In some ways, July 16, 2019, was just another Tuesday at the office for Christina Travers. She manages the day-to-day cash flow for the Low-Income Investment Fund, which finances affordable housing, charter schools, child care centers, health clinics, grocery stores and other projects benefiting low-to-moderate income communities in around 30 states.
As vice president for finance and capital strategies, it’s Travers’ job to make sure every dollar coming in and out of the organization is where it’s supposed to be when it’s supposed to be there. For an organization with $749 million in assets under management, it’s no small job. It got a bit bigger that particular Tuesday, which was unlike any other day in the 35-year history of the organization, because on that single day the Low-Income Investment Fund raised $100 million from investors all over the world who invested in the fund’s first public bond offering.
“It was just such an encouraging day because investor demand was so high, I don’t think any of us anticipated it on our side,” Travers says.
The fund is actually the fifth of its kind to conduct a public bond offering like this, but you can imagine why Travers and her colleagues didn’t expect a ton of demand from investors. They don’t finance luxury condo developments or suburban subdivisions with big SUVs in every driveway — the kind of investments you might imagine as low-risk but still providing a healthy financial return. The fund itself is a nonprofit organization, so it has no profit-hungry shareholders pulling its financial strings and making sure investors come first in all decisions.
But what the Low-Income Investment Fund did have going for it was enough to attract ten times more investor interest than it needed — in other words, in just one day, the fund fielded a billion dollars’ worth of offers to purchase $100 million in bonds.
That level of investor demand is a reflection of more than the strength of the fund’s organization and its 35-year track record of $2.5 billion in loans made so far with less than 0.5 percent of its loans defaulting. It’s also a reflection of a growing appetite for investment opportunities that are able to demonstrate some kind of positive impact on society beyond mere financial return. It’s a glimpse of a world where wealth goes only to these kinds of mission-driven investments and no longer to things like prisons, the fossil fuel industry, or unsustainable logging and mining industries. But that world is still a long way off — if that’s even where we’re going — and there are many dangers that may lie hidden along the path to get there.
To understand the significance of the Low-Income Investment Fund’s recent $100 million bond offering, first understand the distinction between stocks and bonds. While stocks are ownership shares in a company, a bond is basically a loan from the bond investor to the bond issuer, usually with a fixed interest rate over a fixed period of time.
The stock markets may get most of the headlines, but the “fixed income” markets — which includes corporate bonds, municipal bonds, treasury bonds, mortgage-backed securities and other asset-backed securities — are bigger. There are around $30 trillion invested in U.S. stock markets, while there are $43 trillion invested in the fixed income markets. That includes $3.6 trillion invested in municipal bonds, which are famously exempt from federal taxes on the income investors earn from municipal bond interest payments. Meanwhile there are $9.2 trillion invested in corporate bonds with no such tax exemption, including the $100 million recently issued by the Low-Income Investment Fund — as well as bonds to finance prisons, the fossil fuel industry, unsustainable logging or mining industries, and Amazon.
Where do all those investment dollars come from? Almost everyone. If you pay for insurance of any kind, some of those dollars come out of your pocket. Insurance companies take in premiums every month, pay out claims, pay for their employee salaries and other operating costs, and then invest whatever’s left over. Insurance companies now hold more than $6.5 trillion in investments, and 65 percent of that is invested in bonds. If you have a retirement plan, be it a 401(k), an IRA, or a public pension, much of those dollars, too, are invested in the bond markets.
Unless you’re a big insurance company, you’re most likely not buying bonds yourself. Most individuals who might own bonds have outsourced that to whoever manages their retirement assets. Pacific Investment Management Company, better known as PIMCO, manages $1.84 trillion on behalf of pension funds, corporations, foundations and university endowments and individual investors all around the world — and it was one of the larger investment management companies that invested in the Low-Income Investment Fund’s bond issuance in July.
The Local Initiatives Support Corporation (LISC) was the first community development loan fund to enter the public bond markets when it issued $100 million in bonds in 2017. Reinvestment Fund was right on LISC’s heels, issuing $50 million in bonds later that same month — and Reinvestment Fund already did a second public bond offering, issuing $75 million in August 2018. A month after that, Enterprise Community Loan Fund issued $50 million in bonds. Century Housing issued $100 million in a public bond offering in January 2019.
In the bigger picture, these bonds hardly register a blip on most investors’ radar screens — there were $795 billion in corporate bonds and $166 billion in municipal bonds issued in 2018 overall. But the cumulative effect of having more opportunities like these in the bond markets is already clear from the fact that this most recent bond offering from Low-Income Investment Fund got ten times more interest than it needed.
