We are in the midst of a period of intense and frustrating contradictions
for our country in general and for community finance. Just take these examples:
- In an
economy built on and sustained by credit, consumers now understand the
importance of reducing debt levels, while businesses are increasingly
having trouble getting the credit they need to survive, much less to get
the economy growing again. - Meanwhile,
consumers who are seeking to pull in from excessive credit in order to
save are increasingly faced with sudden unemployment that may force them
to tap into their savings, including retirement funds. - In the
effort to prevent the collapse of the financial system, the government has
extended its hand and wallet to large financial institutions and
investment banks, most of which contributed mightily to the current
crisis. At the same time, responsible smaller institutions, which have
served their communities well and continue to do so, have largely been
shut out. These include the vast majority of banks, credit unions, and all
but a very few Community Development Financial Institutions (CDFIs). - Finally,
the need for community development finance has never been greater, yet the
resources to support it have never been under more pressure, generating
both short-term liquidity challenges and long-term funding concerns for
CDFIs.
The challenge for community development finance is to some
extent an extension of what the industry has faced for the past several
years. Since at least 2001, CRA-based support
of CDFIs has become harder to come by, pressured by a combination of demands
for market returns, consolidation of the banking industry, and general
disinterest in CRA. More recently, philanthropies and pension funds, the source
of many grants and investments in CDFIs, are facing enormous setbacks in a
shaky and declining market, leading them to pull back-or at least not
increase-CDFI investments. State and
local governments face enormous budgetary concerns, drying up precious
resources for community financial institutions. And capital markets are frozen,
which has put at least a temporary stop to innovative financial initiatives
that have been championed in the past.
Even resources dedicated to community finance are
pressured. Both the CDFI Fund’s investment
programs and the New Markets Tax Credit have been vastly oversubscribed in
recent rounds, and high-quality applicants turned away. Some relief has come in the recent stimulus
bill, but it is unlikely to be enough. The Low Income Housing Tax Credit market,
a source of both affordable housing and revenues for many CDFIs is in total
disarray with the disappearance from the market of Fannie Mae and Freddie Mac
(not to mention the lack of taxable income in general). And both the generally low, flat yield curve
and financial pressures on CDFI borrowers have hurt, respectively, CDFI spreads
and loan performance.
Community Finance Success Factors
With these contradictions in mind, it is worth reviewing
some of what has made community financial institutions – CDFIs as well as
community banks and credit unions – effective in the long-term and, in some
cases, impressive performers in the short term. In 2008, a year that saw the
toppling of a number of major financial institutions, only one CDFI bank failed.
And the failure rate among banks with under $1 billion in assets was
one-seventh the failure rate for those with assets over $1 billion. There are
five crucial factors behind this success.
First, CDFIs and community banks and credit unions have
dedicated and loyal leadership and staff. These institutions are staffed by
employees who are mission-oriented and loyal to the community that they serve.
Second, these institutions forge a local presence by
understanding the needs of individual customers, opportunities in the
community, and the community’s business and power structure.
Third, they maintain financial flexibility, coupled with a
high degree of individual attention when underwriting. Rather than simply
judging a potential borrower’s risk by a rating alone, CDFIs, as well as many
community banks and credit unions, display a willingness to base risk
assessment on actual knowledge of each individual borrower’s situation.
Fourth, CDFIs and community banks and credit unions work
with their borrowers, combining understanding of individual circumstances with discipline
and persistence, once loans are made. As
unregulated institutions, CDFI loan and venture capital funds also have greater
flexibility to restructure and extend loans when appropriate.
Finally, CDFI loan funds in particular have shown an eagerness
to experiment with levels and types of risk and financial structures to meet
their borrowers’ needs-while retaining the risk on the balance sheet, and so
having a strong interest in the borrowers’ success. This provides them an advantage in servicing
community finance needs compared to the more highly regulated banks and credit
unions, even those that are certified CDFIs.
Why Has this Story Not Been Told?
Notwithstanding the strong performance in the community of
CDFIs and other community-focused financial institutions, there has been little
recognition of their positive role during the public discourse on both the
economic disaster and the economic recovery. One reason is that CDFIs have not done
a good job of measuring performance nor of publicizing it. Many institutions do
not track their performance, and there remains no systemic collection of
performance data. Furthermore, other than CDFI banks and credit unions, CDFI
financials vary greatly and are thus non-comparable.
There are a number of nascent solutions to this problem:
Opportunity Finance’s CARS rating system, which now rates 43 CDFIs of varying
sizes on both financial performance and impact; the risk ratings produced by
the Community Reinvestment Fund for its own use; and the National Community
Investment Fund’s Social Impact Measures for community banks are three.
However, without a broader system of public performance measurement, it remains
difficult to make the argument that remains obvious to community bankers and
advocates: Community finance performs more steadily and successfully over the
long haul relative to many other financial opportunities. This was true long
before the current downturn, and apparently continues to be the case.
There should be a sense of urgency regarding this
fundamental problem. Without better performance data, CDFIs will be at a
disadvantage in the upcoming debate on financial services reform. Moreover,
given the skittishness of the financial markets, performance data will be
essential to CDFI participation when the capital markets become unfrozen.
