The current political and economic climate has focused attention on values, and, as a result, I’m seeing more advisors and clients discussing social impact investing. In its broadest sense, this means aligning clients’ investment portfolios with their values. But more specifically, many people are asking about investing in Community Development Financial Institutions (CDFIs). Today, I want to give an overview of this approach and how it works, as well as provide some resources that you can use to invest your money in that way.

 

What is a CDFI?

CDFIs are private financial institutions that are 100% dedicated to delivering responsible, affordable lending to help low-income, low-wealth and other disadvantaged people and communities join the economic mainstream. Their primary mission focuses on supporting economic growth in the communities they serve, usually by financing small, minority-owned businesses, microenterprises, affordable housing, non-profit and volunteer organizations, as well as services essential to revitalizing low-income neighborhoods.

CDFIs establish relationships with their borrowers and help them navigate some of the technical,  challenging aspects of owning and operating their own businesses. By financing these types of organizations, CDFIs spark job growth and retention in hard-to-serve markets across the nation.  The goal is to help people become financially self-sufficient while also contributing  to economic growth through community redevelopment. Ideally both parties win.  Borrowers receive guidance that makes them more successful, while the CDFI gains deeper knowledge of the local market and community. Additionally, by providing technical assistance, CDFIs increase the likelihood that the borrower will be successful and able to pay back their loan

Under this structure, a variety of institutions serve the broad range of needs. They fall into four different categories:

• Community Development Banks: These federally insured banks are organized like traditional banks. but they are required to have at least 60% of their financing activities targeted to low- and moderate-income communities.
• Community Development Credit Unions: These federally insured financial cooperatives are designed to provide financial services to their individual members. The National Credit Union Administration (NCUA) charters, supervises and insures federal credit unions and insures the deposits up to $250,000 per share owner, per insured credit union.
• Community Development Loan Funds: These loan funds lend to build local businesses, affordable housing, and community facilities. Loan funds’ borrowers are small businesses, nonprofit organizations, charter schools, individuals and organizations involved in community development projects. Loan funds also provide financial counseling to individual and business borrowers.
• Community Development Venture Capital Funds: CDFI-certified venture capital funds pool investor money to make equity investments in private operating companies that yield financial returns while accomplishing community development goals. They also provide equity and management expertise to small businesses, often owned by minorities, that have the potential for rapid growth.

Like many mission-driven businesses, CDFIs strive to be profitable, but profits aren’t their only or even their main goal. They put community first, not the shareholder. They measure their success through the impact they have on the communities they serve. They also focus on social responsibility and inclusion.

 

The impact and Performance of CDFIs

Although the CDFI industry has its roots in many early government programs, the Clinton administration modernized in 1994, when it enacted the Riegle Community Development and Regulatory Improvement Act (“Riegle Act”). This act established the CDFI Fund, a part of the US Department of Treasury, which certifies CDFIs. The Riegle Act also opened up interstate banking, which allowed financial institutions to organize and network across the nation There are over 1,000 CDFIs certified by the U.S. Treasury’s CDFI Fund. They can be found in every state and the District of Columbia, serving both rural and urban communities. As of 2019, certified CDFIs held $136 billion in assets.

When evaluating the scope, performance and impact of the CDFI industry, most of the data comes from the CDFI Fund, the Opportunity Finance Network (OFN) and the Global Impact Investing Network (GIIN).

According to information from OFN, from 1985 through 2014, OFN member CDFIs provided more than $42 billion in lending. These CDFIs led to the creation of 934,000 jobs, 1.5 million housing units, 143,000 community businesses and microenterprises and 9,800 community facilities. As of 2018, their cumulative lending is $54.9 billion, meaning that there was a $12.9 billion increase in financing in just four years.

OFN member CDFIs experience average growth rates in business lending of 7.2% during recessionary years (2007-2009) and 13.2% during post-recessionary years (2010-2016). For comparison, the U.S. Small Business Administration (SBA) 7(a) rates averaged -13.6% during recession years and 17.3% in post-recession years. Not only did CDFIs increase business lending from 2007-2009 while SBA 7(a) lending decreased, they also had lower net-charge off ratios (the difference between gross charge-offs and any subsequent recoveries of delinquent debt). CDFIs average a 4.1% net charge-off ratios

during this time compared to SBA’s 7(a) 13.9%. From 2005-2016, CDFI business lending averaged 2.9% net charge-off ratios in contrast to 6.5% for SBA 7(a) lending.

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.”

 

How to invest in CDFIs

CDFIs receive most of their funding from three sources: banks, the federal government and institutional investors. Despite the varied funding sources, the demand for capital still outweighs the supply. This is where individual investors like you come in.

The most common type of CDFI investment is through a community development loan fund. Loan funds pool capital from many  investors so they reduce risk by diversifying their portfolio of loans.. Several funds now have formal offerings and are registered to offer their notes in multiple states. Others operate more informally and reach out to investors as an extension of their local fundraising efforts.

These  investments have a large social impact, but they can also reduce overall volatility when incorporated into diversified portfolios.. A Morgan Stanley study of over 10,000 equity mutual funds over seven years, found that, on average, impact investing funds had lower volatility than comparable non-impact funds.

To find these options, Debbie Gallant, of Gallant Financial Planning has looked into the Calvert Foundation, which is a highly-regarded, well-developed social impact organization. You can directly invest online in Calvert’s Community Investment Notes. The platform also offers helpful assessment tools that can save you time in trying to evaluate their impact investment.

Additionally, CNote is a technology platform that you may also find helpful in looking for options. It acts as a bridge between individual investors and CDFIs, pooling small investments and funneling them to partner with CDFIs. The platform supports a variety of account types and customers including personal, trust and business accounts. The CNote Flagship Fund, for example, accepts investments from investors of any net worth. You can invest your savings in certified CDFIs that are working to improve community development. You can also earn 2.75% with only a 30-month term and flexible quarterly liquidity if you need your money early. CNote also provides support for financial advisors who want to invest and manage their clients’ funds. And CNote partners with institutional investors, foundations, large banks, and other traditional financial institutions

Depository CDFIs, such as community development banks and credit unions, get capital from customers and non-member depositors. So, you can sign up directly to with these institutions. CDFIs generally offer a modest, fixed rate of return depending on current interest rates and the length of the investment.

Katie Villegas, the owner of Old Peak Financial is a huge fan of CDFIs and frequently recommends them for her clients’ emergency or “rainy day” funds. Her favorite is Self-Help Credit Union. They have CDs that are earmarked for green initiatives that her clients like. “To me, it’s a no-brainer,” she said. “If you’re going to keep an emergency fund somewhere, it might as well be somewhere that is keeping money local and lending to community building initiatives, while also providing a better rate than a typical bank.”

You can find a state-by-state list of CDFIs here.

Keep in mind that all CDFI’s are unique.  There is no single model for CDFIs across the country, since each one serves the needs of the community where they are located. Because of this, it will be a little more difficult to evaluate the risk of an individual CDFI. You will have to employ a substantial amount of due diligence to ensure a specific organization matches the risk profile, impact objectives and financial strength you’re looking for. Companies, such as Aeris and S&P give external ratings to help investors make sure their priorities are aligned before they invest.