Community Investing 101...algerd\home\Desktop\02 Community Investing 101.pptx • Adopted as part of...

$: Community Investing 101...algerd\home\Desktop\02 Community Investing 101.pptx • Adopted as part of the Tax Reform Act of 1986 and written in Section 42 of the Internal Revenue Code$
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algerd\home\Desktop\02 Community Investing 101.pptx

Community Investing 101

National Interagency Community Reinvestment Conference February 8, 2016

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Jonathan Kivell Sandler O’Neill + Partners, L.P.

February 8, 2016

Low Income Housing Tax Credits

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This presentation, and the oral or video presentation that supplements it, have been developed by and are proprietary to Sandler O'Neill & Partners, L.P. and were prepared exclusively for the benefit and internal use of the recipient. Neither the printed presentation nor the oral or video presentation that supplements it, nor any of their contents, may be reproduced, distributed or used for any other purpose without the prior written consent of Sandler O'Neill & Partners, L.P. The analyses contained herein rely upon information obtained from the recipient or from public sources, the accuracy of which has not been verified, and cannot be assured, by Sandler O'Neill & Partners, L.P. Moreover, many of the projections and financial analyses herein are based on estimated financial performance prepared by or in consultation with the recipient and are intended only to suggest reasonable ranges of results. Finally, the printed presentation is incomplete without the oral or video presentation that supplements it. Sandler O’Neill & Partners, L.P. prohibits employees from offering, directly or indirectly, favorable research, a specific rating or a specific price target, or offering or threatening to change research, a rating or a price target to a company as consideration or inducement for the receipt of business or compensation. The Firm also prohibits research analysts from being compensated for their involvement in, or based upon, specific investment banking transactions. Sandler O'Neill & Partners, L.P. is a limited partnership, the sole general partner of which is Sandler O'Neill & Partners Corp., a New York corporation. Sandler O'Neill & Partners, L.P. is a registered broker-dealer and a member of the Financial Industry Regulatory Authority. Sandler O'Neill Mortgage Finance L.P. is an indirect subsidiary of Sandler O'Neill & Partners Corp. This material is protected under applicable copyright laws and does not carry any rights of publication or disclosure.

GENERAL INFORMATION AND LIMITATIONS

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• What Are Tax Credits and Why Are They Used? • Overview of the Low Income Housing Tax Credit (“LIHTC”)

Program • LIHTC Transaction Structure • Example of LIHTC Transaction Structure • CRA Treatment of LIHTC Investments • Recent LIHTC Transactions

Outline

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• Tax credits are utilized by investors to provide an off-set against tax liability; tax credits are used as a financial incentive to subsidize a project or user of financial capital and provide a return to an investor (taken in the form of lower income tax liability over time)

– For tax credit programs, rules vary as to the amount of credits that an investor can claim, the length of time that an investor can claim credits, and the potential triggers of forfeiture of credits

• In contrast to grants or loans, tax credits allow federal, state, and local government agencies to allocate subsidies to a project without directly expending cash.

– For example, the Internal Revenue Service (IRS) and State Housing Finance Agencies jointly administer the LIHTC program

What Are Tax Credits and Why Are They Used?

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• Government: – Less politically-entrenched process of awarding subsidies to projects – Potentially easier for government to administer tax credits versus loans or grants as subsidies – Credits are awarded and received when projects are successful (unlike direct funding via grants

and loans) • Investors:

– Receive an offset against federal, state, or local income tax liability* Increase after-tax income

– Credits are priced by investors to target specific yield thresholds – For banks, equity investments in LIHTC and New Markets Tax Credits (NMTC) may receive

consideration under the Investment Test of a CRA exam* – Common investors in tax credits include banks, insurance companies, and other fortune 500

companies Government Sponsored Enterprises (GSEs) were the largest national investors in LIHTCs prior to 2008*

• Developers/Borrowers: – Receive equity capital from investors who may not otherwise have incentive to invest in a

project – Often do not have to pay cash returns

What Are Tax Credits and Why Are They Used?

