SCD A NMTC Introduction (long) 112012[1]

Stonehenge Community Development – An introduction to the New Markets Tax Credit Program 1

New Markets Tax Credit Program Is this Capital Source Right for Your Organization?

New Markets Tax Credits

Presented by

Matthew Masiel Stonehenge Community Development, LLC


q Objective of presentation q  Introduction

•  Stonehenge Community Development, LLC q  Program & Background

•  Federal Program •  State Program

q NMTC Participants and Process •  Participants deNined •  Introduction to CDEs •  QualiNied Active Low-‐Income Community Businesses •  Low-‐Income Communities •  QualiNied Equity Investments •  QualiNied Low-‐Income Community Investments •  Substantially All •  Recapture •  Professional Service Providers

q  Structuring the transaction q  BeneNits/Considerations q Questions/Comments

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Agenda


Lines of Business q Tax Credit Products: Experience structuring and Ninancing nearly $2 billion in premium tax, income tax and franchise state tax credits across the United States generated by brownNield, Nilm, historic rehabilitation and renewable energy projects.

q Venture Capital & Private Equity: Manages approximately $617 million in 13 regionally-‐targeted funds and mezzanine/growth fund without geographic targets.

q  Community Development: Manages $505.5 million in Federal New Markets Tax Credit (NMTC) allocation, a program administered by the US Treasury to encourage investment in low income communities. In addition, Stonehenge manages $364.4 million in State speciNic NMTC funds in: Alabama, Missouri, Nebraska, Illinois, Florida, Kentucky, Maine, Oregon and syndicates state credits in Missouri and Louisiana.

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Introduction – Stonehenge Community Development, LLC

Stonehenge Community Development, LLC is a subsidiary of its Parent organization Stonehenge Capital Company, LLC. SCC is a nationally recognized specialty Ninance company with expertise in tax credit Ninance, structured Ninance and private equity.

−  Principals: senior managers within Bank One (now JPMorgan Chase) investment banking, merchant banking, investment advisory, securities brokerage and insurance operations.

−  47 professional employees in 8 states; ofNices in LA, OH, NY, MO, AR, TX, FL and AL. −  Principal oversight provided from Columbus, OH and Baton Rouge, LA.

NMTC Portfolio •  National service area •  53 NMTC Transactions •  15 states represented •  Over $113 million in NMTC equity raised •  Closed transactions with 11 institutional investors

•  Financed both non-‐proNit & for proNit •  Typically provided NMTC equity as “last mile” capital

•  Structured as subordinated debt •  Traditionally non-‐amortizing with below market interest rates

Stonehenge Community Development – An introduction to the New Markets Tax Credit Program 4 4

Program and Background

Federal NMTC Program □ The New Markets capital attraction and job growth tool grew out of Jack Kemp’s “opportunity society” vision and his efforts to renew economically distressed communities by providing a hand up rather than a handout. Congressman Kemp was known to say, “You can’t have capitalism without capital.” □ In 2000, to encourage private sector capital investment and job creation in areas in need of economic development, Congress enacted strongly bipartisan legislation creating the New Markets Tax Credit (NMTC) program. □ Since its enactment, Congress has reauthorized the NMTC Program multiple times, allowing for a total of $33 billion of qualiNied investment activity. □ The Treasury Department awarded $3.6 billion of NMTC allocation on April 2013. □ Efforts are underway to reauthorize the NMTC program beyond 2014 by including it in the Tax Extenders package, which has been the program’s legislative vehicle following its original authorization.

The NMTC Program is authorized by section 45D of the Internal Revenue Code.

The NMTC Program is administered by the CDFI Fund (department of the U.S. Treasury). Established in 1994, the CDFI Fund was created for the purpose of promoting economic revitalization and community development through investment in and assistance to community development Ninancial institutions (CDFIs).


Federal NMTC Program Program and Background

The objective of the federal program is to attract investment from the private sector to beneNit operating businesses and real estate projects located in economically distressed communities that have traditionally had

inadequate access to capital due to the perceived greater risk.

5.) QualiNied Low Income Community Investment (“QLICI”)

3.) QualiNied Equity investment (“QEI”)

Investor Community Development Entity (“CDE”)

QALICB Operating business/Real Estate

CDFI Fund

1.) NMTC Application

2.) Allocation of NMTCS

4.) 39% federal tax credit

Low Income Community

1. A CDE submits an application to the CDFI fund to be considered for an allocation of NMTCs. 2. After a competitive review of applications, the CDFI Fund awards an allocation of NMTCs to a CDE. The CDE works with various partners to locate potential QALICBs that are in need of investment. 3. Once the QALICB has been qualiNied and all documentation prepared, an investor will make a QEI into the CDE. 4. In exchange for the QEI, the CDE provides the investor with tax credit authority equal to 39% of the QEI. 5. The CDE provides a QLICI to the qualiNied business.


