New Markets Tax Credit: Minority Entities Are Less Successful in Obtaining Awards Than Non-Minority Entities
Published: 2009-06-18T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Community Development Financial Institutions (CDFI) Fund in the Department of the Treasury has awarded $21 billion of the $26 billion in New Markets Tax Credits (NMTC) authorized to be awarded to Community Development Entities (CDE) between 2001 and 2009. CDEs use the NMTC to make qualified investments in low-income communities. Recent congressional interest has focused on participation by minority CDEs. This testimony is based on a recent GAO report (GAO-09-536). As requested, the report (1) identified the number of minority and non-minority CDEs that applied to the CDFI Fund and received NMTC awards, (2) explained the process by which the CDFI Fund makes awards and summarized application scores, (3) described challenges minority and non-minority CDEs face in applying for and receiving awards and, (4) identified efforts the CDFI Fund and others have taken to assist minority CDEs in applying for awards. GAO analyzed CDFI Fund application data and interviewed officials from minority and non-minority CDEs, the CDFI Fund, and industry groups.
section_title: What GAO Found
paragraphs: From 2005 through 2008, minority-owned CDEs were successful with about 9 percent of the NMTC applications that they submitted to the CDFI Fund and received about $354 million of the $8.7 billion for which they applied, or about 4 percent. Non-minority CDEs were successful with about 27 percent of their applications and received $13.2 billion of the $89.7 billion for which they applied, or about 15 percent. Since GAO issued the report on which this statement is based, the CDFI Fund made 32 NMTC awards totaling $1.5 billion under authority provided in the American Recovery and Reinvestment Act. Minority CDEs received 3 of those awards, totaling $135 million. The CDFI Fund relies primarily on its scoring of applications to determine which CDEs receive awards. As the figure shows, minority CDEs received lower scores than non-minority CDEs in each of the four application sections. Although a CDE's resources and experience in applying are important factors in a CDE's success rate with the NMTC program, when controlling for factors that GAO could measure, minority status is associated with a lower probability of receiving an allocation. It is not clear from GAO's analysis why this relationship exists or whether any actions taken or not taken by the Department of the Treasury contributed to minority CDEs' lower probability of success. Characteristics associated with minority status of some CDEs for which data are unavailable may affect this relationship. If Congress views increased participation by minority CDEs as a goal for the NMTC program, options, such as providing certain preferences in the application process that may benefit minority CDEs, could be considered. The CDFI Fund provides assistance that is available to all CDEs applying for awards, including a written debriefing to CDEs that do not receive awards detailing some of the weaknesses in the applications. Other stakeholders, including industry associations and consultants, hold conferences and offer services to help CDEs submit competitive applications. Should Congress view additional assistance to minority CDEs as important to increasing minority CDEs' participation in the NMTC program, it could consider requiring the CDFI Fund to provide assistance to minority CDEs.

section_title: Letter
paragraphs: I am pleased to be here today to discuss minority Community  Development Entities’ (CDE) participation in the New Markets Tax Credit  (NMTC) program. Congress created the NMTC through the Community  Renewal Tax Relief Act of 2000 to encourage investors to make  investments in low-income communities that traditionally lack access to  capital. Conventional access to credit and investment capital for  developing small businesses, retaining jobs, and revitalizing  neighborhoods is often limited in economically distressed communities or  in communities with large low-income populations. The Community  Development Financial Institutions (CDFI) Fund in the Department of the  Treasury administers the NMTC program and allocates tax credit  authority—the amount of investment for which investors can claim a tax  credit—to CDEs that apply for and obtain allocations. CDEs are domestic  partnerships or corporations with a primary purpose of serving or  providing investment capital to low-income communities or low-income  persons.
Our prior mandated work on the NMTC has focused on the  implementation of the program, the effect of the credit on the behavior of  individual and corporate investors, and efforts by the CDFI Fund and  Internal Revenue Service (IRS) to ensure that CDEs and investors are in  compliance with NMTC program requirements. Recent congressional  interest has focused on minority CDEs’ participation in the program. My  statement is based on our recently released report that you requested,  titled New Markets Tax Credit: Minority Entities Are Less Successful in  Obtaining Awards than Non-Minority Entities. As agreed, the report (1)  identified how many minority-owned or controlled and non-minority- owned or controlled CDEs have applied for and received allocations and  how much they have applied for and received from 2005 through 2008; (2)  explained the NMTC application process and summarized NMTC  application scores for minority and non-minority-owned or controlled  CDEs by CDE type from 2005 through 2008; (3) described the challenges  minority-owned or controlled and non-minority-owned or controlled CDEs  have faced in applying for and receiving NMTC allocations; and (4)  identified efforts the CDFI Fund and others are taking to assist minority- owned or controlled CDEs in applying for NMTC allocations. As  requested, we identified potential policy options that Congress may wish  to consider based on its interpretation of our results.
