The banking bonanza

On a frigid day in February, more than 200 people packed into a ballroom inside the Roosevelt Hotel in Midtown Manhattan — all there to hear about the latest regulatory issues and new legislative proposals reshaping the EB-5 market.

But perhaps more telling than the day’s agenda was the event organizer: the California-based NES Financial. The financial services firm — one of the biggest, if not the biggest, player in EB-5 banking in the country — didn’t even exist until 2005.

While much has been written about the post-recession popularity of the EB-5 program — which offers foreign investors green cards and potential citizenship in exchange for cash investments in the U.S. — less has been written about how it has quietly become a profit center for banks and their various financial partners.

In the last year, a number of financial institutions have edged into the EB-5 space, finding ways to capitalize on the maze-like path that EB-5 capital takes en route to developers’ coffers.

Put simply, the collective cash raised — each investor is required to kick in a minimum of $500,000 — can add up, giving the banks more money to make loans against and generate revenue from. Banks also view it as a way to land lucrative additional work from developers and even investors.

Also, despite the high stakes (the program generates billions of dollars every year) there are few rules governing how capital must be handled in the EB-5 ecosystem.

Until recently, Congress seemed virtually unaware of the open secret that everyone in the industry knows.

“The shocking thing to me, coming from private equity, is there’s no rules around the governance of this money. Zero rules,” said Bonnie Novella, vice president of business development at NES and a former executive at JPMorgan Chase. “There’s many billions of capital that are not being governed.”

Big money, big stakes

Given the amount of capital in play, it’s no wonder that more financial firms are turning their attention to EB-5.

NES estimates that $2 billion to $3 billion in EB-5 capital is raised each year nationally, with a big chunk of that coming from development projects in New York and California.

Yonkers, N.Y.-based Sterling National Bank got into the EB-5 business about a year ago, partly because bank executives hoped it would open doors to more business with real estate developers, said David Bagatelle, president of the bank’s New York metro market.

“We love core, sticky deposits, which of course this generates,” he told The Real Deal, noting that it also fit with the firm’s business model.

Manhattan-based financial services company Greystone has also jumped into the EB-5 game — becoming the first such financial institution to offer soup-to-nuts services to developers.

Greystone’s group, which was formed last year, does everything from raise investor capital to manage EB-5 funds to issue construction loans on EB-5 projects. So far it’s lined up four projects looking for a total of $175 million in EB-5 money.

Justin Gardinier, a former managing director at Greystone and head of the EB-5 group, said the company offers investors an “institutional quality intermediary” to handle their money, since there’s no way to validate a regional center’s ability to raise money. (Developers generally rely on regional centers — the middlemen between investors and developers — as well as banks to raise and manage their EB-5 financing.)

“Very few of them actually have any kind of track record,” he said.

Attorney Gary Friedland, who teamed up with NYU professor Jeanne Calderon to write a research paper on EB-5 finance, called Greystone’s entry into the EB-5 space “significant,” since the firm can handle issues regional centers typically cannot. “For example, they can provide or arrange bridge capital, [and] provide development and construction expertise,” he said. “This can prove especially valuable if we encounter a down cycle.”

Dual channels

Broadly speaking, banks have fashioned two distinct lines of business related to EB-5: administering escrow accounts that hold investor capital and providing bridge loans to developers to tide them over until that EB-5 capital is available.

Holding funds in escrow is not technically required by U.S. Citizenship and Immigration Services, the agency that oversees the EB-5 program. But it’s emerged as a way to reduce risk for both investors and developers.

“If the USCIS doesn’t bless the project, there’s a chance that every dollar collected has to be refunded,” said NES’s Novella.

Similarly, if an immigrant’s green card petition is denied, the project’s sponsor must refund the investor’s money. “If [a developer] raised $30 million and started pouring concrete, where is that money coming from?” Novella said. “That’s a worst-case scenario.”

Servicing these escrow accounts and tracking investor funds for developers and regional centers has created an enormous business opportunity.

NES, for one, has seized on that opportunity. The San Jose-based company was founded in 2005, at first focusing on 1031 exchanges and later applying a proprietary tech platform to EB-5, which provides real-time information to stakeholders.

Between 2010 and 2015, NES said its EB-5 business grew a massive 71 percent, to include 450 projects and $20 billion worth of investor capital.

Novella said the company — which employs 60 CPAs, banking experts and USCIS experts —touches between 40 percent and 50 percent of the EB-5 funds raised nationwide. While it’s not a bank itself, NES has seven banking partners that it feeds business to, including New York-based Signature Bank, SunTrust, Citibank and BankUnited.

Legitimizing EB-5 banking

Given the amount of money at stake, NES — along with Signature Bank and others — signed a letter last year urging Congress to reauthorize the EB-5 program.

The fact that banks are vying for EB-5 business is fueled in part by the U.S. Securities and Exchange Commission’s crackdown on fraud and improper practices in the EB-5 industry.

Still, Novella said, “ineptitude is a bigger problem than corruption.”

For years, regional centers acted as de facto (and unregulated) banks, according to Michael Gibson, the managing director of USAdvisors, a registered investment advisory firm that does due diligence work in the EB-5 world and maintains web portals including EB5projects.com and EB5Info.com. “They didn’t care what it took to raise capital,” he said.

That changed around 2013, when the SEC filed charges against a Chicago EB-5 promoter, Anshoo Sethi, who allegedly bilked 250 Chinese investors out of more than $145 million intended to finance a hotel and conference center in the Windy City.

