Neighborhood Resources Department
TO: David L. Corliss, Interim City Manager
THRU:
FROM: Margene K. Swarts, Community Development Manager
DATE: July 31, 2006
SUBJECT: Section 108 Loan Guarantee and New Markets Tax Credit Programs
As you know, I recently attended training in
The Section 108 Loan Guarantee Program is a HUD sponsored loan program, the proceeds of which are guaranteed by the entitlement communities’ CDBG funds. During the training, great emphasis was placed on the fact that it is a loan program and neither a grant, nor additional CDBG funding. The program can be a significant resource for funding community development projects because the borrowing capacity can be as much as five times the annual CDBG allocation (for Lawrence, approximately $4.5 million) , includes long term (20 years), and reasonably priced financing (currently about 6%) for targeted projects.
Because private sector investors are frequently willing to
provide funds for important community development activities, but are unwilling
to bear the project risk, the Section 108 Loan Guarantee program provides the
“guarantee”, backed by the full faith and credit of the
There are four basic processes for the Section 108 program:
1) Screening of applicable projects.
2) Applying for the Section 108 loan – there is no specific application or application deadline but there is guidance for the application “package”. It is a non-competitive and rolling application.
3) Closing the deal.
4) Servicing of the Section 108 loan – it is necessary to adequately monitor the third party borrower.
There is a broad range of applications of the program including real estate, user business, public facilities, mixed use, loan funds, and housing (rehabilitation, not new construction). The most common uses of Section 108 funds are economic development activities, acquisition of real property by the borrower and associated construction or installation of site improvements, rehabilitation of publicly-owned property not used for the general conduct of government and associated construction or installation of site improvements, or housing rehabilitation, all of which must meet the eligibility guidelines of 24 CFR 570.703. In addition to meeting a CDBG national objective, as noted below, various other federal regulations and requirements related to the CDBG program apply including but not limited to: Labor Standards (Davis Bacon Act), Uniform Relocation and Real Property Acquisition Act, Fair Housing and Equal Employment Opportunity Act, National Environmental Policy Act (NEPA), Environmental Review, Executive Orders, etc.
The program requires both programmatic and financial underwriting and the training stressed that the financial aspect is a very important component of a successful project. Basic programmatic guidelines include 1) project eligibility (examples above), 2) meeting a CDBG national objective: a) activities benefiting low and moderate income persons, b) aid in the elimination or prevention of slums or blight, c) activities designed to meet community development needs having a particular urgency (a very time-sensitive objective), and 3) providing a public benefit. The provision for providing a public benefit is necessary for economic development projects and specifies minimum levels of job creation that must be met. Financial underwriting is mandatory for economic development projects and strongly suggested for all projects.
The required security for the Section 108 Loan is a pledge of all current and future CDBG funds and grants over the loan repayment period and may include additional security as determined by HUD. It should be noted that the Section 108 loan cannot be prepaid within the first ten years of the permanent loan sale. The repayment plan for the project is established by the borrower based on the amount of funds borrowed and term of the loan, and is approved as part of the Section 108 loan program package. However, if payments are not made on the due date, the payment is automatically deducted from the entitlement communities’ CDBG line of credit. Although this lowers the financial risk to the City, if CDBG funds have previously been allocated to particular projects (as is generally the case in Lawrence), funds may not be available for those projects if the repayment has to be made from the CDBG line of credit. The City (borrower) is responsible for negotiating with the third party borrower to cure defaults and as with any loan program, it is very important for the borrower to provide adequate monitoring and oversight.
The New Markets Tax Credit (NMTC) Program is a program operated through the Community Development Financial Institution (CFDI) Fund, which is a division of the U.S. Treasury. The program was designed to spur investment and promote economic development in rural and urban low-income communities and provides investors a credit against federal income tax liability for a qualified investment. This program is frequently used in conjunction with the Section 108 program to encourage private equity. The tax credits are geographically targeted for institutions that invest in low income communities. Therefore, it is necessary for the project to be in a “low income area” that is also in the “service area” of the qualified Community Development Entity (CDE).
The NMTC program is a very sophisticated and highly competitive program that requires a community to partner with an entity with significant expertise and history. According to personnel at the CDFI Fund offices, those are the “only entities currently getting significant funding through this program”.
In order to receive these tax credits, the investor must
invest in a Community Development Entity (CDE) which is a private entity
qualified by the CDFI as having a track record of making loans and investments
in low and moderate income areas. The
CDE is a pass-through entity for the credits and its primary mission must be to
benefit the low income area. The CDE
should have a Board of Directors willing to demonstrate impact and influence in
the low and moderate areas. There are
seven qualified CDE’s in the state of
NMTC allocations are awarded to the CDE and not to the project which is unlike Low Income Housing Tax Credits or Rehabilitation Tax Credits, which are awarded to the project. CDE’s exchange their NMTC awards for investment in the CDE. This investment is knows as the qualified equity investment. Because the NMTC program is a geographic focused area, projects must be located in low income areas. Low income areas are census tracts where the poverty rate exceeds 20% or the median income is below 80% of the greater of the statewide or metropolitan median. In Lawrence, Census Tracts 1, 2, 3, 4, 5.01, 5.02, 8.02, and 9.01 would qualify for the NMTC program.
The most common eligible projects are real estate deals such as loans/investments to operating businesses located in low income areas, development of commercial, industrial, or retail real estate in low income areas, or mixed use projects (commercial income must be at least 20% of the gross income of the property). Less common projects are development of for sale housing in low income areas, loans purchased from another CDE, or financial counseling and other services to businesses and residents located in low income areas.
It is possible for a City to become a qualified CDE. Responsibilities of the CDE with regard to the NMTC program include receiving the qualified equity investments (QEI) and investing them in a qualified active low income community business (QALICB) through a qualified low income community investment (QLICI); compliance with the NMTC program regulations; remaining in good standing with the CDFI Fund; providing periodic reporting to the CDFI Fund, the IRS, and investors; and a demonstration that the benefits of the NMTC are passed on to both the community business and the investors.
As noted above, the NMTC program is a highly sophisticated and complicated financing tool. Staff will continue to monitor the program and look for possible projects that might be worthy of consideration. If the City is interested in participating in this program, it would be a good idea to partner with an entity familiar with the program that also has a good track record of utilizing the program. The technical assistance as well as financial expertise they could provide would be invaluable in this endeavor.