BILL ANALYSIS                                                                                                                                                                                                    Ó



          SENATE COMMITTEE ON GOVERNANCE AND FINANCE
                         Senator Robert M. Hertzberg, Chair
                                2015 - 2016  Regular 

                              
          
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          |Bill No:  |AB 2728                          |Hearing    |6/29/16  |
          |          |                                 |Date:      |         |
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          |Author:   |Atkins                           |Tax Levy:  |No       |
          |----------+---------------------------------+-----------+---------|
          |Version:  |4/25/16                          |Fiscal:    |Yes      |
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          |Consultant|Grinnell                                              |
          |:         |                                                      |
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                     Insurance:  community development investments



          Extends the Community Development Financial Institution Credit  
          until the 2021 taxable year; makes other changes to the credit  
          and other programs relating to insurance company investment.


           Background 

           Tax Credit.  Federal law allows a new markets tax credit for  
          taxpayers' 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 (CDI) (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  







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          Legislature added a credit against the Gross Premiums Tax in  
          1999, also administered by CDI (AB 157, Vincent).  In 2002, the  
          Legislature extended the credit until 2007 (SB 409, Vincent),  
          again until 2012 (AB 2831, Ridley-Thomas, 2006), and finally  
          until 2017, but only allowed CDI to certify new deposits for  
          credits until January 1, 2015 (AB 624, J. Pérez, 2011).  The  
          Legislature then allowed CDI to certify new deposits until  
          January 1, 2017, while increasing from $10 million to $50  
          million each year the amount of investments that generate CDFI  
          credits (AB 32, J. Pérez, 2013).

          For deposits to generate credits, the CDFI must be certified by  
          the California Organized Investment Network (COIN), an office in  
          CDI, 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 48 CDFIs in California.   
          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.  If the  
          investment is approved, COIN certifies the amount of the  
          investment and the credit, which is capped at a total of $50  
          million each year, plus any unused amount from past years.  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.  CDI or the Franchise Tax Board (FTB) may  
          recapture the credit within the 60 month period if the taxpayer  
          withdraws or reduces the amount of the investment below $50,000.  
           

          COIN generally allocates credits twice per year.  In recent  
          years, requests for credits exceeded the amount they are  
          authorized to allocate.  In December, 2015, COIN certified CDFI  
          credits for:








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                 CSAA Insurance Group for its $353,235 investment into  
               Enterprise Community Investment for the California Hotel  
               project in Oakland that provides for the rehabilitation of  
               137 units of affordable rental housing, including 119  
               efficiencies, 34 units for special needs households, and 15  
               units for homeless persons with mental illness.

                 MetLife Insurance Company for its $3 million investment  
               into Genesis LA Economic Growth Corp that will promote safe  
               and healthy communities in underserved areas of Los Angeles  
               County through a learning center that provides summer camps  
               and school enrichment programs, workforce development  
               programs, and funding for a homeless servicing agency.

                 United HealthCare for its $3 million investment into  
               Enterprise Community Loan Fund to support and leverage  
               financing for the development and preservation of  
               affordable housing and Federally Qualified Health Centers  
               for low-income families across the State.  

                 MetLife Insurance Company for its $687,162 investment  
               into Enterprise Community Investment that will leverage  
               additional capital to rehabilitate Gabilan Plaza  
               apartments, an affordable housing project for low to  
               moderate-income families in Salinas.  The rehabilitation  
               will include adding photovoltaic panels and converting ten  
               units for handicap accessibility

          Data call.  Insurers that write more than $100 million in  
          California premium must report to COIN by July 1, 2016 of  
          various categories of investments over the last three years,  
          including community development and green investments, referred  
          to as a "data call."  CDI must report aggregate data relating to  
          specific insurer investments, high-impact investments, and COIN  
          actions to analyze data by December 31, 2016.  These  
          requirements expire on January 1, 2020.  

