Minutes of the Regular Meeting of NMSBIC, October 15, 2012

A regular meeting of the New Mexico Small Business Investment Corporation was called to order on this date at 8:00 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
Mr. Alan Fowler, Secretary/Treasurer
Ms. Roxanna Meyers, Vice Chair
Mr. Clarence L. Smith [designee of Hon. James Lewis, State Treasurer] [by telephone: signed off 9:30]
Ms. Launa Waller [by telephone]

Members Excused: Mr. Lupe Garcia

Financial Advisor to Board: Mr. Russell Cummins

Legal Counsel to Board: Mr. Randall McDonald

Contract CFO: Ms. Dee Brescia

Recording Secretary: Ms. Judith Beatty

Guests Present:
Mr. Brad Steward, Pulakos CPAs
Mr. Jake Dopson, Pulakos CPAs
Mr. Jarred Cobb, Observer

REVIEW AND ACCEPTANCE OF AGENDA

Two amendments were made:

10:55 – remove Judith Beatty from contract renewals.
11:10 – postpone New Mexico Community Capital presentation to next meeting

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

REVIEW AND ACCEPTANCE OF BOARD MINUTES: August 13, 2012

Ms. Meyers moved approval of the August 13 Minutes, as submitted. Mr. Cobb seconded the motion, which passed unanimously by voice vote.

ACCEPTANCE OF AUGUST AND SEPTEMBER FINANCIAL REPORTS

Mr. Cummins reported that, while reviewing New Mexico Community Capital’s August Advisory Committee meeting minutes, he noticed that all of the Q2 investment valuations were not consistent with the financial statements they issued to NMSBIC. He contacted their accountant, who then backdated the Q2 valuations to June 30 and reissued the financial statements. He said the valuation for NMCC had dropped by $621,000 as of June 30, and all of the subsequent financial statements for NMSBIC – July, August and September – have been revised.

Mr. Cummins stated that, because NMSBIC’s audit was already in process, the -$621,000 is reflected in the audited financial statements as an audit adjustment. He said this amount reflects write-downs of two investments in the NMCC portfolio.

Mr. Cummins said NMCC posts their valuations with a lag each quarter and then trues up at the end of their fiscal year, which for them is December 30 (versus NMSBIC’s June 30 fiscal year end), so they would have posted their Q2 valuations in August.

Mr. Cobb stressed the importance of issuing accurate annual reports and asked Mr. Cummins to remind NMCC, along with all of the other equity partners, of the need for NMSBIC to have accurate numbers for its year-end reporting.

Mr. Cummins stated that the only other item of note is the line item for accounting fees in the September financials is higher than usual because of Pulakos’ audit fee ($24,000).

Mr. Cobb moved approval of the August and September financial statements. Mr. Fowler seconded the motion, which passed unanimously by voice vote.

AUDITED FINANCIAL STATEMENTS

• Presentation from Pulakos CPAs
• Review and Acceptance

Pulakos Audit Partner Brad Steward and Pulakos Audit Senior Manager Jake Dopson introduced themselves to the Board.

In light of recent concerns about audit reports issued by the New Mexico Finance Authority, Mr. Fowler asked what the NMSBIC might do to provide assurances to legislators and others that its own audit process is transparent and above board.

Board members agreed that, after Mr. Badal delivers the NMSBIC annual report to the Governor and Legislative Finance Committee, Pulakos CPAs will independently mail the financial statements with a cover letter to the Governor and the Legislative Finance Committee.

Chairman Badal asked if Pulakos is aware of any conflicts of interest between any members of the NMSBIC Board or any of the NMSBIC’s contractors with the Pulakos firm. Mr. Steward responded that Pulakos has not done any work for any of the Board members nor with any of the NMSBIC equity partners, but has done work for companies in the portfolios of NMSBIC’s equity partners. He added that, because this is so far down in the audit chain, it hasn’t changed any of Pulakos’ procedures with the NMSBIC nor the equity partners in question.

Mr. Dopson presented an audit overview. He noted no instances of fraud, opinion shopping or improper activity during the audit, and that the NMSBIC received an unqualified clean opinion.

Board members asked for more detail in the Notes to Financial Statements on the New Mexico Mezzanine Fund, highlighting that changes were made to the agreement when it was renewed, and also to differentiate between the terms of the cooperative agreements with Accion and The Loan Fund, which are very different. Ms. Meyers noted that the Board had made changes to the loan agreements to mitigate risk for the NMSBIC.

