BILL ANALYSIS                                                                                                                                                                                                    Ó

                            Senator Lois Wolk, Chair

          BILL NO:  AB 32                       HEARING:  8/14/13
          AUTHOR:  J. Pérez                     FISCAL:  Yes
          VERSION:  4/17/13                     TAX LEVY:  Yes
          CONSULTANT:  Grinnell                 


            Extends and expands the Community Development Financial  
                              Institution credit.

                           Background and Existing Law  

          Federal law allows a new markets tax credit for taxpayer's  
          qualified equity investments in community development  
          entities, the primary mission of which must be serving or  
          providing investment capital for low-income communities or  
          low-income persons, as certified by the Secretary of the  
          Treasury.  The federal credit is equal to 39% of the  
          qualified equity investment and is spread over seven years.  

          State law does not conform to the federal new markets  
          credit, but instead allows the Community Development  
          Financial Institution credit (CDFI), administered by the  
          Department of Insurance (DOI) (AB 1520, Vincent, 1997).   
          Taxpayers may claim a credit against the Gross Premiums  
          Tax, Personal Income Tax, or Corporation Tax equal to 20%  
          of qualified investments in the form of non-interest  
          bearing deposits, loans, or equity investments of at least  
          $50,000 held for at least 60 months.  Taxpayers can carry  
          over the credit for four years.

          The credit was initially used only to reduce Personal  
          Income Tax, or Corporation Tax liabilities, but the  
          Legislature added a credit against the Gross Premiums Tax  
          in 1999, also administered by DOI (AB 157, Vincent).  In  
          2002, the Legislature extended the credit until 2007 (SB  
          409, Vincent), again until 2012 (AB 2831, Ridley-Thomas,  
          2006), and once more until 2017, but only allowed DOI to  
          certify new deposits for credits until January 1, 2015 (AB  
          624, J. Pérez, 2011).


          AB 32 - 4/17/13 -- Page 2

          For deposits to generate credits, CDFI must be certified by  
          the California Organized Investment Network (COIN), an  
          office in DOI, by demonstrating that it is a private  
          financial institution located in California, its primary  
          mission is community development, and that it lends in  
          urban, rural or reservation-based communities in  
          California.  CDFIs may be banks, credit unions, or  
          non-regulated non-profit institutions organized to provide  
          private capital for community development or investing.  
          There are currently 27 CDFIs in California, down from 50 in  
          2011. CDFIs must use the proceeds of the investment for a  
          purpose that is consistent with its community development  
          mission and for the benefit of economically disadvantaged  
          communities and low-income people in California.

          CDFIs must apply to COIN on behalf of the taxpayer.  COIN  
          certifies the amount of the investment and the credit,  
          which is capped at a total of $10 million each year, but  
          any unused amount from past years may be carried over to  
          future ones.  COIN generally allocates the credits on a  
          first-come, first-served basis; however, if COIN determines  
          that the total amount of investment will exceed the cap, it  
          can prioritize applications with investments that directly  
          benefit low-income persons, or prioritize rental housing,  
          mortgages for community-based residential housing, and  
          self-help housing ahead of single-family housing.  DOI or  
          the Franchise Tax Board (FTB) may recapture the credit  
          within the 60 month period if the taxpayer reduces or  
          withdraws the investment.  

                                   Proposed Law  

          Assembly Bill 32 increases from $10 million to $50 million  
          the amount of investments COIN can certify for CDFI credits  
          each year.  The measure restricts the amount of investments  
          COIN can certify for any one CDFI, combined with its  
          affiliates to 30% of the annual total, unless COIN  
          determines after October 1 that the supply of credits  
          exceeds demand.  Additionally, the measure sets aside 10%  
          of the annual total for investments of less than $200,000,  
          again unless COIN determines after October 1 that the  
          supply of credits exceed demand.

          The measure also modifies the requirement for COIN to  
          prioritize applications when credit demand exceeds supply  


          AB 32 - 4/17/13 -- Page 3

          to place priority on affordable rental housing, housing for  
          veterans, and self-help housing ahead of single-family  

          The bill also extends the date before which COIN can  
          certify investments from January 1, 2015 to January 1,  

                               State Revenue Impact
          According to FTB, AB 32 results in revenue losses of $1.2  
          million in 2013-14 and 2014-15, and $1.5 million in  
          2015-16.  This estimate does not include revenue losses due  
          to credits applied against the Gross Premiums Tax.



          1.   Purpose of the bill  .  According to the author, "From  
          1997-2012 the CDFI Tax Credit and Certification Program has  
          leveraged $27 million in tax credits to generate $135  
          million in CDFI deposits in California's most underserved  
          communities.  Over the last several years, the COIN program  
          has been oversubscribed and with a cap on the amount of  
          investments it has been unable to meet the demand for  
          capital.  The increase in the investment amount proposed  
          under AB 32 as well as the other programmatic changes will  
          allow for more COIN capital to be deployed, more projects  
          to be built, more jobs to be created and more investors to  
          participate.  Community development investments make sound  
          business sense and provide solid returns while bringing  
          much needed capital to low-income communities."