To prepare the report, we analyzed CDFI Fund NMTC application data  from 2005 through 2008. The CDFI Fund did not collect data on program  participation by minority CDEs before the 2005 allocation round. We also  interviewed officials from a variety of similarly sized minority and non- minority CDEs that received NMTC awards and applied for but did not  receive NMTC awards from 2005 through 2008, and we interviewed  industry experts with knowledge of the NMTC program. The report  includes a detailed description of our scope and methodology. We  conducted our work in accordance with generally accepted government  auditing standards.
subsections: section_title: Background
paragraphs: As of the time of this hearing, the CDFI Fund in the Department of the  Treasury has authorized $21 billion of the $26 billion in tax credit  authority to be awarded between 2001 and 2009 to CDEs that manage  NMTC investments in low-income community development projects.  Eligible organizations may apply for and receive NMTC allocations once  they have been certified as a CDE by the CDFI Fund (a CDE that receives  an allocation is often referred to as an allocatee). After the CDFI Fund  makes allocations to CDEs, investors make equity investments by  acquiring stock or a capital interest in the CDEs, called qualified equity  investments (QEI), in exchange for the right to claim tax credits that total  39 percent of their original investment over 7 years. The CDEs, in turn,  are required to invest “substantially all” of the proceeds they receive into  qualified low-income community investments (QLICI). Qualified low- income community investments include (but are not limited to)  investments in businesses, referred to as qualified active low-income  community businesses (QALICB), to be used for residential, commercial  and industrial projects, and other types of investments, such as purchasing  loans from other CDEs.
The CDFI Fund directs CDEs to classify themselves as minority if more  than 50 percent of the CDE is owned or controlled by members of a  minority ethnic group. In the case of a for-profit CDE, more than 50  percent of the CDE’s owners must be minorities; if the entity applying is a  nonprofit organization, more than 50 percent of its board of directors must  be minorities (or its Chief Executive Officer, Executive Director, General  Partner, or Managing Member must be a minority). Representatives from  several minority-owned entities and industry associations that we  interviewed indicated that minority CDEs and other locally-based  community lending organizations may have a better understanding of the  economic conditions and availability of capital in the communities they  serve than other investment organizations serving those same  communities. However, in addition to minority CDEs obtaining NMTC  authority and making investments in low-income communities, minority  populations may benefit from the NMTC in other ways. For example, non- minority CDEs have also made investments in minority businesses that  serve residents in low-income communities. Minority-owned businesses  located in eligible NMTC census tracts may hire or provide services to  minority residents in low-income communities. According to CDFI Fund  officials, it is frequently the case that non-minority-owned businesses  located in NMTC-eligible census tracts with highly concentrated minority  populations could provide economic benefits to minority residents.
Since we issued the report on which this statement is based, the CDFI  Fund announced on May 27, 2009 an additional 32 NMTC awards to 2008  applicants totaling $1.5 billion under authority granted by the American  Recovery and Reinvestment Act of 2009 (ARRA). According to our  analysis, minority CDEs received three of these awards totaling $135  million. Non-minority CDEs received the other 29 of these awards totaling  about $1.4 billion. The analysis presented in our report was limited to  NMTC awards made from 2005 through the original 2008 awards; our  analysis did not include the NMTC awards made in accordance with  ARRA.
section_title: Minority Entities Have Received Proportionately Fewer Awards Than Non-Minority Entities
paragraphs: From 2005 through 2008, minority-owned CDEs were successful with about     9 percent of the NMTC applications that they submitted to the CDFI Fund and  received about $354 million of the $8.7 billion for which they applied, or about  4 percent. By comparison, non-minority CDEs were successful with about 27  percent of their applications and received $13.2 billion of the $89.7 billion for  which they applied, or about 15 percent. Since 2005, the first year in which  the CDFI Fund collected data on minority CDEs, CDFI Fund application  data indicate that 68 minority CDEs have applied for NMTC allocations  from the CDFI Fund for a total of 88 applications. Fifteen minority CDEs  applied for NMTC allocations in multiple years. From 2005 through 2008,  the CDFI Fund received 934 NMTC applications from 566 different CDEs.  Of the 68 minority CDEs that applied, 6 CDEs received a total of eight  NMTC allocations (2 minority CDEs each received two separate  allocations). Minority applicants received about 2.6 percent of the $13.5  billion in total NMTC allocation authority that the CDFI Fund awarded  from 2005 through 2008.