          AB 624 also created the COIN Advisory Board to advise COIN or  
          its successor on the best methods of increasing the level of  
          insurance industry capital in safe and sound investments while  
          providing fair returns to investors and social benefits to  
          underserved communities.  The advisory board is composed of the  
          Insurance Commissioner or his or her designee, and at least one  








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          voluntary member from:

                 An insurance company executive

                 A licensed attorney practicing law

                 A member of the public appointed by the Speaker of the  
               Assembly

                 A member of the public appointed by the Senate Committee  
               on Rules

                 A consumer advocacy group

                 A local economic development practitioner

                 A financial institution or community development  
               financial institution

          Members serve two year terms, staggered by drawing lots at the  
          board's first meeting so that a simple majority serves two-year  
          terms, with the remaining members serving one year terms.  The  
          board is required to meet quarterly, or as directed by the  
          Commissioner, and can be reimbursed for actual expenses.   
          Similar to the tax credits, state law authorizing the board is  
          due to expire on January 1, 2017.  


           Proposed Law

           Assembly Bill 2728 extends the CDFI credit in the Personal  
          Income Tax, Corporation Tax, and Gross Premiums Tax until the  
          2021 taxable year.  The bill also makes the following changes:

                 Adds investments in reservation-based communities and  
               rural area investments onto the list of community  
               development investments for purposes of meeting "data call"  
               reporting requirements,

                 Extends the COIN board's authorization until January 1,  
               2022,

                 Requires priority be given to insurance company  
               investors over all others for purposes of allocating the  








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               CDFI credit, and

                 Provides that investment reductions of less than $50,000  
               trigger a clawback of the total amount of the credit.  


           State Revenue Impact

           According to Franchise Tax Board, AB 2728 results in revenue  
          losses of $600,000 in 2016-17, $1.9 million in 2017-18, and $3.2  
          million in 2019-20.  However, this estimate does not consider  
          the measure's impact on Gross Premiums taxpayers which are  
          approximately 53% of the credit generated.  


           Comments

           1.   Purpose of the bill  .  According to the author, "According to  
          the author, COIN is a collaborative effort between CDI, the  
          insurance industry, community affordable housing and economic  
          development organizations, and community advocates.  COIN was  
          established in 1996 at the request of the insurance industry as  
          an alternative to state legislation that would have required  
          insurance companies to invest in underserved communities,  
          similar to the federal Community Reinvestment Act that applies  
          to the banking industry.  This voluntary program facilitates  
          insurance industry investments that benefit California's  
          environment and its LMI and rural communities.  The program  
          serves as a liaison between insurers that are seeking investment  
          opportunities and the community organizations that are seeking  
          investment capital for projects.  Each year, CDI may award up to  
          $10 million in tax credits annually to leverage up to $50  
          million in community development investments. Under the program,  
          investors receive a tax credit worth up to 20% of their  
          investment in one of the COIN Certified CDFIs and can apply the  
          credit to the state personal income tax, corporation tax or  
          insurer premium tax.  CDFIs are mission-driven community  
          organizations, separate from government control, dedicated to  
          providing financial products and services to low-income  
          communities underserved by traditional financial markets. All  
          CDFIs that are eligible to participate in the COIN CDFI Tax  
          Credit Program must be certified by COIN.  The COIN tax credit  
          currently sunsets on January 1, 2017. If the COIN tax credit is  
          not extended, low and moderate income communities in California  








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          will lose the support of an effective program that incentivizes  
          critical investments in their communities."