Program and Background

State NMTC Programs Following the lead of the successful federal NMTC Program, nine states currently administer this proven capital attraction and job growth tool as a state-‐level incentive.

State NMTC Programs have consistently applied the federal regulations, yet each state implements a speciNic statute and set of rules which are regulated and administered by a state agency.

States have consistently relied on the framework imposed by the Federal regulations while implementing certain nuances to accomplish speciNic objectives. Common distinctions include but are not limited to the following:

•  NMTC Allocation authorized •  Transaction Cap limits •  Timing of credit •  Intended use •  Governance

Program range from $2.5MM -‐ $250MM Traditionally capped at $10MM Structured to take more credits on the back end Finance operating businesses as opposed to real estate State selected economic development, revenue, tourism, etc. cabinet

Source: Novogradac & CO., LLP


Participant Role

Community Development Financial Institutions Fund (CDFI)

•  A department within the US Treasury that administers the Federal NMTC and other similar programs that promote economic revitalization and community development

Community Development Entity (CDE)

•  Recipient of the NMTC allocation from the CDFI. •  Sells tax credits to an investor and uses the proceeds of the sale to make a loan to a borrower

•  Also referred to as a CDE, Lender, or allocatee.

QualiNied Active Low-‐Income Community Businesses

•  Any corporation or partnership (including nonproNits) that satisfy NMTC Program requirements

•  Can be a single purpose entity (SPE) •  Also referred to as a QALICB or Borrower

Leverage Lender

•  Provides required leverage into the NMTC structure to generate tax credit equity from the Investor

•  Sources can include traditional debt, capital campaign proceeds, state/federal grants, etc

NMTC Equity Investor •  Purchases tax credits from the CDE and in turn provides equity to the project

•  Typically a Ninancial institution

Professional Service Providers (PSP)

•  Legal counsel and accountants necessary to ensure the structure and transaction are documented in accordance with the NMTC Program

•  Ensure that all parties are aware of risks associated with a NMTC transaction

Consultants

•  Leverages knowledge and experience to assist the Borrower in understanding the NMTC structure and assembly of the various parties and NMTC allocation required

•  A PSP that may not be present in all transactions

NMTC Participants and Process


To receive awards under the NMTC Program, an organization must be certiNied as a CDE by the CDFI Fund. To qualify as a CDE, an organization must:


Be a domestic corporation or partnership at the time of the certiNication application.

Demonstrate a primary mission of serving or providing investment capital for low-‐income communities or low-‐income persons.

Maintain accountability to residents of low-‐income communities through representation on a governing board of or advisory board to the entity.

•  Service area -‐ A CDE is required to select an area that it serves or intends to serve. Service areas can be a local area, multiple local areas, statewide, multi-‐state, or nationwide.

•  Allocation agreement – Document received after allocation setting forth the rules, regulations, and restrictions the CDE must follow as a condition of its allocation. Based on the CDE’s application and implements the vision put forth in the application.

CDE Application

CDE CertiNication




Management Capacity

Capitalization Strategy

Community Impact

Business Strategy

q  CDEs are awarded an allocation of NMTCs by the CDFI Fund through a highly competitive application process.

q  The application process is divided into 4 speciNic categories (see graphic).

q  A CDE will examine each investment opportunity with consideration to the Business Strategy and Community Impact section of present and future applications.

q  Project alignment with a CDE’s Strategy and Impact is critical in initiating a NMTC transaction.

Components of a NMTC application



1. Project location – must be located in a qualiNied census tract that meets the determination of a low income community.

•  LIC -‐ Census tract where the poverty rate exceeds 20% or the family median income is below 80% of the statewide family income.

•  Approximately 39% of all census tracts in the U.S. are eligible; about 36% of the US population lives in eligible census tracts

•  There must be a “reasonable expectation” that the company will continue to be located in a LIC for the term of the loan.

•  Project location qualiNication should be discussed with a CDE or NMTC Advisor.

2. Non QualiUied Businesses: •  Golf course, liquor store, massage parlor, tanning facility •  Leasing of unimproved real property or residential rental property

•  Development of or holding of intangibles for sale or license •  Certain farming activities

QualiUied Active Low Income Community Business (QALICB)

Project location

Non-‐QualiUied Businesses

3. QALICB Determination: 1. Gross income -‐ must derive at least 50% of gross income from activities in low income community. 2. Tangible Property Test -‐ 40% of the tangible property (owned or leased) is used within the LIC. 3. Services Performed -‐ 40% of the services performed by the business must be in a LIC. 4. Collectibles Test -‐ Less than 5% of the average of the aggregate unadjusted basis of the property is attributable to collectibles. 5. NonqualiLied Financial Property Test -‐ Less than 5% of the average of the aggregate unadjusted basis of the property is

attributable to NQFP which includes debt, stock, etc. Reasonable amounts of working capital are excluded from this calculation.

