Equalize Community Development Fund Questions & Answers
Question: What is the Small Business Administration (SBA)?
Answer: Created in 1953, the U.S. Small Business Administration (SBA) continues to help small business owners and entrepreneurs pursue the American dream. The SBA is the only cabinet-level federal agency fully dedicated to small business and provides counseling, capital, and contracting expertise as the nation’s only go-to resource and voice for small businesses.
The mission of the U.S. Small Business Administration (SBA), under the Small Business Act, as amended, is to maintain and strengthen the nation’s economy by enabling the establishment and vitality of small businesses and assisting in the economic recovery of communities after disasters.
SBA is organized around four key functional assistance areas: financial, contracting, entrepreneurial development, and disaster assistance. The Agency also represents small businesses through an independent advocate and an ombudsman.
Question: What is the Community Reinvestment Act (CRA)?
Answer: The Community Reinvestment Act is intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods, consistent with safe and sound banking operations. It was enacted by the Congress in 1977 (12 U.S.C. 2901) and is implemented by Regulations 12 CFR parts 25, 228, 345, and 195.
The CRA requires that each insured depository institution’s record in helping meet the credit needs of its entire community be evaluated periodically. That record is taken into account in considering an institution’s application for deposit facilities, including mergers and acquisitions. CRA examinations are conducted by the federal agencies that are responsible for supervising depository institutions: the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).
Question: What is the SBA 504 Loan Program?
Answer: The 504 loan program helps small businesses obtain long-term financing to acquire and improve major fixed assets, such as owner-occupied real estate or equipment. The program helps eligible businesses with loan requests that might not otherwise qualify for credit without SBA participation. For real estate, existing buildings financed by a 504 loan must be at least 51 percent owner-occupied, and new construction must be at least 60% owner-occupied. Examples of eligible businesses include manufacturers, hotels and motels, nursing homes, gas stations, and restaurants.
The loans must be used for fixed assets, such as land, buildings, machinery, and equipment, acquired or improved by a small business for use in its business operations.
Loans cannot be used for working capital or inventory. Existing debt may be refinanced in some circumstances, as explained in the following section. Additional restrictions on the use of loan funds may also apply.
To be eligible, businesses must operate as for-profit entities and meet the SBA’s size requirements. A business qualifies under the SBA requirements if it has a tangible net worth of $15 million or less and it has an average net income after federal income taxes for the previous two fiscal years of less than $5 million. Loans cannot be made to a business engaged in real estate speculation or rental investments. Additional restrictions may also apply.
The business must also meet certain economic development objectives. Generally, the business must create or retain one job for every $65,000 guaranteed by the SBA debenture (for small manufacturers, one job for every $100,000 guaranteed) or meet certain community development or public policy goals, as explained later in this report.
Question: What is the difference between an SBA 504 loan and an SBA 7a loan?
Answer: SBA 504 and 7a loans are designed with different purposes in mind. Generally, a 504 loan is designed for financing purchase of a building, financing construction or building improvements, or the purchase of heavy equipment or machinery. A 7a loan is designed for more general purposes that can include a combination of working capital, purchase of an existing business, refinancing existing business debt, or purchase of furniture, fixtures and supplies. Some key elements of each program are described below:
Question: What is the Structure of SBA 504 first lien loans?
Answer: SBA 504 first liens can display attractive risk and return metrics due to their unique credit priority structure.
- The loan-to-value (“LTV”) of the first lien will not exceed 65% for multi-purpose properties or 60% for hospitality and special purpose properties.
- The SBA, by virtue of being in a second lien position of up to 40% of the total project cost, is in a first loss position relative to the first lien loan. In order to proactively protect its lien position, the SBA must retire the first lien loan in order to receive any liquidation proceeds.
Question: Are there any loan or investment size requirements to get CRA credit?
Answer: Bank financing through the 504 loan program may qualify for CRA consideration, depending on loan amounts. In most cases, loans of $1 million or less qualify as small business loans and may be considered under the CRA lending test for banks of all sizes. Intermediate small banks may choose to have small business loans of $1 million or less, which meet the regulatory definition of community development, evaluated as community development loans. Loans of greater than $1 million made under the 504 loan program are considered community development loans under the lending test or the community development test, depending on the bank’s size. In order for a 504 loan to qualify for CRA consideration as a community development loan, it must meet the geographic requirements in the regulation.
Question: How does an investor get CRA credit for investing in the fund?
Answer: An SBA 504 first lien loan is a Community Development Loan if its first lien portion is greater than $1MM.
Examples of community development loans include, but are not limited to, loans to businesses, in an amount of greater than $1 million, when made as part of the Small Business Administration’s 504 Certified Development Company program.
- According to the March 2017 publication by the OCC, banks making 504 loans may qualify for CRA consideration. In most cases, loans of $1 million or less qualify as small business loans and may be considered under the CRA lending test for banks of all sizes. Intermediate-small banks may choose to have small business loans of $1 million or less, which meet the regulatory definition of community development, evaluated as community development loans. Loans of greater than $1 million made under the 504 program are considered community development loans either under the lending test or the community development test, depending on the bank’s size.
- Investing in a fund that makes community development loans is considered to meet the primary purpose of community development as described in the FR notice (Federal Register/Vol. 75, No. 47,Thursday, March 11, 2010, Notices).
