There are $92 trillion in bond markets around the world. Corporations have ready access to those dollars. For example, when Amazon needed $16 billion to acquire Whole Foods, it borrowed it through the bond market.
Now, nonprofit lenders in the U.S. with a mission to make capital meet the needs of poor communities have a foothold into that world.
“When I was in the capital markets I always said, how come we aren’t investing enough here domestically,” says Lisa Jones, who works at the U.S. Treasury’s Community Development Financial Institution (CDFI) Fund, which supports those lenders — community development financial institutions, or CDFIs — nationwide. “We can make investments all over the world, and we can assess the risk. Why can’t we assess the risk here in some of our underserved and low-income communities?”
At the CDFI Fund, Jones built and runs a program that prepares community development lenders to access the bond markets. In April, a CDFI made a bond offering.
In some ways, it was not unlike other bond offerings. An investment banker from a big-name Wall Street firm made a call to a portfolio manager at a financial services firm. (Portfolio managers invest money on behalf of retirement account holders, pension funds, university endowments and insurance companies.) The investment had a high rating from Standard & Poors, one of the big three investment ratings agencies, meaning it was a relatively safe investment. There weren’t any tax incentives or other public subsidies for those who invested in the offering.
In other ways, the move was completely unprecedented. CDFIs specialize in cobbling together the alphabet soup of community development: LIHTCs (Low-Income Housing Tax Credits), NMTCs (New Markets Tax Credits), CDBGs (community development block grants) and many other tools and programs, along with individual donations and philanthropic grants. Many CDFI borrowers are other nonprofits that build affordable housing, community centers, federally qualified health centers, commercial or industrial space, or other facilities in low-income neighborhoods.
The question in April: Would enough portfolio managers be convinced that investing in a CDFI was a risk worth taking?
By the end of the month, not one but two CDFIs had broken into the bond markets. The Local Initiatives Support Corporation (LISC) raised $100 million in the first-ever initial public offering of a CDFI bond, followed closely by Reinvestment Fund, which raised $50 million in its first public bond offering. Both offerings were oversubscribed, meaning each CDFI received more in bids than it was selling.
Jones was ecstatic. Her program is only in its fifth year of operation.
“It’s very exciting in terms of trajectory for the industry,” Jones says. “I am tremendously excited and just overjoyed that it happened at such an early point. I thought it would take a lot longer than this.”
CDFIs have come a long way since their early days in the 1970s and 1980s, before the acronym even existed, when Catholic orders of nuns were their earliest investors. In 1997, there were 196 CDFIs with just $4 billion in assets. Currently, there are 1,031 CDFIs with $136 billion in assets, in all 50 states plus D.C., Puerto Rico and Guam. According to the Urban Institute, CDFIs now make an average of $6.8 billion in loans a year.
At the same time, CDFIs are reaching some low-income areas across the country but not others. The Urban Institute also found that about 10 percent of counties in the U.S. see a lot of CDFI activity relative to their low-income population, while half of U.S. counties see barely any CDFI activity relative to their low-income population.
While CDFIs feel the need to expand, as a sector they are starting to outgrow their existing large sources of capital: foundations and banks.
“We were at a point where we needed to diversify our capital sources,” says Denise Scott, executive vice president at LISC. “We were maxing out the institutions where we could borrow money from.”
Foundations make grants and low-interest loans known as program-related investments (PRIs) to CDFIs. The Ford Foundation pioneered PRIs to CDFIs in the 1980s, and since then the Kresge Foundation and MacArthur Foundation have also become major CDFI investors. The W.K. Kellogg Foundation has around $35 million to $40 million invested in CDFIs in any given year.
And yet, it’s not enough.
“The needs that are out there far outweigh the amount of capital that just traditional grants can cover, and even PRIs can cover,” says Cynthia Muller, a portfolio officer at the Kellogg Foundation. “At the foundation, we see access to a larger swath of capital as beneficial not only to our mission but the CDFI industry writ large.”
Banks, motivated by their obligations under the Community Reinvestment Act, have grown used to making grants and low-interest loans to CDFIs. But any given borrower, from a tiny small business to even the largest corporation, can reach a point where a bank is no longer willing to extend it further credit. No bank wants to put too many eggs into one basket.
CDFIs are starting to reach that point with banks, especially those CDFIs that work on a nationwide basis.
“A lot of CDFIs would say they are capital constrained,” adds Ellis Carr, CEO of Capital Impact Partners, a CDFI with a nationwide footprint, based in the D.C. area.