Community finance advocates have also done a poor job of taking
up space in the public debate. Despite the fact that many in the community
finance world had warned for years about the growth of inappropriate mortgage
lending, they were often ignored. Similarly, the push to make high quality
financial services broadly available to low-income populations with severe
liquidity needs and limited financial understanding received little more than
lip service. On the other side, those who blame the Community Reinvestment Act
for the current financial debacle were able to occupy the airwaves and frame
the debate in spite of their lack of data-and indeed in the face of overwhelmingly
contradictory data.
The upcoming debate on financial services reform presents an
opportunity to contest this persistent and disingenuous line of attack. The Boston and San Francisco
Federal Reserve Banks have collaborated on a volume in which many aspercts of
CRA’s future are considered. Going further, community finance advocates should
begin to aggressively make the case that an affirmative obligation by all
financial services institutions to serve all communities fairly is an essential
part of financial services reform, as is the necessity of government support in
enabling these institutions to exist and thrive.
What Does Community Finance Need Now?
What needs to be done to enable community finance to both survive
and grow-to fill not only the current dire needs, but also provide financial
support for the future in a manner that helps the country avoid the mistakes of
the recent past? And where do things
seem to be heading in Washington
with respect to meeting these needs?
Most important, community financial institutions need
equity. For reasons of scale and because of the relative weakness of the banks
and philanthropies that have supported community finance in the past, the
federal government must step up. This can be done through a fuller deployment
of Troubled Asset Relief Program money, including an allocation to CDFIs
through the CDFI Fund. Beyond TARP, the
CDFI Fund’s appropriation must be increased, and the Fund must be able to
support CDFIs at scale. Two useful steps, taken temporarily for stimulus
funds, but appropriate also for 2010 appropriations, would be to increase the
current limit on CDFI funding of $5 million over three years to a family of
entities and-at least temporarily in recognition of the financial stress of
traditional funders-to modify the matching requirement.
With larger amounts of government funding, there will be a
need to enhance the oversight by the Fund of CDFIs, especially those that are
not subject to regulation as banks or credit unions. Whether this can be effectively done
primarily through the self-regulatory mechanisms we currently have, primarily
CARS and the two major networks, NeighborWorks and Housing Partnership Network,
is a question CDFIs need to be prepared to face.
Second, there needs to be additional project-based and debt
funding. The New Markets Tax Credit (NMTC) has worked far batter than many
expected, given the shallow nature of the subsidy and the complexities that
arise from the NMTC’s flexibility, but it has been vastly oversubscribed. There are many projects that are
“shovel-ready,” awaiting an increase in both the current round and future
rounds. In addition, the credit needs to be extended substantially or made
permanent. Additional tweaks in the program may be necessary to make it
effective in a far less leveraged world, including bringing more of the credit forward.
As important is the need to improve the Low-Income Housing Tax
Credit (LIHTC). Fortunately, there are applicable “shovel-ready” projects. What
is needed is a push to make new project investments attractive again; this is especially
important given the overhang of potentially available credits held by Fannie
Mae and Freddie Mac. On the other hand, the current situation is forcing a
serious re-think of the structure of support for affordable rental housing. The
question stands: Is the distribution of tax credits, which have largely been
supported by two quasi-governmental buyers, the most appropriate course or
should the government support affordable rental housing more directly with
appropriations?
Community finance would also benefit from more funding of
infrastructure (including community facilities) and “green” projects. The
question for Congress, the Executive and community finance will be whether the
forms of funding and eligible projects will be such that those close to the
needs will be able to access them efficiently. While there will certainly be a
need to leverage whatever funding is provided, the era of 20:1 leverage is almost
certainly over. The capital markets,
when they unfreeze, will, appropriately, want to see more support behind the
debt financing they provide.
Last summer’s housing bill provided CDFIs with access to the
Home Loan Bank System. But
implementation has been slow, in part because CDFI collateral is generally not
of the sort the Home Loan Banks like to see.
But Congress knew that when they extended eligibility; in an era when
the Federal Reserve is accepting collateral that all parties agree has no
current discernable value, well-performing CDFI loans should look golden.
CDFIs also require new funding ideas in order to access
broader markets. New debt funding may prove difficult, as is the case with
equity funds. In addition, prices will be higher than has been the case. A
greater emphasis must be placed on social investments as a strategy to carry
the bulk of the load now, as well as to increase the equity base in the future
as capital markets begin to unfreeze.
Finally, community finance needs a better collective
infrastructure. Institutions must find
ways to enhance collective functions.
Some examples already exist: the risk management systems of
NeighborWorks and ShoreBank for their affiliates and Community Reinvestment
Fund for its lender partners; Opportunity Finance Network’s CARS rating system
and policy work; Housing Partnership Network’s and NeighborWorks insurance
projects; the Federation of Community Development Credit Union’s secondary
mortgage market; the training done by many of these organizations. But far more is needed. The Carsey Institute and the Aspen Institute are
starting a project that will provide additional opportunities to scale up
through collective action.
Conclusion
Many communities in the United States face devastation from
the current housing crisis, exacerbated by the deep recession, but communities
served by CDFIs have been hit harder than most.
This is particularly distressing since many of these communities were
brought back to health over the past 30 years through the diligent, consistent,
respectful efforts of CDFIs and other community financial institutions, and
their customers, clients and partners. In
order to continue to serve the neighborhoods and people that so need them, community
financial institutions will need to work together as never before. The case
needs to be made that these institutions can deliver quickly, intelligently and
responsibly — and can do so as well or better than others who are receiving
government help. To have this opportunity, CDFIs and their brethren will need new
strategies to tell the story of their successes-with supporting detail-loudly
and clearly.
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