New rules have been enacted to give so-called community development financial institutions in the United States greater power to draw on a wider range of capital allocators, including family offices and banks.
The author of this article says the U.S. Treasury Department’s rule overhaul will change how community development financial institutions expand across the U.S. and how investors can earn competitive returns. The author is Burnell Hall, president and CEO of New Jersey Community Capital. (Learn more about the author below.) Hall asks why asset managers overlook CDFIs and explains how to change that. The editors share these insights and welcome reader response. Guest writer opinions are subject to the usual disclaimers. Email: tom.burroughes@wealthbriefing.com
New Treasury Department regulations finalized late last year allow certified community development financial institutions (CDFIs) to expand their service areas, adapt to changes in the banking industry, and increase financial inclusion through small loans, finally allowing them to penetrate the lending market.
These changes not only strengthen the core objectives of the Community Reinvestment Act, but also open new avenues for CDFI lenders to serve more communities and attract and leverage more capital from a broader range of allocators, including institutional investors, family offices, and banks.
This is a groundbreaking opportunity for CDFIs, allowing them to scale their efforts nationwide, increase assets under management, and most importantly, expand their positive socio-economic impact in underserved and under-resourced communities. It is an equally groundbreaking opportunity for lenders and investors looking to align financial returns with social impact.
Unique Vehicles
CDFIs are federally chartered financial institutions established under the Riegle Community Development and Regulatory Improvement Act of 1994. There are four different types of CDFIs, but all share a common mission: to “foster economic opportunity and revitalize communities.”
That puts them in a unique position to bridge the gap between undercapitalized communities and the essential resources they need to thrive, putting loans where it matters: 85% of their funding goes to low-income communities, 66% to minorities, 48% to women, and 27% to rural areas, according to a 2022 Opportunity Finance Network study. They’re also resourceful lenders, “leveraging $8 in private sector investment for every dollar of public financing,” as Treasury Secretary Janet Yellen noted.
After all, CDFIs are more than just lenders. They are true partners in community development, operating with a deep understanding of the unique challenges and needs of the under-resourced and under-capitalized communities they serve. They build affordable housing, finance community facilities and infrastructure projects that can revitalize distressed neighborhoods, and provide funding to local businesses that create jobs and support local economies. By providing services like financial education and technical assistance in addition to traditional financial services, CDFIs build the foundation for sustainable growth.
This multi-pronged approach is essential to address systemic barriers to economic participation and foster equitable growth. It is also especially important in communities and neighborhoods that traditional banks have deemed too risky or unprofitable. In this way, CDFIs play a critical role in revitalizing economically fragile markets and diverse communities that have suffered from decades of underinvestment.
New Framework
The announcement of the new CDFI rules coincides with a multiyear period of significant growth for these mission-based lending institutions: The Federal Reserve Bank of New York reports that over the past five years, the number of certified CDFIs has increased by 40%, and their total assets under management have nearly tripled, reaching about $452 billion by early 2023. The new rules are intended to encourage more sophisticated and larger-scale operations by CDFIs.
The new regulations give CDFIs more flexibility to expand their operations and create greater impact than ever before. The most significant change concerns the “target markets” CDFIs serve. For decades, CDFI lenders have been limited to serving geographically designated “eligible areas,” limiting their ability to expand services to other communities. The latest revisions to the CDFI Certification Rules give CDFIs much more flexibility, including the ability to define target markets that cover eligible areas across multiple states and the nation.
But the new rules are more than just a logistical change: They are a strategic expansion of CDFIs’ mission, enabling these institutions to address economic disparities more dynamically and effectively and develop new strategies to meet the changing needs of these communities. The roughly 20-25 CDFIs are poised to benefit greatly from these changes with their mature infrastructure and access to capital markets, but there is also growth potential for smaller CDFIs with upcoming rule changes that encourage CDFIs to achieve unprecedented scale.
Another important regulatory change is the new rules that allow CDFI funds and banks to put more capital into equity investments in communities to meet CRA requirements. The new framework allows CDFIs to offer more than just loans; they can now make direct equity and venture capital investments. This important change gives CDFIs more freedom to support small businesses and startups in historically marginalized communities. Diverse and minority small business owners often lack the intergenerational wealth and networks available to those who are more affluent. By investing directly in community businesses, CDFIs have the opportunity to transform the economic landscape for many of these underrepresented entrepreneurs.
Why Investors Overlook CDFIs
For asset managers, institutional investors, and family offices, CDFIs offer both measurable social returns and competitive financial returns. Their dual social and financial impact also aligns with investors’ growing desire for sustainable and responsible investments. Yet, despite the important role CDFIs play in promoting economic inclusion, they have been overlooked by traditional investors and asset managers.
Many asset managers are completely unaware of CDFIs’ existence, and those who do know about them often dismiss them as mission-driven lenders that don’t care about financial performance. This is an unfortunate misconception. Analysis by CNote, a women-led impact investing platform, points out that CDFIs can create social value while delivering competitive financial returns.
Morgan Stanley noted that sustainable investments such as CDFIs can improve portfolio stability during times of financial stress. For example, CDFIs were recognized for their strong portfolio performance during the COVID-19 pandemic, with CDFI lending funds emerging from the pandemic with stronger capital structures than ever before.
Investors often fail to recognize the sophisticated financial operations that underpin successful CDFIs, which have expanded their capabilities in recent years as their assets under management have grown. Today, the top CDFIs employ skilled financial analysts, apply sophisticated investment tools, and maintain the same operational and financial due diligence standards that institutional investors expect from asset managers.
The CDFI industry’s increasing sophistication and ability to manage large amounts of assets make it an attractive case for impact-oriented investors, and the pool of institutional capital is also expanding: JPMorgan, for example, has allocated more than $2 billion to CDFIs since their inception and continues to increase its commitment.
A Call to Capital Allocators
CDFIs offer many attractive benefits to investors, including diversified portfolios that mitigate risk through strong balance sheets and deep community involvement. Institutional investors are increasingly recognizing CDFIs’ focus on sustainable, purpose-driven investing as a powerful vehicle for enhancing investors’ dual win-win effect of creating social value while delivering competitive financial results.
CDFIs are also adept at deal origination, offering investors a unique avenue to deploy capital in overlooked but emerging markets that deliver both tangible social benefit and competitive financial returns. Leveraging their deep community ties and economic development expertise, CDFIs are able to discover and seize investment opportunities that would otherwise be overlooked. Additionally, CDFIs’ broad range of investment opportunities allows investors to participate in meaningful projects that align with their values ​​and investment goals.
The call to the investment community is clear: by channeling capital to CDFIs, investors can play a vital role in shaping a more inclusive and equitable economy and earn competitive financial returns.
About the Author
Over the past 25 years, the author has executed over $5 billion in real estate investment, financing, and disposition transactions for multifamily, retail, office, and hotel properties in 36 states across the U.S. A former investment banker, public housing executive, and real estate finance professor, Bernel Hall is an expert on large, multi-faceted public-private real estate transactions, small business transactions, and executive leadership.
