By Paige Chapel, President & CEO, Aeris
Most banks recognize that their enterprises can only thrive if their customers also do. And to thrive, those customers need economically diverse and healthy communities in which to live and work. Partnering with local organizations to promote the health of those communities is often a top priority for banks.
Community Development Financial Institution (CDFI) loan funds help to promote healthy communities by providing early-stage credit, capital, and financial services to small businesses, affordable housing and community facilities developers, community organizations, and other types of borrowers. Most commonly structured as revolving loan funds, CDFIs intermediate capital between investors and underserved U.S. communities where capital tends to be scarce. Banks have historically been—and continue to be—a primary capital source for CDFIs.
In part because these loan funds work closely with the communities they serve, many banks partner with CDFIs to pursue community reinvestment, including the type of activity mandated by the Community Reinvestment Act (CRA). CDFIs are attractive partners to banks in part because of their long, 30-plus-year track record of managing capital, with few examples of investor losses.
A bank will typically provide debt to a CDFI that is active in the bank’s CRA Assessment Area. Terms range broadly based on the interests of the bank and the activities and needs of the CDFI—from short term operating lines of credit to long term loans that support a CDFI’s lending to affordable housing and community facilities developers, for example. Some banks also offer CDFIs equity equivalent investments (“EQ2”) with extremely favorable terms that enable the bank to claim an enhanced CRA credit.
In addition to providing loan capital, bankers partner with CDFIs in other ways, including serving on boards of directors or occasionally by providing back office services.
Banks will sometimes refer their customers to CDFIs for financing when a loan applicant is not a good fit for a bank. In Santa Clara, a Bank of the West loan officer introduced a local hair salon owner to Opportunity Fund, a California CDFI, resulting in a $25,000 loan. In this instance, the bank retained a loyal deposit customer, Opportunity Fund gained a new borrower, and the salon continued to employ more than a dozen people. “I'm loyal to people who are good to me. That's why I work with my bank, and why I was happy to work with Opportunity Fund,” Sandra, the business owner, said of the relationship.
Many banks with charitable giving programs also provide grants to CDFIs, which are most commonly organized as nonprofit corporations. CDFIs use grant dollars to leverage additional debt and expand their lending activity. Most CDFIs are high-touch lenders, and many have technical assistance and financial education programs for borrowers and community members that are sometimes grant-supported. Banks may claim additional CRA credit for grants under the CRA Investment Test. In short, the number of variations on bank-CDFI partnerships are numerous and worthy of exploration.
Banks and CDFIs will also frequently co-invest in projects. In New Orleans, Philadelphia-based CDFI, Reinvestment Fund, provided financing that is helping turn a vacant 10-story building into workforce affordable housing, retail space, and a federally qualified health center. Banks are important partners in the transaction, with US Bank and Iberia Bank serving as financing partners in the deal.
There are several resources available to help banks find CDFIs that operate in their Assessment Areas. Opportunity Finance Network, the national network of CDFIs, and the CDFI Fund at the U.S. Department of the Treasury both maintain lists of CDFIs by geography. Aeris maintains a sortable database of CDFIs that have completed our rating process and/or whose data is available to investors in our database, which is akin to the FDIC’s call reports. From the Aeris CDFI Selector, users can download free Fact Sheets with high-level performance data, while Aeris’ rating reports and data tools provide more in-depth information that dozens of banks around the country use to support their own due diligence. Another resource is the National Interagency Community Reinvestment Conference, which is organized by the Federal Reserve Bank of San Francisco and can be an additional source of information and ideas for bank-CDFI partnerships.
A glimpse at the performance indicators and metrics in Aeris rating reports and analytic tools highlight the key risks and mitigants that CDFI investors typically keep their eye on when underwriting a loan or investment to a CDFI. These include: portfolio quality and asset management practices, capital structure and net worth protection, earnings history and composition, liquidity strength, and management and governance capabilities—the same criteria banks use to underwrite most borrowers, but with a focus on the unique characteristics of CDFIs.
Some of the most effective partnerships between banks and CDFIs arise when the partners recognize the unique value each brings to the table. Although CDFIs and banks are in similar businesses, the past decades have shown that the relationship between the two has been a success story in serving hard-to-reach borrowers in America’s redeveloping communities.
This post is provided solely for information purposes and should not be considered investment advice, nor should it be construed as an endorsement by Aeris of any product or provider.
Aeris has provided ratings, data and consulting that support investment in community development financial institutions (CDFIs) since 2004.