*Source – “Low Income Housing Tax Credits: Affordable Housing Investment Opportunities for Banks” OCC – March, 2014

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• Adopted as part of the Tax Reform Act of 1986 and written in Section 42 of the Internal Revenue Code

• The LIHTC program is the largest federal program for equity investing in the development of new, or acquisition and rehabilitation of existing, affordable housing units*

• Program involves state agencies allocating federal tax credits to developers based on a series of scoring criteria (e.g. target levels of Area Median Income (“AMI”) served by a project) – Criteria are described in each state’s Qualified Action Plan

• To qualify for LIHTC financing, a project must have a minimum of 20% of units serve individuals earning no more than 50% of AMI or 40% of units serve individuals earning no more than 60% of AMI* – Tenant-paid rent does not exceed 30% of total income, adjusted for household size; units are therefore kept affordable for all

residents based on their income levels

– Developers of LIHTC projects often set rents for all units at affordable levels

• LIHTC equity is one of several “sources of funds” in financing an affordable housing project

• LIHTC has historically resulted in several billion dollars of private investment annually and the development of over two million units of affordable rental housing since the program was established in 1986*

Overview of the LIHTC Program


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• LIHTCs are awarded to projects (i.e. developers receive the credits via the affiliated legal entity responsible for the development) and sold to investors. – After being awarded an allocation of LIHTCs from a Housing Credit Agency for a qualifying

project, a developer can sell the credits directly to an investor or to a syndicator, who identifies, underwrites, and manages LIHTC investments on behalf of an investor or group of investors. A syndicator can also manage the financial reporting and other ongoing program compliance once the project is built and placed in service.

– The chart below shows a sample transaction flow for LIHTC financing*:

Overview of the LIHTC Program


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• Two types of transactions: 4% and 9%: – These percentages relate to a project’s “eligible basis” – 9% credits – competitively awarded to projects, and limited in availability – 4% credits – automatically attached to tax-exempt debt, and awarded on a first-come,

first-served basis Bond purchasers don’t pay tax on interest, so the underlying interest rate on debt is lower

than a “taxable” loan

– Equity from the sale of tax credits supplies about 70% of the project cost on a 9% deal, and 30% of the project cost on a 4% deal. The chart below shows historical yields on LIHTC investments*

LIHTC Transaction Structure


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Example of LIHTC Transaction Structure – New Construction

Sources of Funds

Equity (bank investor – owns 99.99% of development entity) $10,654,507

Permanent Loan (from a Bank or Non-Bank Financial Institution)

$3,349,521

Second Mortgage (State Housing Agency Subordinate Loan Program)

$914,672

General Partner Equity (owns .01% of Development Entity) $1,300

Total Sources of Funds $14,920,000

Uses of Funds

Land Costs $650,000

Construction Hard Costs $10,760,832

Soft Costs $2,252,168

Developer’s Fee $1,257,000

Total Development Costs $14,920,000

• LIHTC investors effectively own 99.99% of the entity which owns the project being developed

• Investors review the project budget and decide on their proposed “pay-in schedule” and total equity amount*

• This calculation is determined through the project’s eligible basis and projected investor benefits schedule

• On LIHTC projects, investors claim tax credits for 10 years and the project’s compliance period runs for 15 years*

• Other Sources of Funds in a project include CDBG, HOME, FHLB AHP, and other state and local programs


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• An important incentive for banks investing in LIHTCs is the CRA consideration they may receive for making these investments.* – A bank may receive CRA consideration for community development activities related to LIHTC projects and

funds, provided the activities benefit a bank’s assessment area or a broader statewide or regional area that includes the bank’s assessment area(s) (AA). The bank’s AA(s) need not receive an immediate or direct benefit from the bank’s participation in the activity, provided the purpose, mandate, or function of the activity includes serving geographies or individuals located within the institution’s AA(s). Examiners consider these activities even if they do not benefit the bank’s AA(s), as long as the bank has been responsive to community development needs and opportunities in its AA(s).*

