## An Overview of the CDFI Industry

### INTRODUCTION

Throughout the country, many urban and rural communities lack access to adequate financial services. Without the necessary capital, these communities are unable to create business opportunities or generate economic growth. Consequently, they remain underdeveloped in contrast to communities that have ready access to banking resources and capital.

***“Community development finance seeks to counter social, economic, and political patterns and behaviors that make and keep people poor.”***  *—The Brookings Institution*

Community Development Financial Institutions, referred to as CDFIs, work to address these inequalities by investing in these underserved communities. CDFIs are local community lenders who provide loans and financial services to residents who may not qualify for, or have access to, traditional financial services. Historically, there are many reasons why mainstream banks have excluded potential borrowers, including gender, race, or a lack of previous business experience. However, none of these factors are necessarily indicative of future financial performance. Indeed, for decades CDFIs have succeeded in improving the economies and financial well-being of communities across the nation. The mission behind the CDFI industry is:

***“To expand economic opportunity for underserved people and communities by supporting the growth and capacity of a national network of community development lenders, investors, and financial service providers”***  *— US Treasury CDFI Fund*

### CDFI INDUSTRY FORMATION

The CDFI industry began to form in the latter half of the twentieth century. In the 1950’s and 1960’s, there was a housing and credit boom across America. While many white Americans were prospering, low-income and minority communities were generally excluded from this economic growth because mainstream banks and institutions deemed these communities too risky for investment. There was a common practice among banks called “redlining” where the banks would draw red lines on physical maps around neighborhoods deemed too risky for investment. They refused to provide loans or financial services to those areas. Since so many parts of the country were prospering, there was a noticeable gap in opportunity, development, and wealth. In terms of access to financial resources, it was clear that these communities were left behind. In effort to fight this discrimination, the government passed the Community Reinvestment Act in 1977. This act, known as the CRA, encouraged financial institutions to meet the needs of every part of the community they served.

In the 1960's, as part of the War on Poverty campaign, the Johnson Administration helped launch Community Development Corporations (CDCs) to serve low-income communities. These early CDCs laid the foundation for the modern CDFI industry. In the 1970's, community development credit unions and banks, including South Shore Bank in Chicago in 1973 and Santa Cruz Credit Union in 1977, formed to serve individuals and religious institutions. During the following years, the community development finance industry continued to grow, but it wasn't until the 1990's when it truly emerged as a formidable agent in the finance industry.

The modernization of the CDFI industry is largely due to the work of the Clinton administration. In 1994, Clinton enacted the Riegle Community Development and Regulatory Improvement Act. This act established the CDFI Fund and opened up interstate banking, which allowed financial institutions to organize and network across the nation. The CDFI Fund was created within the U.S. Department of the Treasury and it is an organization that provides federal support to individual CDFIs serving low-income communities. Its establishment was critical in the development, organization, and modernization of the community finance industry. At the same time as the Riegle Act, President Clinton called for a review of the Community Reinvestment Act. In 1995, the revised act qualified loans and investments in CDFIs as fulfilling CRA requirements.

### UNDERSTANDING THE CDFI MODEL

A CDFI is a local community institution that plays a similar role to that of a bank. They provide capital, loans, and financial resources to their customers. However, CDFIs go beyond the scope of a traditional bank, as they provide community outreach programs, business resources, and financial counseling. CDFIs establish relationships with their borrowers and help them navigate some of the more technical and challenging aspects of owning and operating their own businesses. This is beneficial to both parties; the borrower has guidance to help them become more successful and the CDFI gains deeper knowledge of the local market and community. Furthermore, if the CDFI provides technical assistance, then it often increases the likelihood that the borrower will be successful and able to pay back their loan:

***“With cumulative net charge-off rates of less than 1 percent, CDFIs lend prudently and productively in unconventional markets often overlooked by conventional financial institutions.”***  *—Lisa Mensah, President and CEO of the Opportunity Finance Network*

CDFIs acquire their capital from banks, the government, foundations, and even individual investors. This capital goes on to fund the individual investment and capital demands of the CDFI and the community they serve. For decades, CDFIs have been instrumental in bringing quality financial services to underserved, low-income populations left behind by mainstream banks and institutions.

***“CDFIs are an important part of the small business lending ecosystem, providing capital to businesses that cannot access traditional financing. As mission-driven lenders, increasing access to affordable, responsible capital for business owners with limited options: women, people of color, startup firms with limited revenue and less than perfect credit, is a key component of the CDFI lending strategy.”***  *—Lisa Mensah*

In contrast to financial institutions that focus solely on the bottom line, CDFIs also measure their success through the impact they have on the communities they serve. Along with making prudent lending decisions, CDFIs focus on creating and saving jobs, improving the financial well-being of local residents, and helping their communities prosper. In fact, many CDFIs are nonprofit organizations. Indeed, some CDFIs generate revenue, but their main priority is community development, not maximizing profits. CDFIs align themselves with community needs rather than capital market demands.

Since every community is diverse, there is no single CDFI model that can be replicated and copied around the country, each one must meet the needs of the community where they are located. However, that does not mean that CDFIs are unestablished, unsupported, or untrustworthy. The CDFI industry is organized by the CDFI Fund, which is part of the U.S. Department of the Treasury. In order for an organization to gain certification from the CDFI fund, they must be a private, non-governmental institution whose primary mission is community development. CDFIs come in four forms: banks, credit unions, loan funds, and venture capital funds. Each has a different structure, risk profile, and target lender, with the majority organized as loan funds.

