Types of Section 108 Projects

1. NCDA – Winter Conference 2013Economic Development using Community Development Block Grants/Section 108 Loan Guarantees

2. Types of Section 108 Projects • Commercial development • Offices, retail, mixed-use, hotel • Operating businesses • Manufacturing and service sector businesses • Industrial development • Industrial park Slide 2

3. Types of Section 108 Projects • 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

4. Uses of 108

5. Why Use Section 108? • Job creation • Larger, capital-intensive projects • Below-market interest rates • Flexible financing options • Mitigate impact of CDBG cuts Slide 5

6. Section 108 Advantages • 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

7. Section 108 Advantages • 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

8. Section 108 Basics

9. Lending Features • 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 Slide 9

10. Section 108 Underwriting:Program and Financial

11. Program Underwriting

12. Eligible Applicants (24 CFR 570.702 and 570.711) • 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 Slide 12

13. Program Underwriting Basics • 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

14. Financial Underwriting

15. Risk & Return • 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 Slide 15

16. Section 108Financial Underwriting • 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 Slide 16

17. Six FinancialUnderwriting Guidelines • Costs are reasonable • Financing is committed • Section 108 is not substituting for non-federal funding • Project is financially feasible • Return to owner is reasonable (avoid windfall benefits or undue enrichment) • Pro-rata disbursements of funding Slide 17

18. Sources & Uses • Understand features of all financial “Sources” • Confirm and evaluate “Uses” of funds • Do “Sources” = “Uses” ? Slide 18

19. Sources • Debt—borrowing from lenders • Equity—ownership/investor • Cash or contributed asset • Section 108 — “gap” subsidy Slide 19

20. Uses • 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 Slide 20

21. Cash Flow Real EstateBusiness Income Sales - Expenses - Cost of Sales + G&A (no depreciation or interest) = Net Operating Income = Earnings b/f Taxes, Depr., interest Minus Debt Minus Debt = Cash Flow = Cash Flow Minus Income Taxes Minus Income Taxes Slide 21

22. Collateral:Pledge of CDBG • 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 Slide 22

23. Collateral:Additional Loan Security • 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) Slide 23

24. Structuring the 108 • 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) Slide 24

25. Structuring the 108 • 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 Slide 25

26. Repayment Sources • Level I – Loan • Repayment - generally, CDBG used as source of repayment • Collateral • pledge of existing and future CDBG • Pledge of additional loan security Slide 26

27. Repayments - Third-Party Loan • 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 Slide 27

28. Section 108Examples

29. Example: Business Deal • 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).

30. Example: Business deal continued • Uses of funds: • purchase a 25,000 sq. ft. building • purchase additional equipment • Working Capital • Benefit: Job creation ( 25 FTE) in LM area Underwriting process is two-fold: • Program requirements • Financial

31. Example Business Deal Program Underwriting • 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]

32. Cash Flow Real EstateBusiness Income Sales - Expenses - Cost of Sales + G&A (no depreciation or interest) = Net Operating Income = Earnings b/f Taxes, Depr., interest Minus Debt Minus Debt = Cash Flow = Cash Flow Minus Income Taxes Minus Income Taxes Slide 32

33. Example Business Deal Financial Underwriting • 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

34. Financial Underwriting contd. • 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.

35. Business Deal Underwriting Conclusion • Program requirements are met • Finance: • Costs are reasonable compared to similar businesses • Other Financing is firmly committed incl private financing • Project seems financial feasible • Owner is not unduly enriched • Pro-rata timing of disbursement • Project is recommended for funding

36. Example: Mixed-Use Real Estate Deal Slide 36

37. Memphis, TN—Court Square Center: Programmatic Underwriting • 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

38. Cash Flow Real EstateBusiness Income Sales - Expenses - Cost of Sales + G&A (no depreciation or interest) = Net Operating Income = Earnings b/f Taxes, Depr., interest Minus Debt Minus Debt = Cash Flow = Cash Flow Minus Income Taxes Minus Income Taxes Slide 38

39. Memphis, TN—Court Square Center: Financial Underwriting Cash Flow Operating Income $2,107,000 Operating expenses - $343,000 Other Project Expenses $559,000 Net Operating Income (NOI) = $1,205,000 Annual Debt Payment= $916,800 NOI ÷ ADP = Debt Coverage Ratio (DCR) of 1.31

40. Memphis, TN—Court Square Center: Financial Underwriting Collateral • Partnership Interests • Lien on Real Property • Loan to Value = less than 80%

41. Section 108Application & Approval Steps

42. Application Pre-submission Requirements (24 CFR 570.704(a)) • Consult with HUD Field Office • Draft application and publish for citizen review and comment • Prepare final application, with citizen comments considered Slide 42

43. Final Application Components • Project Description • Eligible Activity(ies) • National Objective • Public Benefit Standard • Sources and Uses • Project Structure and Participants Slide 43

44. Timing • 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) Slide 44

45. Section108 Loan Guarantee • 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 Slide 45

46. Contact Information • Paul Webster – Director, Financial Management Division (FMD) – 202-708-1871 • Hugh Allen – Deputy Director, FMD, 202-402-4654