- An equity investment in a fund may meet the Lending Test for CRA.**
- If an institution has made an equity or equity-type investment in a third party, community development loans made by the third party may be considered under the lending test
- (d) Lending by a consortium or a third party. Community development loans originated or purchased by a consortium in which the bank participates or by a third party in which the bank has invested: (1) Will be considered, at the bank’s option, if the bank reports the data pertaining to these loans under §25.42(b)(2); and (2) May be allocated among participants or investors, as they choose, for purposes of the lending test, except that no participant or investor: (i) May claim a loan origination or loan purchase if another participant or investor claims the same loan origination or purchase; or (ii) May claim loans accounting for more than its percentage share (based on the level of its participation or investment) of the total loans originated by the consortium or third party.
- Investing in the Fund is similar to making an individual loan due to the Fund’s ability to earmark individual loans to CRA-motivated investors. Earmarked loans will qualify for CRA credit that is the same as if the institution made a loan directly as long as loans are made in the bank’s CRA assessment area.
- We should also note that at least two banks have received investment test credit in their CRA exams for investing in the Fund, even though the Fund contained no loans in these bank’s assessment areas. There is considerable variability in how different CRA examiners look at things, so there can be no guarantee that a different examiner, in different circumstances would react the same in a similar situation, but these two precedents should help make the case.
Question: What is the difference between Lending Test credit and Investment Test Credit under the CRA?
Answer: CRA exams procedures include two tests: the CRA Small Bank Lending Test and the Community Development Test.
The Lending Test considers the institution’s performance according to the following criteria.
- Loan-to-deposit ratio
- Assessment area concentration
- Geographic distribution
- Borrower profile
- Response to CRA-related complaints
The Community Development Test considered the following factors.
- Number and dollar amount of community development loans, qualified investments and community development services
- The responsiveness of such activities to the community development needs of the assessment area
Consideration is given in the evaluation to the bank’s lending and community development performance within its assessment area(s). The CRA requires each financial institution to define one or more assessment areas (AAs) within which its CRA performance will be evaluated. Evaluations can include discussions with management regarding banking strategies, as well as considerations for assessment area sizes, branch locations, lending activity, and credit and community development needs and available opportunities.
Banks must achieve at least a satisfactory rating under each test to obtain an overall satisfactory rating. This evaluation does not include any lending or community development activity performed by affiliates.
For the Community Development Test, examiners look at data on community development loans, qualified investments, and community development services since a bank’s prior CRA evaluation.
Examiners will look at a bank’s responsiveness to the community development needs of its AAs through community development loans, qualified investments, and community development services. Examiners consider the institution’s capacity and the need and availability of such opportunities. Of course, primary consideration in an examination is given to loans, investments and services within a bank’s assessment area. However, if a bank is judged to be addressing the needs within its AA, consideration may also be given to loans and investments that benefit the community development needs of a bank’s broader regional area.
Question: If The Fund currently holds no loans in our Assessment Area (AA), will The Fund seek new investments in my AA if we choose to invest?
Answer: Once an investor invests in the Fund, the adviser then begins a comprehensive effort to find qualifying investments in the investors assessment area. In addition, we have two different ways for banks to invest in The Fund.
- Traditional investment in mutual fund. After getting prospectus, an investor will fill out an application and wire funds to The Fund trustee at the end of the month.
- An investor can subscribe to the fund by depositing 5% of the subscription with The Fund. The remaining 95% funding can be called by The Fund as loans in the investors assessment area are found and purchased.
We should also note that at least two banks have received investment test credit in their CRA exams for investing in the Fund, even though there were no loans in the Fund in these banks’ assessment areas. There is considerable variability in how different CRA examiners look at things, so we can’t guarantee how a different examiner, in different circumstances would react in a similar situation, but we do have at least two precedents to help make the case. We can direct you to each bank’s CRA exam results if you are interested.
Investing in a mutual fund involves risk including the potential loss of principal. There can be no assurance that the Fund will achieve its investment objectives. An investment in the Fund is an appropriate investment only for those investors who can tolerate a high degree of risk and do not require a liquid investment. Investors may lose some or all of their investment in the Fund. The Fund is not designed to be a complete investment program and may not be a suitable investment for all investors.
Capital raised through leverage will be subject to interest and other costs, and these costs could exceed the income earned by the Fund on the proceeds of such leverage. There can be no assurance that the Fund’s income from the proceeds of leverage will exceed these costs. However, the Adviser seeks to use leverage for the purposes of making additional investments only if it believes, at the time of using leverage, that the total return on the assets purchased with such funds will exceed interest payments and other costs of the leverage.
CRA Strategy Risk
The Fund’s goal of holding 504 First Lien Loans so that Fund investors that are subject to regulatory examination for CRA compliance may claim their Fund investment as a community development loan or as a qualified investment under the CRA will cause the Adviser to take this factor into account in determining which loans the Fund will purchase and sell. Accordingly, portfolio decisions will not be exclusively based on the investment characteristics of the 504 First Lien Loans, which may have an adverse effect on the Fund’s investment performance.
504 First Lien Loans are not readily marketable. Illiquid 504 First Lien Loans may impair the Fund’s ability to realize the full value of its assets in the event of a voluntary or involuntary liquidation of such assets and thus may cause a decline in the Fund’s NAV. Shareholders will not have the right to redeem their shares. However, in order to provide some liquidity to shareholders, the Fund will conduct periodic repurchase offers for a portion of its outstanding shares.
504 First Lien Loans are not guaranteed by the SBA, the U.S. government or by its agencies, instrumentalities or sponsored enterprises. The Fund has no limitation on the amount of its assets that may be invested in securities or other financial instruments that are illiquid. Investment in the Fund involves significant risk and is suitable only for persons who can bear the economic risk of the loss of their investment.
The Equalize Community Development Fund is distributed by Foreside Fund Services, LLC which is not affiliated with Equalize Capital or any affiliate. Foreside is not a registered investment advisor and does not provide investment advice.