Minutes of the Regular Meeting of NMSBIC, December 10, 2012

A regular meeting of the New Mexico Small Business Investment Corporation was called to order on this date at 8:08 a.m. in the conference room of the WESST Enterprise Center, 609 Broadway Blvd., N.E., Albuquerque, New Mexico.

A quorum was present:

Members Present:
Mr. Joseph H. Badal, Chair
Mr. Sam Cobb [by telephone]
Mr. Lupe Garcia
Ms. Roxanna Meyers, Vice Chair
Mr. Clarence L. Smith [designee of Hon. James Lewis, State Treasurer] [by telephone]
Ms. Launa Waller [by telephone]

Members Excused: Mr. Alan Fowler, Secretary/Treasurer

Executive Director/Investment Advisor: Mr. Russell Cummins

Legal Counsel to Board: Mr. Randall McDonald

Guests Present:
Mr. Robert De Pasquale, Pulakos CPA
Ms. Leslie Elgood, CEO, New Mexico Community Capital
Mr. J. Michael Schafer, Managing Director, New Mexico Community Capital

REVIEW AND ACCEPTANCE OF AGENDA

Ms. Meyers moved approval of the Agenda, as published. Mr. Garcia seconded the motion, which passed unanimously by voice vote.

REVIEW AND ACCEPTANCE OF BOARD MINUTES: October 15, 2012

Mr. Garcia moved approval of the October 15 Minutes, as submitted. Ms. Meyers seconded the motion, which passed unanimously by voice vote.

PULAKOS CPAs’ PRESENTATION OF IRS FORM 990: ROBERT DE PASQUALE, SENIOR TAX MANAGER

Mr. De Pasquale reviewed the Form 990 with the Board and responded to various questions from Board members.

Board members asked Mr. Cummins and Mr. De Pasquale to have further discussion about: 1) fleshing out the description of the mission of the NMSBIC (page 19 of Form 990) to include the organization’s lending programs; and 2) making a distinction between management and program allocation of Mr. Cummins’ time and hours for Board members, and to consider appropriate revisions with respect thereto prior to filing.

Ms. Meyers moved to approve the Form 990 with the changes, as recommended. Mr. Garcia seconded the motion, which passed unanimously by voice vote.

NEW MEXICO COMMUNITY CAPITAL, ROYALTY FUND PRESENTATION

As background, Chairman Badal stated that, when NMCC approached him and Mr. Cummins several weeks ago about funding a new entity, they told NMCC that the NMSBIC was top-heavy on the venture/equity side, and felt the NMSBIC had too much exposure to venture/equity investments. He and Mr. Cummins have had several meetings with NMCC about how the NMSBIC might consider working with NMCC, including with a lending program. NMCC’s response to these conversations would be in the form of a presentation on NMCC’s proposed royalty fund. He commented that the royalty fund concept is unique and interesting.

NMCC CEO Leslie Elgood and Managing Director J. Michael Schafer appeared before the Board.

Ms. Elgood said NMCC was founded in 2004, and its primary purpose at the time was to put venture capital into underserved and rural communities. NMCC considers the NMSBIC to be one of their cofounders. Their fund management company is a wholly owned subsidiary under a nonprofit parent, which is a fairly unique structure and gives them a competitive advantage. NMCC has collective expertise of 80+ years of investing, nonprofit, accounting and management experience.

Ms. Elgood said NMCC has raised over $8 million from private and public funding since inception, which has gone directly to investing in, and and providing business technical assistance services to New Mexico businesses. They are the only organization in New Mexico that holds dual certification as a CDFI from the U.S. Department of the Treasury to serve both tribal and non-tribal communities. In addition, they are the state’s minority partner for New Market tax credits, and have helped deploy $187 million of tax credits in the last four years.

Mr. Schafer stated that the New Mexico economy is largely comprised of companies with revenues of $1.5 million to $10 million. Many of these companies could grow more if they had access to additional capital, but banks are not lending. Outside of the Albuquerque-Santa Fe corridor, equity investing is not well understood and is not easily accepted.

Mr. Schafer noted that NMCC has invested $45,000 utilizing a royalty structure investment model in a Deming company that is the world leader in organic greenhouse produce. He said the royalty structure allows NMCC to take a percentage of the company’s revenues to repay the investment until either 1) NMCC gets a desired rate of return or 2) a desired multiple. He said NMCC chose the latter with a 2x return. He said the company has done very well and has exercised an option to repay the loan ahead of time; as a result, a return in the range of 40% is expected over a 2-year timeframe from the investment.