The banking industry has also profoundly changed. There are half as many banks today as there were in the mid-1990s, when banks first started investing in CDFIs on a large scale.
“As banks have merged, if we’ve had exposure to both banks, it is not uncommon that one plus one doesn’t equal two,” says Don Hinkle-Brown, CEO of Reinvestment Fund. “It’s not uncommon for the resulting merged bank to want less exposure.”
Looming tax reform under President Donald Trump’s administration may reduce the ability of LIHTCs and NMTCs to attract investment. The market for Low-Income Housing Tax Credits is already starting to feel the effects of an anticipated corporate tax cut: Fewer investors are interested in purchasing those credits than there used to be.
The bond markets are a whole new ocean of capital, with different faces and different rules, and different procedures to learn, but also some key benefits.
Bond market investors don’t put any constraints on geography or purpose of borrowed funds. While state and municipal governments often sell bonds to finance affordable housing, those funds are limited only to the geographies for which they are issued, sometimes limited to specific projects, and only for affordable housing. The bond financing negotiation process with state and municipal governments also takes time, sometimes political dealing, and sometimes a ballot measure.
By going directly to the bond market, CDFIs can access much more patient and friendly capital than they’re used to getting. Banks typically make loans with terms of three to five years to CDFIs, but those terms are getting shorter and shorter, and the interest rates are changing from fixed to variable. LISC was able to borrow money from the bond market at fixed interest rates on terms as long as 20 years. That means it can turn around and make more long-term, fixed-rate loans to its borrowers.
“We were getting to the point of having to think about saying no because it was getting to a point of demand for a little bit longer-term loans than we make and we didn’t have any capital for that,” says Christina Travers, vice president and treasurer at LISC.
By going directly to bond market investors this past spring, LISC and Reinvestment Fund are now able to deploy that capital wherever it’s needed most and with longer terms and greater flexibility to meet the needs of low-income communities, whether it’s housing, health clinics, educational facilities, commercial and industrial space, or beyond.
“Long-term money meant we could make investments in deals we might not otherwise make investments in,” says LISC’s Scott.
The rooftop community garden at New Settlement Community Center, a LISC-financed project in the South Bronx (Photo by ESKW)
Bond market capital won’t ever eliminate the need for philanthropy or public subsidies for community development, but it’s one more ingredient for CDFIs to mix into their alphabet soup of tools and programs. The portfolio managers who invested in April’s two CDFI bond offerings understand that they are adding to the mix, not replacing anything in it.
“The benefit of going to the market is you get another tier in the capital stack,” says Alex Jovanovic, an investment manager at Trillium Asset Management. Through one of the many investment funds it manages, Trillium invested $2 million in LISC’s bonds.
Two forces are now at work to bring more CDFIs into the bond markets.
On the investor side, some are already expressing their interest in more CDFI bonds.
“Since the LISC transaction priced, several investors — those that participated in the deal and those that did not — have inquired about CDFI bonds and Morgan Stanley’s expectations about developments in CDFI bond issuance,” says Grace Chionuma, an executive director at Morgan Stanley, whose investment bank arm conducted LISC’s bond offering.
Some of the CDFI bond investors, like Trillium, are also committed to educating their peers about the merits of investing in CDFI bonds.
“We’re a relatively small player, but if we can get somebody who is managing $5 trillion to act on these issues, it could have a big systemic impact,” says Jovanovic.
Meanwhile, back at the CDFI Fund, Jones’ program continues to expand. The program just announced its latest round of new participants, bringing the total number of participating CDFIs up to 24. (LISC and Reinvestment Fund are participants.)
Accessing the bond market won’t be right for all CDFIs, but it does make room in the industry to do more.
“Bonds allow us to understand and develop partnerships naturally with a community or expand partnerships where there may not be a bank or foundation,” says Carr. “It allows us to be at the peak of our creativity.”
At the end of the day, retirement savings, insurance companies, and foundation and university endowments aren’t going away anytime soon. Corporations and governments have historically been the only ones with direct access to the biggest market where those funds get invested. Now, for the first time, specialized community development lenders have gained direct access to that market, too. With all that’s going on in the world, in this country, in this year, that’s welcome news.
Oscar is editor of Next City. Before that, he was a Next City contributing writer and 2015-2016 Equitable Cities Fellow. Since 2011, Oscar has covered community development finance, community banking, impact investing, equitable and inclusive economies, affordable housing, fair housing and more for media outlets such as Shelterforce, B Magazine, Impact Alpha, and Fast Company.