CDFI-Issued Report Shows NMTC Program Working Well
The New Markets Tax Credit (NMTC) program works as designed.
That’s the key takeaway of a 66-page report, Compliance Review of New Markets Tax Credit Program, that was released this week by the Community Development Financial Institutions (CDFI) Fund.
The report was conducted by Summit Consulting LLC as commissioned by the CDFI Fund based on questions about CDE compliance and the NMTC program by the Government Accountability Office (GAO) and others.
The NMTC program is designed to attract private investment capital in underserved markets by providing a credit against federal income tax in exchange for equity investments in community development entities (CDEs). The CDEs then make flexible debt or equity investments in operating businesses and real estate projects in low-income communities. In the history of the program, more than $50 billion in NMTC authority has been allocated, including last year’s record combined $7 billion allocation round.
Each NMTC allocation agreement specifies compliance and reporting requirements to ensure public benefit–requirements that include flexibility to allow financing that best meets the needs of the businesses in the low-income communities. That flexibility complicates efforts to determine specific outcomes and to verify compliance–which led the CDFI Fund to commission a report to create a further understanding of compliance risks.
There were four main sections of the report, the first two covered here:
Consistent CDE Compliance
Each allocation agreement requires compliance and reporting to ensure public benefits, including various options to best meet the needs of businesses and to permit CDEs to deploy unique strategies to do so. Once the CDE receives an award to carry out its strategy, its commitment becomes binding.
The report found widespread compliance by CDEs with allocation agreements. In fact, the result went beyond that: Every evaluated investment complied with the applicable CDE’s allocation agreement.
One of the primary compliance requirements is for CDEs to offer flexible financing products to qualified active low-income community businesses (QALICBs), through at least one of three flexible products criteria:
- debt with a designated number of flexible features,
- interest rates at a designated percentage below market, or
- equity or equity-equivalent financing, such as debt with royalties, warrants or convertible debt.
The report showed that not only did all the CDEs offer products with one of the flexible criteria to QALICBs, nearly 60 percent went beyond by offering products with two or three of the flexible criteria.
Another requirement is to invest in distressed communities, which are census tracts that equal or exceed a 20 percent poverty rate or have a median family income 80 percent or less of the area median income (AMI).
The study found that nearly 50 percent of NMTC capital (nearly $15 billion for the projects studied) went well beyond this basic requirement and invested in highly distressed neighborhoods. Further, there was no evidence of NMTC investments being concentrated in areas in or adjacent to affluent areas. In fact, most NMTC investments are in distressed census tracts surrounded by other distressed census tracts–a target of the program.
In short, CDEs not only comply with allocation agreement requirements to provide flexible financing in distressed areas, they greatly exceed them.
Distribution of Program Benefit
The Urban Institute and GAO both raised questions about whether fees charged by CDEs and investors may diminish the program benefits. The Summit Consulting report provides an unflinching answer: No.
The report highlights the benefit to QALICBs from flexible financing provided by CDEs and says fees “do not appear to significantly affect the QALICBs’ cost of capital.” In fact, the report says the CDEs often use these fees to capitalize loan funds that provide similar flexible financing to other businesses in low-income communities–meaning the fees are frequently reinvested in the community.
The report found that CDE fees averaged 8.7 percent of the QEI over the seven-year compliance period, or about 1.25 percent per year.
Other Issues, Conclusions
The report also examined the degree of public investment in NMTC transactions and provided some CDE best practices.
It concludes with a recommendation of additional reporting enhancements to further encourage CDEs to implement best practices as policy–but emphasizes that current industry practices are largely aligned with the NMTC program’s objectives.
Bottom line? This, from the conclusion: “The research also found that many CDEs go beyond the compliance requirements, with most providing capital that is more flexible than required by the allocation agreement and investing in communities that are more highly distressed than mandated by statute.”
Look forward to additional discussion of this report’s findings in the September issue of the Novogradac Journal of Tax Credits.