• Examples of activities that may be eligible for CRA consideration include direct investments in LIHTC projects, predevelopment financing or construction/permanent financing to LIHTC projects, investments in funds that specialize in funding and managing LIHTC projects, and technical assistance to nonprofit organizations that help identify and counsel potential low- or moderate-income residents.*

• In addition, a bank may receive CRA consideration for activities that revitalize or stabilize designated disaster areas and designated distressed or underserved nonmetropolitan middle-income geographies. Activities in these specially designated areas must benefit the bank’s AA(s), or a broader statewide or regional area that includes the bank’s AA(s), in order to receive CRA consideration. In limited and specific instances, a bank can make qualified investments in disaster areas that are outside these areas, provided the bank has adequately been responsive to needs in its AA(s).*

CRA Treatment OF LIHTC Investments


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Recent LIHTC Transactions

Warren Residence: New York, NY Warren Residence is a 61-unit supportive housing property in the Wakefield neighborhood of the Bronx in New York City. The building was developed by Praxis Housing Initiatives, a NY-based non-profit organization. The property was built to LEED Platinum standard and had a total development cost of $19.6 million. Sources of funds included Low Income Housing Tax Credit equity, New York City Development of Housing Preservation and Development, and a bank lender.

In addition to housing units and on-site social services, the building has an on-site greenhouse and teaching kitchen for nutrition and cooking classes.

North Santa Fe Apartments: Vista, CA

North Santa Fe Apartments is a 68-unit apartment community located on North Santa Fe Avenue, directly across the street from the Vista Transit Station in Vista, CA. The 1.4 acre transit-oriented development is located in one of the few North County SANDAG Smart Growth areas, and is part of the city’s Downtown Specific Plan. The land for the $20.5MM development was provided via ground lease by the City of Vista and sources of financing included Low Income Housing Tax Credit equity, CDBG funds, an AHP grant, and bank debt. The development is certified as Green Point Rated (Platinum level), and is part of the SDG&E California Advanced Home design program. Apartments include Energy Star appliances, heat pumps, and pin florescent lighting. Also, roof-mounted solar thermal preheats water for the high efficiency gas-fired central hot water boilers.

Fixed-Income Investments

Rachel Firschein, Senior Vice President Fixed Income Capital Markets Raymond James & Associates [email protected] 844-350-4529

Raymond James & Associates, Inc., Member New York Stock Exchange/SIPC

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What are Targeted Mortgage Backed Securities?

Targeted MBS are agency pools (Fannie Mae, Freddie Mac, Ginnie Mae) backed by single-family loans that are CRA eligible. Most are 100% income qualified borrowers (at or below 80% of area median income), but pools may also be made up partly or fully with loans in census tracts that are low- or moderate-income.

Pools consist of loans made within an institution’s designated assessment areas (or other geographic areas that the institution desires) and are custom tailored to each institution buying them.

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How Would a Sample Transaction look involving Targeted Mortgage Backed Securities?

Once an institution’s assessment areas (AA) are established, a loan file with specific loan details is shown with an offering price.

This price will vary depending on many factors including scarcity of product/geography, amount needed, underlying security price, and availability of competing executions.

If the institution decides they want to purchase the group of loans or a subset of the loans and create a pool, a final price is agreed upon along with a settlement date of the trade and the loans are packaged into an agency MBS and sold to the institution.

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What are Potential Benefits and Risks of Investing in Targeted MBS?

Potential Benefits: – CRA investment test credit for the amount of the pool – Reduction in credit risk (via an Agency credit guarantee) – Attractive yields relative to other investment vehicles – Capital management benefits (lower capital charges/ability to pledge at Federal Home

Loan Bank) – Increased liquidity in the event that the institution wants to sell the MBS – Helps increase supply of financing for affordable single-family housing

Potential Risks: – Mortgage-related securities are subject to prepayment risk

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Targeted Multifamily CRA Securities

In addition to purchasing targeted single-family MBS, institutions can also receive CRA investment test credit by purchasing targeted multifamily securities (for example, Ginnie Mae project loans and Fannie Mae DUS loans)

These securities can include a variety of project types, including Section 8 and other affordable rental housing, affordable healthcare facilities, and assisted living facilities.

