New rules have been developed to allow what are called Community Development Financial Institutions in the US to expand their remit, drawing capital from a wider range of allocators – including family offices and banks.

The author of this article says that revamped US Treasury department rules will change the way that Community Development Financial Institutions scale up across the US, and the way investors can obtain competitive returns. The author is Bernel Hall, president and CEO of New Jersey Community Capital. (More about the author below.) Hall asks why wealth managers overlook CDFIs, and explains how that can be changed. The editors are pleased to share these insights and invite readers to respond. The usual disclaimers apply to views of guest writers. Email tom.burroughes@wealthbriefing.com

New US Department of Treasury regulations finalized late last year that make it possible for certified Community Development Financial Institutions (CDFIs) to expand their service areas, adapt to changes in the banking industry, enhance financial inclusion with smaller loans and more are finally trickling into the lending marketplace. 

These changes will not only strengthen the core purpose of the Community Reinvestment Act but also unlock new pathways for CDFI lenders to serve a far greater number of communities and attract and leverage more capital from a broader spectrum of allocators, including institutional investors, family offices and banks.

This is a game-changing opportunity for CDFIs, enabling them to scale their efforts nationally, increase their assets under management and, most importantly, magnify their positive social and economic impacts in underserved and under-resourced communities. It is an equally game-changing opportunity for lenders and investors who want to align financial returns with social impact.

Unique vehicles 
CDFIs are federally certified financial entities established under the Riegle Community Development and Regulatory Improvement Act of 1994. While there are four different types of CDFIs, all share a common mission “to foster economic opportunity and revitalize neighborhoods.” 

As such, they are uniquely positioned to bridge the divide between undercapitalized communities and the essential resources they require to thrive and lend where it counts with 85 per cent of funds going to low-income areas, 66 per cent to minorities, 48 per cent to women and 27 per cent to rural areas, a 2022 Opportunity Finance Network Survey notes. They are also resourceful lenders, “leveraging $8 in private sector investment for every $1 of public funding,” US Secretary of the Treasury Janet Yellen noted.

Ultimately, CDFIs are more than just lenders – they are true partners in community development, operating with a deep understanding of the unique challenges and needs of the under-resourced and undercapitalized communities they serve. They engage in building affordable housing, financing community facilities and infrastructure projects that can revitalize struggling neighborhoods, funding local businesses that create jobs and support local economies and more. By providing services such as financial education and technical assistance alongside traditional financial services, CDFIs create foundations for sustainable growth. 

This multi-faceted approach is essential for addressing systemic barriers to economic participation and fostering equitable growth. It is also especially critical in communities and neighborhoods that traditional banks may deem too risky or unprofitable. In these ways, CDFIs play a vital role in revitalizing economically precarious markets and diverse communities, many of which have suffered from decades of disinvestment. 

A new framework 
The release of new CDFI rules coincide with significant multi-year growth of these mission-based lenders. Over the past five years, the number of certified CDFIs has increased by 40 per cent, and their total assets under management have nearly tripled, reaching about $452 billion as of early 2023, the New York Federal Reserve reported. The new rules are aimed at encouraging more sophisticated and larger-scale operations among CDFIs.

The new regulations will give CDFIs more flexibility, allowing them to scale their operations and create an impact as never before. The most significant change relates to the “target markets” CDFIs serve. For decades, CDFI lenders have been locked into serving geographically designated “qualifying areas,” limiting their ability to expand their offerings to other communities. The latest revisions to the CDFI Certification rules will give CDFIs far more flexibility, starting with the ability to define a target market covering multiple states and qualifying areas nationwide.

The new rules, however, represent far more than a logistical change; they are a strategic expansion of the CDFI mandate, enabling these institutions to address economic disparities more dynamically and effectively – and to develop new strategies that can meet the evolving needs of these communities. While approximately 20 to 25 CDFIs are poised to significantly benefit from these changes due to their mature infrastructure and access to capital markets, there is a potential for growth among smaller CDFIs as well thanks to the forthcoming rules changes, which incentivize CDFIs to achieve scale as never before.

Another significant regulatory change is a new rule allowing the CDFI Fund and banks to channel more capital into equity investments within their communities to meet CRA requirements. The new framework permits CDFIs to offer more than just loans; they can now make direct equity and venture capital investments. This critical change will allow CDFIs more freedom to support small businesses and startups in historically marginalized areas. Diverse and minority small business owners often lack the generational wealth or networks that are available to more affluent populations. By investing directly in community businesses, CDFIs have an opportunity to transform the economic landscape for many of these underrepresented entrepreneurs.

Why investors overlook CDFIs
For wealth managers, institutional allocators and family offices, CDFIs offer both measurable social returns and competitive financial returns. Their dual impact – social and financial – also aligns with investors’ growing appetite for sustainable and responsible investments. Yet despite their critical role in fostering economic inclusivity, CDFIs have often been overlooked by traditional investors and wealth managers. 

Many asset managers are simply unaware that CDFIs exist, and those familiar with them frequently dismiss them as mission-driven lenders unconcerned with financial performance. This is an unfortunate misconception. Analytics by women-led impact investment platform CNote noted that CDFIs can generate social value while providing competitive financial returns.

Morgan Stanley noted sustainable investments such as CDFIs can also improve portfolio stability, even in times of financial stress. For example, CDFIs were recognized for their strong portfolio performance during the Covid-19 pandemic and CDFI loan funds emerged from the pandemic with stronger capital structures than ever.

Investors frequently don’t recognize the sophisticated financial operations that underpin successful CDFIs, which have scaled their capabilities as they have increased assets under management in recent years. Today, top CDFIs employ seasoned financial analysts, apply advanced investment tools and maintain the same operational and financial diligence standards that institutional allocators expect from their asset managers. 

The CDFI industry’s increasing sophistication and capacity to manage substantial assets presents a compelling case for impact-oriented investors. It has also attracted a growing pool of institutional capital. JP Morgan, for example, has allocated more than $2 billion to CDFIs since their inception, and continues to increase its commitments.

A call to capital allocators
CDFIs offer investors a host of compelling benefits, starting with diversified portfolios that mitigate risk through strong balance sheets and deep community engagement. Institutional allocators increasingly recognize CDFIs, with their focus on sustainable, purpose-driven investments as a powerful vehicle for enhancing investors’ double-bottom-line impact: they generate social value while providing competitive financial results.

CDFIs are also adept at originating deals, offering investors a unique avenue to deploy capital into overlooked yet emerging and growing markets that can deliver both tangible social returns and competitive financial returns. By leveraging their deep community ties and expertise in economic development, CDFIs can uncover and seize investment opportunities that might otherwise be overlooked. Furthermore, a broad spectrum of CDFI investment opportunities allows investors to engage in meaningful projects that align with their values and investment goals.

The call to the investment community is clear. By channeling capital into CDFIs, investors can play a pivotal role in shaping a more inclusive and equitable economy and earn competitive financial returns.

About the author
Over the past 25 years, the author has executed over $5 billion in real estate investment, lending, and disposition transactions for multi-family, retail, office, and hotel properties in 36 states throughout the US. A former investment banker, public housing executive, and real estate finance professor, Bernel Hall is an expert in large, multi-faceted public-private real estate transactions, small business transactions and executive leadership.