BILL ANALYSIS                                                                                                                                                                                                    



                                                                     SB 777


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          Date of Hearing:  August 9, 2016


                      ASSEMBLY COMMITTEE ON BANKING AND FINANCE


                               Matthew Dababneh, Chair


          SB  
          777 (Lara) - As Amended August 4, 2016


          SENATE VOTE:  Vote not relevant


          SUBJECT:  The California Finance Lenders Law:  application




          SUMMARY: Exempts from the California Finance Lenders Law (CFLL)  
          any person who makes one commercial loan in a 12-month period.


          EXISTING LAW:  Exempts from the CFLL any person who makes five  
          or fewer loans in a 12-month period, if the loans are commercial  
          and incidental to the business of the person relying upon the  
          exemption. (Financial Code, Section 22050(e))


          FISCAL EFFECT: Unknown


          COMMENTS:


           Need for the bill.









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           According to information provided by the author:



            A person engaged in the business of lending in California is  
            required to be licensed under the CFLL, unless an exemption  
            from licensing applies.


            The New Markets Tax Credit (NMTC) industry has only recently  
            learned that a California Financial Lenders License (CFLL)  
            exemption enacted effective in 2014 -- AB1091-Skinner  
            (Stats.2013, c. 243, 1)--  changed the prior exception to the  
            licensure requirement from one commercial loan in any year to  
            five or fewer  loans that are "incidental" to the lender's  
            business. It appears that the change was intended to make the  
            exemption more useful without providing a means for a person  
            to engage in an unlicensed business of making 5 commercial  
            loans a year. For example, the change arguably benefits a  
            venture capital firm mostly making equity investments but  
            structuring a few investments as debt in a year, and finding  
            that the existing bridge loan exemption for VC firms is too  
            restrictive. 


            However the change was intended, it has resulted in big and  
            unanticipated problem for the NMTC industry because NMTC  
            transactions are carried out by creating a subsidiary which  
            raises tax credit equity and makes a loan to a qualifying  
            borrower.  Unlike a venture capital fund, which might make a  
            few loans incidental to its primary business of making equity  
            investments, NMTC lenders are typically formed primarily for  
            the purpose of making one loan in a low income community.   
            That is the way the Federally-authorized NMTC program is  
            designed.  So the industry, which historically relied upon  
            the" no more than one loan" exception, is encountering big  
            problems with the "incidental" requirement of the new  
            exemption as it is not possible to argue that the loan is  








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            incidental.




            This is a big problem as it may make it virtually impossible  
            for community service entities such as The East Los Angeles  
            Community Union (TELACU) and San Francisco-based Low Income  
            Investment Fund (LIIF) to close NMTC deals in California, at  
            least in the short term, and may drive this valuable and  
            scarce tax credit equity to other states, causing California  
            to lose very significant Federally-funded tax credit financing  
            targeted to California's neediest communities.
          


           History of NMTC:


           


          The NMTC was authorized in the Community Renewal Tax Relief Act  
          of 2000 (PL 106-554) as part of a bi-partisan effort to  
          stimulate investment and economic growth in low income urban  
          neighborhoods and rural communities that lack access to the  
          capital needed to support and grow businesses, create jobs, and  
          sustain healthy local economies.


          Through the NMTC Program, tax credit authority is allocated to  
          Community Development Entities (CDEs) through a competitive  
          application process. CDEs are financial intermediaries through  
          which private capital flows from an investor to a qualified  
          business located in a low-income community. CDEs use their  
          authority to offer tax credits to investors in exchange for  
          equity in the CDE. Using the capital from these equity  
          investments, CDEs can make loans and investments to businesses  
          operating in low-income communities on better rates and terms  








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          and more flexible features than the market.


          The NMTC program attracts capital to low income communities by  
          providing private investors with a federal tax credit for  
          investments made in businesses or economic development projects  
          located in some of the most distressed communities in the nation  
          - census tracts where the individual poverty rate is at least 20  
          percent or where median family income does not exceed 80 percent  
          of the area median.


          A NMTC investor receives a tax credit equal to 39 percent of the  
          total Qualified Equity Investment (QEI) made in a CDE's and the  
          Credit is realized over a seven-year period, 5 percent annually  
          for the first three years and 6 percent in years four through  
          seven. If an investor redeems a NMTC investment before the  
          seven-year term has run its course, all credits taken to date  
          will be recaptured with interest.




          Banks can receive Community Reinvestment Act (CRA) consideration  
          for their investments in CDEs, or for the pro rata portion of a  
          loan originated by a CDE, based on the bank's percentage of  
          equity ownership in the CDE. A bank can also receive a partial  
          credit for the investment and a partial credit for the loan. The  
          investment in the CDE must benefit a bank's assessment area or a  
          broader state or regional area that includes its assessment  
          area.  In the case of leverage structure transactions, the  
          equity investor and the leverage lender each may receive CRA  
          consideration based on the pro rata share of their investment.



          In a standard transaction, the NMTC is typically used to reduce  
          the interest rate on the loan to the borrower, a Qualified  
          active low-income community business (QALICB) below what the  








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          market would otherwise dictate. The transaction is structured as  
          follows: An investor makes a QEI into a CDE (often through a  
          sub-CDE created as a single-transaction entity), and the CDE  
          then makes a Qualified low-income community investment (QLICI)  
          (almost always a loan) to an eligible project (QALICB). The  
          investor receives two cash streams over the seven-year  
          compliance period: the interest payments on the loan to the  
          QALICB, passed through the CDE, and the tax credits the investor  
          claims on federal tax returns. The tax credit allows the CDE to  
          offer the QALICB a considerable reduction in interest rates,  
          while allowing the investor to receive market rate returns on  
          the investment.  


          For example, in a $10 million QLICI the investor receives a tax  
          credit of 39 percent on the $10 million, or $3.9 million.  This  
          works out to annual rate of return to the investor of  
          approximately 5.6 percent as a result of the tax credits.


           Background:




           In 2013 the Legislature passed AB 1091 (Skinner), Chapter 214,  
          Statutes of 2013 which established an exemption from the CFLL  
          for entities making five or fewer commercial loans in a year if  
          those loans were incidental to the business of the person  
          relying on the exemption.  Prior to the passage of AB 1091 the  
          CFLL exemption for de minimis commercial lending activity was  
          one commercial loan in a 12-month period.  The change created by  
          AB 1091 has now raised questions concerning whether lending  
          activity relating to the NMTC program is "incidental" and  
          therefore subject to the existing exemption.  Since the existing  
          CFLL exemption doesn't work for NMTC loans, SB 777 would restore  
          the previous exemption that allows a person to make one loan in  
          a 12 month period in addition to keeping the existing exemption  
          of five or fewer loan loans that are incidental.








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           Amendment:


           The addition of the one loan per year exemption would provide  
          two loan limit exemptions in the CFLL.  It was intended, at the  
          time, with the change created by AB1091 (Chapter 243, Statutes  
          of 2013) that the five or fewer loans that are made incidental  
          to the person's main business was a sufficient exemption.  It  
          was unanticipated that this change would harm the work of CDEs  
          utilizing the NMTC program. Yet, at the same time, it is unclear  
          how these two loan exemptions will coexist and what effect it  
          may have on the broader market.  Therefore, staff recommends a  
          sunset date of January 1, 2020 for this exemption so that it can  
          be reevaluated at a future date.



          REGISTERED SUPPORT / OPPOSITION:




          Support


          The East Los Angeles Community Union (TELACU) - Sponsor




          Opposition


          None on file.











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          Analysis Prepared by:Mark Farouk / B. & F. / (916)  
          319-3081