Senate Finance Committee Chairman Max Baucus (D-Mont.) released a summary of the Family and Business Tax Cut Certainty Act of 2012, as approved by the Senate Finance Committee. The Senate Finance Committee approved a package of more than $205 billion in tax cut extensions for families and businesses by a bipartisan vote of 19-5. The Bill, once finalized, will be posted on the Committee’s legislation website. The summary of the proposed Family and Business Tax Cut Certainty Act of 2012 describes an extension of the Federal New Markets Tax Credit Program for two additional years at $3.5 billion dollars of New Markets Tax Credit allocation each year.
CDFI Fund Opens 2012 Round of New Markets Tax Credit Program
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.
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.
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.
Food Deserts: A New Markets Tax Credit Oasis
In its 2011 allocation agreement the CDFI Fund added the “Food Desert” as one of the two secondary criteria which a community development entity may use to qualify a site as “highly distressed” under the Federal New Markets Tax Credit Program. This change in the allocation agreement is significant in light of the President’s proposal to extend the Program for two additional years and designate that at least $500 million ($250 million per year) will support financing healthy food options in distressed communities as part of the Healthy Food Financing Initiative. The 2011 allocation agreement defines a Food Desert, as either: 1) a census tract determined to be a Food Desert by the U.S. Department of Agriculture (USDA), as identified in USDA’s Food Desert Locator Tool; or 2) a census tract that qualifies as a Low-Income Community and has been identified as having low access to a supermarket or grocery store through a methodology that has been adopted for use by another governmental or philanthropic healthy food initiative. In addition, the 2011 allocation requires that QLICI activities increase access to healthy food. As a result, with the extension of the Federal New Markets Tax Credit program there will be an increased focus by community development entities on the development of affordable food centers in food deserts.
New Markets Tax Credit Demand and Pricing on the Rise
The reduction of the annual allocation of New Markets Tax Credit authority by the CDFI Fund from 5 billion dollars to 3.5 billion dollars after the expiration of Stimulus legislation and the increased awareness of the benefits of the Program have created a tremendous demand on community development entities who receive an allocation. of New Markets Tax Credit authority. Sponsors seeking to identify New Market Tax Credit allocation for projects should be aware that community development entities are focused on transactions which result in substantial job creation and supermarkets in designated food deserts. The good news for sponsors is that investors are paying higher prices for New Markets Tax Credits. Accordingly, while it has become more challenging to identify allocation, the equity generated for a project through an allocation of New Markets Tax Credits should be greater than in prior years.