The CDFI Fund’s process for making NMTC awards takes place in two  phases. NMTC applications are first reviewed and scored by a group of  external reviewers selected by the CDFI Fund who have demonstrated  experience in business, real estate, or community development finance.  CDEs that meet or exceed minimum thresholds in each of the four main  application sections (business strategy, community impact, management  capacity, and capitalization strategy) and an overall scoring threshold (out  of a total of 25 points in each application section) advance to the second  phase where they are re-ranked based on their scores in the business  strategy and community impact sections of the application and half of the  priority points awarded to CDEs that demonstrate a track record of  investing in low-income communities and investing in unrelated entities.  CDFI Fund staff review the amount of allocation authority that the CDE  requested and, based on the information in the application materials,  award allocation amounts in the descending order of CDEs’ final ranking  based on their re-ranked scores.
According to our analysis of NMTC application data, of the 88 applications  submitted by minority CDEs, 31 applications met the minimum threshold  scores to advance to the second phase of the NTMC review process from  2005 to 2008. By comparison, during this same time period 518 of the 846  applications submitted by non-minority CDEs met the minimum  thresholds to advance to the second phase of the review process. Overall,  non-minority CDEs scored about 11 points higher than minority CDEs on  NMTC applications from 2005 through 2008. As figure 1 shows, minority  CDEs’ scores differed the most from non-minority CDEs’ scores in the  capitalization strategy section of the application, where non-minority  CDEs scored 25 percent higher than minority CDEs. Non-minority CDEs  scored between 15 percent and 17 percent higher than minority CDEs in  the business strategy, community impact, and management capacity  sections of the application.
To identify challenges minority and non-minority CDEs face in obtaining  NMTC allocations, we interviewed representatives from minority and non- minority CDEs, and we analyzed CDFI Fund application data. While both  our testimonial evidence and statistical analysis have limitations, they  generally show that a CDE’s capacity, measured by asset size in this case,  is associated with an increased probability of obtaining an award. CDEs  we interviewed generally said it can be difficult on the NMTC application  to demonstrate the capacity to effectively use the NMTC and the  experience in investing in low-income communities necessary to obtain  allocations. According to officials from several CDEs we interviewed,  demonstrating the relative impact of NMTC projects through the NMTC  application may be particularly difficult when smaller, community-based  CDEs compete for allocations against large banks and financial  institutions that may have the capacity to undertake larger projects with  more easily identifiable economic impacts.
Our statistical analysis of all CDEs that applied from 2005 through 2008  demonstrates that the probability that a NMTC applicant will receive an  award is associated with certain factors. For example, after controlling for  other characteristics, larger CDEs, as measured by asset size, appear to be  more likely to receive NMTC awards, while smaller CDEs are less likely to  receive awards. When controlling for factors we could, our analysis also  shows that minority status is associated with a lower probability of  receiving an allocation. It is not clear from our analysis why minority  status is associated with a lower probability of obtaining an allocation or  whether any actions taken or not taken by the Department of the Treasury  or the CDFI Fund contributed to this statistical relationship. Other factors  for which our statistical analysis is unable to account, such as experience  with the application process, may also be reasons why minority CDEs  have not been as successful in obtaining NMTC allocations as non- minority CDEs.
For example, according to our 2006 report, certain minority-owned banks  have higher loan loss reserves and operating costs than non-minority  owned peers. These types of characteristics could potentially affect the  competitiveness of minority CDE NMTC applications, particularly in the  business strategy and management capacity sections of the applications.  Also, according to industry association representatives, minority-owned  banks have traditionally had a more difficult time accessing capital  markets than their non-minority peers, and our analysis of the CDFI Fund  application data show that minority CDEs score lowest in the  capitalization strategy section of the application. Our analysis indicates  that these differences are not explained by the size of the CDE—that is,  they are not problems shared, on average, by other small, non-minority  CDEs that applied for NMTC allocations. However, these differences could  be associated with some other feature that minority CDEs share with non- minority CDEs for which we do not have data to include in our analysis.
