AB 797 for the Wonks
This is a Substack for wonks, so I guess I should do the wonky explanation
The above was a warning label for those who are not wonks. If the label was not clear enough, this post is going to do the technical explanation that needs to be said but casual readers could be bored by. Just wanted to make it clear up front. My wife gets bored by my explanations of all this, so I thought I would do the courtesy for everyone else.
I am going to do this post by a Question and Answer format as I think it is simpler to explain a complex subject that way.
What is AB 797, Community Stabilization Act (Harabedian)?
The bill, as we see it, was created to provide a financing mechanism to policymakers where a new source of capital (Community Reinvestment Act or CRA) can be used to address a policy question- in this case, how do you provide homeowners a bid to ensure their property value is not lost due to a disaster (hence the Community Stabilization Act).
How does the financing mechanism work?
The financing works, as we see it, by the State of California (or any other State) issuing a security to the capital markets. The security receives in CRA monies invested by banks (or potentially other sources) and places those funds into a security which distributes the money to qualified nonprofits in a community (as the bill lays out) to purchase land at fair market price as determined by the bill but in congruence with the Governor’s moratorium.
Nonprofits must be approved by the State, have specific criteria including community representation, and be transparent in how they spend the money allocated under this program.
Why nonprofits as the recipients?
Trust is essential for a project like the one in AB 797 to work. Having been involved in community-led coalitions, nonprofits are the right nexus to ensure all interests are captured. As we have learned, the idea behind nonprofits being the mechanism is there is a public disclosure requirement for nonprofits in a community, as well as a requirement for community representation on the board of directors, among other transparency measures, ensuring there is a level of oversight necessary to build trust in a community for an effort like this one.
What happens to the property when it is purchased?
Properties are “held in trust,” which differs from a “land trust.” Land trusts hold properties “in trust,” but without a required disposition date. AB 797 outlines how the nonprofit will hold the properties until the values recovered, but not indefinitely because it the goal is also getting the properties through the recovery period and back into the hands of residents. So, the term “trust,” means a “temporary trust,” not necessarily a land trust.
How do investors get paid?
Investors get paid when the property is sold, the “liquidity event.” They get a portion of the increase in value to recover their investment. The State gets its portion for issuing the security. The nonprofit will also get a portion of the sale value to recover any costs of operating the property (i.e. cost of acquisition, maintenance, sale).
Why CRA?
CRA is a unique space in the financing world today. CRA is, as we joke, a “voluntold” requirement for banks, and must be taken seriously. CRA investments are primarily divided (as one executive explained it to me), roughly 50% debt, 25% equity, and 25% donations.
Within those pools, the 50% in debt are loans to either companies/people in qualifying communities. Many of the loans are “pooled” through what are called Community Development Financial Institutions (CDFIs), which allocate the pooled money from a bank to multiple small recipients as loans.
The “equity” portion of the pool of funds usually finds its way into tax credits such as New Market Tax Credits, Low Income Housing Tax Credits, Opportunity Zone investments, and importantly, municipal bonds. Banks, typically, for regulatory reasons, do not take direct ownership of companies (actual equity from an investors’ point of view).
Donations are direct grants, “in kind” donations such as volunteer time, and so forth. I call the “donations” portion, the “light the money on fire” portion of CRA as there is no “return on investment” that bankers are usually accustomed to- the investment is truly the community. Because CRA requires investments in specific areas, including “disaster areas,” it seems the use of CRA is a logical one to finance post-disaster efforts.
CRA, importantly, is a source of funds which is virtually undeveloped. There is a “delta” of $180 billion between what has been issued and what is currently being placed. That kind of gap calls for usage, and is a “material” amount to be tapped if properly packaged. Furthermore, anecdotally, we know CRA “repackages” investments to get credit. In other words, there is a need even within the existing $280 billion currently issued for new product since they need to take existing product and resell it again to meet their numbers without the multiplier demand existing.
An estimate of $1.5 billion would be needed to fund the goal of AB 797 if 50% of property owners in Altadena sold and at $500,000 per lot. That is a mere rounding error on the $280 billion and less than 1% of the delta, so there is a huge source of funds which can be tapped if properly packaged, and funds that can be used with a goal of “just do not lose me money” as the basis- a very different source of capital that can be catalyzed.
Why the State to issue the security?
