BILL ANALYSIS Ó
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