The End at the Beginning? Think Early About the Unwind of New Markets Tax Credit Deals
By Caitlin Jones
5 min read
Tax Credit Advisor, August 2010: In a federal new markets tax credit (NMTC) transaction, just getting to the closing table can be exhausting enough for participants. So who wants to think about how the transaction will unwind in seven years at the end of the NMTC compliance period?
But according to speakers at a recent conference, the plans for implementing an exit strategy should be formulated at the front end of the deal, to avoid problems and potentially costly mistakes down the road. The program’s first NMTC projects are reaching the seven-year milepost now.
“Most developers are not prepared for the basic mechanics of an unwind, the “˜who does what, when and how’,” said Al Shehadi, of Enterprise Community Investment, Inc., in comments at a Washington, D.C. conference held by Novogradac & Company LLP. “You should start to prepare for the unwind at close.”
Columbia, MD.-based Enterprise, a leading national provider of community development capital and expertise, has established itself as one of the largest NMTC allocatees in the nation. Enterprise has been awarded more than $600 million in NMTC allocation and financed more than 45 NMTC projects throughout the U.S. Its first group of NMTC projects will begin unwinding in 2011. “We have started to think about the mechanics of unwinding, both for our own portfolio and in terms of the consulting practice that we have with developers and other CDEs,” Shehadi noted.
NMTC transactions can have complicated deal structures. This is particularly true for leveraged NMTC transactions. In a leveraged structure, an investment fund is created, which collects and combines debt received from a so-called “leverage” lender with the equity received from the investor to make a qualified equity investment in the CDE. The advantage of a leverage structure is that it allows a project to NMTC-enhance a larger proportion of the total funding sources. The CDE then typically makes two loans to the QALICB (a senior “A” loan, mirroring the “leverage” loan and subordinate “B” loan, reflecting the net NMTC equity proceeds to the project).
At the end of the seven-year compliance period, the investor has claimed all of the new markets tax credits and wants to exit the transaction, and the loans need to be paid off or refinanced.
Transaction documents typically give the investor an option to “put” – sell its interest – to the developer/ sponsor for a pre-determined price during a limited time period. If the put is not exercised by the end of this put period, there is generally a subsequent “call” period during which the sponsor can buy out the investor’s interest. The sponsor is typically responsible for notifying the investor of the approaching put date. Shehadi said put and call exercise periods generally range from 3 to 6 months.
Speakers said there is no industry standard for put prices; they vary widely, from a nominal $1,000 up to significantly larger amounts. Call prices must be at fair market value, usually determined by an appraisal at the time of the call exercise.
Three Goals
People doing NMTC transactions, Shehadi said, should have the following three goals in preparing for the unwind of an NMTC transaction:
- “Be prepared for your unwind well before the end of the seven-year new market tax credit compliance period. You don’t want to be starting to think about how you transaction unwinds four or five months after the compliance period ends and you’re well into your put period.”
- “The sponsor-developer needs to at least give some thought to what happens if the put is not exercised [by the investor], and what you would do in that scenario.” In 99 of 100 cases, the investor will exercise their put, the speakers said. But if they don’t, sponsors need to be prepared to exercise the call and to know in advance where they will get the money to cover the call price if it will be more than a nominal amount.
- Where there is hard third-party leveraged debt maturing at the same time as the NMTC unwind, “in addition to the unwind, you’re going to have a refi. You need to be prepared for it, and think through that refi at the same time you’re thinking through the unwind.”
Shehadi advised deal participants (sponsors, investors, CDEs) to start preparing for the unwind at the time the NMTC transaction closes. In particular, participants should prepare a summary memo outlining the details of the future unwind, including the put date; put period; put price; the put process and which party initiates it; the entity that can exercise the put; the call period; the procedure for determining the call price; etc.
“Six months or more prior to the end of the [NMTC] compliance period, dust that memo off, pull it out,” says Shehadi. “You’ve got your game plan.”
After preparing the deal unwind memo, Shehadi concluded, “Remember where you put it. There’s no point putting all this information down and then not being able to find it in seven years.”
