CDFIs: Serving the Underserved and Making Missing Markets

Surekha Carpenter 00:03
If you’ve seen one CDFI, you’ve seen one CDFI, because they are so unique and so diverse across the entire industry.

Jonathan Kivell 00:12
CDFIs have been called financial first responders.

Jacob Scott 00:15
That’s ingrained in their ethos is that they want to be able to give those loans that otherwise wouldn’t be made.

Carlos Naudon 00:20
We have a saying that we are of the community, for the community and in the community. It goes back to, you know, neighbors helping neighbors, in essence.

Adriana 00:28
We are a hardworking people. We just want to progress.

Nathaniel Kressen 00:32
Welcome to Bank Notes, the podcast from the Federal Reserve Bank of New York. This season, we’re going to focus on a small subset of the U.S. financial system, Community Development Financial Institutions, or CDFIs, and how they support economic growth at the local level. The CDFI industry is made up of all different kinds of institutions operating in different ways, and the unique challenges and opportunities within this space offer a glimpse into how a project called Making Missing Markets from the New York Fed might take shape. I’m your host, Nathaniel Kressen, and this is “CDFIs: Serving the Underserved and Making Missing Markets.” The views expressed here do not necessarily represent those of the New York Fed or the Federal Reserve System. Episode 1, “What are CDFIs? (Financial First Responders).” CDFIs, or community development financial institutions, is a sector that’s made up of all different kinds of institutions, each working in their own way to achieve one common mission: improving economic outcomes for communities who are underserved.

Jacob Scott 1:40
My name is Jake Scott, I’m an analyst here on the community development team at the Federal Reserve Bank of New York.

Carmi Recto 01:44
My name is Carmi Recto. I am a community development specialist.

Jonathan Kivell 01:48
My name is Jonathan Kivell, I’m the director of community investments.

Nathaniel Kressen 01:52
This team released a pair of reports examining the CDFI industry.

Jonathan Kivell 01:55
CDFIs have been called financial first responders. They are institutions that are certified by a sub-agency of the U.S. Treasury called the CDFI Fund. A CDFI can be a bank, it can be a credit union, it can be a loan fund or a venture capital firm. So just having the designation of community development financial institution doesn’t signal exactly what type of organization something is.

Carmi Recto 02:22
It’s intentionally broad to try and address a lot of disinvestment from all different angles in these underserved communities.

Nathaniel Kressen 02:31
To better understand how CDFIs operate and fit within the broader economy, we’re going to use the ocean as an analogy for financial markets. It’s calm, it’s choppy, it’s deep in some places, shallow in others, and folks who want to brave the open waters need some kind of a vessel to carry them. Enter CDFIs, and as Jonathan mentioned, the ways in which they look and float are all different. A CDFI can be a loan fund or a venture capital firm, investing in projects that’ll improve the living and working conditions across households in a certain area. A CDFI can also be a member-owned credit union, providing financial services informed by the needs of the surrounding community. A CDFI can also be a community bank serving local credit needs. Many of these CDFI vessels are traversing deep waters, connecting communities on shore to pools of public and private investment. And then there are some CDFIs that stick to their little inlets, concentrating hyper-locally. But no matter the scope, no matter the size, CDFIs are looking to bring greater access to underserved markets. Many times, they are serving as financial vessels helping people and communities get to where they need to go.

CDFIs Provide Capital Where It’s Needed

Jacob Scott 03:41
If you want to get ahead in this country, if you want to economically develop, if you want to move up that ladder, you need access to capital. You need access to credit, and CDFIs can kind of provide that capital to communities that otherwise might not get it.

Nathaniel Kressen 03:53
Getting capital into communities can look a number of different ways.

Jonathan Kivell 03:58
From the 1500 CDFIs or around 1500 CDFIs in the country, there is a wide variety of financial services and products that are intended to serve low- and moderate-income communities, anything from checking accounts, personal loans, auto loans, to broader real estate financing, small business financing, some of which has subsidies from other government programs, and some of which does not.

Surekha Carpenter 04:21
There are these gaps, right, like either physical gaps that exist when a bank might not exist in a place, that can happen. But there can also be gaps just in folks being able to access credit.

Nathaniel Kressen 04:34
This is Surekha Carpenter, researcher from the Richmond Federal Reserve and one of the co-authors of the national CDFI survey.

