DAVID KAVANAUGH
‘A good deal’

Banks are increasingly making use of a new approach to community reinvestment by buying into low-income housing developments as a way to leverage funds with New Markets Tax Credit, while at the same time satisfying requirements of the Community Reinvestment Act.

According to David Kavanaugh, partner in the Affordable Housing and Syndication department at the Boston law office of Nixon Peabody, the sole purpose of the New Markets Tax Credit initiative is to encourage new business investments and initiatives by banks in low-income communities around the state.

But banks have further incentive to enter into new markets tax agreements – meeting CRA requirements.

Banks, which are required to have a satisfactory CRA rating from their regulators in order to complete a merger or consolidation, or open new branches or switch charters, can generally include the investment in a tax credit project as among the “qualified investments” held by the bank for credit under the Community Reinvestment Act.

“The lending test is the most heavily weighted and in these tax credit deals, the bank is getting a double benefit in CRA if it’s involved in the lending aspect and/or the investment benefit by investing in syndicators,” said Michael Hatfield, division director of Fleet National Bank’s Community Investment Group.

By making an equity investment in an eligible “community development entity,” investors, including banks, can receive New Markets Tax Credit worth more than 30 percent of the amount invested over the life of the credit, according to the Coalition of Community Development Financial Institutions.

“These loans are investments that qualify for New Markets Tax Credit and can qualify for CRA credits. It’s a great situation for banks and they can make the loans that they are already planning to make and in addition get a 39 percent tax credit,” said Kavanaugh. “It’s a good deal, but the way it’s going to work out is that banks have to make loans [upfront] in order to get CRA credits.”

When the Tax Reform Act of 1986 created the opportunity for investors to reduce their tax exposure through tax credits for affordable housing programs, community development organizations began creating tax credit investments for clients as a way to secure funding for building in low-income communities.

The New Markets Tax Credit program, enacted in December 2000 by the U.S. Treasury Department, which oversees the program, permits taxpayers to receive a credit against federal income taxes for making qualified equity investments in designated community developments.

The tax credit program is available for residential rental projects – either for new construction or rehabilitation. The low-income housing tax credits are allocated to development projects and the credit provided to the investor totals 39 percent of the cost claimed over a seven-year credit allowance period.

According to Philip Rosenblatt, partner at the Boston-based law firm Nutter McClennen & Fish, banks represent a unique group of corporate investors that can benefit from low-income housing tax credit investments.

Rosenblatt, a tax attorney focusing on low-income housing tax credits, works with large investors including Fleet National Bank to make sure the investment is facilitated correctly and the investment vehicle is properly maintained.

Rosenblatt said investments are usually constructed as “warehouse” investments – an investment vehicle designed to prevent the financing of geographically clustered buildings that could be destroyed by a single natural disaster and keep investors from putting too much financing with one project developer.

“Banks find tax credit shelters useful because it offsets [the bank’s] tax liability and it tends to be a pretty valuable investment,” said Rosenblatt. “But a bad investment is a whole other story. You can leverage a $70 million warehouse line to finance a lot of different properties and make sure they are all geographically dispersed so that you avoid natural disasters. That way, the bank or investor makes more money on various properties than on one property and diversifies the risk.”

While there are many different types of investment vehicles, those community developments that are awarded funding have the ultimate decision as to how the money is distributed, according to Kavanaugh.

“Everybody has their own plan … In general, many of the awardees are going to use the money for loans or investments or commercial or mixed-use real estate projects in low-income communities … and some are focused are historic renovations,” said Kavanaugh.

Working the Numbers

In Massachusetts, the Massachusetts Housing Investment Corp. and Nuestra Development Fund received New Markets funding in the amounts of $25 million and $1 million, respectively, in 2002, and according to Kavanaugh, “[The Massachusetts Housing] Investment Corp. is planning on using money for commercial real estate and making investments in businesses like property management and construction and other community and economic development businesses.”

So why are the community developers starting to sell tax credits to banks? Simply stated, because the developers need the money to build the projects.

“There are always loans that banks aren’t going to make because the numbers just don’t work. The beauty of the New Markets Tax Credit is that banks can get a tax credit and make the numbers work … and projects that couldn’t get financing before are now going to be able to get financing because banks can take into account the tax credit,” said Kavanaugh. “It’s a tax credit [immediately] and in the long run there is a project built.”

Fleet National Bank’s Community Investment Group is an investor in the New Markets Tax Credit program and, according to Hatfield, there are plenty of incentives for banks to engage in this type of tax credit.

“Fleet as an investor has investment relationships with several syndicators that all serve in the same kind of role and … Fleet has invested in the various funds that are available for affordable housing,” said Hatfield.

As a lender, Hatfield said, Fleet provides a number of construction loans for low-income housing development but such investments often entail significant risks.

“One thing that is critical on tax credit deals is that you also have other sources of soft debt. From a risk point of view, this helps the bank share the risk of all the things that can occur during the construction,” said Hatfield.

Hatfield said Fleet does direct investments with community development intermediaries like Boston Community Capital, but the bank does not directly invest in a particular deal or specific project.

Elyse Cherry, chief executive officer of Boston Community Capital, said the idea behind the tax credit is to get the capital into the New Markets areas, which are sometimes referred to as low-market areas, but there is always a challenge to an investor.

“The broad idea is to use the tax credit to get new capital, but the notion of doing community economic development on the tax side is always a challenge,” said Cherry.

Cherry said the difference in New Markets Tax Credit program, compared with other credit programs under the Tax Reform Act, is the type of development an investor invests in.

“When you build housing [using New Markets Tax Credit] it stays in one place – the house isn’t going to pick up and move across the street. When you try and do this with businesses, the challenge is that the business decides it needs to move out of the area and that [poses] a risk to bank,” said Cherry.

Cherry said the benefit of New Markets Tax Credit is the opportunity to work with banks that can supply the funding because, in order to receive the credit, “you have to be a good entity … and then partner with banks and say there is an equity piece and a debt piece and management piece that needs to be funded.”

Melanie Nayer may be reached at mnayer@thewarrengroup.com.