Community banks, credit unions, loan funds, and other institutions that provide financial services to underserved areas and groups are watching with great interest, and some concern, as the federal government prepares to revise longstanding rules governing their operations.
The CDFI Fund, an agency of the Department of the Treasury, will in April issue new requirements for the certification of community development financial institutions (CDFIs) and the data they must report to the government. It will be the first time the legal definition of a CDFI has substantially changed since the agency began granting certifications in 1997.
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The Department of the Treasury is still accepting comments on the CDFI Fund’s annual reporting requirements and data collections tools.
Comments are due Jan. 27.
While institutions do not need to have CDFI status to offer mission-oriented loans, savings accounts, and other products, certification allows them to apply to the CDFI Fund for grants and subsidies to use for lending capital or operating costs, depending on the program. The CDFI Fund manages 10 programs, including its $165 million CDFI Program, a $355 million bond guarantee program, and the $5 billion New Markets Tax Credit. Certification also attracts dollars from outside investors looking to meet their social justice goals, making it an attractive option for a variety of financial institutions.
Given major changes in the world of finance over the past 25 years and steady growth in the number of certified institutions, the initiative has broad industry support. The number of CDFIs has climbed from 196 in 1997 to nearly 1,400 now.
“We’ve learned a lot about what CDFIs can do and what works,” says Dafina Williams, an executive vice president at the Opportunity Finance Network (OFN), a network of more than 370 CDFIs. “This is an important opportunity for the CDFI Fund to really try to maintain the integrity of that certification. These updates are [also] an acknowledgment that the credential needs to evolve to be able to meet the current capital needs of communities, while also building in enough flexibility for the CDFI industry to continue to grow.”
The new rules will modify the tests that organizations must pass to be certified as CDFIs.
Currently, CDFIs must provide at least 60 percent of their products, both in number of products and dollar volume, to low- and moderate-income communities. The products and services they provide to those communities must meet CDFI standards. They must serve qualifying populations called “Target Markets,” which can be economically distressed areas, low-income populations, or historically disadvantaged racial groups within designated geographic areas.
The organizations also have to satisfy accountability requirements, usually by having members of the community or people who represent their target populations on their boards.
Strengthening the Mission Test
CDFI executives say changes are needed for a few reasons. For one, the industry originates tens of billions of dollars in loans and investments annually, yet wide racial wealth and homeownership gaps persist. That could be in part because CDFIs still provide only a small fraction of all lending and financial services, but also because their products are not getting to the right people or having the intended effects. Some CDFIs may be satisfying the tests, for example, by lending in an economically distressed census tract, but without actually serving many low-income people.
Lenwood Long, president and CEO of the African American Alliance of CDFI CEOs, notes that among CDFI banks in Mississippi that offer mortgages, only 11 percent of their mortgage loans went to Black borrowers, per 2020 federal data. That’s lower than the percentage of mortgages from all types of lenders that went to Black borrowers, which was 16 percent. In Mississippi, 40 percent of the population is Black.
“You have some community banks that are CDFIs, doing just enough to get by for certification,” Long says. “If you peel the onion back, you will weep. Not from the onion, but from what you see in terms of service to poor people, brown and Black people.”
Long says more CDFIs should follow the example of Hope Credit Union, a Black-led CDFI in Mississippi that made 80 percent of its mortgage loans to Black borrowers in 2020. “The CDFI Fund wants to make sure that those organizations that are, quote, ‘CDFI-certified’ meet the true intent of that certification—that they are serving communities of color, serving communities that are low-income,” Long says.
A major goal of the new rules is to address these problems. The agency wants to ensure that all CDFIs are actually providing mortgages, business loans, bank accounts, and other financial products and services to low-income and underserved communities, and that federal funding does not flow to institutions that are not significantly focused on serving those goals.
In a line that garnered notice among industry executives, CDFI Fund Executive Director Jodie Harris told the audience at a conference in October 2022 that “some CDFIs may not be able to meet certification standards,” and as a result may no longer qualify for funding and technical assistance from the agency. She added that certification “is not for every financial institution just doing good work,” but for “those who are working at the margins and beyond, to consciously and deliberately make an impact.”
The proposal aims to do that in part by strengthening the requirements for CDFI certification. If approved, CDFIs must demonstrate that they have an acceptable community development mission and a community development strategy, and that their products and services won’t harm consumers. For instance, loans that include balloon or interest-only payments or those with high fees will be viewed as predatory.
More Flexible Markets
Changes are also needed to enable CDFIs to grow and compete with non-CDFIs, particularly newer financial technology or “fintech” firms that operate across geographic boundaries, industry experts say.
The Minneapolis-based Community Reinvestment Fund (CRF) is one of the oldest and biggest CDFIs, serving low-income “Investment Area” Target Markets in 15 states. Several years ago CRF asked for permission to expand beyond those states and serve markets across the country, but the CDFI Fund simply never acted on the request, CEO Frank Altman says. That limited the number of people CRF can serve.
“Expanding that has been extremely difficult. We’ve asked numerous times to get more states and have just not been able to get the CDFI Fund to take action,” he says.