Surekha Carpenter 04:41
I have heard a saying that says if you’ve seen one CDFI, you’ve seen one CDFI, because they are so unique and so diverse across the entire industry. We’ve met with a lot of folks from a lot of different organizations. Some of them are so small. Some of them are like, literally, one to two employees, but they do what they need to connect. Even if they’re only serving like five folks a year, that is connecting five more folks to an auto loan or a mortgage.

Nathaniel Kressen 05:12
As Surekha notes there is a powerful connecting force that CDFIs provide. It comes down to connecting underserved communities with capital. And this work builds upon a longstanding legacy, one that stretches back well before the CDFI certification was established.

Access to Capital Issues Have Existed Throughout History

Jacob Scott 05:28
The CDFI fund itself and the CDFI industry itself was formalized in 1994, but essentially what that did is it just codified and formalized kind of this industry of existing institutions that had really been around as early as the mid- to late-1800s. You know, you saw these minority depository institutions popping up after the Civil War to address the credit needs of communities that were completely excluded, oftentimes legally excluded, from the finance system. Then in the 1930s, 1940s you started seeing mutual support organizations, these kind of non-profit organizations. In the 60s and 70s, you started seeing these community development corporations. So this kind of hodgepodge industry of organizations, primarily financing entities, that were doing this community development work, and then in 1994 those were formalized with this CDFI certification.

Longstanding Work Now Taking Centerstage

Nathaniel Kressen 06:14
The first of those two reports published out of the New York Fed found that there’s been somewhat of a sea change moment happening in the sector over the last five years.

Lisa Cook 06:22
It is encouraging to see that the industry is growing both in terms of number of certified CDFIs and total assets held.

Nathaniel Kressen 06:30
This is Governor Lisa Cook from the Federal Reserve’s Board of Governors, speaking at an event at the New York Fed that brought together CDFIs from across the country.

Lisa Cook 06:37
From 2018 to the start of 2023, the number of certified CDFIs rose 40 percent and assets have nearly tripled.

Jacob Scott 06:47
I mean, the industry went from just a few hundred of these institutions that were formally recognized to today, almost 1,500. Just in the last five years, we’ve seen that the total assets have almost tripled, you know, it’s a $450-billion-dollar industry nowadays.

Nathaniel Kressen 07:00
More institutions means more access to capital.

Jacob Scott 07:03
To the extent that you’re measuring success as growth of the industry, getting more of these institutions, doing more loans, doing more financial support, having more assets, there has been a lot of success in growing that industry.

Nathaniel Kressen 07:15
One piece of background: In 2021, Congress passed the Emergency Capital Investment Program, which provided $9 billion dollars in capital directly to CDFIs and MDIs, which are minority depository institutions. This allowed them to keep lending to underserved markets during the pandemic.

CDFIs Ideally Positioned to Affect Change in LMI Communities

Carmi Recto 07:32
CDFIs were identified as really helpful as we were all sort of coping with this unknown world during the pandemic. And that was demonstrated by all of this public funding funneled through the CDFI industry. Having sort of a dedicated line from those programs demonstrates their visibility and their reputation as an important distribution channel of public funding into low- and moderate-income communities.

Nathaniel Kressen 08:03
In other words, because CDFIs come in all shapes and sizes and operate with a mission of supporting economic development at the local level, they were ideally positioned to effect change in these areas.

Lisa Cook 08:15
Research from the Federal Reserve Bank of Dallas indicates that mission-driven financial institutions, including CDFIs, provided more Paycheck Protection Program—PPP—loans to borrowers in low- and moderate-income communities and majority-minority communities than their traditional counterparts.

Christina Travers 08:34
Financial institutions aren’t structured to meet the demands of low- and moderate-income communities, kind of hence why we exist.

Nathaniel Kressen 08:42
This is Christina Travers, Chief Financial Officer at LISC, the Local Initiative Support Corporation.

CDFIs Take a Flexible Approach

Christina Travers 08:48
We’re like a large national nonprofit that also invests in communities. Like, we do grants, but we also do lending and investment for basically anything you can think of, affordable housing, small businesses. Overall, we’re just looking for helping communities be places that people can live and work and have small businesses and raise families.

Nathaniel Kressen 09:13
So basically, CDFIs provide all different kinds of services.