### ASSET SIZE AND DISTRIBUTION IN CDFI

**Table: Asset Size of Certified CDFIs (By Type) as of January 2016**
| CDFI Type | Total Assets | Total Assets % | Average of Total Assets | Median Assets |
| --- | --- | --- | --- | --- |
| Bank or Thrift | $37,927,503,000 | 35% | $318,718,513 | $215,786,600 |
| Credit Union | $56,672,216,871 | 52% | $208,510,176 | $52,993,128 |
| Loan Fund | $14,185,047,966 | 13% | $27,070,702 | $7,007,023 |
| Venture Capital Fund | $208,763,372 | 0% | $14,911,669 | $4,661,726 |
| **Total** | **$107,993,531,209** | **100%** | **$116,876,116** | **$19,731,943** |

Credit Unions make up 27% of all CDFIs but account for the majority (52%) of the assets. On the other hand, 51% of certified CDFIs are loan funds, even though loan funds only comprise 13% of total assets.

### PERFORMANCE OF CDFIs

***“CDFIs have succeeded by all obvious measures”***  *—The Brookings Institution*

Although the CDFI industry is relatively new, as an asset class, it still has decades of performance history. When evaluating the scope, performance, and impact of the CDFI industry, most of the data is available through the CDFI Fund, the Opportunity Finance Network (OFN), and the Global Impact Investing Network (GIIN).

A report done by the Urban Institute found that between 2011 and 2015 CDFIs lent more than $34.3 billion. The majority of this investment (64%) went to areas that had at least one of the following characteristics:

1. An unemployment rate of 10 percent or higher
2. A poverty rate of 20 percent or higher
3. 50% or more residents earning less than 200 percent of the federal poverty level
4. A population with at least half non-white residents

CDFI loan funds account for two-thirds to over ninety percent of all loan volume to historically underserved borrowers. The CDFI industry has continued to grow throughout the years. In 2012, certified CDFIs (through the CDFI Fund) awarded $1.92 billion in loans. In 2016, the total amount of loans and investments originated by CDFI program awardees was $3.6 billion. Most recently, in 2017, CDFI Fund members awarded $5.03 billion in loans. This steady and consistent growth of the CDFI Fund corresponds to the growth and development of CDFI industry as a whole.

### CDFIs AND COMMUNITY INVESTING

CDFIs exist to move money to people and places missed by traditional lenders. It is our industry’s view that in order to have an economy that supports innovation in all 50 states, especially in areas where growth has lagged or poverty is high, there is an urgent need to invest in the partnerships that will create more small businesses.

There are a number of reasons why the CDFI industry has continued to experience remarkable growth over the past decade. One of the biggest causes is the affordable housing crisis in the United States, which only got worse after the Great Recession. According to the National Low Income Housing Coalition, there is a shortage of more than 7.4 million affordable rental homes among extremely low-income renters. In concrete terms, this means that there are only 35 affordable and available units for every 100 extremely low income households.

Since CDFIs primarily serve low-income neighborhoods, community development includes the construction of affordable housing. Thus, over the years CDFIs have financed the construction of thousands of affordable housing units, and their presence is crucial in working towards a solution to the crisis. With an increasingly high demand for affordable housing, CDFIs gain business, which in turn leads to growth.

### CDFI FINANCIAL RECORD: RISK & RETURN

***“CDFIs have demonstrated that financing non-conforming customers works if it is done in a way that recognizes the market’s and the customers’ idiosyncrasies…that financing women and minority homeowners and business owners is not only possible but profitable, and that race and gender are not reliable indicators of financial performance”***  *—The Brookings Institution*

A research report conducted for the Office of Financial Strategies and Financial Research of the CDFI Fund found that CDFI banks and credit unions “have no more risk of financial failure than mainstream financial institutions,” and despite serving predominantly low-income markets, CDFI banks and credit unions “had virtually the same level of performance” as mainstream financial institutions, and in fact CDFIs were even “more efficient than mainstream institutions.”

Investments in CDFIs also generate consistent financial returns. According to the GIIN, the overall average interest rate was 2.9%. However, interest varies based on size and sector of the community development loan fund (CDLF, a type of CDFI). Housing CDLFs paid the highest interest rates, while funds lending to microenterprises yielded the lowest return to investors.

### WEATHERING RECESSIONS AND NATURAL DISASTERS

CDFIs perform well even during recessionary times. Some CDFIs are linked to the American Recovery and Reinvestment Act, which is a countercyclical stimulus government program aimed at reducing the extreme effects of the business cycle. During times of economic contraction and recession CDFIs obtain additional funds through this program which they use to stimulate economic growth. This is due to the theory that CDFIs are needed even more during times of recession to avoid low-income and financially-underserved communities from falling even farther behind.

### CHALLENGES

Despite its successes, the CDFI industry has also faced some difficulties since its inception. The main challenge CDFIs have encountered is not having a solid infrastructure to allow for widespread use and acceptance. Without easy access to investors, CDFIs can struggle with acquiring enough capital to meet funding goals to reach all of the underserved population they serve.

CDFIs receive most of their funding from three sources: banks, the federal government, and institutional investors. However, it is a misconception that these three sources completely meet the industry’s demand for capital. With the main sources of funding under political threat and maxed out, it is more important than ever for CDFIs to secure new avenues of capital.

### CONCLUSION

***“CDFIs have enjoyed broad bipartisan support for decades. Now, by finding new sources of private capital, CDFIs are able to amplify their impact. The model is a proven success and will only increase reach as private money empowers CDFI investment to go further”***  *–Mark Zandi, The Reinvestment Fund’s Board Vice Chair, and Chief Economist, Moody Analytics*

The CDFI industry has experienced considerable growth since the early community development credit unions of the 1970's. While CDFIs have undoubtedly made positive impacts in communities across the country, there are still many areas that remain underserved or struggle to secure investments that can keep up with new economic development. Over the past few decades, CDFIs have proven themselves to be prudent financial institutions that deliver measurable positive impact.