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The American Banker - 11/1/02

"New Markets" Tax Credit Draws a Flood of Applicants

Hundreds of banks, credit unions, and loan funds are vying for a sliver of a new government tax credit, but only a fraction of them will be walking away winners.

Under the New Markets Tax Credit Program, the Treasury Department is to award tax credits on $2.5 billion worth of projects to spur development in poor neighborhoods. The winners will pass tax breaks on to their investors, which include banks, insurance companies, investment banks, corporations, and even wealthy individuals.

The Treasury certified 544 companies as "community development entities" earlier this year, and 345 of them then submitted New Markets proposals for development projects totaling $25.8 billion.

The department's Community Development Financial Institutions Fund, which disburses money for development, has set a yearend deadline for deciding who gets the credits.
"I think this is evidence of the tremendous need for equity capital in low- income areas and of the numerous organizations that are trying to improve these low-income communities," said Tony T. Brown, the Treasury fund's director.

Though created in January 2000, the tax credit is being allocated for the first time this year. The president of the Federal Home Loan Bank of Atlanta has called it "the biggest stimulus for economic development in the last 20 years."

Investors in community development entities approved for the credits will get 39% of their investment in the form of an income tax credit over the next seven years. Then they will get their money back, along with what community development experts say should be a modest return, comparable to what mainstream development investments yield.

This proposal-and-allocation process will be repeated every year until 2007, when the $15 billion committed to the program will run out.

For the banks that invest in program participants, this means significant tax savings, investment returns, and, not insignificantly, Community Reinvestment Act credit. Mark Pinsky, the president and chief executive officer the National Community Capital Association, a Philadelphia-based trade group, said that the program is also a good way for banks hesitant about community development lending to get their feet wet.

"The New Markets Tax Credit is going to open doors for a lot of new investors, and I hope this program creates relationships for the long term," said Mr. Pinsky, whose group represents the 603 banks, thrifts, credit unions, and other financial companies designated as "community development financial institutions" by the Treasury fund. Most of these qualified as community development entities too.

For the communities, meanwhile, the program means an influx of billions of dollars of investments along with new development.

The applications came from 46 states - no one from Kansas, Rhode Island, Nevada, or Wyoming applied - and solicited for development projects ranging in value from $300,000 to $1 billion in both rural and urban census tracts where more than 20% of the population is below the poverty line.

Mr. Brown said that the most demand by dollar amount came from Washington, D.C., while Maryland sent the most applications.

Mr. Pinksy said that several members of his group said they wanted to apply for the tax credit earlier this year, but that he had no idea interest was so high. "I'm thrilled there is so much demand and so much competition for opportunities to invest in underserved markets," he said. "Now the challenge for CDFI Fund is to sort through these and find those that are going to produce the greatest social benefit and impact."

The Treasury fund will narrow down the applicants with a points system that rates performance in four categories: business strategy, capitalization strategy, community impact, and management capacity. Applicants can also score points for having a history of serving low-income communities.

Michael Blumfield, the director of marketing for Minneapolis-based Community Reinvestment Fund, said that putting together a project and capital-raising plan that met all of the Treasury's criteria was not an easy task. His fund's project, valued at $125 million, would make it the middleman for investors and small community development groups that fund "nontraditional small businesses."

Like Community Reinvestment Fund, most of the other applicants probably have a long history investing in low-income areas, Mr. Blumfield said. "You have to have a pretty well-balanced organization to meet all the criteria, and you also had to have good capital management experience," he said.

City First Bank in Washington, D.C. - which has been around for four years and invested more than $50 million in community development projects - applied for the tax credit with a proposal worth $107 million. Seven million dollars would go into expanding capital at the $50 million-asset bank so it can increase its lending in low-income areas. The other $100 million would go to creating a commercial real estate fund focused on bringing retail, community facilities, and small office projects into underserved neighborhoods in Washington.

Cliff Kellogg, the bank's president and chief executive officer, said the tax credit has drawn in a dozen interested investors from larger banks and insurance companies.

"I like to call it the 'second-look' credit; it makes investors take a second look at opportunities in the market," he said. "It's not so generous that we can do things without competition, but it does give us a little extra juice to make the deal."

Self-Help Venture Fund, an affiliate of Self-Help Credit Union in Durham, N.C., has been funding community development since 1980 and proposed a $200 million project. Eric Stein, the fund's president, said that the company hopes to fund minority-owned shopping centers, charter schools, and health-care facilities in both urban and rural areas.

Mr. Stein said that he expects demand from investors to be just as high as it was from community development entities, especially since most had interested investors lined up before they applied for the tax credit. "I don't think people applied for it if they didn't have the prospect of getting investors, and if it is ten times oversubscribed, then I think they can easily find investors for one-tenth of the demand," he said.

Mr. Brown said that he knows of several companies interested in investing in New Markets tax credit projects. "The program has certainly generated a lot of interest," he said. "I have had several conversations with investment banking firms and Fortune 100 corporations that have looked at the program in addition to the Financial Services Roundtable."

The Washington-based Roundtable, a trade group of large financial services companies, sent out an announcement to its members in the summer encouraging them to contact community development entities. It also released a handbook on how both members and their communities could benefit. David Liddle, a spokesman for the group, said that the Roundtable is still getting inquiries from interested members.

J.P. Morgan Chase ~Co. in New York has done its share of community development lending - nearly $1 billion in the past year - and it also plans to up its investment with the help of the tax credit. Mark Willis, the executive vice president of its community development group, said that the company has talked with a lot of groups, primarily in New York, Delaware, and Texas, that have applied for the tax credit.

While Mr. Willis acknowledged that the company is interested in the tax credit benefit and the likely CRA credit, it is by no means the driving force behind J.P. Morgan's investment. "The key issue in this business is what has the most impact on the community, and we look as this as a tool that will help the community and improve it," he said.

As for the smaller banks, the Federal Home Loan Bank of Atlanta is trying to initiate investment in New Markets projects by offering matching funds. It will match any investments by its members, who are primarily community banks in the Southeast, up to $100,000 if they are in approved New Markets projects. This way the members will get the 39% income tax credit as well as some return on its investment as well as the Home Loan Bank's.

Though banks investing in community development entities will get CRA credit, the CRA creditworthiness of these investments will not be determined until revised CRA guidelines come out. Regulators had said it would issue the revision by July 2002, but that deadline passed and no new timetable has been set.

The Community Development Financial Institutions Fund is hoping tax credit will also lure investors other than banks and credit unions, both of which have always been the primary investors. And many in the industry say they are already seeing interest from nontraditional community development investors like wealthy individuals and investment banks.

In one of its two applications, the Community Reinvestment Fund of Minneapolis proposed a $125 million partnership with Bear Stearns Cos. As part of the proposal, the New York-based investment bank would look for loans that qualify for the New Markets credit and then sell them to the fund.

The Treasury Department will most likely issue its next round of tax credits, equal to $1.5 billion, by mid-2003. Another $2 billion worth of credits will be issued in both 2004 and 2005, and then $3.5 billion will be available in both 2006 and 2007.

Mr. Pinsky, with National Community Capital Association, pointed out that while the interest in the program is high now, it will be even more competitive in the following years, as smaller applicants and investors waiting to see the results of the first round start getting involved.

"While there are some early movers that want to play a big role in the market, there are also a fair number of CDFIs and banks that are unsure of how it's going to play out and are sitting back on the sidelines for a bit," he said.

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