The securities include loans for projects that are targeted to low-moderate income residents, contain a high percentage of Medicaid recipients, and/or low-moderate income census tracts.

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Targeted Multifamily CRA Securities (continued)

Multifamily securities are generally a single project, with income and prepayment characteristics that are different from single-family MBS.

Most multifamily securities have some type of pre-payment protection. The securities are also very liquid.

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This Investor Presentation does not constitute a recommendation or an offer or solicitation for the purchase or sale of any security or other financial instrument or to adopt any investment strategy. Any offer or solicitation with respect to any security will be made by means of a Preliminary Official Statement or Official Statement which will describe the actual terms of such security. In no event shall the Underwriters be liable for any use by any party of, for any decision made or action taken by any party in reliance upon, or for any inaccuracies or errors in, or omissions from, the information contained herein and such information may not be relied upon by you in evaluating the merits of participating in any transaction mentioned herein. The Underwriters make no representation as to the legal, tax, credit, or accounting treatment of any transactions mentioned herein, or any other effects such transactions may have on you and your affiliates or any other parties to such transactions and their respective affiliates. You should consult with your own advisors as to such matters. Nothing in these materials constitutes a commitment by the Underwriters or any of their affiliates to enter into any transaction. No assurance can be given that any transaction mentioned herein could in fact be executed. Past performance is not indicative of future returns, which will vary. Transactions involving securities and financial instruments mentioned herein may not be suitable for all investors. You should consult with your own advisors as to the suitability of such securities or other financial instruments for your particular circumstances. Additional information is available upon request.

New Markets Tax Credits

Dan Alger

Vice President, Urban Investment Group

Goldman Sachs

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A Leading Impact Investor in the US Urban Investment Group

Goldman Sachs’s unique place in the impact investment market stems from our long-standing commitment to double bottom line investing, and ability to draw upon the people, capital and expertise of the firm to deliver strong results

Through its comprehensive community development platform, UIG has committed over $4.7bn of GS capital to revitalize underserved communities

UIG investments have helped finance: 19,000 affordable housing units 5.8 million square feet of neighborhood serving

retail and commercial space dozens of community facilities that provide

essential social services and job opportunities to neighborhood residents

thousands of temporary construction and permanent jobs

4 of 8 US social impact bonds financings Over 700 small business loans through our

10,000 Small Businesses initiative

UIG is a leader in demonstrating the viability of a “double bottom line” strategy: investing both the firm’s and clients’ capital to produce strong financial results, while having a positive social impact on the communities in which we live and work

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UIG’s Portfolio is diversified by product type, geography and impact Urban Investment Group

Over $4.7 billion of capital committed

249 projects

Projects & investments across 23 US states

Strong risk management via dedicated Asset Management & Construction Services group

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Products Urban Investment Group

Low Income Housing Tax Credits Available to equity investors in real estate projects that provide eligible rental housing for low income individuals

New Markets Tax Credits

Available to equity investors in projects that provide debt or equity financing to commercial real estate projects located in developing communities as well as economic development projects and certain types of businesses

Historic Tax Credits Available to equity investors in projects that promote historic preservation and community revitalization through qualified historic rehabilitation projects

CDFI Lending / Facilities

Loans to intermediaries who provide capital for community development purposes. These can include credit facilities for Community Development Financial Institutions (CDFIs) that provide capital to small businesses, affordable housing, community facilities and supportive housing

Fund Investments CRA eligible third-party managed funds including Small Business Investment Companies (SBICs) as well as funds

that are set up to generate CRA credit for banks. Some funds contain Mortgage Backed Securities, actively tradable pools of securitized home mortgages made to LMI homeowners