Speaking to NMCC’s responsiveness in its meetings with him and Mr. Cummins about ways the NMSBIC portfolio might be better balanced between equity and lending, Chairman Badal said the issues addressed were: 1) how can the NMSBIC, through a partner, get more money out into the rural community; and 2) how can it turn the money around more quickly so it can be put to use again.

Mr. Schafer reviewed the proposed New Mexico Royalty Fund structure:

• NMCC is creating a $5 million equity fund ($1.5 million is already committed).
• NMCC proposes that the NMSBIC loan $2.5 million at 2.5% interest to the $5 million royalty fund, that NMCC would call as needed. NMCC would put the money (equity and debt money, two-to-one) into royalty structure investments in specific companies.
• There would be no fees paid by NMSBIC.
• NMSBIC would be paid from cash flow, not an exit event.
• Returns would be generated by royalties on portfolio company gross revenues derived from 5 to 9 investments of $100,000 to $1 million each.
• This “win-win” structure allows investors to generate returns when the company is doing well, and has a finite date when the royalty structure ends. Sample royalty terms would be a royalty payment of 3% of gross revenue, and 2x total return in 3 years.
• Mr. Schafer said this royalty fund structure can replace traditional bank debt. He said NMCC has met with nearly every bank president of all of the major banks in New Mexico, and the across-the-board response has been, “This is a great idea; I have customers that could use this right now.”

Mr. Schafer reviewed the royalty fund investment structure, noting that the return of capital would first go to repay debt (the NMSBIC loan), and the equity investors would be in the first loss position. As a CDFI, NMCC intends to access a CDFI grant that would be used to create a $500,000 loan loss reserve fund.

Referring to the Board documents, Ms. Meyers noted that the market value of the NMSBIC’s share of the existing NMCC fund was $3.417 million as of 6/30/12, and at 10/31/12 (including capital calls since 6/30/12), its amount invested in the NMCC fund was $3.654 million.

Mr. Schafer stated that most of the losses can be attributed to fees paid since 2007. In terms of investment loss, NMCC has a portfolio of 10 companies and has write-offs on 2 of them.

[Ms. Elgood and Mr. Schafer left the proceedings.]

Questions and comments by Board members included:

• How does NMCC determine that the company has enough cash flow to make the payments?
• What kind of covenants do they have in place that would impact the company’s cash flow? If they spend this money on marketing activities, there is the potential that no income would come from the use of the capital for several months.
• If the NMSBIC is going to begin loaning money in an unsecured lending environment, it should call it that, because that is essentially what it is, with the NMSBIC relying on its partners to determine the feasibility of making unsecured loans to small businesses.
• It should be a condition that NMCC have some corpus of cash (e.g., the proposed loan loss reserve fund) against which it would cover a portion of missed royalty/interest payments.
• Is this a good vehicle, and is NMCC the right choice to manage it?

Chairman Badal suggested that Board members consider under what conditions they might support the royalty fund structure and to email their thoughts to Mr. Cummins.

OCTOBER 31, 2012 FINANCIAL REPORTS

Mr. Cummins reviewed the financials.

• NMSBIC moved $3.28 million out of the NM Bank & Trust money market fund into US Bank. NM Bank & Trust had proposed new collateral and safekeeping agreements. Rather than pay legal fees to make the changes to the collateral agreement, NMSBIC moved the funds to US Bank, where the deposits are 100% collateralized under an existing collateral agreement.
• NMSBIC is using June 30, 2012 numbers for the investment valuations until the new valuations come in.
• New Mexico Mezzanine Partners has been using cash flow from interest income received from borrower loan payments to cover management fees and expenses, reducing the amount NMMP has requested from NMSBIC in capital calls. Because NMSBIC needs to accurately reflect remaining committed capital and IRR numbers in the financials, NMMP will provide NMSBIC with a detailed reconciliation of the amount of management fee and expense offset so the numbers can be trued up.

Mr. Cobb moved for approval of the financials, as presented. Mr. Smith seconded the motion, which passed unanimously by voice vote.

EXECUTIVE DIRECTOR/INVESTMENT ADVISOR REPORT

Follow-up item: industry benchmarking

In response to a request at the last meeting, Mr. Cummins said he has included benchmarking information from The Loan Fund and Accion in the Board packet, including a CDFI comparison of small business lending in New Mexico, Colorado, Arizona and Utah that includes The Loan Fund, Accion and WESST. He said the comparison takes into account loan size and operating expenses, and also compares self-sufficiency, which is a ratio of loan interest income divided by operating expenses. He noted that The Loan Fund is 82% self-sufficient, Accion is 41% self-sufficient and WESST is 5% self-sufficient, as compared to the industry average of 62% for CDFIs in this asset range ($10-$50 million).

