The Opportunity Zone legislation was passed to motivate economic development and bring jobs to communities that have long been passed over. These distressed communities have been unnoticed by mainstream capital markets for too long, and now is the perfect time for Community Development Financial Institutions (CDFIs) and Opportunity Zone funds work together in low-and-moderate-income (LMI) communities.
CDFIs are community banks, credit unions and community loan funds who are already working in the qualified OZ areas. CDFIs know the communities and their needs, have relationships with community organizations and legislators in those areas, and already provide the debt or loans to the businesses and development projects in the areas. A CDFI fund is an entity under the U.S. Department of Treasury and goes through the certification process to apply in regional areas to provide loans for businesses and development projects. However, equity is not in their wheelhouse and so it is logical for CDFIs to work together with OZ fund managers.
THE ROLE OF CDFI’s
It is not easy for CDFIs to participate in the OZ program. Since the OZ incentive is catered toward equity investments, it provides a challenge to the CDFI funds because they are more designed with a debt or lending capacity, which is a challenge for CDFIs to participate in the program. A majority of CDFIs aren’t designed and structured for equity, they are designed for debt.
Currently, CDFIs rely heavily on large CDFI bank institutions and foundations to provide their capital market with programs like the Equity Equivalent Investment (EQ2), which is a capital product for CDFIs and their investors. It is a financial tool that allows CDFIs to strengthen their capital structures, leverage additional debt capital, and as a result, increase lending and investing in economically disadvantaged communities. They also rely on Program Related Investment (PRI) that lend capital to smaller CDFIs at a very low interest rate which allows them to re-lend to businesses and development projects in low-income and underserved communities. In return, large banks receive Community Reinvestment Act (CRA) credits and foundations fulfill their mission.
HOW CAN CDFI’s PARTICIPATE IN THE OZ PROGRAM?
Who would provide their capital market investments? Banks and foundations are not driven to create capital gains and CDFIs do not have the expertise or experience of raising equity investment nor to administer the fund.
The answer is for CDFIs and QOF to combine their resources through a joint venture partnership for win-win opportunities that provide a triple benefit for CDFIs, QOFs and low-income communities as a whole.
How would a Joint Venture Partnership be structured between CDFIs and OZ funds? The OZ fund partner would perform the roles of managing the QOF, be involved in the capital raising, administration, exit strategies, and have the experience with the equity market instrument. CDFIs would perform the roles of facilitator for the OZ community, act as originator for the suitable transactions, facilitate relationships with community leaders and officials, go through the process of making sure the project is qualified, secure the renderings, deliver the senior or subordinated debt to a transaction in order to fill a gap, and work through the financing portion of the transaction together with provision of expertise in certain financing products.
HOW TO LEVERAGE CDFI’s INVESTMENT PRODUCTS WITH QOF’s
New Market Tax Credits Program (NMTC)
The NMTC permits individual and corporate taxpayers to receive a 39% tax credit against federal income taxes for making Qualified Equity Investment (QEI) in Qualified Low-income community (QLIC) business or real estate project. Averaging a 6% increase equity investment over seven years to the project or business, the investment needs to stay in the project for a minimum of seven years. For a QOF investment to defer capital gains, and also to eliminate capital appreciation, it needs to stay in for 10 years.
Bank Enterprise Award Program (BEA)
The BEA Program provides equity-like loans to certified CDFIs that demonstrate serving or providing loans or investments in lower income or underserved communities. The awards also help banks and thrifts offset some of their risk and meet capital ratio requirements. The BEA program provides up to $100,000 for the Technical Assistance Program to provide training, financial literacy courses, and housing counseling. The Financial Assistance Program provides up to $2 million for housing and business development loans to low-income communities. The Financial Assistance Program provides grants and matching dollars, which OZ funds can provide the matching equity investment to invest in low-income communities. The program is administered by the U.S. Department of Treasury’s Community Development Financial Institutions (CDFI) Fund.
The CDFI Bond Guarantee Program
This program provides CDFIs access to a significant source of capital. By providing guarantees of bonds issued by certain qualified bond issuers, the CDFI Bond Guarantee Program injects new and substantial capital into the nation’s most distressed communities. CDFIs can gain from the potential scale of the CDFI Bond Guarantee Program, which offers long-term credit at below-market interest rates. The CDFI’s bond issuers can issue a minimum of $100 million so they can provide loans for smaller CDFIs for a minimum of $10 million for each CDFI. OZ funds can partner with larger CDFI’s bond issuers to provide the equity investment, since the CDFI’s investment, with a guarantee from the federal government, could be a great way for OZ funds to invest in OZ communities. These bonds are 100 percent guaranteed by the U.S. government. But the program does not offer grants or direct loans, but instead is a federal credit subsidy program.
CDFI funds and OZ funds together can play an important role of increasing capital in underserved and lower income communities. By partnering together, they can realize the true purpose of the OZ legislation, helping to provide capital in those underserved communities.