          2.   Policy Questions  .  Taxpayers claiming the CDFI include  
          some of the world's largest financial institutions and  
          insurance companies, including Pacific Life Insurance  
          Company, JP Morgan Chase, and Blue Shield of California.   
          These firms are highly sophisticated investors, and  
          allocate billions of dollars daily in various asset  
          classes.  The credit AB 32 seeks to extend and expand  


          AB 32 - 4/17/13 -- Page 4

          subsidizes these firms' investment in CDFIs with the intent  
          that capital will flow to productive uses in low-income  
          communities in California.  As such, AB 32 poses three  
          major policy questions: 
                 First, is it the proper role of the state to use  
               tax credits to direct private investment decisions?   
               These firms are successful because of their expertise  
               in intermediating capital, and would deposit funds in  
               CDFIs if it made sense from an asset allocation  
               perspective.  Because tax credits are funded by  
               forgoing revenue that could be used for other  
               government services or tax reductions, is increasing  
               and extending the CDFI credit both appropriate and  
               worth the cost?
                 Second, if the state wants to direct investment  
               into low-income areas, the CDFI credit is a tool that  
               serves as a carrot, not a stick.  Federal law's  
               Community Reinvestment Act (CRA) provides considerable  
               regulatory encouragement for federally-regulated banks  
               to invest in low-income areas.  Instead of tax  
               credits, California could adopt its own CRA and  
               require banks and insurance companies to invest in  
               specified areas as a condition of doing business in  
               the state.
                 Lastly, is the CDFI scalable?  Simply because  
               taxpayers are claiming more tax credits today than in  
               previous years doesn't necessarily mean that it's  
               successful, as evidenced by now-repealed Enterprise  
               Zone tax credits, in which credit usage grew as the  
               economies within the zones stagnated.  AB 32's  
               quintupling of the credit amount is an affirmative  
               statement that the credit is highly successful, and  
               more is better.  What evidence indicates that  
               increasing CDFI credits will lead to more economic  
               growth in these areas?

          3.   Growing appetite  .  After many years of lack of demand  
          for CDFI credits, efforts by Insurance Commissioner Dave  
          Jones have increased demand for the credits.  Because of  
          this increase, the Commissioner argues that AB 32's  
          increase in the cap is necessary as many taxpayers want to  
          make investments, but this year's allocation plus carryover  
          amounts from previous years have already been claimed.   
          According to DOI, insurance companies generally make  
          investments in the third and fourth quarters of the year,  
          and, CDFIs will make deposits and put them to work this  


          AB 32 - 4/17/13 -- Page 5

          year should AB 32 be enacted.  However, is this problem  
          more a result of the first-come, first-served methodology  
          for allocating credits?  The law directs COIN to certify  
          investments that qualify when they come in the door - only  
          later in the year can COIN prioritize some applications  
          over others (See Comment #7).  The Committee may wish to  
          consider whether the CDFI credit should be expanded as AB  
          32 calls for, or whether it should delete the first-come,  
          first-served method in favor of an allocation system that  
          identifies stronger applications. 

          4.   Measuring performance  .  CDFIs apply to COIN to certify  
          the amount of the investment eligible for the credit;  
          however, the CDFI isn't required to state the projects it  
          funds using the increment of investment proceeds that  
          generate credits for investors.  While COIN reviews a  
          CDFI's general lending practices, collects and publishes  
          information about investors, the amount of the investment,  
          and the CDFI receiving it, no information exists about the  
          specific projects that happen due to the credit that  
          wouldn't without it.  Without information showing the  
          specific things the state bought with the foregone revenue  
          that funds the tax credit, how can the Legislature  
          accurately measure the CDFI credit's performance?   
          Additionally, COIN's records generally list the identity of  
          the investor, but not always, sometimes listing "private  
          investor."  The Committee may wish to consider requiring  
          CDFIs to specify the projects that will be funded using the  
          deposits that give rise to tax credits, and identify the  
          taxpayers that receive the credits.

