The Making of an Equitable Community Development Loan Product – Next City
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The Making of an Equitable Community Development Loan Product

A woman architect working on plans

(Andrey Popov / iStockPhoto)

As chief lending officer at Capital Impact Partners, Diane Borradaile oversees the community development loan fund’s business development team and its team of underwriters.

On one side, she manages the folks responsible for bringing in new potential borrowers, encouraging them to push the envelope with smaller, less experienced developers — especially people of color or women. On the other, she manages the folks responsible for saying “no” to deals that are too risky. It can make for some interesting conversations.

“When there are irreconcilable differences,” Borradaile says, “I try to find a middle ground for them.”

Lately, Capital Impact Partners has been making a push to work with more borrowers of color. As a community development loan fund, its borrowers are generally for-profit or nonprofit developers building affordable housing or mixed-use developments, grocery stores, community health clinics, youth centers, senior centers, charter schools, or other projects serving historically redlined or disinvested communities. But even in a city like Detroit, where the loan fund has financed over $200 million for 40 projects so far, 90 percent of those dollars went to white developers, despite the city’s population being 79 percent black.

There’s a lot that goes into why that disparity exists, and a lot that goes into eliminating that disparity. Capital Impact Partners found help addressing that disparity from the U.S. Department of Treasury’s Community Development Financial Institutions Fund, or CDFI Fund as it’s known. Capital Impact won a grant this fall from the CDFI Fund, which it will leverage to offer a new loan product tailored to meet the needs of borrowers of color.

Meanwhile, Congress recently rebuffed the Trump Administration’s request to zero-out the CDFI Fund’s main grant program. Instead, the Fiscal Year 2020 appropriations bill passed by Congress contains $165.5 million for the program. That’s good news for community development lenders across the country, especially as more of them are also starting to realize, like Capital Impact Partners, that they have much work to do when it comes to being more connected to the communities they were created to serve.

“It’s tools like [this grant from the CDFI Fund] that make this happen,” Borradaile says. “We want to use the grant to bridge the gap between what we believe will better meet the needs of [developers of color] versus what we traditionally think a loan should look like.”

Parts of community development lending can seem similar to an individual buying a home. There’s usually an appraisal to determine the value of the property, which determines the amount any lender can give you. If the property is in a formerly redlined area or really just about any predominantly black or brown neighborhood, appraised values can be prohibitive when they’re lower than what’s needed to rehabilitate a home or build a home on a vacant lot. Known as the appraisal gap, it affects community development lending, too, though some community development lenders have found ways around that barrier.

But the appraisal is just the beginning. Lenders generally lend less than the full value of a property. Banks will typically provide a loan worth seventy or eighty percent of the value of the property, or a lower percentage if the borrower wants to owe less to the bank.

Community development lenders like Capital Impact Partners will go all the way up to ninety-percent loan-to-value. Borrowers still have to find a way to cover the rest.

“It’s gospel that you should have equity invested in the projects, that it keeps borrowers interested and committed,” Borradaile says.

But even with a higher loan-to-value ratio than a bank, Capital Impact Partners realized it was still running into structural inequality because the racial wealth gap means that people of color still have far less access to wealth they can call upon in order to provide the equity needed to do a community development project, even if it was just ten percent of a deal.

“Equity comes out of part of your wealth, comes out of your network of like-minded folks with whom you’ve done business over the years,” Borradaile says. “If structural racism has limited the ability to accumulate wealth, of course you’re not going to have the money for equity.”

But the obvious step led to another potential barrier. Borradaile and her team wanted to offer loans at 100 percent of loan-to-value ratio, to get past the equity barrier. That meant, however, a higher-than-usual debt load for the borrower, which translates to higher-than-usual monthly payments on the loan. More precisely, the amount a borrower would have to pay every month on the loan was a higher percentage of the property’s monthly rental income than lenders usually like to see. That means developers might have to charge above market-rate rents to their tenants — essentially undermining or defeating the purpose of any given affordable housing or other community development project.

So Borradaile and her team also decided they could extend the term of the loan, from their usual 15 to 20 years to 25 or even 30 years. By extending the term of the loan, they could keep the monthly payments low enough to achieve the social purpose of the projects. But that leads to yet another set of potential barriers.

“Everything that makes your money be out longer exposes it to risk,” Borradaile says.

On top of the longer terms, Borradaile says the projects they are seeing borrowers of color interested in are generally smaller, in part because most of them have less experience than larger, wealthier, white developers.

“If you’re doing a five unit building rather than a twenty unit building, if you have one unit vacant, you’ve lost 20 percent of your income, so it’s higher risk for smaller buildings,” Borradaile says.

Capital Impact Partners might be more than willing to take on that higher risk, but it’s not a tree made of money. It’s managing funds from banks and increasingly from retirement funds including public pensions and 401k plans, as well as cash from insurance companies — which hold $6.4 trillion in cash and investments.

The loan fund’s access to those larger pools of money are heavily dependent on its S&P rating. While such ratings are imperfect in many ways, they’re still relied upon by the big money managers who control access to most of the nation’s wealth. Getting a ratings downgrade can mean losing access to those pools, or paying a higher interest rate.

In order to take on riskier loans without upsetting the ratings analysts and larger investors, Capital Impact Partners needs to set aside a little bit of extra cash as a reserve in case of its borrowers missing payments. That’s where the CDFI Fund grant comes in.

Capital Impact Partners received a $650,000 grant from the CDFI Fund, which it plans to use in support of $12.5 million in loans under the new product guidelines tailored for borrowers of color over the next three years. Eighty percent of the grant will go into a reserve for the new loan product, and the remaining 20 percent will fund its Equitable Development Initiative (EDI) — which provides training and technical assistance to developers or aspiring developers of color in Detroit and Capital Impact’s hometown of Washington D.C.

Capital Impact’s Equitable Development Initiative has supported 47 developers of color over two cohorts in Detroit so far, and just announced its first D.C. cohort with 35 members. It’s expecting to announce another Detroit cohort with 20 members in January.

Borradaile is looking forward to the borrowers out of that program coming to her team. It reminds her a bit of her time in community development banking in the 1990s, when New York City ran a program requiring developers who built affordable housing on land acquired from the city to form joint-ventures with minority and women contractors who aspired to become full-fledged developers.

“General contractors or fairly substantial contractors of color were coupled with a white, usually male affordable housing developer as a mentor,” Borradaile says. “Some of the dollars and projects were set aside for this program. This seems to be a memory, though, that nobody shares.”

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.

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.

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