Chairman Badal commented to Pulakos that the NMSBIC is in discussions with its lending partners about making additional adjustments to the agreements in order to provide better protections to the NMSBIC. He said footnoting those changes in next year’s audit would be helpful.

Ms. Meyers asked Mr. Cummins to find out which companies in the underlying portfolios of NMSBIC’s private equity partners have not had audits completed.

Mr. Cobb cautioned that some of these companies are startups or small shops that cannot bear the cost of an audit.

Mr. Steward said Pulakos does not have a recommendation with respect to auditing underlying companies. He noted that, in addition to independent people accounting for all of the transactions, there is also NMSBIC oversight, such as the reading of the minutes of the advisory committee meetings.

Chairman Badal asked Pulakos to make this clear in a letter to the NMSBIC. Mr. Steward agreed to have Pulakos issue a “no material weakness letter.”

Mr. Fowler moved approval of the audit subject to the changes discussed today, and subject to the procedures discussed in sending the audit/annual report to the Governor and LFC. Mr. Cobb seconded the motion, which passed unanimously by voice vote.

NMSBIC ANNUAL REPORT

Mr. Cummins presented a draft of the NMSBIC annual report, to be delivered to the Governor and LFC. He said this year’s annual report includes a cover letter and will have, as attachments, a report and the audited financial statements. He added that he received very helpful suggestions from Mr. McDonald.

Board members made suggestions for changes, including adding language saying that the NMSBIC made changes to its lending agreements to enhance its position relative to risk; adding a “Board Activities” section mentioning conferences, meetings and events attended by Board members; including a statement about how the economic environment has impacted the NMSBIC over the past few years; and discussing key takeaways from the Board retreat.

Board members also suggested adding a concluding paragraph about the NMSBIC’s strategy going forward. This would include bringing the significant amount of equity exposure the NMSBIC has more in balance with the lending side.

Ms. Meyers moved for approval of the Annual Report, with the changes, as discussed, and as approved by Chairman Badal. Mr. Fowler seconded the motion, which passed unanimously by voice vote.

[Break.]

EXECUTIVE DIRECTOR/INVESTMENT ADVISOR REPORT

Accion

Mr. Cummins reported that he met with Accion COO Rob Boosman and CFO Greg Henderson on August 18, and had a productive discussion about changing their existing participation agreement to a revolving line of credit and what the terms and covenants might be. He said he suggested, subject to NMSBIC Board approval, that Accion and the NMSBIC could agree to terminate the existing participation agreement, allowing the existing loans to stay in place and run off, and that a new $3.5 million secured line of credit could be put in place, with the amount available for funding reduced by the outstanding balance under the current participation agreement. As the participations are paid down, the amount available on the line of credit would increase.

Mr. Cummins said he also discussed having Accion make a blanket pledge as additional collateral. Accion instead suggested they provide over-collateralization of 125%. Mr. Cummins said he suggested limiting the loan size, but Accion felt that would be a problem for them, especially with 125% over-collateralization, as it would exclude too much of their balance sheet.

Mr. Cummins said Accion noted that their other bank lines of credit and bank loans are for outside of the state of New Mexico, and that the NMSBIC is their only source of funding for loans in New Mexico.

Mr. Cummins said he suggested removing the smaller loans from collateral, and Accion expressed concern that they could run out of collateral if the smaller loans aren’t included.

Chairman Badal noted the Board’s concerns about Accion’s ability to underwrite their larger loans. Chairman Badal said he feels Mr. Cummins has alerted Accion to the Board’s concerns about their 7% historical loan loss experience and that the Board is looking for less risk and more responsible underwriting on Accion’s part.

Mr. Cummins stated that, under the proposed change, Accion would make all of the underwriting decisions and would be responsible for all of the losses. Right now, Accion has full authority to make underwriting decisions and the NMSBIC takes 75% of the losses.

Ms. Meyers discussed her experience and concerns in meeting with Accion about their lending process. She suggested that Mr. Cummins and Ms. Meyers meet with Accion Director Anne Haines Yatskowitz and discuss ways of achieving better efficiencies in processing loans.

Asked by the Chair to comment, Mr. Cummins stated that Accion is making loans with looser underwriting standards than a bank would make, but that is part of their mission, and they also do an outstanding job at bringing in contributions to support their operations. He questioned whether it is the NMSBIC’s role to step in and assist Accion as suggested, and also suggested we should take comfort from the fact that the NMSBIC will be taking steps to protect itself and shift more responsibility and risk to Accion under a proposed new agreement with the NMSBIC.

