New Markets Tax Credit Coalition was advised that the release of the 2012 NOAA and application is unlikely to occur by the end of June. The delay of the release of the 2012 NOAA and the New Markets Tax Credit application by the CDFI Fund may result in awards being made as late as the summer of 2013.
The Future of NMTC Targeted Population Transactions
In 2011 the Service released final regulations which provide how “targeted populations” may be treated as “low income communities” where projects are eligible for the New Markets Tax Credit. Similarly the CDFI Fund amended the form of its allocation agreement to elevate the “targeted populations” criteria to one of its four primary criteria. The result is that satisfaction of the “targeted population” requirements under the Code may alternatively qualify a project as located in a “low-income community” and the satisfaction of the requirements under the allocation agreement may elevate the project to “highly distressed” status. Historically “targeted population” transactions have been challenging because of the added requirements of initially qualifying individuals as “low-income individuals” and insuring that future individuals will qualify as “low-income individuals” during the 7 year tax credit compliance period. While the final Treasury regulations and the revision to the allocation agreement will encourage the use of the “targeted population” criteria, the qualification and compliance requirements of using the “targeted populations” criteria will continue to be a hurdle for both community development entities and tax credit investors for all but the most compelling projects.