NMTC Related Loans Loans to NMTC projects, which generate NMTCs and provide capital to underlying projects, including community serving retail, charter schools, or nonprofits

Bridge / Pre-development Loans

Loans that fund operating capital for uses including bridging government contracts, seeding new business lines or funding predevelopment expenses for real estate projects (with and without land collateral

Direct Equity Equity investments are made through joint ventures with developers and operators in CRA-eligible real estate

projects. In addition, equity investments are made in community development enterprises, including small businesses and businesses that serve LMI areas

Construction Loans / Letters of Credit

Lead role or participations in construction loans or Letters of Credit that finance CRA-eligible real estate development projects

Qualified School Construction Bonds (QSCBs)

Help fund school construction, rehabilitation, repair, and land acquisition. They provide federal tax credits for bond holders in lieu of interest in order to significantly reduce an issuer’s cost of borrowing for public school construction projects

Social Impact Bonds Innovative and emerging financial instrument that seeks to leverage private capital to support high impact social programs through pay-for-success structuring

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Program Background

Enacted in 2000 to spur economic and community development and job creation in low-income communities by attracting private capital

Administered by the Community Development Financial Institutions Fund of the U.S. Treasury Department

Since the NMTC Program's inception, the CDFI Fund has made 912 awards allocating a total of $43.5 billion in tax credit authority to CDEs through a competitive application process

NMTC program allows companies and developers to access public subsidy to make projects that benefit low-income communities feasible

New Market Tax Credits

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New Market Tax Credit Case Study Makers Village, Newark, NJ

Urban Investment Group Case Study

Investment Overview In December 2013, GS closed a $10.7 million equity

investment and a $5.1mm senior loan to finance Phase I of the redevelopment of a 69,000 square foot industrial building located in the Ironbound neighborhood of Newark, New Jersey (“Project”)

In January 2015, GS closed a $12.4 million equity investment and GS closed a $2.8mm senior loan to finance Phase II of the Project

Upon completion of the Phase I and II renovations, the Project’s anchor tenant will be AeroFarms, an innovative clean-technology firm founded in 2004 that builds, owns, operates, and leases state-of-the-art vertical farm systems for urban environments

AeroFarms’ award-winning, proprietary aeroponic and LED technologies will allow its urban farms to grow up to 22 crop turns per year, compared to 3 turns per year via conventional methods. AeroFarms’ systems also require no pesticides and use 95% less water

In the Project’s first and second phases, AeroFarms will occupy 56,000 square feet and will create approximately 66 new permanent quality jobs at the site in a community with an unemployment rate that is more than 1.6 times the national average. Aerofarms is working with the Ironbound Community Corporation to recruit and train local employees

Project Summary The Project, which is situated on a three-acre site in the heart

of the Ironbound community at 212 Rome Street, will transform the currently underutilized Class C building into highly efficient Class A light industrial space, available to meet the needs of Newark’s 21st century economy

Makers Village is in direct response to City and community’s goal to reposition functionally obsolete industrial buildings in the area to attract and retain innovative light manufacturing companies to increase local employment and promote economic development

The Project also meets the goals of Newark’s Sustainable Action Plan by stimulating urban agriculture and engaging youth in food education and literacy

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Basic Structure

How is a Transaction Structured?

Representative structure assuming $10 million of NMTC allocation

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What is a QALICB?

How is a Transaction Structured?