Mr. Cobb stressed that Accion is the only microlender of its kind in the state, and he hopes there is philosophical agreement among the Board members that Accion plays an important role for the NMSBIC and for entrepreneurs in New Mexico. He cited the fact that the NMCDLF is an improved organization because of changes the NMSBIC made in its agreement with them, so offering such assistance without directly micromanaging can indeed produce greater efficiencies.

Chairman Badal agreed with Mr. Cobb’s point and recommended that Mr. Cummins’ and Ms. Meyers’ meeting with Accion include raising the point that the NMSBIC was able to strengthen the NMCDLF’s loan program through changes to the covenants in its agreement with the NMSBIC.

Ms. Meyers agreed with Mr. Cobb and the Chair, but reiterated her concern about the need for increased efficiencies within the Accion organization, given that this is taxpayer money and that necessitates responsible lending and investment standards.

Mr. Fowler wondered if there are benchmarks in microlending that can be referred to.

Chairman Badal asked Mr. Cummins what the typical loss experience of New Mexico banks is, as compared to Accion’s 7% loan loss, and Mr. Cummins responded that it has been 0.75% over the last three years.

Mr. Cobb said it would be useful to know how a 7% loan loss compares in the microlending world.

Mr. Cummins noted that, if one were to apply the Prudent Investor Rule, which balances yield with diversification and safety, a 7% loan loss would necessitate a 7+% interest rate on loans from NMSBIC to Accion.

Mr. Cobb said that rate raises the question of whether Accion would be able to efficiently deliver capital to New Mexico businesses. If it can’t, then the NMSBIC is not complying with the legislative intent of the Small Business Investment Act. He agreed that, while the Act does not say anywhere that it is acceptable to lose money, the NMSBIC cannot realistically move forward with the guarantee that it will never lose money in a lending or equity relationship.

Ms. Meyers and Mr. Cummins said they would meet with Ms. Yatskowitz to discuss their concerns and get feedback from her on the NMSBIC’s proposal to create a $3.5 million secured line of credit with Accion.

Ms. Meyers asked Mr. Cummins to follow up on Mr. Fowler’s question about whether there are organizations similar to Accion in the U.S. and, if so, to request their financial statements so they can be benchmarked.

Flywheel Ventures

Mr. Cummins reported that he met with Kim Sanchez Rael, General Partner of Flywheel Ventures, who discussed the idea of establishing a “Dorm Fund” within the NM Gap Fund. He said the NM Gap Fund date for new investments ends on December 31, 2012, and since Ms. Sanchez Rael does not feel she could put the Dorm Fund in place by that date, she is considering approaching the NMSBIC Board and asking for an extension. He said the idea behind the Dorm Fund would be to set aside roughly $50,000 for investments in businesses started by college students, with the NM Gap Fund investing about $5,000 in each of ten different companies.

Mr. Cummins stated that The Gap Fund cannot make any more capital calls because they have drawn all of their money, but they have about $500,000 on their balance sheet.

Mr. Cobb said he was not present at the meeting when the NMSBIC Board approved The Gap Fund, but with the NMSBIC’s 97% exposure, he did not feel they had enough skin in the game.

Ms. Meyers asked Mr. Cummins to prepare a spreadsheet of each of the NMSBIC’s funds, with the underlying companies’ equity from NMSBIC, how much has been deployed, the net balance, and a summary of the agreement the funds have with the NMSBIC.

Mr. Cummins said Ms. Sanchez Rael did not have a specific proposal when he met with her. The money on The Gap Fund balance sheet can be used for new investments through December 31, 2012, and for follow-on investments and to pay fund expenses, such as for audits.

Mr. Cummins said he told Ms. Sanchez Rael he would present her Dorm Fund idea to the Board and would report back to her on the Board’s thoughts about it.

Mr. McDonald stated that Ms. Sanchez Rael is essentially asking for an extension of time to make more investments for a total of up to $50,000.

Chairman Badal noted that NM Gap Fund has $2 million committed with $2 million funded, and a value of $1.2 million (which includes the $500,000 in cash).

Mr. Cobb commented that, if the Board is going to start looking at how it needs to preserve the corpus of the NMSBIC Fund, it has to start looking at how much skin in the game its equity partners have going forward; and as it amends and evolves its relationships with them, that needs to be a key component.

