The New Markets Tax Credit (NMTC), passed by Congress with bipartisan support in December 2000, is the most significant federal subsidy for economic development of depressed areas in thirty-five years. Designed to stimulate the flow of investment capital into underserved areas, it is intended to bring about the direct investment of at least $30 billion into these areas over about twenty years period and is likely to leverage 2 to 4 times that much in additional investment.

The NMT Credit is an incentive in the form of a credit against federal taxes provided to investors to induce them to invest in economically distressed areas where capital for a broad range of investments has not been available.

The NMTC eligible projects include manufacturing and service businesses, to commercial and industrial projects such as retail real estate developments, office buildings and warehouses, to mixed use commercial and housing developments to community facilities such as child care centers and charter schools.

NMTC’s are a shallow credit, providing an investor with tax credits over seven years equal to only 39 percent of the amount invested.2 In order for an investor to recover the full amount of capital invested as well as a return on capital, the project in which the funds are invested must generate significant economic benefits. By contrast, investors in the Low Income Housing Tax Credit (LIHTC) are able to recover their investment and a satisfactory return from the tax credits alone. To quantify the benefit provided by the NMTC to projects, it is generally thought to lower the interest rate on a loan by about 2 ½ to 5 percent (250 to 500 basis points) relative to a market interest rate, depending on the term of the loan, the CDE and other factors. If the credit is used as leverage, it typically creates approximately twenty five (25) percent equity in a real estate transaction. The credit stays in the deal for a seven year period and is typically forgiven entirely after the seventh year. Given today’s credit market, NMTC can be the difference between a project happening or not happening.

The credit is competitively awarded by the CDFI Fund of the US Department of Treasury to financial intermediaries known as community development entities, or CDEs.

The CDFI Fund. The responsibility for administering the program rests with the U. S. Department of the Treasury, which has assigned it to the CDFI Fund. The tax issues, of course, are the responsibility of the IRS, and the IRS and CDFI Fund have worked closely on the program.

CDEs. The CDFI Fund awards New Markets Tax Credits to organizations known as Community Development Entities (CDEs), which are meant to function as financial institutions sensitive to the needs of targeted communities; the CDEs raise capital from investors in exchange for the tax credits and other economic benefits, and invest that capital into projects they select. A CDE is a new acronym and a new concept invented for this program. It is built upon the idea of the CDFI (community development financial institution), which is a kind of community development bank, an institution that knows the credit needs of the community and has the skills and knowledge to seek out credit-worthy businesses or projects that mainstream banks might overlook.

There are three statutory criteria for qualification as a CDE.

• The primary mission of the entity must be serving, or providing investment capital for, low-income communities or low income persons.
• The entity must maintain accountability to residents of low-income communities through their representation on any governing board of the entity or on any advisory board to the entity.
• The entity must be certified by the Secretary of the Department of Treasury as being a qualified community development entity. Organizations apply to the CDFI Fund to be certified as CDEs.

The CDE is the entity that receives the Federal credit from the Department of Treasury. The CDE invests these credits into qualified real estate projects. The CDE earns fees from the NMTC closing plus receives a negotiated rate of return on the equity that is below market. At the end of the NMTC period, the invested equity typically stays in the deal with no pay back or minimal pay back required by the ownership team.

New Market Tax Credit Investment Process

Once the CDE has received its allocation of credits, it is in a position to start investing in Qualified Businesses. As defined by the Federal statute, a Qualified Businesses must operate “within a low-income community. It cannot be a liquor stores, racetracks, gambling facilities, massage parlors, hot tub or suntan facilities, golf courses and country clubs. A real estate project located within a qualified census tract is a Qualified Business.

The players and or concepts in a NMTC Equity Deal also known as the Leveraged Model include the following:

• Equity Investor: A NMTC Leveraged transaction requires an equity investor who purchases the credits from the CDE. Equity investors are typically larger national banks like US Bank, Wells Fargo and Chase. In the Beerline transaction, US Bank has agreed to be the Equity Investor.
• CDE: A NMTC transaction requires a CDE to participate because this is the entity that has the credits. In the Beerline transaction, the First-Ring Industrial Redevelopment Enterprise (F.I.R.E) is the CDE.
• Senior Debt/Leveraged Lender Provider: A NMTC transaction requires a senior debt provider to provide a seven year interest only loan. The loan in a NMTC transaction is at stand-still for the entire seven-year period. A sinking fund is created based on an amortization schedule so that there is a principal reduction after the seventh year.  In the Beerline transaction, Equitable Bank would be the Senior Debt Provider.

• Sub-CDE or QLICB (Qualified Low Income Census Business): A special entity is created to serve as the Borrowing entity. This entity receives both the equity from the credit purchase and the debt from the lender. All funds must be available at closing.
• Sinking Fund/Loan Buy In Fund: Typical NMTC Leveraged Transactions have a side agreement between the Debt Provider and the Borrower. This side agreement creates either a sinking fund for principal pay down after the seventh year or a Loan Buy In Fund which results in the Borrower buying into the loan on an annual basis thus reducing the exposure of the bank during the seven year period. The Loan Buy In approach results in the Borrower providing an annual payment over the seven year period that reduces the Senior Lender’s loan participation but the total loan remains the same. In essence, the Borrower ends up becoming a participating lender on its own loan. As a participating lender, it would receive its pro rata share of the interest earned distribution. This approach provides a reduction in the total bank exposure over the seven year period while maintaining the loan amount so as not to conflict with New Market Tax Credit Legislation.

Senior Debt Provider Issues

The most talked about issues regarding the senior debt provider’s involvement in a NMTC transaction includes:

• Fixed Interest Rate: The interest rate has to be fixed for the seven year compliance period.
• Ability to Foreclose: The Senior Debt Provider can foreclose on a property. The Senior Debt Provider and the Equity Investor would then have to find another project to invest in/loan to so that the credit investor did not lose it tax benefits.
• First Collateral Position/Securitized Interest in the Sub-CDE: The Senior Debt Provider does not have a traditional first collateral position on the real estate. It does however have a first position or securitized interest in the Sub-CDE which provides the same level of protection as the traditional first collateral position.
• Side Agreements: The Senior Debt Provider and the Borrower may have side agreements regarding surplus cash flow to provide the Senior Debt Provider greater coverage including the creation of a sinking fund/loan buy in fund or interest rate hedge through the pledging of extra project cash flow.