All five community development loan funds that have issued public bond offerings so far carry federal certification as a community development financial institution (CDFI). It means, among other things, that they have to report on how they are serving low-to-moderate income communities to the U.S. Treasury every year. There are currently 542 CDFI-certified loan funds out there, but there won’t be a flood of these loan funds into the bond markets anytime soon. It took decades for these five CDFIs to get themselves to the scale and level of sophistication to even consider it, while also building up a track record and also building up enough cash reserves to give investors confidence that they could withstand a downturn. Each had to go out and get a rating first from a major investment ratings agency — all five have an investment-grade rating from Standard & Poor’s (S&P).
Not every community development loan fund is destined for a bond offering. But as more are considering a bond offering, there are some important caveats to keep in mind.
The Action Center on Race & the Economy has spent a few years now digging into abuses in the bond market. Co-founder and co-executive director Saqib Bhatti first noticed what was happening during the Great Recession, in the aftermath of foreclosure crises that crippled municipal budgets. He saw a pattern of Wall Street both helping cause foreclosure crises by peddling predatory subprime mortgage loans, then swooping in with predatory municipal bond deals to try to help cities make ends meet.
As Bhatti continued the research he discovered what was happening to the entire island of Puerto Rico. At the behest of investment banks swooping in to offer some cash in the short-term, the government of Puerto Rico was signing onto outrageously predatory bond terms that resulted in the territorial government owing nine times more in interest payments than it actually borrowed.
“The question that comes to mind is why now — is this something that CDFIs need and go to investment banks or is this something pitched to them from bond underwriters,” Bhatti says. “Often a lot of these things originate with the underwriters. If it came from the underwriters, what are some of the risks that CDFIs might not have thought about.”
Bhatti’s research also led him to school districts, hospital systems or local government entities that found themselves paying hundreds of millions a year in interest payments to bondholders, payments they couldn’t cut lest they risk defaulting on their debts — instead being forced to cut teachers, hospital workers and other essential workers in order to close budget deficits. From Puerto Rico to Chicago to California, bond deals driven by underwriters have left many public agencies in precarious positions.
Bhatti isn’t aware of any predatory bond deals targeting community development loan funds, but warns that it doesn’t mean it won’t happen as these bond offerings become more commonplace.
Upon a review of all five CDFI bond offering documents so far, Next City did not find any similar repayment schedules like those in the Puerto Rico government bond offering documents that promised interest payments adding up to more than the amount borrowed.
“Even if those kinds of strings don’t exist now, there is potential for them to exist in the future,” Bhatti says. “As you open the door for the greater investment of Wall Street interests in this sector, how will it ultimately threaten to change this sector over time? We don’t want the community development finance sector more beholden to Wall Street as opposed to the communities they are supposed to serve. It would defeat the purpose of having this sector.”
So far, it’s been the community development loan funds approaching investment banks like Morgan Stanley and Bank of America Merrill Lynch to serve as bond underwriters.
“We haven’t seen many investment banks knocking on CDFIs doors saying we’d like to do a bond for you,” says Dan Nissenbaum, CEO of Low-Income Investment Fund. “Because it’s complicated, and right now because it only applies to a small slice of the industry.”
The motivation from CDFIs to conduct these sophisticated bond market offerings so far has been to diversify their own funding sources. CDFIs typically get their funding through loans or grants from banks, foundations, and government. The fixed-income markets are bigger than all of them combined.
Each time around, everyone at every stage of the transaction gets a little more familiar with how these public bond offerings can work for community development. Before coming to the Low-Income Investment Fund, Travers spent ten years working at LISC. So this was the second time she has played a key role in a $100 million CDFI bond offering. Things were a lot smoother this time around.
“Everyone involved all the way down to S&P has been through this process a couple of times now, so we all have a sense of what’s coming and that makes it really efficient,” Travers says. “A lot of the kinks have been ironed out.”
Editor’s note: A previous version of this article mistakenly omitted Century Housing’s $100 million bond offering. We’ve corrected the error.
This article is part of The Bottom Line, a series exploring scalable solutions for problems related to affordability, inclusive economic growth and access to capital. Click here to subscribe to our Bottom Line newsletter. The Bottom Line is made possible with support from Citi Community Development.
Oscar is Next City's senior economics correspondent. He previously served as Next City’s editor from 2018-2019, and was a Next City Equitable Cities Fellow from 2015-2016. Since 2011, Oscar has covered community development finance, community banking, impact investing, economic development, housing and more for media outlets such as Shelterforce, B Magazine, Impact Alpha, and Fast Company.