NCDA – Winter Conference 2013Economic Development using Community

Development Block Grants/Section 108 Loan Guarantees

• Commercial development – Offices, retail, mixed-use, hotel

• Operating businesses– Manufacturing and service sector businesses

• Industrial development– Industrial park

Types of Section 108 Projects

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• Loan Pools– Business development & expansions

• Multi-family rental housing rehab – Rehab vacant building into residential use

• Infrastructure/Public facilities– Community center, roadwork, under grounding

utilities

Types of Section 108 Projects

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Uses of 108

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• Job creation• Larger, capital-intensive projects• Below-market interest rates• Flexible financing options• Mitigate impact of CDBG cuts

Why Use Section 108?

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• Spread capital costs over time• Long-term funds at reasonable fixed rates• Flexibility in repayment

– Provision for interest-only

• Flexibility in structure– Senior debt instrument– Subordinated debt instrument

Section 108 Advantages

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• Leverage of limited public dollars ($5 of Section 108 for every $1 CDBG funds)

• Non-competitive & rolling application process• Not a General Obligation (GO) for borrowing

community• Local decision-making

Section 108 Advantages

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Section 108 Basics

• Long-term debt: up to 20 year term• Flexibility of loan structure

– Possibility of interest only payments– Flexible principal repayment schedule– Negotiable collateral/subordination arrangements

• Historic low interest rates– Short-term, interim rates - 3 month LIBOR and– Long-term, permanent rates - “low spread" above

the 2, 5, 7, and 10-year U.S. Treasury notes

Lending Features

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Section 108 Underwriting:Program and Financial

Program Underwriting

• Entitlements jurisdictions • Non-entitlement public entities assisted by

states that administer CDBG (Small Cities)• States (added in 2009) – conduit for Section

108 loans to non-entitlements

Eligible Applicants (24 CFR 570.702 and 570.711)

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– Eligible Activities• Subpart M • 24 CFR 570.703

– National Objectives• Subpart C • 24 CFR 570.208• 70% low-mod benefit – primary objective

– Public Benefit 24 CFR 570.209(b)• If “special economic development” activity• If public improvements shared by more than 1 business

Program Underwriting Basics

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Financial Underwriting

• Risk and return affect both lenders’ (debt) and owners’/investors’ (equity) willingness to fund a deal

• Private Debt: Risk of repayment, operating losses• Equity: Risk of not earning rate of return• Risks for Section 108 applicant include

– Program compliance, including public benefits/# of jobs

– Repayment from 3rd party to local government for repaying Section 108 funds

Risk & Return

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• 24 CFR 570.209(a) and 24 CFR 570 Appendix A provides six key underwriting and evaluation guidelines for economic development projects

• Following guidelines not mandatory, but must conduct basic underwriting in order to receive a Section 108 loan

Section 108Financial Underwriting

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1. Costs are reasonable

2. Financing is committed

3. Section 108 is not substituting for non-federal funding

4. Project is financially feasible

5. Return to owner is reasonable (avoid windfall benefits or undue enrichment)

6. Pro-rata disbursements of funding

Six FinancialUnderwriting Guidelines

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• Understand features of all financial “Sources”• Confirm and evaluate “Uses” of funds• Do “Sources” = “Uses” ?

Sources & Uses

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• Debt—borrowing from lenders

• Equity—ownership/investor– Cash or contributed asset

• Section 108 — “gap” subsidy

Sources

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• Identify where the money goes– Breakout project’s hard costs (construction, equipment) and

soft costs (e.g., professional/financing fees)

• Evaluate reasonableness of all costs– Compare to costs standards

• Schedule draws of Sources to timing of Uses– Predevelopment, closing, construction, cost certification,

certificate of occupancy, lease-up

Uses

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Real EstateBusiness

Income Sales - Expenses - Cost of

Sales + G&A(no depreciation or interest)= Net Operating Income = Earnings b/f Taxes, Depr., interestMinus Debt Minus Debt= Cash Flow = Cash FlowMinus Income Taxes Minus Income Taxes

Cash Flow

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• All Section 108 Guaranteed Loans require pledge of current and future CDBG for repayment of Section 108 loan

– States pledge CDBG for non-entitlement communities’ Section 108 guaranteed loans

– Entitlement communities pledge CDBG for entitlement communities’ Section 108 guaranteed loans

Collateral:Pledge of CDBG

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• In addition to CDBG pledge, other security is required. (Evaluate Adequacy of Collateral):– Real Property: 80% Loan-to-Value – Machinery & Equipment:

• New: 80% of cost, less other senior debt• Used: 90% of appraised net liquidation value, less other senior debt

– Inventory: 50% of average of ending balances of last 3 operating years

– Accounts Receivable: 80% of average of ending balances of last 3 operating years

– Revenues (e.g., Tax Increment Financing, parking revenues, revenues from loan portfolios)

Collateral:Additional Loan Security

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• Can the deal be done without Section 108?• Debt has to be sized to fit cash flow - DSC (Debt Service Coverage)• Debt has to be sized to fit collateral

– LTV (Loan to Value)

Structuring the 108

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• Level I: Community borrows funds to carry out community/economic development activity

– Repaid with CDBG funds over term; and/or– Repaid with other pledged revenue sources (e.g. TIF)– Flexibility and variation depending on project type, source of

repayment, and nature of parties

• Level II: Community borrows funds to re-lend to Third Party Borrower (business or developer)