The SEC’s subsequent surveillance didn’t just focus on the most egregious fraud cases, it thrust the entire EB-5 fundraising system under the microscope.

One (very unintended) consequence of those enforcement actions — along with the fact that it’s illegal to pay an unregistered financial agent for the sale of securities — has been the emergence of an offshore EB-5 financial system. That system has encouraged less scrupulous regional centers to pay U.S. attorneys and other unaccredited brokers for bringing them investors, even though they are not be registered agents. “These guys set up accounts in Hong Kong and the Caymans to avoid the SEC,” said Gibson.

At the NES conference, attorney Daniel Lundy, head of the compliance division at the law firm Klasko, called EB-5 a “game of ‘follow the money.’”

Novella added that EB-5 money can flow through as many as four bank accounts before reaching its intended recipient, the developer.

The SEC’s recent case against Flushing attorney Hui Feng, who was accused of pocketing $1.2 million in commissions after illegally raising EB-5 money in China, highlights how money hopscotches around the globe to get to, say, a developer in New York.

According to the SEC, Feng was not permitted to raise funds since he’s not a registered securities broker. Feng maintains he was providing legal services to EB-5 clients whose interest was investing the required amount to obtain a U.S. green card, and not necessarily profit.

Court documents allege that in 2014, Feng set up a Hong Kong entity called Atlantic Business Consulting Ltd. in order to accept payments from seven U.S. regional centers, including two in New York — Lam NYC EB-5 Regional Center and American Regional Center for Entrepreneurs.  “Under the request of the regional center, we have to give them a foreign entity or individuals for them to enter the [finder’s] agreement with and wire the funds to,” Feng told SEC investigators, according to a transcript of a December 2014 deposition.

One such agreement, with California-based American Dream Fund, named Feng’s mother-in-law as the beneficiary of a $30,000 finder’s fee for each investor referred to the regional center.

Asked during the deposition if the investors knew about the finder’s fee, Feng said, “There’s tons of information online about how the deals are done. So we just didn’t put it in writing in the contract that we are receiving these finder’s fees.”

At a February 2015 deposition, an SEC investigator asked Feng, “Did your wife’s mother know that her name had been placed on a finder’s fee agreement?”

“I couldn’t know,” he replied.

‘Bridging’ the backlog

For better or for worse, EB-5’s popularity has continued to grow since 2010, creating a backlog of investors.

With more than 17,000 pending EB-5 immigration applications, investors are now facing a roughly 16-month processing time for their immigration forms, which include the I-829 and the I-526, the latter of which needs to be approved before developers can access the capital.

This backlog has, not surprisingly, created another business opportunity.

To deal with it, banks are offering bridge loans to developers, who often need the cash injection to start or continue construction.

Citibank, for example, offers bridge loans to developers using EB-5 funds to develop in low-income communities. While Citi declined to comment, its marketing materials note that standard loans range from $20 million to $75 million.

Similarly, Signature Bank’s capital markets group has championed the use of municipal bonds to hold developers over until EB-5 investor capital comes through. The bank, which has $33.45 billion in assets, has handled $3.4 billion in EB-5 funds to date. Signature did not respond to multiple inquiries.

In Sterling’s case, the bank rolled out both escrow servicing and bridge lending as part of its EB-5 offerings. “That creates an opportunity for us as a bank,” said Ricky Fischer, who oversees the bank’s EB-5 group. He stressed that the bank provides interim financing only if the deal meets certain criteria.

“As a lender, there’s profit on the interest spread and whatever fees are generated. Functioning as an escrow agent, there’s deposit revenue generated,” said Fischer, adding that the bank evaluates projects based on a worst-case scenario in which the government does not approve the immigration petitions.

“The escrow can typically lead to crossover potential” in the form of future business with developers, he noted.

It’s not just banks getting in on the action. Mark Edward Partners, a New York- and Palm Beach-based firm, sells EB-5 insurance. For $10,000 per policy, it will repay $500,000 of investor capital if USCIS doesn’t approve the investor’s green card. “The longer [the backlog is], the better it is for our insurance product,” said company Vice President Marc DiFanti, one of the panelists at the NES conference.

The risk reality

EB-5 financing, of course, isn’t without risks to developers because there are relatively few rules on how money is raised. Still, Sterling’s Bagatelle said his bank is bound by regulations at the Federal Deposit Insurance Corp. and the Federal Reserve System. Chief among them are requirements imposed on the financial services industry in the wake of the World Trade Center attacks in 2001, which were strengthened by the Dodd-Frank Act.

“We’re required to understand not just who the [EB-5] clients are who are placing the funds but also the source of funds,” said Bagatelle, who declined to disclose the volume of Sterling’s EB-5 business.

At Sterling, money that comes into the bank undergoes a compliance review and sits in a collection account, where background checks are conducted in compliance with the Office of Foreign Assets Control and Patriot Act. If clean, the funds are put in escrow.

Overall, Sterling has $12 billion in assets, and Bagatelle projected EB-5 would be material to its bottom line. Down the line, he estimated EB-5 could account for “hundreds of millions” of dollars in business. “With that being said, we’re not putting all our eggs [in one basket]. It’s not 50 percent of our balance sheet or even 10 percent,” he said.

http://therealdeal.com/issues_articles/the-banking-bonanza/

Mentions

• NES Financial
• UNITED STATES SECURITIES AND EXCHANGE COMMISSION
• U.S. Citizenship and Immigration Services
• USAdvisors
• Michael Gibson
• Hui Feng