Community development finance has played an important role in community revitalization over the past 30 years and may be even more important in the current financial climate. But today community development finance institutions (CDFIs), as well as many community banks and credit unions face significant funding stress. This brief highlights the importance of refocusing support of CDFIs to sustain and rebuild health communities across the United States

Huelsman, Mark

Seidman, Ellen

English

UNH Scholars' Repository

Carseyi n s t i t u t ePolicy Brief No. 11winter 2009The Promise and Responsibility of Community FinanceBy EllEn SEidman and maRk HuElSmanwe 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,	con-sumers 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	Develop-ment	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,	Community	Re-investment	Act	(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. The Cra is a u.s. federal law designed	to	encourage	commercial	banks	and	savings	associ-ations	to	meet	the	needs	of	borrowers	in	their	communities,	including	low-	and	moderate-income	neighborhoods.	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	pres-sured.	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 FactorsWith	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	cru-cial	factors	behind	this	success.First,	CDFIs	and	community	banks	and	credit	unions	have	dedicated	and	loyal	leadership	and	staff.	These	institu-tions	are	staffed	by	employees	who	are	mission-oriented	and	loyal	to	the	community	that	they	serve.Second,	these	institutions	forge	a	local	presence	by	un-derstanding	the	needs	of	individual	customers,	opportuni-ties	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	situa-tion.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 Hasn’t This Story  Been Told?notwithstanding the strong performance in the community of	CDFIs	and	other	community-focused	financial	institu-tions,	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	prob-lem:	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,	with-out	a	broader	system	of	public	performance	measurement,	it remains difficult to make the argument that remains obvious	to	community	bankers	and	advocates:	Community	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	ap-propriate	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 cur-rently	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	better	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	oversub-scribed.	There	are	many	projects	that	are	“shovel-ready,”	awaiting	an	increase	in	both	the	current	round	and	fu-ture	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	ap-plicable	“shovel-ready”	projects.	What	is	needed	is	a	push	to	make	new	project	investments	attractive	again;	this	is	espe-cially	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	govern-ment	support	affordable	rental	housing	more	directly	with	appropriations?Community	finance	would	also	benefit	from	more	fund-ing	of	infrastructure	(including	community	facilities)	and	“green”	projects.	The	question	for	Congress,	the	Execu-tive	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,	appropri-ately,	want	to	see	more	support	behind	the	debt	financing	they	provide.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	appar-ently	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	popu-lations	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	contradic-tory 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	aspects	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	communi-ties	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	sup-ported	community	finance	in	the	past,	the	federal	govern-ment	must	step	up.	This	can	be	done	through	a	fuller	de-ployment	of	Troubled	Asset	Relief	Program	money,	includ-ing	an	allocation	to	CDFIs	through	the	CDFI	Fund.	Beyond	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	Partner-ship	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.	ConclusionMany	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,	intel-ligently	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	support-ing	detail—loudly	and	clearly.  2 C a r s e y  i n s t i t u t e  C a r s e y  i n s t i t u t e  3a B o u T  T H E  a u T H o R SEllen	Seidman	is	Executive	Vice	President,	National	Pro-gram	and	Partnership	Development	at	ShoreBank	Corpora-tion and a senior Fellow at the new america Foundation. Mark	Huelsman	is	Program	Associate	at	the	New	America	Foundation.Building knowledge for families and communities The Carsey institute at the university of new Hampshire  conducts independent, interdisciplinary research and  communicates its findings to policymakers, practitioners  and the general public. Huddleston Hall73 main Street durham, nH 03824(603) 862-2821www.carseyinstitute.unh.eduThe Carsey Institute Reports on Community Development  are supported by the annie E. Casey Foundation, the Ford Foundation, and the W.k. kellogg Foundation.  4 C a r s e y  i n s t i t u t e

The promise and responsibility of community finance

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The promise and responsibility of community finance

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