How it Works: Transaction Structure – The Leverage Model

Overview

Basics of NMTC

Transaction Structure

Process

CDF-qualified Census Tracts

CDF, like many other CDEs participating in the NMTC program, typically uses the “leverage model” to generate additional capital to provide “gap financing” for projects and businesses.  A typical CDF NMTC transaction is illustrated in the diagram below, the components of which are described beneath.  


INVESTMENT FUND

The tax credit investor (typically a bank) creates an investment fund to pool tax credit equity with other financing sources.  In almost every case, all sources of funds flow simultaneously at NMTC closing, requiring that all sources be available and ready to fund at or prior to closing. Two primary sources feed into the investment fund:

Leverage Loan
In order to maximize the tax credits it can claim, the investor (through the Investment Fund) needs to make a Qualified Equity Investment in the CDE that is larger than its equity investment. This typically is done by borrowing the rest of the capital needed to fund the QEI in what is called a “leverage loan.” Leverage loan proceeds are sourced from a number of different types of capital depending on the nature of the project. Leverage sources have included commercial bank loans, bridge loans, grant proceeds, charitable donations, tax increment financing (TIF), HUD 108 loans, and others.

Investor Equity
The size of the investor’s tax credit equity investment is based on the amount of benefit the investor will ultimately claim. Because the investor’s claim of the tax credit occurs gradually over the 7-year NMTC compliance period, the NMTC equity amount will reflect a discount against the full 39% NMTC benefit to reflect time-value-of-money.


QUALIFIED EQUITY INVESTMENT

When fully funded, the Investment fund makes a “Qualified Equity Investment” into a CDE, which triggers the flow of New Markets Tax Credits benefits to the investor. The total tax credit available to the investor is equal to 39% of the Qualified Equity Investment (QEI) amount, which is equivalent to the total size of the transaction being financed.


QUALIFIED LOW-INCOME COMMUNITY INVESTMENTS

CDEs use the proceeds of a QEI to make Qualified Low-Income Community Investment (QLICI) loans to the QALICB. These QLICI loans are made in two pieces to mirror the leverage loan and the NMTC equity layers at the Investment Fund level:

  • The A Loan amount mirrors the leverage loan amount
  • The B Loan mirrors the tax credit equity amount net of fees, closing costs, and NMTC-related expenses. At the end of the seven-year NMTC compliance period, the Project Sponsor frequently has the opportunity to purchase the B Loan via a “put/call” agreement for a low cost, thus converting the B Loan into a permanent subsidy to the project. This net subsidy is generally about 20% of the total financing amount.


EXAMPLE TRANSACTION

An investor pays $0.77 per $1 of tax benefit, which translates into $0.30 of NMTC equity per $1 of total QEI invested ($0.77 x 39%). On a $10 million NMTC transaction with $0.77 pricing, the NMTC investor would be entitled to $3.9 million of tax credits over 7 years and would pay in about $3 million of NMTC equity into the investment fund at closing. To claim $3.9 million of tax credits, the investor would need to make a $10 million QEI in the CDE, of which $7 million would be in the form of a leverage loan. The CDE would in turn make an A loan and a B loan into the QALICB, which would be equivalent to the $10 million QEI less legal and transaction fees, providing the project with net subsidy of approximately $1.5 to 2.0 million.