Mr. Cummins said Ms. Sanchez Rael reported that NM Gap Fund invested $200,000 in Cinnafilm earlier this year, which was structured as a loan, and she expects it to be paid back in 18 months. Cinnafilm is an established business and needed some additional working capital. He said she also expects to use most of the $500,000 left on the balance sheet before the end of 2012 to make a couple of investments in the form of loans.

Mr. Cobb recalled that the concept behind the NM Gap Fund, when presented to the NMSBIC Board, was to provide startup money to entrepreneurs. He said he was never under the impression that they were going to lend money to existing businesses that need additional working capital.

Board members agreed that they were not comfortable with extending the term of the NM Gap Fund given the 97% exposure the NMSBIC has in the Fund as well as the investment results of the NM Gap Fund to date.

New Mexico Mezzanine Partners

Mr. Cummins reported that NMMP contacted him in September, between NMSBIC Board meetings, and said they were asking the Advisory Committee members (which includes Mr. Cummins) to vote on two items: (1) to expand the Investment Committee to four persons from three and add Lynn Carrozza as the fourth member; and (2) to extend the fund life an additional year to September 25, 2015. Mr. Cummins explained that NMMP was planning to issue a loan commitment letter to a potential borrower for a $1.2 million loan with a 3-year maturity date, and General Partner Mike Doolittle did not believe it would be appropriate to issue a commitment letter for a loan that matures after the fund end date.

Mr. Cummins said he contacted Chairman Badal and Mr. McDonald to discuss his authority to vote on the two items, and, with input from Messrs. Badal and McDonald, subsequently abstained from the vote, with the other four members of the Advisory Committee voting in favor. He said he advised NMMP that he would provide them with any feedback on the Board’s position regarding the changes. Mr. Cummins said he personally feels these two changes were appropriate, noting that the NMSBIC has extended the life of the fund for new investments, and NMMP in this case is trying to make new investments.

Mr. Cummins stated that the extension granted earlier this year (the first of two extensions allowed) was to give them additional time to make new investments, so this would be the second. He said the existing agreement states that their fund ends September 25, 2013, at which time they must have all of their investments wound up and paid off, so these two extensions would extend that date to September 25, 2015.

Mr. Fowler moved to ratify the changes made by the NMMP Advisory Committee. Mr. Cobb seconded the motion, which passed unanimously by voice vote.

NMCDLF – RECOMMENDED CHANGES TO LOAN AGREEMENT

Mr. Cummins reported that he and Chairman Badal met with the NMCDLF to discuss the proposed changes to the loan agreement, with the following results:

1. NMCDLF’s request to increase loan limit per borrower from $350,000 to $500,000.
• No change recommended at this time.
2. NMCDLF shall make commercially reasonable efforts to ensure to ensure that a majority at least 30% of NMSBIC loans are made to borrowers outside of Albuquerque metro area.
• This change is reasonable given NMSBIC’s desire to have NMCDLF increase other sources of funding, and USDA funding is primarily intended to be deployed outside the Albuquerque metro area.
3. NMCDLF shall maintain the NMSBIC’s portfolio so that it does not include any loans that have been charged off or which are 180 120 days or more in default.
4. NMCDLF shall maintain the NMSBIC’s portfolio so that it does not include any loans that have been amended or restructured more than once within any 12-month period.
5. NMCDLF shall maintain at least 10% of its total assets in the form of cash or equivalents. Borrower shall maintain 10% of the NMSBIC committed loan amount in unrestricted cash.
6. Borrower shall have or maintain a ratio of total liabilities to unrestricted assets greater than 10 to 1.
• NMCDLF requested that this covenant be removed. NMSBIC recommended no change, as it is prudent to have a leverage covenant, which was acceptable to NMCDLF.
7. Borrower shall maintain the NMSBIC additional collateral portfolio, which shall consist of loans with outstanding balances at least equal to 5% of the value of all NMSBIC loans. Borrower shall create and maintain the NMSBIC Additional Collateral Portfolio as a separate loan portfolio.
• It was suggested to NMCDLF that over-collateralization and the cash control account both be replaced with a blanket pledge agreement or, alternatively, a first lien on its headquarters building. These suggestions were not acceptable to NMCDLF, which would like the Board to consider removing one or both of the additional collateral requirements. No change is recommended at this time by NMSBIC. NMCDLF agreed to no change at this time but would like to continue discussion.
8. Borrower shall maintain a Control Account… an amount that… is at least equal to or greater than 105% of all amounts owed by Borrower to Lender.
• NMCDLF requested we remove this covenant. See #7 above.
9. Loans made by Borrower under Agreement shall not exceed 70% of total of all outstanding loans made by Borrower.
• NMCDLF requested that this covenant be removed. NMSBIC recommended no change, as it would like to encourage NMCDLF to continue to work to diversify its sources of funds. This is acceptable to NMCDLF.
10. Quarterly cash calls and quarterly reporting.
• NMCDLF requested that cash calls be changed to monthly and to continue quarterly reporting. While a change to monthly cash calls is acceptable, it would also require a change to monthly reporting for proper reconciliation and review controls. NMCDLF is not prepared to change to monthly reporting, however, so NMSBIC recommends no change. This is acceptable to NMCDLF.
11. The loan delinquency percentage for loans 90 days or more delinquent shall not exceed 5.0%.
• NMSBIC proposes this as a new covenant. NMCDLF agrees to this change, as it is consistent with their internal policy.
12. NMCDLF made a supplemental request that the NMSBIC either give them a $100,000 grant or else reduce their rate on their line of credit from 2.5% to 2.0% for a three-year period. Either alternative would give them additional funding to allow them additional working capital to hire more lending staff.
• NMSBIC recommended reducing the interest rate to 2.0% for two years. This is acceptable to NMCDLF.

