This essay was originally published via ImpactPHL Perspectives, a multi-part series which explores the many facets of the impact economy in Greater Philadelphia from the perspectives of its doers, movers, shakers and agents of change.
Most low-income communities in the U.S. have access to an important resource that few people outside of these communities know: a CDFI, or community development financial institution.
CDFIs are private community lenders dedicated to delivering social and economic impact by providing responsible, affordable financing to disinvested people and communities.
Why are CDFIs important?
If you live in a community whose streets are dotted with check cashers, liquor stores, and blighted buildings, chances are there are few if any bank branches and very little investment overall. Without access to capital, residents can’t start or grow a business, purchase or rehab a home, or oftentimes, have access to quality childcare and healthcare facilities. CDFIs provide access to capital that creates opportunity and leads to real change that wouldn’t otherwise be possible.
CDFIs provide prudent, patient capital to address local community needs
CDFIs are an integral part of the communities they serve, understanding the specific needs and developing products to address those needs. And they are experts at what they do. Not only do they create positive impacts in communities of perceived high risk, but they also have a 30-year history of doing so while maintaining very strong portfolio and financial performance. CDFIs’ net loan charge-off rate is less than one percent, comparable to FDIC-insured banks. And CDFIs are financially sound, with an average net worth ratio of 32 percent.
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CDFIs provide responsible alternatives to the high-cost payday loans that keep many lower-income households in a cycle of debt.
CDFIs serve markets that mainstream financial institutions are not able to reach. In these disinvested markets, CDFIs finance microenterprises and small businesses that create self-employment opportunities and create new jobs; affordable housing for veterans, senior citizens and other vulnerable populations; community facilities that provide vital health care services in medically underserved communities; and commercial real estate that brings, for example, the first full-service grocery store to a food desert.
CDFIs provide fairly-priced mortgages that allow lower income individuals to start building wealth through homeownership; credit builder loans that help individuals restore their FICO score; citizenship loans that cover the upfront costs of the US citizenship application process; and responsible alternatives to the high-cost payday loans that keep many lower-income households in a cycle of debt.
In addition to connecting individuals and communities to capital, CDFIs provide financial literacy education, technical assistance to small business owners, and first-time homebuyer counseling to ensure their borrowers succeed. More than 1,000 CDFIs are holding more than $100 billion in assets throughout the US. While this industry is small relative to the mainstream banking and credit union industries, it is critically important to the markets CDFIs serve. A mission-focused financial institution that wishes to become a CDFI can apply to the US Treasury Department for CDFI certification.
CDFIs provide fairly-priced mortgages that allow lower income individuals to start building wealth through homeownership.
CDFIs come in many shapes and sizes. They can be regulated depository financial institutions — banks or credit unions or non regulated loan funds or venture funds. Half of all CDFIs are loan funds. Nearly one-third are credit unions. Banks and bank holding companies comprise 20 percent while venture funds are the least common at only 2 percent of all certified CDFIs. Of the 53 CDFIs in Pennsylvania, New Jersey, and Delaware, 38 are loan funds, nine are credit unions, four are banks or bank holding companies, and two are venture funds.
CDFIs function as traditional financial institutions in untraditional markets
How are CDFI banks, credit unions, and venture funds different from their mainstream counterparts? CDFI banks and CDFI credit unions provide the full array of products and services that mainstream banks and credit unions do, but they are distinct in the markets they serve and the composition of their products. For example, United Bank of Philadelphia, an African American controlled and managed bank, has “a particular focus on, and sensitivity to, groups that have been traditionally underserved, including Blacks, Hispanics, and women.”
Of the 53 CDFIs in Pennsylvania, New Jersey, and Delaware, 38 are loan funds, nine are credit unions, four are banks or bank holding companies, and two are venture funds.
CDFI credit unions offer far more products specifically targeted to lower-income populations than do mainstream credit unions, such as credit builder loans. Take credit builder loans: more than three-quarters of CDFI credit unions offer these very small loans and the counseling that goes with them compared to only 5 percent of all credit unions.
Unlike traditional venture funds that seek homerun financial returns and invest primarily in New York and Silicon Valley, CDFI venture funds seek a community impact return in the form of job creation rather, and they bring venture capital to small cities and rural areas throughout the country. For example, Innovation Works, located outside of Pittsburgh, focuses on companies “with the greatest likelihood of regional economic impact.”
Loan funds are perhaps the most diverse and flexible group of CDFIs. In the greater Philadelphia area, they range from the $1 million microloan fund Entrepreneur Works (Philadelphia) to the $8 million small business fund First State Community Loan Fund (Wilmington) to the $62 million community services and housing fund New Jersey Community Capital.
One of the biggest and most well-known CDFIs in the greater Philadelphia region, the Reinvestment Fund, is a $400 million fund investing in a wide range of real estate transactions. Because they are unregulated, CDFI loan funds have the flexibility to work patiently with borrowers through tough times such as the Great Recession rather than being required to write off loans.
CDFIs provide a low credit risk entry into impact investing for mainstream investors
CDFIs are vital community assets. Like every financial institution, they need access to low-cost capital which they, in turn, lend to their communities. Impact investors can put their money to work for CDFIs by lending to a loan fund, making an equity investment in a venture capital fund, or making a deposit in a CDFI bank or CDFI credit union.
They can do even more by moving their banking relationships to a CDFI bank or a CDFI credit union. CDFIs find projects and individuals in need of financing and conduct due diligence to determine financial soundness and community impact of each prospective deal. CDFIs offer a high-impact fixed-income alternative, allowing investors to move their fixed-income assets from Wall Street to Main Street.
By investing in a local community lender—their CDFI—-an investor can have deep impact in the communities and places that matter most to them.-30-
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