– Repaid by Third Party Borrower with revenues from project;– Repaid by Third Party Borrower with other pledged revenue

sources and guarantees

Structuring the 108

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• Level I – Loan– Repayment - generally, CDBG used as source of

repayment

– Collateral • pledge of existing and future CDBG • Pledge of additional loan security

Repayment Sources

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• Level II - Loan

• Repayment – 3rd party borrower loan payment (p & i) to local

government borrower. Debt service payment cannot be less than Section108 debt service

• Collateral - CDBG pledged by State or Unit of local gov’t - Additional loan Security – State or Unit of Local gov’t pledges interest in 3rd party loan, including security for loan

Repayments - Third-Party Loan

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Section 108Examples

• Local food products business founded in 2006 • Existing 18,000 sq. ft. facility seeking to expand. • Experienced business owner• Total project cost is $2.6 mil,• Section 108 request is for $469,000 • Sources of funds : bank loan, SBA loan and owner

equity(cash).

Example: Business Deal

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• Uses of funds:– purchase a 25,000 sq. ft. building– purchase additional equipment– Working Capital

• Benefit: Job creation ( 25 FTE) in LM areaUnderwriting process is two-fold:

• Program requirements• Financial

Example: Business deal continued

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• Eligible Activity: Special Economic Development 24 CFR 570.203/570.703(i)(1)

• Nat. Objective: Benefit to LM persons through job creation 24 CFR 570.208(a)4(i) and (v)

• Public Benefit : Applicable per 24 CFR 570.209(b) # jobs created & retained < $50k in CDBG $$(incl. 108) per job [ $469,000/25 = $18,760 per job]

Example Business Deal Program Underwriting

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Real EstateBusiness

Income Sales - Expenses - Cost of

Sales + G&A(no depreciation or interest)= Net Operating Income = Earnings b/f Taxes, Depr., interestMinus Debt Minus Debt= Cash Flow = Cash FlowMinus Income Taxes Minus Income Taxes

Cash Flow

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• Profit and Loss(P&L) statement Analysis:– Trend is gradual growth (increase in sales)– Trend is stable cost of goods(COGS) compared to sales

• Cash Flow Analysis:– Sales – (Cost of Sales + G&A)=Earnings b/f Taxes, Depr., int.– cash flow available for debt service / total debt service

(incl. 108)– Desire at least 1.2 for 108 deals

Example Business Deal Financial Underwriting

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• Balance Sheet Analysis :– positive & increasing working capital[current assets(CA)-

current liabilities(CL)]– Stable Current ratio [CA\CL]– Good cash mgmt(receivable and payable ratios averaged less than

40 days)

• All other funds are committed– Commitment letter from bank and net worth statement of

owner were submitted with application.

Financial Underwriting contd.

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• Program requirements are met• Finance:

Costs are reasonable compared to similar businessesOther Financing is firmly committed incl private financing Project seems financial feasibleOwner is not unduly enrichedPro-rata timing of disbursement

• Project is recommended for funding

Business Deal Underwriting Conclusion

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Example: Mixed-Use Real Estate Deal

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– Eligibility of Activities• Development of commercial/office/retail space, under

24 CFR 570.703(i)(1) and 570.203(b)• Rehabilitation of housing, under 24 CFR 570.703(h) and

570.202(b)(1)

– National Objective• Elimination of slums or blight, pursuant to 24 CFR

570.208(b)(1)

– Applicable Public Benefit Standards [570.209(b)]• $3,500,000/140 FTEs= $25,000 per FTE

Memphis, TN—Court Square Center: Programmatic Underwriting

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Real EstateBusiness

Income Sales - Expenses - Cost of

Sales + G&A(no depreciation or interest)= Net Operating Income = Earnings b/f Taxes, Depr., interestMinus Debt Minus Debt= Cash Flow = Cash FlowMinus Income Taxes Minus Income Taxes

Cash Flow

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Cash Flow

Memphis, TN—Court Square Center: Financial Underwriting

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Operating Income $2,107,000Operating expenses - $343,000Other Project Expenses $559,000Net Operating Income (NOI) = $1,205,000

Annual Debt Payment= $916,800

NOI ÷ ADP = Debt Coverage Ratio (DCR) of 1.31

Collateral– Partnership Interests– Lien on Real Property

• Loan to Value = less than 80%

Memphis, TN—Court Square Center: Financial Underwriting

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Section 108Application & Approval Steps

• Consult with HUD Field Office• Draft application and publish for citizen review

and comment• Prepare final application, with citizen

comments considered

Application Pre-submission Requirements (24 CFR 570.704(a))

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1. Project Description2. Eligible Activity(ies)3. National Objective4. Public Benefit Standard5. Sources and Uses6. Project Structure and Participants

Final Application Components

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• HUD approval of application for Section 108 loan guarantee commitment is approximately 90 days. It depends on a number of factors:– Quality of the application and whether additional

documentation is required– Complexity of project– Time of year (near holidays, budget hearings, and

local processes)

Timing

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• Promissory Notes - Variable/Fixed interest rate notes issued by states or units of local gov’t.s • Loan Guarantee

- HUD issues loan guarantee for each note pledging full faith and credit of U. S. for repayment of each note

Section108 Loan Guarantee

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• Paul Webster – Director, Financial Management Division (FMD) – 202-708-1871

• Hugh Allen – Deputy Director, FMD, 202-402-4654

Contact Information

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