Mr. Cummins commented that a key issue for CDFI loan funds is their ability to leverage, i.e., access capital that they can use to lend out. The industry average for a CDFI is 4:1. The Loan Fund’s leverage ratio is 6:1 and Accion’s is 1:1.

The Loan Fund

Mr. Cummins reported that the changes approved at the last Board meeting have been finalized, and the documents have been signed, implementing the changes to the loan terms.

Mr. Cummins noted that The Loan Fund total delinquencies rose to 13.9% as of September 30, from 7% as of June 30, but there were no delinquencies over 90 days. The increase was partly due to a matured loan that was in the process of being refinanced at a traditional bank. Other delinquencies were caused by outstanding late charges. These issues were resolved in October and the delinquency rate dropped to 9.5% as of October 31.

Mr. Cummins stated that The Loan Fund has $1.6 million of loans that they expect to close within the next two months. They have indicated an interest in discussing an increase in their NMSBIC line of credit in the first quarter of 2013.

Equity partners

• End of fund life information has been provided from all of the equity partners and is scheduled for discussion at next month’s strategic planning session.
• Mr. Cummins attended the Flywheel Ventures annual LP meeting in November. Flywheel’s investments outside of New Mexico (in which NMSBIC does not have ownership) are doing very well, while investments for some companies inside New Mexico may generate successful exits in the future.
• New Mexico Community Capital paid $92,667 to NMSBIC in November, which was the second quarterly installment payment on a two-year note for the return of capital related to the Aero-Mechanical Industries stock buyback.
• New Mexico Mezzanine Partners had a second successful loan payoff and disbursed approximately $210,000 to NMSBIC in November.
• Mr. Cummins and Chairman Badal attended Verge Fund’s annual LP meeting in October. The meeting included a fund overview and presentations from several of the individual companies.
• Mesa New Mexico Growth Fund I is scheduled to close on November 30. The only remaining asset in the partnership is about $4,000 in cash, of which NMSBIC’s share is $3,730.
• Mesa New Mexico Growth Fund II (NMGF II) has a few assets, one of which is ClingZ, which remains active. Mr. Cummins and Chairman Badal visited ClingZ in October and learned more about the company’s operations.
• With respect to assets remaining from its investment in High Desert Chile, Inc., NMGF II entered into a purchase agreement in October to sell the chile processing plant in Deming. The NMSBIC’s share of the loss related to this sale will be roughly $140,000. NMGF II also has a verbal agreement to sell the chile processing equipment in mid 2013.

Short-term investments

• State Investment Council Vice Chairman Peter Frank has suggested that the NMSBIC consider becoming an SIC client for its short-term investments, where the SIC would manage the NMSBIC’s excess funds and possibly provide a better return than the NMSBIC currently receives through money market accounts and CDs. The NMSBIC would have immediate access to the funds for expenses, capital calls, and new loans/investments. Discussions with SIC are continuing, with any arrangement subject to NMSBIC Board approval.

Potential new investments

• Discussions with Enchantment Land Development Company continue, but there is no new information at this point regarding participation in an SBA 504 loan program.
• As discussed below, discussions have occurred with the New Mexico Mortgage Finance Authority regarding a possible lending program. Mr. Cummins reminded the Board that RDC Advisors, LLC previously had a consulting arrangement with MFA. This consulting arrangement has been terminated and there is no current conflict of interest. However, given the discussion with MFA regarding a lending relationship with NMSBIC, and as managing member of RDC Advisors, LLC, Mr. Cummins feels it appropriate to re-disclose his past relationship with MFA.

MESA CAPITAL PARTNERS, AUDIT WAIVER REQUEST, NMGF I

Mr. Cummins stated that Mesa Capital Partners has requested that their annual audit for New Mexico Growth Fund I be waived. The fund is in the process of liquidating its few remaining assets and would like to reduce expenses.

Mr. Cobb recalled that NMSBIC paid their audit expenses last time and found no deficiencies. He said he felt it appropriate to waive this requirement, given that they are in the process of liquidating.

Mr. Cobb moved to not require Mesa Capital Partners to do an audit with respect to New Mexico Growth Fund I for its fiscal year ending November 30, 2012. Mr. Garcia seconded the motion, which passed unanimously by voice vote.