The State issues the security so it automatically qualifies as a municipal bond, thus making it CRA eligible without having to determine whether the investment meets other CRA eligibility requirements. So, not only does the money go to a disaster area, it also meets CRA eligibility because of the fact it is municipal finance.
Why are you not using a debt instrument?
Debt is a commonly used mechanism to fund municipal efforts. In this case however, speed is critical to success and debt requires ballot measures and guarantees which do not exist or are too timely to get implemented.
If there is a way to finance development for a project without debt, there is a huge market for that type of investment since there . The “offset” is there must be what is called a “commercialization” component of the investment. For instance, if you are investing in a utility upgrade, for the value of the investment to worthwhile, the hope is the revenue generated by the project will reimburse the initial investment (what we would say if we invested in a stock). So, while the debt is not burdening the project, there is also a “profit” component or “appreciation” that will also need to be considered. If you can find the right mix, then there is a way to get there and use a new security like that envisioned here.
We need to use capital which does not require fixed payments to “stand up” an effort with minimal debt and faster implementation (i.e. do not need to worry about Proposition 13 limitations due to guarantees). The question is “how?” The answer is what AB 797 creates.
So the securities are issued, banks will “buy” them to comply with CRA, the funds are distributed to the State and then allocated to community nonprofits to be invested in properties in the community, which are then held in trust until the values recover and are sold. Then what?
The money invested is returned to investors via paying off the allocation from the State and then the State distributing the returns to investors based on the pre-determined formula. The project winds down until the next time the State needs to issue the securities.
What is needed from the Federal Government?
Recently, the federal government rescinded regulations issued around CRA, which will have far reaching effects. In the current environment, there are no guarantees “regulations” will remain, especially for an effort of this size. Regulations are not statute, and statute is what matters. Therefore, we suggest statutory changes to the CRA to ensure a program like AB 797 can be implemented without any “regulatory risk,” which will include the following:
Include CRA investments as “qualifying” if the investment is made in a governors or presidentially declared disaster zone for a period of time (invested within 24 months is our suggestion).
Allow CRA investments in bonds issued by states or municipalities (or tribal governments) to qualify automatically for CRA credit without locality requirements.
Securities issued by states or municipalities which offer “equity” instead of “tax exempt debt” are considered exempt from Private Activity Bond limitations (the current $4 billion cap in California) because there is no tax exemption, but count as Private Activity Bonds for the purposes of qualifying as CRA eligible.
These three asks do not affect any financial standing for the federal government, allowing for the deployment of the bond issued under AB 797 and beyond to be used for the purposes of the Community Stabilization Act.
Obviously the securities can be used beyond merely the purposes of AB 797, where else can the securities be plugged into the “capital stack?”
The capital stack, as it exists for the fires today, is limited because there is no “free” money from CDBG-DR, or “cheaper” money from tax exempt bonds as the Urban Land Institute (ULI) report outlines and the from press reports from Washington. There is a huge “hole” in the capital stack for a volume of money needed to fund the efforts (almost like a bridge loan or mezzanine debt). AB 797, if deployed right, can solve a portion of or all of that “hole.”
There is more that such a security can offer as well. The versatility of the security is critical to rapid deployment to specific problems. Where there is a commercial viability, the security can be used.
For instance, we can purchase land and hold it in trust as we discussed here. What about the rebuild? Can we use the security for rebuilding housing for those who are low and moderate income (LMI)? Can it be a mechanism to get people back into homes affordably? We think so (and subject to another Substack). What about utilities? Certainly investors will take a “coupon clipping” return for funding infrastructure. What about insurance? We will need to address how insurance will be issued in fire-facing areas (as well as those areas like the Gulf Coast and Atlantic Seaboard vulnerable to hurricanes). Is there a way to create a mutual insurance company or companies funded by CRA and using these types of bonds? Economic Development is another huge application for these types of securities.
With the proper constructs, there is a way to deploy these funds more effectively and efficiently than is currently done, allowing for “equity” value instead of just “debt.” Another area becoming more clear is follow-on investments from the COVID-related stimulus grants. Will the government continue to fund such investments or will a new source of capital be required?
Where commercialization is a goal/possibility, these securities can be used to invest in projects which make sense.
Starting back at square one however, AB 797 is a completely different way of seeing financing for policymakers and a tool needed to address the bigger challenges on the horizon. First things first, get people stabilized. Get their property a bid. Stop the stories of people selling for less than the property was worth. Give people hope. That is what AB 797 is all about. Then, once it is in place, you can see what else can be done.