          5.   LAO's take  .  AB 2831 (Ridley-Thomas) required the LAO  
          to prepare an analysis of the CDFI credit.  LAO's April 14,  
          2011 letter to the Chair of the relevant committees in the  
          Assembly and Senate included four conclusions, among them:
                           Economic Impact.  It is very difficult to  
                    estimate the impact of the tax credits, although  
                    we suspect that in many cases investments in the  
                    CDFIs would not have been made in the credit's  
                    absence.  It is true that some of the credits  
                    have benefited larger CDFIs that are capable of  
                    raising funds in other ways and for which the  
                    credit-funded investments represent a smaller  
                    portion of their total assets.  Even in these  
                    cases it seems likely that the tax credits helped  
                    generate investment activity that otherwise might  


          AB 32 - 4/17/13 -- Page 6

                    not have been funded.
                           Credit Percentage Seems Reasonable.  This  
                    credit is set up like most in-vestment credits in  
                    that it refunds a percentage of the invested  
                    amount, and 20 percent is the equivalent of about  
                    2.5 to 3 percentage points on a ten-year loan at  
                    prevailing interest rates.  This is about  
                    one-half of the interest rate spread between a  
                    fairly safe investment and a very risky one.  For  
                    example, recently, the difference between the  
                    rates on a BBB (low investment-grade) bond and a  
                    CCC ("junk") bond was about 6 percent.  While we  
                    have no reason to believe that a 20 percent  
                    subsidy is too high or too low, it is possible  
                    that changing conditions in financial markets in  
                    the future could warrant a different subsidy  
                    percentage for this credit. 
                           Owned Versus Rental Housing.  The CDFIs  
                    have supported both rental and owner-occupied  
                    housing, including both construction and mortgage  
                    loans.  Credit standards for home purchase loans  
                    have increased markedly since the collapse of the  
                    housing market. In order to benefit lower-income  
                    individuals, it may make sense for housing  
                    development efforts to focus more on rental  
                    housing at least in the near future.   
                    Accordingly, the Legislature may wish to consider  
                    focusing the tax credit more on CDFI investments  
                    in rental housing opportunities to benefit  
                    low-income populations.  NOTE - AB 624 allows DOI  
                    to prioritize rental housing and other use over  
                    single-family homes if total investments exceed  
                    the legal cap.
                           First-Come, First-Served Tax Credits Can  
                    Be Problematic.  In some prior years, the program  
                    has hit its annual cap. If the credit is retained  
                    in its current form, it may be advisable to  
                    authorize COIN or some other entity to award the  
                    credits competitively instead of on a first-come,  
                    first-served basis.  This might allow the state  
                    to prioritize CDFI investments that best fit  
                    desired policy objectives-for example, by  
                    directly benefiting lower-income people instead  
                    of benefiting projects that merely are located in  
                    lower-income areas


          AB 32 - 4/17/13 -- Page 7

          6.   Recent history  .  In 2011, the Committee heard AB 624  
          (J. Perez), which would have doubled the amount of the CDFI  
          credit and extended the authorization for DOI to certify  
          investments for the credit until January 1, 2017.  The  
          Committee approved the bill with amendments that deleted  
          the doubling of the investment amount, extended the ability  
          for taxpayers to claim the CDFI credit until 2017, but  
          didn't allow DOI to certify new investments after January  
          1, 2015.  

          7.   Amendment Options  .  Should the Committee want to  
          approve AB 624, but make changes to the CDFI credit  
          program, it could amend the bill to:
                 Prohibit or lower the priority for credit  
               allocations those investments by banks and financial  
               institutions required by CRA, thereby ensuring that  
               California isn't subsidizing compliance with existing  
               federal law;
                 Grant regulatory authority to COIN to adopt a  
               scoring process that allows it to set goals and  
               evaluate applications to direct available resources  
               toward the best projects; 
                 In combination with requiring CDFIs to disclose  
               specific projects and taxpayers as suggested in  
               Comment #3, change the bill's prioritization of rental  
               housing projects being affordable to a requirement,  
               similar to state and federal low-income housing tax  
               credits; and
                 Delete or reduce the bill's expansion of the annual  
               amount of investment that generates a credit from $10  
               million to $50 million.
                 Defer action on the measure, as the CDFI credit  
               does not sunset until 
               January 1, 2015.

                                 Assembly Actions  

          Assembly Revenue and Taxation 9-0
          Assembly Appropriations            16-0
          Assembly Floor                77-1

                        Support and Opposition  (08/08/13)

           Support  :  3CORE Financial Mentoring Perspective; American  


          AB 32 - 4/17/13 -- Page 8

          Federation of State, County and Municipal Employees;  
          Association of California Life and Health Insurance  
          Companies; California Department of Insurance (sponsor);  
          California United Bank; Century Housing Corporation;  
          Clearinghouse Community Development Financial Institution;  
          Corporation for Supportive Housing; Enterprise Community  
          Investments, Inc.; Farmers Insurance Group;  Grossman  
          Financial Management; InSight at Pacific Community  
          Ventures; Karuk Community Loan Fund, Inc.; Los Angeles LDC;  
          Northeast Community Federal Credit Union; Northern  
          California Community Loan Fund;  Opportunity Fund Northern  
          California; Pacific Coast Regional Small Business  
          Development Corporation; Personal Insurance Federation of  
          California; Rural Community Assistance Corporation;  
          Roxborough, Pomerance, Nye and Adreani, LLP; San Luis  
          Obispo Housing Trust Fund; Self-Help Federal Credit Union;  
          The Association of Financial Development Corporation.

           Opposition  :  Unknown.