          2.   Policy Questions  .  Taxpayers claiming the CDFI include some  
          of the world's largest financial institutions and insurance  
          companies, including Charles Schwab, JP Morgan Chase, and  
          MetLife.  These firms are highly sophisticated investors,  
          allocating billions of dollars to various asset classes.  The  
          credit AB 2728 extends serves to subsidize these firms'  
          investment in CDFIs with the intent that capital will flow to  
          productive uses in low-income communities in California, with  
          the credit percentage intended to compensate them for the  
          additional risk of depositing funds in a CDFI instead of safer  
          investments with lower returns.  As such, this credit poses  
          significant policy question, such as whether it is appropriate  
          for state government to use tax credits to subsidize private  
          investment, and if so, are CDFIs the right thing to subsidize?   
          Additionally, because tax credits are funded by forgoing revenue  
          that could be used for other government services, is extending  
          the CDFI credit worth its cost?  

          3.   Performance  ?  The Legislature first enacted the CDFI credit  
          in 1999, extended it three times, and increased the investment  
          amounts that generate credits fivefold in 2013, for a total of  
          $10 million in credits annually.  However, it's unclear whether  
          the revenue foregone by allowing tax credits for firms to hold  
          deposits in CDFIs performs better than direct public investments  
          in low-income communities, such as affordable housing,  
          transportation, and other public works.  The CDFI credit may  
          also overlap with other programs subject to significantly more  
          oversight, such as the Low-Income Housing Tax Credit.  However,  
          COIN argues that the credit allows COIN certified CDFIs to  
          access otherwise inaccessible capital and fund investments that  
          the CDFIs would not have been able to fund had they received a  
          traditional loan.  COIN adds that the COIN CDFI Tax Credit is  
          unique because, unlike traditional CDFI loans, it gives COIN  
          certified CDFIs access to insurer capital, access to zero  
          interest capital, and full use and control of the investment  
          with the condition that loans be made in accordance with the  
          CDFI's mission.  COIN adds that

                 Insurers do not typically invest in CDFIs; however,  
               through the COIN CDFI Tax Credit Program insurers, like  
               MetLife, have made more than $10 million in qualified  








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               investments annually into COIN certified CDFIs. In 2015,  
               COIN awarded MetLife Insurance Company $600,000 in tax  
               credits for their $3 million investment to Genesis LA, a  
               COIN certified CDFI.  Genesis LA used this investment to  
               make a $1.35 million loan to MERCI, a nonprofit  
               organization that provides direct services to adults with  
               severe developmental disabilities living in East Los  
               Angeles and the San Gabriel Valley. Genesis LA's loan  
               helped MERCI finance an expansion that will allow them to  
               serve 120 new clients and create approximately 29 new jobs.  
                The loan from Genesis LA leveraged another $4.8 million to  
               finance the project. Genesis LA and MetLife were introduced  
               through the COIN Program, and MERCI is an example of an  
               investment that would not have been possible without the  
               investment terms required by the COIN Program

                 Many investments funded by COIN certified CDFIs,  
               especially those in rural areas, would not be possible but  
               for the requirement that investments qualified through the  
               COIN CDFI Tax Credit program be either zero interest  
               loans/deposits, equity investment or equity-like debt  
               instruments that allow the CDFI full use and control of the  
               investment for the 60 month term.  One example of such an  
               investment is the Local Initiatives Support Corporation's  
               (LISC) investment into Self-Help Enterprises (SHE) to  
               finance well replacement costs for rural residents of the  
               Central Valley.  Well replacement costs range from $20,000  
               to $35,000 depending on location, soil conditions and  
               availability of drillers.  Conventional lending agencies  
               cannot provide home equity lines of credit to homeowners  
               while personal loan limits do not provide enough funding to  
               cover the total cost and have interest rates and terms that  
               are unfavorable to those already struggling to make ends  
               meet. Traditional interest bearing CDFI loans would have  
               prevented LISC and SHE from conducting this necessary  
               program; however the COIN qualified zero interest loan  
               removed these financing barriers.

          The Committee may wish to consider the return on the state's  
          current level of investment in the CDFI program, and whether  
          superior alternatives exist to support investment in California  
          communities with high levels of unemployment and poverty.

