ImpactAlpha, May 28 – Looking for a silver lining to the COVID crisis? It could be that the crisis is the catalyst to finally strengthen and scale the small business finance and support ecosystem that has existed outside of mainstream financial channels for decades.
Key to that ecosystem: the community development financial institutions, or CDFIs, and other local organizations that heroically rushed relief aid to small businesses, including minority-owned and rural businesses that struggled to access federal aid. Yet, like their borrowers, CDFIs are typically under-resourced.
How to build on and expand the role of these community-based financial organizations was the topic of ImpactAlpha’s Call #17 last week. Agents of Impact turned out to explore ways to “10X” the impact of these vital organizations and expand the flow of capital for small businesses and nonprofits seeking to re-open and recover from the COVID crash.
Bruce Katz of Drexel University’s Nowak Metro Finance Lab kicked off the discussion with a stark assessment of the crisis and its impact. As America starts reopening, “what you’re going to see is the country focused on the loss of small businesses, the death of Main Street in many parts of our communities, which are not just centers of commerce, but nodes of civic life.”
That will hit home, literally, and could spark a broad rethinking about the role of these community-based channels, which Katz has called a “parallel system.” He predicts not just an upsurge in the role of CDFIs and other alternative lenders, but new models for providing capital and services to Main Streets businesses.
“We’re going to come out of this crisis with a different kind of system for community capital, and for community regrowth and community wealth,” said Katz. “We have to completely recreate every single aspect of the ecosystem going forward.”
One such effort: a Community Recovery Vehicle designed by Calvert Impact Capital and Community Reinvestment Fund that provides common infrastructure and a special purpose vehicle that can buy up loans from CDFIs and free up capital for more lending.
It’s only by “turbocharging” the infrastructure that capacity-constrained CDFIs will get “anywhere near that demand that we know exists in these communities across the country,” said Calvert Impact Capital’s Beth Bafford.
James Bason of New York-based CDFI TruFund noted the huge demand that he and other CDFIs face from struggling small businesses. “Given the magnitude of this disaster, it’s really stressing us from a capacity level.”
A $100 million pilot of the model in Chicago received more 11,000 applications from businesses seeking $300 million. The day after The Call, New York Governor Andrew Cuomo announced a $100 million small business fund that will channel $100 million through five local CDFIs (was he listening in?). Calvert helped structure and raise money for the New York Forward Loan Fund, as it’s called, while CRF’s Connect2Capital provides the common intake platform for applications from small businesses.
Another key to the model: catalytic capital. “There’s a certain amount of risk capital, call it equity or first loss guarantees or what have you, at the bottom that is a kind of catalytic capital” whether from a foundation or, in the case of Chicago, the city, explained ImpactAlpha’s David Bank.
Such catalytic capital is “a way of doing impact investing that makes a lot of sense when the world is totally uncertain, and full of risk,” added MacArthur Foundation’s Debra Schwartz. “That’s what it was built for.” In addition to seeding and scaling efforts, catalytic capital “is necessary to sustain the business model of CDFIs,” she said.
The Community Recovery Vehicle is intended to be a model for a $1 billion national fund and, ultimately, a $20 billion government-backed fund to fuel a massive small business recovery effort. “We are trying to figure out how to make sure government is a partner in this work, because scale cannot happen without them,” noted Bafford.
Even while new models are being created, CDFIs are rising to the challenge. “I think we’ve 5X’d collaboration over the past 90 days, and maybe there’s another 5X to go,” said CRF’s Patrick Davis. “We’ve seen some really fantastic examples of rapid collaboration” that we haven’t seen in the past, he said. Minneapolis-based CRF, for one, has stepped up to process loans for partner CDFIs that were not eligible to lend under the government’s Paycheck Protection Program.
“It’s not just CDFIs,” added Davis. “We need to create this very robust ecosystem that should include development finance agencies, quasi public institutions, community banks and credit unions. There’s a much broader community here” that needs to be better integrated in order to provide the types of capital and the scale of capital that’s going to be required.
Cat Berman of CNote pointed to the need to expand the investor base. “We’ve traditionally looked at government and foundations as some of the critical investor base for CDFIs, and I think it’s time that we expand that.” CNote has helped broaden the base by enabling foundations, family offices, banks and high net worth individuals to easily park idle cash with CDFIs.
The scaling of community financing channels is not without headwinds, however. Last week, the Office of the Comptroller of the Currency, a regulatory agency, rushed out changes to the Community Reinvestment Act that could lead to less funding for CDFIs. “CRA is vital to communities and the work of impact investors” said Fran Seegull of U.S. Impact Investing Alliance. “The new OCC rule changes could undermine decades of work and billions of dollars and badly needed community capital.”
MacArthur’s Schwartz wrapped up the call with some parting thoughts. “Reinvention and rethinking,” she declared, were the themes that came through.
Schwartz reminded call participants of the decades-long process of institution-building that has led to the “overnight success” of CDFIs. MacArthur and Ford Foundation, for example, began investing in CDFIs in the 1980s and 1990s. “It took not just our investments, but many, many other investments and long years of leadership to build the systems and build the institutions,” which enabled CDFIs to rise to today’s challenges.
“I hope, if anything, investors will take that long-term horizon and that institution-building perspective to heart because that’s what we’re going to need as we go through this next wave,” aded Schwartz. “I’m hopeful because there are some big ideas here to reinvent and to make things a lot better.”