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Summer 2001 - Federal Reserve Bank of Boston


by James Carras

Providing capital to low-income urban and rural communities is a key issue for America in the twenty-first century. Problems holding back investment in urban communities include prejudice, crime, and poor public education. Rural areas suffer from additional problems including obsolete industries, population loss, and low educational achievement. Coupled with these social obstacles, vast changes in the financial servic-es industry have resulted in the closing of inner-city and rural branch facilities. Despite these obstacles, successful investment approaches have been identified. In addition, a substantial federal com-mitment to leverage private capital, known as the New Markets Tax Credit Program, is working its way through the governmental imple-mentation process.

The legislation, signed by President Clinton as part of the Community Renewal Tax Relief Act of 2000, authorizes $15 billion in tax credits for private investments over the next seven years. New Markets Tax Credits (NMTCs) will have the potential to enhance capital flow for economic development in "new market" low- and moderate-income communities ù both urban and rural. The credits are valid only for investment in commercial enterprises and businesses such as office buildings or grocery stores; they may not be used for housing, for which the Low-Income Housing Tax Credit is available.

One reason the program is likely to leverage private investment is because the Community Reinvestment Act's investment test prompts banks to be proactive in making debt and investment capital available to low- and moderate-income communities. Often, private investors make investments in community development projects through intermediaries, such as community development financial institutions. In the future, these intermediaries will include a new category of institutions called "community development entities." NMTCs are available only to private investors in eligible community development entities. Private investors include corporations, banks, insurance companies, and individuals. Banks are the most likely users of these tax credits because they are the predominant investors in community development financial institutions. They provide these institutions with capital and in turn they receive a return on their investment, Community Reinvestment Act investment test "credit" and potentially a Bank Enterprise Act award from the U.S. Treasury Department's Community Development Financial Institution Fund. A community development entity must have as its primary mission serving or providing investment capital for low- and moderate-income communities. These entities must be certified by the Treasury and must maintain accountability to the community, with either community representatives serving on the entities' board of directors or in an advisory capacity (the regulations are still under construction). Community Development Financial Institutions (CDFIs) certified by the Treasury's CDFI Fund, or by the Small Business Administration as Specialized Small Business Investment Companies, are automat-ically community development entities. Community development corporations that establish for-profit subsidiaries or limited-liability companies or partnerships may also qualify. New corporations or partnerships that meet the community development mission and community- accountability requirement may also be eligible. How does the New Markets Tax Credit Program work? Tax credits will be allocated to community development entities through the Treasury's community development program - the Community Development Financial Institutions Fund (CDFI Fund). The allocation process will be competi- tive and community development entities with successful track records, either directly or through affiliate organizations, will receive priority. Coastal Enterprises, Inc., a nonprofit community development corporation and certified CFDI with over twenty years of experience serving Maine, was designated a community development entity in early July. After a community development entity has received its allocation, it may distribute the tax credits to its investors. Investors will receive tax credits based on the amount of their equity investment. Equity investments (either stock or capital interest) must be paid in cash and made within five years of the Treasury's tax-credit allocation to the entity. Tax credits are claimed by investors during seven years, starting on the date of the investment and on each anniversary; 5 percent is claimed for each of the first three years and 6 percent for each of the next four years. This stream of credits totals 39 percent, with a present value of approximately 30 percent. (Investors may carry back unused credits to years ending after January 1, 2001.) Funding of the program starts at $1 billion in 2001 and rises in increments to an authorized $15 billion in 2006 and 2007. Community development entities (CDEs) can use tax credit investment proceeds to fund loans or make equity investments in for-profit and nonprofit businesses or other CDEs. For example, a CDE could invest in a community development corporation's project to build a daycare center in a low-income area.

The equity provided by the CDE may then enable the community development corporation to persuade other investors to support its project. CDEs may also purchase loans from other CDEs, provide financial counseling and other services, or finance their own eligible activities. For example, an entity could develop and manage commercial real estate, such as an office building or shopping center. A community development entity must use "substantially all" of the tax credit investment proceeds for the above purposes. When final guidelines are published, the Treasury Department will define the term "substantially all," which will include at a minimum any allowances for administrative expenses, loss reserves, and expenses related to both a start-up period for placing investments and a wind-down period for recovering investments. In addition, a CDE must track how tax credit investments are used if less than 85 percent of its gross assets are so invested. Two Treasury divisions will administer the New Markets Tax Credit program: the CDFI Fund will certify community development entities and make tax credit allocations and the Internal Revenue Service will develop regulations. Both the Fund and the IRS will monitor program compliance. Applications for community development entity certification and allocations of NMTCs are not expected to take place until late fall 2001; allocations should occur in 2002. Businesses eligible for investment by community development entities must meet the following four tests: 1. Fifty percent of the business must be derived from conduct within the low-income community; 2. A substantial portion of the services performed by the business' employees must occur within the low-income community; 3. The majority of the facilities must be located within the low-income community; and 4. Less than 5 percent of the business' assets can be held in unrelated investments. A community is determined to be an eligible low-income community if its census tract has a poverty rate of at least 20 percent or if the median family income does not exceed 80 percent of the statewide median; or, in metropolitan areas, if the median family income does not exceed 80 percent of the greater of the statewide median or the metropolitan area's median. The Treasury Department may also approve a particular area within a census tract as a low-income community. Community development programs such as the New Markets Tax Credit and the CDFI Fund reflect the current mind-set of utilizing market-driven approaches to revitalize economically distressed communities. Coupled with economic forces turning to low-income urban communities for retail opportunities, these capital resources will enhance the ability of community developers to meet their mission and goals.

What Is the CDFI Fund? The CDFI Fund provides capital and technical assistance to community development venture capital and loan funds. Through its Core Program, the CDFI Fund provides grants and loans to bolster investment and loan capital. The Fund's technical assistance component (known as the Small and Emerging Community Development Financial Institutions Assistance Program) enables CDFIs to build capacity through training, enhancing technology, and consulting services. The CDFI Fund also provides grants to banks for community development investments through the Bank Enterprise Act Program. Organizations are limited to $5 million in assistance during any three-year period.

What Is the New Markets Venture Capital Program? The Small Business Administration offers further support to community development through the New Markets Venture Capital Program. Passed in December 2000, the program is providing up to $50 million this year in direct support of community development venture capital companies. Community development entities can apply for both the New Markets Tax Credit and Venture Capital Programs.

For More Information New Markets Tax Credit Program

Community Development Financial Institution Fund

New Markets Venture Capital Program

About the Author: James Carras is Principal of Carras Community Investment, Inc. a consulting firm providing development finance advisory services to regulated and nonregulated financial institutions. Mr. Carras is also conducting a series of community development finance workshops for the Federal Reserve Bank of Boston in 2001; the next are September 26 in Portland, ME and October 24, in Springfield, MA. He can be reached at

James Carras Carras Community Investment, Inc.