          4.   Alternatives  .  The CDFI credit serves as a carrot, not a  








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          stick, by subsidizing investments made by banks and insurance  
          companies.  Instead, the Legislature could instead enact  
          requirements similar to federal law's Community Reinvestment Act  
          (CRA), which provides considerable regulatory encouragement for  
          federally-regulated banks to invest in low-income areas.  
          California could adopt its own CRA to require banks and  
          insurance companies to invest in specified areas as a condition  
          of doing business in the state

          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 not have been funded.

                 Credit Percentage Seems Reasonable.  This credit is set  
               up like most investment 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  








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               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.  (In response to this point, AB 624 allowed  
               CDI 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

          5.   MCO  .  Recently, when enacting the new Managed Care  
          Organization (MCO) Provider Tax, the Legislature reduced the  
          gross premiums tax rate from 2.35% to 0% for specified premiums  
          received on or after July 1, 2016, and on or before June 30,  
          2019 (SBx2 2, Hernández, 2016).  The application of this  
          temporary 0% rate is limited to premiums received by an insurer  
          that provides health insurance and has a corporate affiliate,  
          which is either a "health care service plan" or "health plan,"  
          contracted with the State Department of Health Care Services to  
          provide Medi-Cal services.  As such, health insurers may not  
          have much demand for the CDFI tax credit in the next three  
          years, as it cannot be applied to reduce its MCO tax obligation.

          6.   What about us  ?  The Small Business Investors Alliance  
          requested amendments to AB 2728 to allow equity investments in  
          "Small Business Investment Companies," to qualify investors for  
          CDFI credits.  The Alliance argues that its ownership model,  
          which relies on a combination of private investment and proceeds  
          of bonds issued by the United States Small Business Association,  
          and investment expertise can provide superior returns to the  
          current CDFI credit.  









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          7.   Bored of boards  .  AB 2728 extends the statutory  
          authorization of the COIN Advisory Board until January 1, 2022.   
          However, the Insurance Commissioner can create and convene any  
          advisory board that he sees fit without explicit direction from  
          state law, and nothing in its current law grants it any formal  
          regulatory powers.  The Committee may wish to consider whether  
          extending the COIN Advisory Board's existence in statute is  
          necessary.

          8.   Incoming  !  The Senate Committee on Insurance approved AB  
          2728 on an 8 to 0 vote on June 22nd.  The Committee on  
          Governance and Finance is hearing the bill as the committee of  
          second reference.


           Assembly Actions

           Assembly Revenue and Taxation           9-0

          Assembly Insurance                      13-0
          Assembly Appropriations                 20-0
          Assembly Floor                          80-0

           Support and  
          Opposition   (6/23/16)


           Support  :  Insurance Commissioner Dave Jones; 3 Core; Advocation,  
          Inc.; Burbank Housing Development Corporation; Cal Coastal: A  
          Small Business Leader; California Apartment Association;  
          California Department of Insurance; Century Housing; Clearing  
          House Community Development Financial Institution; DCA Capitol  
          Partners; Enterprise Community Investment; First General Bank;  
                                                                            Fresno Community Development Financial Institution; Fresno  
          Economic Opportunities Commissio;; Genesis LA Economic Growth  
          Corporation; Housing Trust Silicon Valley; LISC; Mercy Housing;  
          Neighbor Works Home Ownership Center; Neighbor Works Home  
          Ownership Center Sacramento Region; Neighbor Works Orange  
          County; Neighborhood Housing Services of the Inland Empire;  
          Pacific Community Ventures; Personal Insurance Federation of  
          California; Redwood Valley Little River Band of Promo Indians;  
          Roxborugh Pomerance Nye and Adreani; Rural Community Assistance  
          Corporation; San Luis Obispo County Housing Trust Fund; Small  
          Business Finance-CDC; Star Mountain Capita, LLC; Tri Counties  








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          Bank; United Native Housing Development Corporation; VEDC;  
          Ventura County Community Development Coroperation; WNC and  
          Associates.

           Opposition  :  Unknown.


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