Why CDFIs are Worth Learning About
What is the best way to revitalize areas that suffer from low median income, high unemployment, and social immobility?
When I originally heard the term “un-banked”, I had no idea what people were talking about. I figured anyone could go to a bank and open an account. That is not the case. People with low income, minimal assets, or limited credit histories do not have access to all of the products and services that banks offer and many of us take for granted. Unfortunately, this is why many people in poor communities turn to payday lenders. It is also accounts for a lack of entrepreneurial activity, continuing the cycle of poverty.
What is the solution? Focus on helping people in low income communities develop their full potential by becoming entrepreneurs, homeowners, skilled workers, and recipients of mentorship.
CDFIs were first created with racial justice in mind.
“Redlining” was common practice in the 1960’s. Banks were systematically avoiding investments in certain areas based on demographics. This practice disproportionately affected Black Americans. President John Kennedy was the first to funnel an unprecedented amount of federal money to combat the social and racial discrimination that was occurring at the local level by funding community-based vehicles. These vehicles evolved and eventually became known as Community Development Financial Institutions (CDFIs). While they originally were created to help Black Americans in the South, they soon expanded nationwide and started supporting a variety of other causes, including women’s rights. (Women could not get a credit card in their name without their husband’s signature until 1974.)
The CDFI Fund was created to organize and strengthen the growing number of CDFIs.
In 1994, the CDFI Fund was created as part of the U.S. Treasury. Community banks can now become CDFI-certified to receive government funding, access to training programs, grants, and other benefits to help better serve the communities in which they operate. CDFIs are held to high reporting and regulatory standards and they compete for money by demonstrating strong performance and positive impact.
CDFIs have continually adapted to best serve the needs of their community, such as helping business owners during the covid-19 pandemic as they wait for the federal loans and grants to arrive. They understand the nuances in their local community and support initiatives that are aligned, such as healthy food financing to address the food deserts that exist in low income areas. (Healthy food financing entails financing the building of grocery stores and helping owners equip their stores with healthy food options.)
Private investors can invest in CDFIs.
While larger institutions and community foundations have invested in CDFIs for decades, it was difficult for individual investors to build a diversified basket of CDFIs until fairly recently. Here are a couple options now available to you.
CNote Flagship Fund
CNote is an investment platform that allows you to invest your money in a diversified portfolio of CDFIs. CNote’s Flagship Fund is currently paying investors 2.75% and offers quarterly liquidity. CNote tracks their impact, including the number of jobs created, loans funded, and the percentage of capital deployed to women and minorities. To date, $50M has been committed to CNote and 100% of investors have had their money paid back on time, with interest.
Calvert Community Investment Note
The Calvert Community Investment Note invests in a broad spectrum of community development, affordable housing, micro-finance, and small businesses. About 20-30% of the note is currently in CDFIs. The note is paying rates ranging from 0.5% to 3.5% depending on the maturity. Here is a list of Calvert’s projects that you can view by impact type or geography. Calvert tracks their impact including the number of loans issued. To date, this fund has invested $2.5B over 25 years and 100% of investors had their money paid back on time, with interest.
What is the risk associated with community investments?
CDFIs are lending to a portion of the population that traditional banks deem to be risky. CDFIs had higher delinquency rates (5.29% vs. 3.53% during 2001-2015) than traditional banks, but lower net charge-off rates (0.65% vs. 1.05%). CDFIs are more mission-driven and lenient in terms of accommodating late payments and working with the borrower, keeping net charge-off rates low. Regardless, charge-offs will occur and for that reason CDFIs, similar to traditional banks, are required to have layers of protection, including a loss reserve.
In comparison to traditional banks, community investments have some unique risks, which is why diversification is important.
CDFIs are typically smaller than traditional banks and may be less resilient when there are operational changes. For example, if there is a change in key leadership, that may affect the performance of the community investment.
CDFIs may also receive grants from foundations and other organizations that help to fund their operations. If those funding sources disappear, that will affect investors.
CDFIs have a place in an Impact Investment Portfolio.
Here are a couple of suggestions on how to integrate CDFIs into your portfolio.
Take 10% of your cash reserve, which is likely earning around .8% right now, and move it to CNote’s Flagship Fund, where it will earn 2.75%.
CNote offers quarterly liquidity. While your money will have more impact if you allow it to work long term, you can withdraw 10% of the investment, or $20K, whichever is greater, in the event you need the money for an emergency.
Invest 10% of your Corporate Bond holding in the Calvert Community Investment Note.
The note offers access to private bond markets, is geographically diverse (about 60% domestic and 40% international), and is uncorrelated with a traditional bond portfolio. This note is not entirely in CDFIs, but a good portion of it is and you can learn about the other investments in their portfolio, such as the Forest Resilience Bond, which is working to reduce California wildfires.
Custom solutions for impact investors.
If you have never heard of a CDFI, you are not alone. Ask your advisor about community investments and how you can integrate them into your portfolio. Don’t settle - ensure your portfolio is constructed with an eye on impact, as well as performance. My firm’s team of virtual financial advisors can help.
Linda Rogers, CFP®, EA, MSBA is the owner and founder of Planning Within Reach, LLC (PWR). Originally from New Jersey, Linda services clients nationwide and is based in San Diego. She leads the design of PWR's investment portfolios which utilize broad, low-cost investments that integrate environmentally, socially, and governance (ESG) factors.
Planning Within Reach, LLC (PWR) is a virtual fee-only and fiduciary wealth management firm offering one-time comprehensive financial planning, ongoing impact-focused investment management and tax preparation services. PWR is a woman-owned firm that specializes in busy professionals and impact investors. Planning Within Reach, LLC and their advisors do not receive commissions and do not hold any insurance licenses or brokerage relationships.