Sadie McKeown 09:17
What we look for are the gaps. We’re not looking for what works, we’re looking for what doesn’t work so that we can figure out how we can support it, and bring the resources that the communities need, particularly to the smallest buildings and the smallest businesses, who have the least sophistication to be able to access capital. And that’s the theme, is access to capital.

Nathaniel Kressen 09:40
This is Sadie McKeown, the president of Community Preservation Corporation.

Sadie McKeown 09:44
One of the things we talk about at CPC, is we don’t say no, we say how? So, even if a deal comes to committee, and it seems like a no, we don’t say no initially, we say, “Okay, well how else can we make this work?” If it’s a borrower that’s particularly illiquid, he doesn’t have a lot of cash, maybe we try to help them find a partner that can bring some cash resources, so we can stay in the deal.

Nathaniel Kressen 10:05
What we’re hearing is that CDFIs take a nimble, creative, holistic approach to tackling the issues facing underserved communities.

CDFIs Driven by Mission to Solve Persistent Problems

Elise Balboni 10:13
We do work through local partners on the ground and have longstanding relationships with them so there’s an element of trust and understanding between partners that makes both want the financing to work out. My name is Elise Balboni and I’m President of Enterprise Community Loan Fund, the CDFI arm of Enterprise Community Partners, one of the largest national nonprofit community development organizations in the country. These impediments have been created over decades, and at Enterprise, we really see home as the launching point and a prerequisite for mobility.

Sadie McKeown 10:48
Housing is foundational to neighborhoods and communities. It’s also foundational to people. If you have security in the place that you live, and you don’t have to worry about it, you can worry about other things, like “How’s my health? Should I get more education?” You have the opportunity to advance in your life because you’re not worried about, “Am I going to be here next month?

Nathaniel Kressen 11:12
CDFIs are driven by their mission, because financial insecurity is a problem that persists.

Elise Balboni 11:18
I’m an optimist and a pessimist. So because I do say, we’ve been doing this for 50 years, and we haven’t solved the problem. So, you know, so to a certain extent, that’s kind of depressing. On the other hand, you have to fight the fight and not give up.

Carlos Naudon 11:35
You see studies, most people don’t have 500 bucks, that they can, they can draw in an emergency.

Nathaniel Kressen 11:41
This is Carlos Naudon, the CEO of Ponce Bank, a community bank that’s also a CDFI operating in the Bronx.

Carlos Naudon 11:48
If you look at a little history the South Bronx was beginning to burn in the 60s. It was being abandoned by everybody from, you know, government to private enterprise to public health services, et cetera. And so the reason the bank was founded was that a group of Puerto Rican, mostly migrants, small business owners and community activists said that in order for the community to survive in the South Bronx, it needed sources of capital and sources of banking. Well, the needs of the community back then are literally the same that they are today. It’s shocking to me, in a sense, rewarding too, but it’s shocking the number of people that we open accounts for that did not have a bank account before. It is hard to fathom, but it’s there. There are banking deserts throughout New York City.

CDFIs Tailor Their Solutions by Listening to the Community

Cathi Kim 12:46
Credit unions are democratically governed and they’re cooperatives, meaning that they are owned by and led by the members.

Nathaniel Kressen 12:55
This is Cathi Kim from Inclusiv, which is both the trade group for CDFI credit unions as well as a CDFI credit union itself.

Cathi Kim 13:02
Each member has one vote, and so it doesn’t matter how much you have in your account, and that leads to increased opportunities to develop products that are specifically designed for and responsive to the needs of the communities that they serve.

Carlos Naudon 13:18
We have a lot of folks that don’t have credit scores, or have low credit scores, not because there’s an unwillingness to pay, but because they don’t have credit. And so we look at alternative ways of determining the willingness and ability to repay, and we do a lot of what we call financial mastery. We don’t call it financial literacy, as most people do, because you’re calling somebody illiterate when they think they need financial literacy. And also, most of our folks live paycheck to paycheck. And let me tell you, it takes a lot of mastery to do that.

CDFIs Also Move the Needle on Systemic Issues

Nathaniel Kressen 13:55
All CDFIs are seeking to foster greater economic opportunity at the community level. Some pair those efforts with moving the needle on other issues.

Sadie McKeown 14:03
We’re really trying our best today to drive as much, not just energy efficiency, but decarbonization in housing and electrification.

Nathaniel Kressen 14:11
Community Preservation Corporation started introducing green energy requirements as part of their lending to affordable housing developers.

