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Community investment vector

Impact Investing and CDFIs

June 18, 2019

As the Gupta Governance Institute continues our dialogue on The Business of Nonprofits, it is important to discuss the growing world of Community Development Financial Institutions (CDFIs). Although CDFIs have existed for more than thirty years, their recent growth offers new hope for nonprofit organizations seeking access to capital and for foundations seeking impact investments. CDFIs focus on lending for impact to nonprofits and underserved communities, helping borrowers succeed, and providing an alternative source of capital not offered by traditional financial institutions. For foundations and endowments, CDFIs provide a high-quality, fixed-income “impact investment” option for those seeking to increase their mission-aligned investments.

We asked Pam Porter, CEO of Stepping Stone Partners, LLC to provide background information on CDFIs so that nonprofit leadership can consider developing an important source of capital to support their entity and for foundations seeking an effective way to invest for impact.

Community Development Financial Institutions (CDFIs) are mission-driven financial intermediaries that serve low income communities across the United States. CDFIs are vital partners for both nonprofit and endowment leaders. CDFIs make loans that banks are not typically able or willing to make, provide technical assistance to the borrowers to help them succeed and repay their loan, and then relend the money into the community. This creates a virtuous circle of opportunity and multiplier effect of community development. If you don’t know the CDFIs in your community, then run, don’t walk, to find and meet the CDFIs serving your community!

CDFIs are certified by the U.S. Department of the Treasury, operate in all 50 states, and have a thirty-year track record operating in low-income communities. In aggregate, more than 1,100 CDFIs in the United States lent over $11 billion in 2018 to build homes, health and community centers, and to finance business and consumer loans. CDFIs receive their loan capital from mission-directed investors such as foundations, hospitals, universities, individuals as well as from the banking and public sectors.

Investing in CDFIs represents an impactful, high-quality, fixed-income asset class. Some of the largest foundations and endowments in the country utilize investments in CDFIs to achieve the double bottom line impact of financial return and social impact. This article provides a short primer on the value proposition for investment officers of endowments at foundations, health or educational institutions to start and grow their impact investing with CDFIs.

How it works – financial flow of funds: CDFIs use mission-directed investments, called loan capital, to make low-cost loans to individuals, organizations, developers, and business owners. CDFIs support the borrowers to succeed and, as a result, achieve repayment rates exceeding 98% , comparable to that of commercial banks. Loan capital recycles into the community creating a ripple effect of economic development, and when the investment is due, investors are repaid in full, with interest.

Social impact: In addition to the financial return, the social impact of loans made by CDFIs transforms communities through businesses formed and jobs created; child care, educational, health care facilities built, expanded, and renovated; homes built or rehabilitated; access to healthy food expanded; and affordable consumer financial services offered.

Why invest through CDFIs: Investing in CDFIs provides impact investors, and especially foundations with value beyond the financial return and social impact. By investing in a CDFI, instead of alternatives such as directly investing in a real estate project or business, impact investors achieve the benefits of leverage, diversification, risk mitigation, and operational efficiency.

Leverage and diversification: CDFIs typically pool their capital to serve their target market. As a result, investors achieve both diversification and leverage for their specific investment.

Risk mitigation: CDFIs manage their balance sheets through prudent allocation of loan loss reserves to absorb potential losses. Thus, an investor’s loan capital is cushioned against risk.

Operational efficiency: CDFIs operate in challenging communities and serve potential borrowers with complicated circumstances. The core competencies of CDFIs enable them to operate successfully by providing support services, underwriting and servicing loans in the community.

By investing in a CDFI, a foundation gets a triple win: social impact aligned with its mission and values; financial return with leverage, diversification, and risk mitigation; and finally, operationally efficiency to invest in complicated situations.

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