According to CDFI Fund officials, the CDFI Fund has conducted outreach  intended to reach all CDEs that may have an interest in applying for  NMTCs and CDFI Fund staff have given presentations to industry  associations, such as the New Markets Tax Credit Coalition; the National  Bankers Association (NBA), an industry organization that represents  minority-owned banks; and at FDIC conferences targeted to minority- owned institutions. According to CDFI Fund officials, they have more  recently developed a relationship with the Department of Commerce’s  Minority Business Development Agency that they hope will lead to  additional applications by minority CDEs. The CDFI Fund also provides a  written debriefing to each CDE that does not receive an allocation to assist  the CDE in future application rounds. This debriefing provides the  unsuccessful CDE with information about its scores in each of the  application sections and written comments on areas of weakness within  each of the four main application sections. Officials from some CDEs we  interviewed noted that the debriefing document helped them submit more  competitive application materials in future rounds. Officials from a few  CDEs noted that the debriefing comments were not consistent from one  year to another.
External stakeholders, including representatives from industry  associations we identified, hold conferences and offer varying degrees of  assistance to CDEs submitting competitive NMTC applications. In  addition, CDEs often hire consultants to assist them with completing their  NMTC applications. Consultants offer a range of services to CDEs,  including reviewing NMTC applications for completeness and depth of  responses to completing the entire NMTC application for an applicant.  According to CDEs we interviewed, fees charged by consultants cover a  broad range based on the services that the consultant provides. For  example, officials from several CDEs indicated that they paid consultants  less than $5,000 to review their NMTC applications while others paid  consultants as much as $50,000 for a more complete set of services.
section_title: Potential Options
paragraphs: The legislative history for the NMTC does not address whether Congress  intended for minority CDEs to benefit directly from the NMTC program.  However, if Congress intends for minority CDEs’ participation in the  NMTC program to exceed the current levels and Congress believes that  minority CDEs have unique characteristics that position them to target the  NMTC to its most effective use, Congress may want to consider legislative  changes to the program should the New Markets Tax Credit be extended  beyond 2009. Potential changes that could be considered include, but  would not be limited to the following: (1) similar to provisions for certain  federal grant programs, requiring that a certain portion of the overall  amount of allocation authority be designated for minority CDEs; (2) in  accordance with information we obtained in discussions with several  experts in economic development, exploring the potential for creating a  pool of NMTC allocation authority to be dedicated specifically for  community banks (minority banks that are certified CDEs, in most cases,  would likely compete with non-minority community banks with similar  characteristics for NMTC allocations); or (3) similar to other federal  programs where preferences are given to targeted populations, offering  priority points to minority CDEs that apply for NMTC allocations. In  addition, a fourth option would be for Congress to direct the Department  of the Treasury and the CDFI Fund to explore options for providing  technical assistance in applying for and using NMTC allocations to  minority CDEs.
Although these options could increase the amount of NMTC authority  awarded to minority CDEs, in part because we could not definitively  identify the reasons why minority CDEs have scored lower on the NMTC  application than non-minority CDEs, the options may not address the  underlying reasons for lower minority CDE success. In addition,  implementing these changes would require addressing a number of issues,  including legal and administrative concerns, associated with such changes  in the NMTC application process.
The CDFI Fund reviewed a draft of our report and agreed with our key  conclusion that minority CDEs have not received awards in proportion to  their representation in the application pool, but did not comment on our  options. The CDFI Fund’s response letter is reprinted in appendix VII of  our report. The CDFI Fund also provided several technical comments on  our report, which we incorporated as appropriate.
Chairmen, this concludes my remarks. As I noted earlier, the more detailed  findings and conclusions of our review of minority CDEs’ participation in  the New Markets Tax Credit program can be found in our recently issued  report (GAO-09-536). I would be happy to answer any questions you or  other members of the subcommittees may have.
section_title: Contacts and Acknowledgments
paragraphs: For further information on this testimony, please contact Michael Brostek  at (202) 512-9110 or brostkem@gao.gov. In addition, contact points for our  Offices of Congressional Relations and Public Affairs may be found on the  last page of this statement. In addition to the individual named above,  Kevin Daly, Assistant Director; LaKeshia Allen; Don Brown; Thomas  Gilbert; Cristian Ion; Jean McSween; Ed Nannenhorn; and Cheryl Peterson  made key contributions to this testimony.
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