Sadie McKeown 14:17
Going back to the magic of the first mortgage, we could tell the developers, “If you come to us, we’ll give you a little bit of a lower rate, but we want you to do this energy efficiency.” Hopefully, that drives deep affordability, because we’re again, lowering the amount of the commodity that you’re using, and so we’re lowering the cost of operating the property, and you’re contributing to the solution of reducing carbon and taking carbon out of the atmosphere, and then really making buildings more resilient.

CDFIs’ Unique Business Model Has Both Advantages and Drawbacks

Nathaniel Kressen 14:44
Flexibility and responsiveness are themes that we keep hearing emerge about CDFIs.

Elise Balboni 14:49
Because we’re working with our partners where they are, each loan is a snowflake. Each loan is unique.

Jacob Scott 14:57
That’s ingrained in their ethos, is that they want to be able to give those loans that otherwise wouldn’t be made. Because they have that connection with the community, they’re able to make those kinds of marginal loans, but those loans are then hard to sell on the secondary market. Because if I’m just an investor trying to buy up a bunch of loans to make a buck, I don’t have that connection in the community necessarily. So I want those traditional financial metrics, and so that’s where that tension can arise.

Nathaniel Kressen 15:20
CDFIs’ willingness to operate a little differently also introduces an interesting push-pull dynamic. To meet the needs of their specific communities, they originate bespoke, tailormade products to meet borrowers where they are. However, that can mean that the portfolios of CDFIs are made up of loans that are far from standardized, which can limit their ability to sell those loans in the secondary market.

Carmi Recto 15:41
One way traditional financial institutions can access the secondary market is that they originate a loan to a borrower, and they make it such that the loan is meant to be pooled with other loans that have similar terms. Going back to the CDFI industry, that can be a little bit challenging for a lot of the loans that CDFIs make because at their core they want to be making the loans that don’t have the same look and feel.

Jacob Scott 16:09
And just to take a step back, when we’re thinking about what is a secondary market, this is a very simplistic analysis but not coming from a background of finance I think it, hopefully, this is a helpful explainer, is like, if I’m a lender, right? Literally, I’m just lending money, $10 to somebody, and they’re going to pay me back in a year, I could just sit and wait for them to pay me back those $10 in a year, and then I can give those $10 out again, you know, a year later. Alternatively, I could lend them that money and then sell that loan to an investor, someone else, and then use the proceeds of that sale to lend to someone else, and so it increases the amount of capacity I have to lend. And so, when you think about that in CDFI terms, what that looks like is a CDFI can lend to the community, it can then sell that loan, use the proceeds to then lend again to that community, or to other communities, or to other loan types. It just expands their capacity to lend.

Nathaniel Kressen 16:57
It’s common practice for financial institutions to bundle and sell the loans they make. It takes loan assets off the books and brings capital in the door, which covers the costs of operation and allows them to make more loans. CDFIs are no different, they need access to capital. This can come in the form of government lending, grants, philanthropic giving, customer deposits in the case of CDFI banks and credit unions, or loans and investments from banks and other entities—but each of those sources of funds might carry restrictions in terms of how they can be used.

Surekha Carpenter 17:29
A kind of common challenge, regardless of CDFI type, is access to flexible and long-term capital. It might seem straightforward that the lending institution needs lending dollars. They also need to secure rent, and you know, their payroll. These CDFIs are looking for money on good terms because they are turning around and delivering and applying capital on great terms to their clients.

Nathaniel Kressen 18:00
So is it possible to both remain flexible and responsive to community needs and tailor their tailormade approach to what secondary buyers are looking for?

Jonathan Kivell 18:10
Our research has been exploring the possibility that CDFIs think of themselves in a sort of capital markets orientation, to a certain extent, whereby they would originate loans that are relatively standardized and they’re doing so at a volume and scale that would allow for those loans to be pooled and then sold into a secondary market.

Jacob Scott 18:36
I think a really big mindset shift, at least for me as we were going through this process, was realizing that this would probably be, at least to start, an additive product. It would not so much be that the loans they’re currently making or that currently sit on their books would be securitized and sold. Maybe some might do that, I’m not saying that might never happen. But I think as we’ve done a lot of work on this, this would be an additional product that they could offer to their communities. So there would be some term sheet of agreed upon terms, agreed upon conditions, that then they could lend on those terms to the communities and then sell those loans. So it would allow them to meet demand that they’re not currently able to meet while still separately doing the kind of bespoke or artisanal lending that they’re doing right now. So, it wouldn’t be instead of what they’re currently doing, it would be in addition to what they’re currently doing.

