Proponents of the new markets tax credit (NMTC) say that one of the incentive’s strengths is its flexible approach to community investment, allowing community development entities (CDEs) to employ a range of methods and financing tools to drive capital into underserved communities. 

With this flexibility, however, comes a host of compliance considerations.

Panelists at the Novogradac 2019 New Markets Tax Credit Conference in January discussed some of the hottest NMTC compliance topics, including certain questions arising from the Community Development Financial Institution (CDFI) Fund’s “NMTC Certification, Compliance Monitoring and Evaluation Frequently Asked Questions” document, the challenges that CDEs can encounter in meeting their allocation agreement requirements, issues presented by targeted populations transactions and the CDFI Fund’s consideration of “but for” requirements for NMTC transactions.

Frank Buss, a Novogradac partner, moderated the panel, featuring Scott Lindquist, a partner at Dentons; Kelly Clements, NMTC relationship manager for PNC Bank; and Joseph Bredehoft, a partner at Husch Blackwell.

FAQs 44-46

Panelists discussed FAQs 44-46 of the “NMTC Certification, Compliance Monitoring and Evaluation FAQs,” which were added to the document in a series of updates, the most recent of which was issued April 2017. FAQs 44-46 deal with what expenditures by a qualified active low-income community business (QALICB) or its affiliates do and do not qualify for reimbursement from qualified low-income community investment (QLICI) proceeds and what obligations CDEs have when financing such reimbursements.

Lindquist said that, although these requirements have been in effect for some time, they continue to present issues in many transactions.  It is critically important for QALICBs and CDEs to consider, as early as possible, the structure of the transaction, the age and nature of expenditures that are expected to be reimbursed and the timing of the reimbursements in relation to the expected closing date.

Lindquist indicated that the key limitations are that, if QLICI funds are being used, directly or indirectly, to fund a qualified equity investment (QEI), the expenditures that are being paid or reimbursed either cannot be more than 5 percent of the amount of the QLICI (which is a small number for most deals), or they cannot have been incurred more than 24 months prior to the closing of the QLICI.  Furthermore, even if expenditures are less than 24 months old they must be reasonable expenditures that are directly attributable to the business of the QALICB and for a legitimate business purpose, incurred in the normal course of operation, and similar in amount and scope when compared to expenditures by a similar entity for a similar project under similar circumstances.” Lindquist said that these criteria can raise a number of issues when trying to evaluate whether particular reimbursements qualify. 

For example, many transactions involve developer fees. Lindquist noted that if a QALICB is affiliated with a real estate developer and the developer charges a developer fee to the QALICB, that can be categorized as being in the normal course of operation, but where this is not the case, it can be more difficult to justify. This should be discussed early in the process because often the developer fee is a source for project funding needs. The most important take-away is that these kinds of issues should be looked at early in the deal, because it generally takes several months to close, and you don’t want to find out a week before closing that you have payments or reimbursements that don’t qualify and a resulting shortfall in funding.

FAQ 45 deals with the documents CDEs are required to obtain and maintain to establish compliance with FAQ 44.  This includes information and documentation necessary to trace the use of QLICI proceeds, and CDEs are required to verify compliance on an ongoing basis after closing. Panelists discussed how FAQ 45 is sometimes overlooked, but is crucial to consider.

“The best case scenario is that the deal kicks off, you get the documents and everything’s in order,” advised Bredehoft. “Keep an eye on when you close and when that 24-month period ends. You don’t want to think outside the 24-month period. At some point, expenses do start falling off.” Panelists discussed ways to keep track of the 24-month period’s “moving red line,” including creating and maintaining a detailed spreadsheet of dates and expenditures.

Having the right partners in place can help prevent delayed closings and other costly mistakes. “This is where the relationship between the CDE, investor and QALICB becomes key to the success of the project. They must cooperate to ensure they get to the finish line as soon as possible in order to preserve the greatest amount of reimbursable costs,” said Clements.

Buss asked panelists whether there are any lingering questions about FAQ 46, which limits reimbursement values. Panelists said the CDFI Fund’s response is straightforward and that the actual cost, not the appraised value, must be used. 

“You can’t reimburse for the appreciated value,” noted Bredehoft. 

Allocation Agreement Requirements

Allocation agreement requirements were also a hot topic, including flexible product requirements, investments in non-metropolitan counties and other innovative investment requirements, and verifying that transactions meet those requirements. 

“CDEs have to offer flexibility in their products–equity or interest rates below a designated percentage,” said Bredehoft. “What I see is usually 50 percent below market interest rates is what qualifies as a flexible product. If you don’t meet that standard you can use other factors:  lower than standard origination fees, higher than standard loan-to-value ratios, nontraditional forms of collateral.”

Lindquist said that the allocation process is extremely competitive and CDEs try to get as many points as they can by checking off boxes.  Once they’ve done that, they have to go out and find deals that meet these commitments. For example, it can be challenging to do small QLICIs—the legal fees and CDE fee and cost structures can make it uneconomical to do these small deals. It requires the right combination of parties, forms and more to get them done.

Targeted Populations

Conference panelists also discussed the compliance challenges involved in targeted population transactions. Clements had a straightforward take. “If you can avoid them, don’t do them–or you can expect to pay a lot for them,” said Clements. “They’re difficult to close, are more costly and require greater effort throughout the compliance period. CDEs and investors tend to stay away from these transactions due to the amount of ongoing compliance and monitoring needed. The documentation, like annual or semiannual Agreed Upon Procedure reports that have to be done to ensure compliance adds cost for the life of the project, not to mention the additional legal work usually needed to simply get the deal closed.”

Lindquist noted that, unlike the other requirements for being a QALICB, the targeted population requirements are ones that a borrower can fail pretty easily. 

“But for” Analysis

Conference panelists closed their presentation with discussion on the CDFI Fund’s consideration of whether and how it might impose requirements on CDEs to show that their NMTC transactions meet a “but for” standard.  This is being undertaken in response to a recent GAO report, and it could have significant impacts on the NMTC program.  Industry participants were urged to monitor this closely and provide input to the CDFI Fund. 

Conclusion

“Our conference panel touched on several compliance topics that continue to be important issues to participants in the NMTC industry,” said Buss. “As our conference speakers noted, navigating NMTC compliance requirements can be challenging, so it’s important to consult with a trusted and experienced advisor.”