Qualified Active Low Income Community Business (QALICB) is any corporation or partnership (including not for profit corporations) engaged in the active conduct of a qualified business that meets all 5 of the following requirements and is not engaged in an excluded business or activity

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Five Basic Requirements

Tangible Property – at least 40% of the use of tangible property (owned or leased) of the business is within a LIC

Services – at least 40% of the services performed for the business by its employees (by amount paid) is performed within a LIC

Gross Income – 50% of total gross income must be derived from active conduct of qualified business in LICs — (Gross Income test deemed satisfied if Tangible Property or Services test met at 50% instead of 40%) — No Employees – A business without employees can meet the Gross Income and Services tests if it meets the

Tangible Property test at 85%

Nonqualified Financial Property - Less than 5% of the average unadjusted basis of the property of the QALICB can be attributable to certain nonqualified financial property

— Includes debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, annuities and other similar property

— Excludes reasonable amounts of working capital

Collectibles — Less than 5% of the average of the aggregate unadjusted basis of the property of the QALICB can be attributable

to collectibles (i.e., antiques, stamps, etc.) — Excludes collectibles held primarily for sale to customers in the ordinary course of business

What is a QALICB?

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Excluded businesses and activities

QALICBs and their tenants cannot operate a: — Country club — Private or commercial golf course — Massage parlor — Hot tub facility — Suntan facility — Racetrack or other gambling facility — Store the principal business of which is the sale of alcoholic beverages for consumption off premises (bars,

supermarkets and convenience stores selling liquor are generally OK)

Other excluded businesses: — Businesses which develop or hold intangibles for sale or license — Certain farming businesses — Rental real estate

— Can’t be residential rental property – less than 80% of gross rental revenue from residential rental units — Substantial improvements must be located on the property

Note that a portion of the business may qualify as a QALICB — A portion of a business may qualify as a QALICB if that portion of the business (i) would meet the QALICB

requirements if separately incorporated and (ii) has a completely separate set of books and records. However, any portion of an investment or loan made by a CDE to such a business will not be a QLICI to the extent that it is not used for the portion that is treated as a QALICB.

— This is useful for businesses that are not located exclusively in low-income Census tracts.

What is not a QALICB?

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Taxpayers who make Qualified Equity Investments (“QEIs”) in eligible CDEs claim credit against Federal income taxes

The QEI must remain invested or be reinvested for seven (7) years Tax credit is equal to 39% of the QEI and claimed over seven (7) years (5%, 5%, 5%, 6%, 6%, 6%,

6%)

NMTC Investment Fund

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Taxpayer makes an equity investment in a special purpose entity (the “Investment Fund”)

A lender provides a loan to the Investment Fund — Lender can be unaffiliated third party such as a bank, a CDFI or a governmental entity; or — Lender can be an affiliate of the Taxpayer; or — Lender can be an affiliate of the Borrower

Investment Fund makes a QEI in the CDE using the proceeds of both the equity investment and the loan, for which it receives tax credits equal to 39% of the amount of the entire investment

NMTC Investment Fund

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Community Development Entities (“CDEs”) must use “substantially all” (i.e., more than 85%) of the QEI to make Qualified Low-Income Community Investments (“QLICIs”) in QALICBs, typically in the form of loans

QLICIs typically track Investment Fund capitalization with an “A” loan equal to the Leverage Loan amount and a “B” loan equal to the NMTC equity net of fees and expenses

Community Development Entity New Market Tax Credit Allocatee

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Specially created entity certified by the CDFI Fund

Entity with a primary mission to serve or provide investment capital for LICs or low-income persons

Entity that agrees to maintain accountability to residents of low-income communities through representation (more than 20%) on governing or advisory boards

In 2015, 76 CDEs received allocation of NMTCs — 76 CDEs (or 29 percent of the total applicant pool) were provided with allocation awards — 263 CDEs applied for allocations, requesting a total of approximately $19.9 billion in allocations — The CDFI Fund made allocation awards totaling $3.5 billion, or about 18% of the total amount

requested by applicants — Allocation awards range in size from $15mm to $75mm

What is a CDE?

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Basic Criteria

Businesses (including real estate) that own property, derive income from, or provide services in a low-income community — Poverty rate > 20% or — Median income < 80% AMI

A low income community may be defined as an area of higher distress when the following qualifications are met — Poverty rate > 30% or — Median Income < 60% of AMI or — Unemployment rate at least 1.5x national average — Note: In some cases, alternative criteria can make area “highly” distressed

NMTC Eligibility

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