It is no secret that demand for New Markets Tax Credit (NMTC) Allocation is incredibly high. Over the life of the NMTC program, only about 28% of the hundreds of applicants each round actually receive an award. This demand has allowed the Community Development Financial Institutions (CDFI) Fund, the branch of the Treasury that administers the NMTC program, to utilize the application process to affect positive changes to the way the NMTC industry works in practice.
How has the NMTC program influenced the industry as a whole?
“As the NMTC program has grown, it has become a critical tool for community development organizations to advance their mission,” says Scott Szeliga, a CohnReznick audit partner. Due to the competitive nature of the program, the CDFI Fund has the ability to drive NMTC investments in a particular direction by awarding points to applicants who agree to make investments under more stringent criteria, or in a specific part of the country.
“Obtaining a NMTC allocation has become so important that most Community Development Entities (CDEs) do not hesitate to commit to the more stringent investment criteria in recent allocation applications in hopes of securing an award,” Szeliga explains. If a CDE receives an award, the CDFI Fund can then “lock in” investment criteria by including such criteria in the allocation agreements, ensuring the CDE will do as they promised in their allocation application.
The transformations are gradual, but positive
The changes that have taken place throughout the process have made the NMTC a better program and have increased the likelihood that one day the NMTC program will become permanent. Some of the industry changes have been gradual. For example, the competitive nature of the program has had a noticeable impact on fees taken by CDEs throughout the life of a deal. As the program has matured and demand for allocation has remained high, CDEs have been more willing to reduce the amount of fees taken during the life of an investment in order to increase their chances of obtaining allocation. The level of detail required by the fee section of the allocation application provides enough clarity that all fees during the transaction cycle are disclosed. This allows the CDFI Fund to better understand the total amount of fees expected to be taken by all applicants, which helps level the playing field.
Most CDEs are only required to make 75% of their NMTC investments for a particular allocation in census tracts that qualify as targeted distressed communities. However, Szeliga explains, “We also have seen CDEs go well above their required percentage of investments made in targeted distressed communities.” It is also very common for a CDE to have a policy that 100% of their investments will be made in these qualifying census tracts.
Another gradual change has been the percentage of qualified equity investments (QEI) required. “While the tax code only requires 85% of a qualified equity investment to be invested into a low-income community, we typically see CDEs locked into QEI usage percentages in the 95% – 97% range,” maintains Szeliga. The increased detail required in the application related to fees, as mentioned above, has also given clarity to the equity usage percentage.
The creation of the innovative investments section
In addition to the gradual changes occurring over the years, high demand for NMTC allocation has allowed the NMTC program to move quickly to drive investments in various directions. Through the allocation application, the addition of the innovative investments section has become one of the required criteria for a CDE in their allocation agreements. As an example, the CDFI Fund has used this section to drive NMTC investment into states that have been underserved by the NMTC program. This section has also been used to drive more NMTC investments into non-real estate deals, investments with original terms of 60 months or less, as well as investments that are $2 million or less. In response, the industry has experienced an increase in the number of revolving loan fund deals as CDEs look to meet the new innovative criteria.
The evolution of the NMTC program impacts the road ahead
As the NMTC program matures, more and more CDEs are meeting the standard requirements in the application process. This means there are plenty of groups that score high in the management capacity and capitalization strategy sections of the application. The competitive nature of the program propels applicants to differentiate themselves in the business strategy and community outcomes sections.
With the increase of qualified applicants, CohnReznick foresees that the demand for NMTC allocation will remain strong. This continued demand will ensure that CDEs drive investments to areas highlighted in the innovative investment section of the application and will encourage investments in the most distressed communities throughout the country.
What Does CohnReznick Think?
The demand for NMTC allocation has ultimately been a catalyst for positive change in the NMTC program. It also allows the NMTC program to be extremely flexible for a federal program – which is key to the program’s staunch support in Washington. The continued improvement of the NMTC program and its unique flexibility has helped place it in a prime position for consideration to become permanent.
Contact
For more information, please contact Scott Szeliga, audit partner, at [email protected] or 410-783-7472.
