BILL ANALYSIS Ó SENATE COMMITTEE ON GOVERNANCE AND FINANCE Senator Robert M. Hertzberg, Chair 2015 - 2016 Regular ------------------------------------------------------------------ |Bill No: |AB 2728 |Hearing |6/29/16 | | | |Date: | | |----------+---------------------------------+-----------+---------| |Author: |Atkins |Tax Levy: |No | |----------+---------------------------------+-----------+---------| |Version: |4/25/16 |Fiscal: |Yes | ------------------------------------------------------------------ ----------------------------------------------------------------- |Consultant|Grinnell | |: | | ----------------------------------------------------------------- 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 AB 2728 (Atkins) 4/25/16 Page 2 of ? 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: AB 2728 (Atkins) 4/25/16 Page 3 of ? 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 AB 2728 (Atkins) 4/25/16 Page 4 of ? 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 AB 2728 (Atkins) 4/25/16 Page 5 of ? 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 AB 2728 (Atkins) 4/25/16 Page 6 of ? 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 AB 2728 (Atkins) 4/25/16 Page 7 of ? 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 AB 2728 (Atkins) 4/25/16 Page 8 of ? 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 AB 2728 (Atkins) 4/25/16 Page 9 of ? 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. AB 2728 (Atkins) 4/25/16 Page 10 of ? 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 AB 2728 (Atkins) 4/25/16 Page 11 of ? Bank; United Native Housing Development Corporation; VEDC; Ventura County Community Development Coroperation; WNC and Associates. Opposition : Unknown. -- END --