LOAN AND INVESTMENT PROPOSALS:

MFA Proposed Line of Credit

Mr. Cummins stated that he has been meeting with MFA Deputy Director Joseph Montoya and, until recently, Director of Housing Development Linda Bridge (who recently left MFA). MFA has made a proposal that the NMSBIC would make an unsecured loan to MFA in the amount of $1.5 million at an interest rate of 2%, with a 10-year term. MFA currently has a loan with Wells Fargo Bank under the same terms.

Mr. Cummins said that, under the MFA’s Primero Loan Program, MFA has committed $6 million of their own cash. MFA has a $1.5 million loan from Wells Fargo. If the Wells Fargo loan were matched by the NMSBIC, the loan program would have a balance of $9 million.

Mr. Cummins said MFA has permanent loan financing for multifamily housing projects around the state. These projects are typically funded with 40% equity from tax credits that are sold to investors, and the proceeds used as equity for the projects. He said 35% to 40% comes from traditional lending sources, and MFA usually provides a junior lien. He stated that the Primero loans are used for various interim financing needs prior to the permanent loan take-out.

Mr. Cummins said MFA’s total assets at the end of 2011 were $1.5 billion, and their net assets were $263 million. Revenues were $98 million in 2011, with $71 million in operating expenses. The change in net assets (net income) was $26 million in 2011.

Mr. Cobb suggested a shorter loan term than 10 years, such as 2 years.

Chairman Badal noted that MFA has generally been the biggest user of tax-exempt bonds in the state and he would want to make sure that the MFA wouldn’t be pushing up against the allocation limit. In such a case, MFA would not be able to finance their permanent loan take-outs through the tax-exempt bond program.

Ms. Meyers asked about MFA’s procedures for ensuring that development and construction loan soft costs are not excessive.

Mr. Cummins agreed to go back to MFA to discuss a 2-year loan period; monitoring of soft costs versus hard costs; what kind of loan to value there would be; clarity on take-out; and other matters raised in today’s discussion.

Board members agreed that they were favorably disposed to considering this loan arrangement subject to the due diligence, and that because of housing shortages in certain high growth areas of the state such as Lea County, this proposed loan would help to support job growth.

Cottonwood Technology Fund II Proposed Investment

Mr. Cummins said Cottonwood is currently raising capital for Fund II and has approached the NMSBIC for a possible investment.

Mr. Cummins stated that Cottonwood Technology Fund II is a limited partner structure that the NMSBIC has done in the past. Mr. Cummins noted that the NMSBIC has a high concentration of this type of investment.

Mr. Cummins also stated that the Cottonwood funds invest throughout the Southwest. Investment opportunities are presented to investors, who evaluate each opportunity and decide whether or not to invest in each company. There is an individual limited partner agreement for for each porfolio company. NMSBIC would only be able to invest in New Mexico companies, therefore it would be paying management fees for some out-of-stateinvestment opportunities in which the NMSBIC could not invest. Further, reviewing each investment opportunity would create additional overhead, and there could be a problem with confidential company information being reviewed by the NMSBIC Board in meetings subject to the Open Meetings Act. For these reasons, Mr. Cummins said he did not believe this was an appropriate investment structure for NMSBIC.

Ms. Meyers moved to endorse Mr. Cummins’ recommendation that the NMSBIC not invest in Cottonwood Technology Fund II. Mr. Garcia seconded the motion, which passed unanimously by voice vote.

DRAFT NMSBIC RISK ANALYSIS

Review of the NMSBIC Risk Analysis was deferred to the January 21, 2013 strategic planning meeting.

STRATEGIC PLANNING MEETING: JANUARY 21 – PROPOSED AGENDA

The Board reviewed the proposed agenda for the strategic planning meeting and agreed to meet on January 21, 2013, from 9:00 am to 3:00 pm, which would include both a strategic planning session and the regular Board meeting.

CONFLICT OF INTEREST STATEMENTS: RANDY MCDONALD

Mr. McDonald said the NMSBIC Conflict of Interest Policy and Certificates of Compliance were emailed to individual Board members for their signature and that as of the meeting, he had obtained signed Certificates of Compliance from all Board members.

CHAIRMAN’S COMMENTS

Mr. Smith commended Chairman Badal and Mr. Cummins for their excellent presentation before the Investments & Pensions Oversight Committee in November.

Chairman Badal thanked Mr. Cummins for doing an excellent job of representing the NMSBIC since May, 2012.

Chairman Badal encouraged Board members to attend at least one of the annual meetings of the NMSBIC’s equity partners, as they are very informative and interesting.

ADJOURNMENT

Its business completed, the NMSBIC Board adjourned the meeting at 11:45 a.m.