CDFIs Give Underserved a Leg Up

First Southwest Bank • January 13, 2020

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This year, Lee Blalock saw homeownership—a dream he'd held for years—become a reality.

Blalock, who works in law enforcement in the Montgomery, Alabama, area, received a mortgage from HOPE Credit Union, a community development financial institution that provides mortgage loans and commercial financing in low- and moderate-income (LMI) neighborhoods. HOPE personnel counseled him on getting his finances in order, advising him ahead of applying for the home loan to make timely payments on credit cards and personal loans.

Without that help, Blalock said he would likely not be a homeowner today. HOPE "walked me through the process," he said.

Community development financial institutions, or CDFIs, partner with government, banks, and other entities to cater to the financial services needs of underserved markets. Recent research indicates the growing importance of the services these specialized institutions offer. Among respondents to the 2019 Federal Reserve CDFI Survey, 73 percent cited increased demand for their products and services from April 2018 to April 2019. Furthermore, 86 percent said they expect higher demand during the next year, and 32 percent of CDFIs that took the survey received more loan requests than they could fulfill during 2018.

Acting as more than a lender

In addition to providing loans and investments, CDFIs offer resources to help consumers improve their finances and assist entrepreneurs in building their businesses. CDFIs can include credit unions, venture capital funds, and banks.

"CDFIs help design and create appropriate financial products that are sustainable and affordable, especially for underserved borrowers," said Sameera Fazili, engagement director on the Atlanta Fed's community and economic development team. "They make sure their customers can manage that financial product by giving technical assistance or financial education to help the borrower be successful."

Since helping distressed areas is core to their work, CDFIs are willing to make loans for a wide range of business purposes in areas that aren't well served by traditional banks. "Many of the small businesses that a CDFI is helping do not have a strong asset or collateral base," said Grace Fricks, president and chief executive of Access to Capital for Entrepreneurs, an Atlanta-area CDFI that works with small and large companies. "That makes business [lending at a CDFI] riskier than traditional lending," she said.

Across the Atlanta Fed's six-state district, CDFIs have worked to revive LMI areas by investing in community facilities and housing developments as well as small businesses.

HOPE Credit Union, based in Jackson, Mississippi, serves underbanked customers and economically distressed communities in Alabama, Arkansas, Louisiana, Tennessee, and its home state. Its products include no-fee checking accounts, personal loan programs that help borrowers build credit, and mortgages tailored to LMI buyers who typically would not pass traditional underwriting systems.

In the aftermath of the housing crisis, HOPE increased its lending to minorities, underwriting its own mortgages to serve consumers who were good risks but whose credit scores might be less than perfect. The percentage of the company's mortgage loans made to people of color climbed to 81 percent in 2017, up from 55 percent a decade earlier. "We have the right product, but more important than the product is our philosophy," said Ed Sivak, HOPE executive vice president and chief policy and communications officer. "It's a philosophy that's inclusive and seeks to meet people where they are in life."

United Bank, based in Atmore, Alabama, is a traditional bank that invests heavily in neighborhood development. The company has used awards from federal government programs such as the Capital Magnet Fund and New Market Tax Credits to help businesses in distressed areas expand their operations and finance development of affordable housing, hospitals, and other facilities. Last year, United used $70 million in loans to help finance 372 small businesses, of which 123 were minority- and women-owned.

"The work we do as a CDFI changes the trajectory of the communities," United's president and chief executive Bob Jones said.

Pathway Lending, a Nashville-based CDFI, offers small business owners loans as small as $5,000 and as much as $1 million. The CDFI has grown in recent years after it expanded educational resources for small business owners and opened separate centers that train women and military veteran entrepreneurs. "Most of our entrepreneurs are great at making and selling a widget," said Clint Gwin, Pathway Lending president. "They just haven't figured out the intricacies of running a business." Because their clients can lack expertise, Pathway's advisers help businesses project cash flow and understand financial statements. They typically work with clients for the duration of their loans, often from four to six years, to help foster success.

The CDFI also makes loans of up to $5 million to developers who build affordable rental housing. It also lends to businesses implementing projects that decrease energy consumption and thus pare their operating expenses. Businesses that reach out to Pathway have typically been turned down by a traditional bank, Gwin said.

Operating under capital constraints

Although CDFIs provide significant impact, one obstacle they face is limited access to capital resources that impedes the investments they can make. "There's a whole set of challenges related to capital availability," said Will Lambe, a former senior adviser in the Atlanta Fed's community and economic development team who is now director of capital solutions at Enterprise Community Partners, a nonprofit organization and CDFI that supports affordable housing. Increasingly scarce funding from government sources and changes in the banking industry have strained resources available to community development lenders, he said.

To address the challenges tied to raising capital, CDFIs have looked to new investment partners. Fricks, the Access to Capital for Entrepreneurs president, said more private foundations and national banks are showing interest in working with CDFIs to help boost their diversity and inclusion efforts.

"We have increasingly started working with health care institutions, hospitals, and insurance companies," Lambe said. This year, Enterprise Community Partners launched a $100 million national fund, including $50 million from Kaiser Permanente, that will develop and preserve more than 3,200 affordable homes in the insurer's service areas. Lambe also said some technology companies are beginning to support affordable housing projects.

Gwin, the Pathway Lending president, cites a need for heightened awareness of CDFIs' work. "There are a lot of customers who, if they knew about us, would use us because we offer great products, and those products typically come with a lot of services to help entrepreneurs or homeowners," he said. "We are a well-kept secret."

As reform efforts are under way around the Community Reinvestment Act (CRA)—which was initially developed to ensure that banks serve their communities equitably—the CDFI industry has also called for changes to the CRA, including providing incentives for banks to partner with them and expanding CRA assessment areas to include more rural communities. (A 2018 Economy Matters article addressed the lack of access to financial services in some areas, and the role of CDFIs in ameliorating the challenges.)

Jones, the United Bank CEO, said CDFIs' work in outreach, engagement, and financial literacy is labor intensive, costly, and takes time but typically doesn't affect a CRA rating. The current law "is dated and not compliant with the current economic environment and the role of CDFIs in general," Jones said. He is hopeful that the CRA overhaul would bring progress.