Mr. Cummins stated that NMCDLF currently has $7 million in loans outstanding, so the half percent reduction in the interest rate would amount to about $35,000 less interest income to the NMSBIC. However, this will hopefully be offset over time with increased loan volume.

Ms. Meyers moved approval of these recommendations, as presented, and to authorize preparation of documents for Chairman Badal’s signature. Mr. Fowler seconded the motion, which passed unanimously by voice vote.

CONTRACT RENEWALS: DEE BRESCIA, RANDALL MCDONALD, FINANCE NM, WEBSITE (HOLLY CO.)

Mr. Cummins recommended approval of one-year contracts with the following independent contractors, and approval for the Chairman and President to be authorized to execute contracts on behalf of the NMSBIC:

1. Brescia Consulting, LLC, for accounting services: $128/hour plus NMGRT.
2. Randall McDonald, attorney, for legal services: $198/hour plus NMGRT.
3. Holly Company, Finance NM: $17,500 annually, plus NMGRT ( paid quarterly; down from $36,000/year).
4. Holly Company, for NMSBIC website: $2,000 annually, plus NMGRT (paid annually, up from $1,800/year)

Ms. Meyers so moved. Mr. Cobb seconded the motion, which passed unanimously by voice vote.

BOARD DISCUSSION RE: PLANNING FOR END OF FUND LIVES

Chairman Badal said discussion on this issue may need to take place during a strategic planning session.

Chairman Badal stated that some of his concerns include what happens when the equity funds reach their termination dates and what happens to the assets within those funds.

CHAIRMAN’S COMMENTS

Chairman Badal reported that he and Mr. Cummins attended an extensive number of meetings this month, including the Sandia Corporation’s research meeting, which was very informative.

Chairman Badal stated that the new Board has been in place for about 18 months, and complimented the members for the work they have done and the thought they have put into the NMSBIC’s mission and processes. He commented, “We’ve been whipsawed by macroeconomic events we had no control over, and I know it has been a very, very difficult period of time.”

Board members agreed to hold a strategic meeting in January prior to the January 20 legislative session.

[Ms. Meyers excused herself from the proceedings.]

Mr. Cobb stated that Midcontinent Business Unit/Chevron North America has purchased Chesapeake Energy’s assets in the Delaware Basin portion of the Permian Basin for $6.9 billion, and intends to spend $1 billion in the next fiscal year on exploration within 50 miles of Hobbs. He said he is proposing that the Hobbs City Commission approve a public-private partnership for a multifamily housing plan; and, if approved, there may be some opportunities around some of the discussion the NMSBIC had at its August retreat in Hobbs. His hope is that the NMSBIC will consider ways it can partner in some activities taking place in Hobbs.

Mr. Cobb also reported that the LES (Louisiana Energy Services) board has informally agreed to spend another $978 million on more cascade halls for the nuclear enrichment project.

PRESENTATION TO PAUL GOBLET

Chairman Badal presented Mr. Goblet with a plaque, thanking him for his “visionary leadership, passion and service as Investment Advisor to the New Mexico Small Business Investment Corporation from 2001 to 2012.”

ADJOURNMENT

Its business completed, the NMSBIC Board adjourned the meeting at 11:30 a.m.