In the wake of the current pandemic, philanthropy has an extraordinary opportunity to help steer the nation toward a more equitable economic future (see “An Economy for All”). Community development financial institutions (CDFIs) can play a crucial part in this essential work by building effective supports for both main-street small businesses and nonprofit organizations that may otherwise miss out on COVID-19 response efforts, but they need philanthropy’s support.
Community organizations and minority-, immigrant-, or women-led businesses have traditionally been overlooked by mainstream financial institutions. And the forgivable loans initially made available through the U.S. Small Business Administration’s (SBA’s) massive $349 billion Paycheck Protection Program overlooked many again. Funds have been depleted in just a few short weeks, with early analysis showing that billions of dollars went to large companies and missed several outbreak hotspots.
The implications are deeply disturbing. As Patrick Davis, VP of Program Strategy and Development at Community Reinvestment Fund, USA (CRF) explains: “If we do not authentically and intentionally create the right resources for these organizations now, this crisis will widen the racial wealth gap, worsen outcomes for low-income and low-wealth communities, and wipe out an entire segment of our economy.”
By channeling resources into CDFIs and the innovative partnerships that support them, philanthropy can catalyze both short- and long-term impact to help save small businesses and nonprofits that may otherwise be left behind. CDFIs are trusted partners with a lending infrastructure built on social capital, cultural competency, and long-standing borrower relationships. Crucially, CDFIs are both committed and accountable to community development: the U.S. Department of Treasury mandates that at least 60 percent of CDFI financing activities serve one or more low- and moderate-income (LMI) populations or underserved communities, and CDFIs regularly exceed that percentage.
Working with CRF, which is in turn collaborating with a large group of CDFIs and other partners on a community-centered COVID-19 response, the Arabella Advisors team has identified three primary ways funders can support CDFIs in this unprecedented time of economic need:
- Provide Operating Grants
Many CDFIs need to swiftly build their internal capacity by hiring a mix of full-time employees and contractors to work with their existing customers on loan restructuring and workouts. CDFIs are generally more flexible, patient, and proactive than other lenders regarding loan restructuring, and they have a history of working with borrowers to defer payments, restructure loan terms, and extend amortization schedules to mitigate borrower distress. Such work requires a seasoned and culturally competent asset management staff who can understand the individual needs of each small business and develop plans that work for lenders and borrowers alike. CDFIs who see this moment as an important opportunity to lean in and continue to extend credit for small businesses will also need to hire additional loan professionals to meet enormous needs. Beyond human capital, CDFIs must make infrastructure investments in their technology, loan origination, and loan servicing platforms. Given the nature of how the pandemic has increased the need for remote work capabilities, CDFIs may also need to make investments in online collaboration tools and electronic signature platforms to continue lending at a rapid pace.
- Make Program-Related Investments (PRIs)
PRIs have been a great tool for philanthropic organizations to provide loan capital to CDFIs, while also allowing foundations to make investments as part of their required five percent annual distribution. Historically, PRIs have mainly been in the form of longer-term, low-interest rate loans: the CDFI would use the PRI to fund the loans it makes, but if those loans didn’t perform, it would still need to pay back the PRI in full. While this continues to be a useful source of funding for CDFIs, many are not in a position to take on additional debt. CDFIs are likely to see significant increases in their percentage of non-performing loans and as a result need access to sources of liquidity that do not strain their balance sheets. PRIs can be used to invest directly into a fund or other intermediary that would then purchase portions of loans originated by CDFIs. This would enable the CDFIs to continue lending without negatively impacting their own financial viability by shifting some of the risk of these loans to the fund or intermediary.
- Disperse Equity Injections
Perhaps most importantly, CDFIs need to be in a healthy financial position to lean in and continue providing credit to the small businesses who are least likely to access resources elsewhere. CDFIs have been undercapitalized for decades, with limited sources of equity beyond the Financial Assistance Awards offered annually by the CDFI Fund at the Department of Treasury. Given that CDFIs are, for the most part, nonprofit organizations, “equity” on their balance sheets comes in the form of unrestricted grants. Philanthropy can step in to make direct net asset grants to CDFIs, allowing them to reduce their leverage ratios and manage potential losses within their current portfolios. Even at reduced leverage levels of 8x-10x, equity injections into CDFIs will still be highly impactful in allowing them to grow their lending base.
As “first responders” for community organizations, CDFIs are poised to move significant capital to small businesses and nonprofits at scale, more nimble and patient than traditional lenders, and share a deep commitment to achieving community development goals and creating close partnerships with borrowers to meet their needs. Time and again these institutions were on the frontlines of emergency lending during a series of recent natural disasters, the 2008 recession, and the September 11th attacks.
On April 21, the White House and congressional leaders finalized a new deal that will allocate $310 billion more into the Paycheck Protection Program, with $60 billion required to be distributed by small and medium-sized financial institutions, including CDFIs, that are better positioned to serve the communities described above.
We anticipate that the sheer volume of need will mean that CDFIs continue to need additional support from philanthropy. Now is the time for philanthropy to step up and create partnerships that help advance a more equitable economic future.
About the Author: Ryan Ulbrich is a director on Arabella’s advisory team. He works with a range of institutional, corporate, and family philanthropies and impact investors to develop strategies, implement and evaluate programs, convene learning and working groups, and oversee donor collaboratives to advance common goals.