QALICB Determination



Low Income Community (LIC) •  LIC -‐ Census tract with poverty rate >20% and/or annual median income (AMI) is <80% of statewide average. •  Allocatees have the option to commit to serve areas of high distress

•  Census tracts with poverty rate >30% and/or <70% of AMI and/or a unemployment rate 1.5X National Average

•  Allocatees also have the option to commit to serve rural and/or urban areas.

A preliminary qualiNication tool can be located on the websites hosted by Novogradac & Company, LLP and Reznick Group. All potential NMTC projects must be conNirmed by the CDFI Fund Mapping System.

□ The CDFI Fund, Novogradac, and Reznick mapping programs currently rely on census data that was collected in 2010. The 2000 census data is not longer applicable as of June 30, 2013



QualiUied Equity Investment (QEI)

QEI QEI -‐ the investment in a CDE in the form of either stock or a capital interest. It must be acquired at original issue solely in exchange for cash.

Substantially all (85%) of such cash must be used to make QualiNied Low-‐Income Community Investments.

Timing of Investment: 1.) A QEI must be received by the CDE within 5 years of receiving an allocation of NMTCs. 2.) The CDE has 12 months to make a QLICI once cash has been received.

This equity investment is the amount that, ultimately, will generate NMTCs provided that certain criteria are met by the CDE in making the QLICIs.



QualiUied Low Income Community Investment (QLICI)

A QLICI can be issued in 1 of 4 ways, but most commonly as -‐ 1. Any capital or equity investment in, or loan to, any QALICB in a LIC.

QALICB

LIC

QLICI

2. The purchase from another qualiNied CDE of any loan made by such entity which is a QLICI. 3. Financial counseling and other services (e.g., advice regarding organization and operation) to QALICBs, and residents of LICs. 4. Any equity investment in, or loan to, any CDE (Second CDE) by a CDE (Primary CDE).

Timing of Investment: QLICI proceeds are required to be spent by the QALICB within 12 months of the investment. Failure to do so may lead to the disqualiNication of the entity’s status as a QALICB.



•  Substantially All -‐ 85% of the QualiNied Equity Investment received by the CDE must be invested in QALICBs. The test must be met for each annual period during the 7-‐year credit period. The 85% threshold is reduced to 75% in year 7.

Substantially All

Failing to satisfy the 85% requirement (“substantially all”) is 1 of the 3 tax credit recapture triggers.

1.  Direct Tracing: At least 85% of the proceeds of the speciNic QEI can be traced

to eligible investments. 2.  Safe Harbor: At least 85% of the CDE’s aggregate gross assets are invested in

QLICIs.

Substantially All will be measured by 1 of the 2 following methods -‐



Recapture

Recapture is caused if any of the following 3 events occur: 1. The CDE ceases to be a qualiNied CDE 2. Equity investment proceeds no longer satisfy the Substantially All requirement. 3. The equity investment is redeemed or cashed out by the CDE.

Due to the severity of the recapture penalty, all participants are motivated in the documentation process to minimize the risk of recapture.

• Recapture -‐ A violation of NMTC regulation requires the tax credit investor who made the equity investment into the CDE to repay the full value of the tax credits plus any additional penalties imposed by the IRS.



QEI QLICI

Professional Service Providers (PSPs)

QALICB

Legal Counsel #1 Legal Counsel #2 Legal Counsel #3

CDE Investor Accountants

TBD – NMTC Consultant

•  Accountants – Required in a NMTC transaction. Works with all participants to Ninalize transaction structure and projections.

•  Legal Counsel – Required in a NMTC transaction. Prepares and reviews all documents required to satisfy the represented participant. Number of Nirms will vary depending on the complexity and structure of the transaction.

•  NMTC Consultant – Not required or utilized in all NMTC transactions. Primarily works with a QALICB in structuring transaction, locating allocation and coordinating transaction participants.



Investor-‐operated CDE model •  Investors have the ability to establish a wholly owned CDE. •  Investors will use the CDE subsidiary to invest directly in QALICBs. BeneNit to Investor – SatisNies tax credit appetite, provides commercial customers with favorable rates/terms, strengthens customer relationships and satisNies community and economic development requirements. BeneNit to QALICB – Can include but is not limited to: reduced interest rate on loans.