Nathaniel Kressen 19:21
Some CDFIs have been exploring how to standardize their products while also serving the needs of their customers. Others have been going the opposite direction.

Donna Gambrell 19:31
So now you have CDFIs that are getting S&P ratings and things like that, which is kind of interesting, on the one hand. On the other hand, you also have CDFIs who are saying, “You know what? We’re going to abandon this whole credit score matrix. We’re going to get rid of the credit box that banks use and really start with something different and unique and innovative that really does cater to the needs of our audience.”

Nathaniel Kressen 19:55
Donna Gambrell is the former head of the CDFI Fund, currently runs Appalachian Community Capital, and serves as the board chair for the Opportunity Finance Network. She’s worked long enough in this sector to know that progress can look a number of different ways.

Donna Gambrell 20:09
So you’ve got the extremes on both ends, those who are becoming much, much more sophisticated in the finance piece, and then those who are saying, “We’re going back, back to our roots, and even further back, beyond our roots, to say, ‘What are the real basic ABC building blocks that need to happen to bring somebody on and help them, you know, start and grow a business, or get into a home, or whatever the case may be.'”

Nathaniel Kressen 20:36
Let’s take a look at risk. How risky are these loans that CDFIs are making? How is it compared to other sectors?

Jacob Scott 20:43
It’s not that they’re making these loans that are so risky that they don’t pay back, or that the industry is constantly seeing, you know, delinquencies or charge-offs. If you look at the data that is available, there’s not, you know, perfect data. It does look like CDFIs, very seldom, very, very rarely fail entirely. Even if sometimes their loans, the borrower might have a little trouble paying them off, they end up, they do end up paying them off. So, it’s not necessarily that CDFIs, they’re not necessarily charities who are going out there not expecting to make that money back. They do anticipate that the loans will be paid back. It’s just that otherwise that loan may not have been made. It doesn’t fit the typical borrower profile. It might not fit the typical collateral profile.

Cathi Kim 21:22
The distinction between perceived and actual risk is one that comes up all the time, and one of the things we do at Inclusiv is to look at the data. What we’ve seen time and time again, from the Great Recession to today, what we found is that the performance, the delinquencies and the net charge-offs for CDFI credit unions is no different than the top 100 largest commercial banks, so they’re able to go more deeply into the market, and there is not a notable or statistically significant difference in the losses to the institution. You know, during times of economic uncertainty, financial institutions tend to kind of pull back credit, decrease loan originations, but for us as CDFIs, if anything, what some of our members have shared is like, “No, we got this.”

Nathaniel Kressen 22:13
In their role as financial first responders, CDFIs are, indeed, good in a crisis.

Carlos Naudon 22:21
When PPP came around, we discovered that a lot of Uber drivers, Lyft drivers, and taxi drivers couldn’t get loans because they didn’t have the kind of paperwork that is normally required. And so we started alliances with some not-for-profit organizations and taxi alliances, etc. And I joke that at one point our parking lot looked like LaGuardia Airport. It was all yellow cabs out there. But, you know, we were able to help them. Most of them were not banked, and we were able to help them get PPP loans, and now we have many of those drivers that remain good customers of ours because of that, because a lot of our folks spoke their language and understood. It goes back to neighbors helping neighbors, in essence.

Conclusion

Nathaniel Kressen 23:17
The work of CDFIs has ripple effects. They offer financial services and opportunities where they’re in short supply, and fund projects that uplift communities more broadly. The industry is growing and changing, in some cases becoming more sophisticated in terms of how they do the work they do. And yet the same issues persist for those the work is intending to serve. Carlos’s story about the taxi drivers touched on the important roles that trust and understanding play, and it’s something we heard echoed across conversations. This episode served as a primer on the institutions within the CDFI sector. The next will focus on the people at the center of this work, on both sides of the desk, lenders and borrowers, because you can’t spell CDFIs without “community.” Bank Notes is production of the Federal Reserve Bank of New York. Research and resources from this episode, as well as more information about the CDFI sector, can be found at the link in this episode’s description.