Third-‐party model •  An Investor will make a QEI investment in a CDE. BeneNit to Investor – SatisNies tax credit appetite, relies on the CDE for underwriting and compliance management, and reduced exposure to recapture. BeneNit to QALICB – Can include but is not limited to: debt cancellation, Nlexible rates/terms, and limited principal amortization.

Models and Structures Structuring the Transaction


Models and Structures

Leveraged structure – Most commonly used •  A leverage lender provides a non-‐recourse loan to an Investment Fund, a SPE created solely for the purposes of the transaction.

•  The leverage loan is added to the equity from the NMTC Investor to create a larger QEI and deliver greater beneNit to the QALICB.

•  Tax credit investor receives 100% of the tax credits. •  The sources of a leverage loan should be discussed with all Participants prior to initiating documentation.

Structuring the Transaction

Non-‐leveraged structure – Less commonly used •  Primarily used in the early stages of the NMTC program. •  Investment in the QALICB is based on the equity only and is not combined with debt.

NMTC structures are conNigured to suit the transaction; however, all structures essentially can be categorized as either a non-‐leveraged or leveraged structure.


Third Party – Leverage Structure: Representative of $10MM transaction on a gross basis

Structuring the transaction

Investment Fund, LLC (SPE created on behalf of transaction)

Total fund = $10,000,000 Tax Credit Equity = $2,730,000 Leverage loan = $7,270,000

Leverage Lender $7,270,000 non-‐recourse loan with market or below market rates

Tax Credit Investor Assume – $0.70 per credit

Receives -‐ $3,900,000 in tax credits Provides -‐ $2,730,000 in TC equity

Community Development Entity, LLC

Bank loan

Cash

A Loan ▪ ReNlection of leveraged loan ▪ $7,270,000 with market or below market rates ▪ 1st Mortgage

B Loan ▪ ReNlects monetization of TC equity ▪ $2,730,000 with a below market

rate (typically 1-‐2%) ▪ Subordinate debt or equity

QALICB

▪ $3.9 million NMTC ▪ Annual interest payments (or cash Nlow)

▪ QEI -‐ $10 million equity

▪ Annual interest payments (or cash Nlow)

▪ QLICI A = $7,270,000 ▪ QLICI B = $2,730,000

▪ $2,730,000 NMTC equity

▪ $3,900,000 in tax credits

▪ $7,270,000 leverage loan

▪ Debt service


BeneUits to the QALICB BeneUits and Considerations

Patient Capital Over Term: •  7 year term •  Limited principal amortization

•  Below market interest rates Low Cost Capital Over Term:

BeneNits

•  Typically structured as subordinated debt •  CDEs will commit to a selection of the 13 speciNic Nlexible terms

Flexible Terms

•  Portion of debt effectively forgiven through an option agreement with the investor

•  Tax impact of debt forgiveness mitigated through long term debt structure (For ProNits only)

Favorable BeneUit at Unwind

•  Federal NMTC equity provides approximately 20% beneNit at the end of the compliance period

•  State NMTC equity provides approximately 15% beneNit at the end of the compliance period

•  Federal and State credits can be layered, under the right circumstances, to increase the overall beneNits to a business/project

Equity like capital:


Considerations for the QALICB

Hard debt must be repaid/reUinanced at term

BeneUits and Considerations

•  Hard debt reduced as a result of NMTC Equity •  Cash Nlow savings over period can offset funds required for repayment •  Cash Nlow invested in business over 7 year compliance period can accelerate growth and strengthen credit proNile such that a business is in a better position to reNinance or repay debt at end of term

•  Business will have a long term low cost debt instrument on the balance sheet which helps to stabilize capitalization over the term

•  Cash Nlow savings over 7 year compliance period can offset funds required for repayment

•  Cash Nlow invested in business over 7 year compliance period can accelerate growth and strengthen credit proNile such that a business is in a better position to reNinance or repay debt at end of term

•  A sale of business/assets is allowed so long as jobs, assets, and services remain located in or continue to serve a LIC

•  CDE lender is likely to stay in place in a change of control scenario to prevent NMTC recapture

Sale of business or other change of control can be a challenge

Prepayments disallowed during NMTC period

Transaction Fees

•  Despite front end costs, patient and below market rate capital Nills the gap enabling the project to move forward

Considerations Mitigants


Questions? Questions/Comments

Matthew P. Masiel Stonehenge Capital Company, LLC 7733 Forsythe Blvd. Suite 1100

St. Louis, MO 63105 (O) 614-‐545-‐7250

[email protected] www.stonehengecapital.com

SCD A NMTC Introduction (long) 112012[1]

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