The current proposal would remove that administrative barrier, eliminating most requirements for geographic boundaries on markets and making it easier for organizations to serve more customers.
Those changes will allow CDFIs to serve disadvantaged people in far-flung locations and may help them compete with non-CDFI firms that operate online and are not restricted by geography, said Chrystel Cornelius, CEO and president of Oweesta Corporation in Colorado. Oweesta is a Native American CDFI Intermediary, meaning it provides funding and technical services to other CDFIs.
For a Native CDFI, “their target market is either their county or their reservation boundaries proper, but they will lend to any tribal member within the United States. If you’re from an Oklahoma tribe, and you just started a business and live in Washington, you can still qualify under that program,” Cornelius says. “I see benefits in those measures, because with the Native population, over half do not live in these communities.”
Altman says he’s excited that the revised rules will allow a Target Market that encompasses multiple qualifying areas across the country, relieving CDFIs of the need to apply for each state individually, and greatly expanding the number of low-income customers CRF can serve. “The idea of a national, low-income Investment Area Target Market is really great music to our ears,” he says.
Limiting Loan Options
Along with these promising new options, CDFI executives say the proposed revisions also contain some serious flaws. They say they hope the agency remedies the problems when it issues its final rule. While the deadline for comments on the certification changes has passed, the Treasury Department is accepting comments on the CDFI Fund’s annual reporting requirements and data collection tools through Jan. 27.
One of the flaws is a new requirement that, if a CDFI is serving Native Americans as its racial Target Market, a certain percentage of the customers must provide paperwork showing they are members of federally recognized tribes, Cornelius says. Customers would no longer be able to self-identify their ethnicity, as members of other racial groups do, which could bar some Native Americans from benefiting from CDFI programs. She describes the proposed new requirement as regressive and colonialist.
“Why are we the only race that is excluded from self-identifying?” Cornelius asks. “We know in terms of access to capital and credit, and financial stability, that we have some of the lowest statistics of all minority populations in the United States. So we find it a little bit confounding.”
Another major concern is the proposed ban on certain types of loans seen as potentially predatory, such as interest-only loans or mortgages with hefty balloon payments. Many Native Americans can’t qualify for a conventional mortgage because they lack credit histories, have low credit scores, or can’t afford down payments and mortgage insurance. However, they can qualify for a short-term loan of 5 to 7 years with a balloon payment at the end, which gets them into the banking system so they can build a credit history, Cornelius says.
Typically, they can later get a second loan with better terms through the CDFI or a conventional bank that has a relationship with the CDFI, she says. They then pay off the initial loan early and avoid the balloon payment. Cornelius estimates that 80 percent of mortgage borrowers from Native CDFIs use balloon mortgages. While the CDFIs also offer credit-building and credit-repair loans, those may still not give borrowers sufficient credit history to qualify for a mortgage, making the balloon loans essential for Native communities, she says.
While Native CDFIs may still try to offer balloon mortgages, under the CDFI Fund proposal those loans would no longer help them remain certified as CDFIs, collateral damage in an effort to avoid the common exploitative uses of those types of loans. “If that were to go through, we could see a lot of Native CDFIs lose their certification, not be able to provide mortgage products in order to gain certification, or not be able to count [Target Market] majorities of their portfolio and lending efforts, because they fit outside of the guidelines of what’s defined as responsible financing practices,” she says.
Some Native CDFIs fear that if their communities lose access to unconventional loans, Native homeownership could plummet.
Another problem is that small CDFIs often cannot offer conventional 30-year loans, because the long payoff period leaves them without capital in the interim, Cornelius and Altman say. Short loans structured with balloon payments allows them to do mortgage lending and enable their customers to buy their first homes.
Altman says one of the advantages of the CDFI system is that many are unregulated financial institutions, such as nonbank mortgage lenders, that can offer unconventional products. “The limitations that come with regulated financial institutions don’t always apply to CDFIs. That gives CDFIs the flexibility to come up with products and services that meet the changing needs of their target markets,” he says. “With this proposal, those products will all be subject to review, or will have to be on sort of a check-the-box, pre-approved basis.”
He argues that would risk choking off those unique sources of capital. “That could be a serious, unintended consequence of what’s being proposed,” he says.
Who Counts as Accountable?
The proposed rules contain many other tweaks that could create headaches, such as updated accountability measures. Altman says he mostly applauds the accountability proposal, which would strengthen guidelines for the makeup of CDFI governing boards and advisory boards. Among other requirements, it will mandate that 60 percent of advisory board members be connected to the institution’s Target Market.
The potential problem stems from a proposed change to rules on which people count as “accountable” to a Target Market. Currently, for a CDFI serving a low-income Targeted Population, a qualifying board member could be a low-income person, or someone who works for or serves on the board of a mission-driven organization that primarily serves low-income people, such as a nonprofit service provider (or another CDFI that serves low-income people).
But the new certification requirements say that only executives of low-income serving organizations could satisfy that requirement—not board members. And there are only so many executives to go around, particularly in areas like tribal lands where there are few such individuals who meet the CDFI Fund standards for board membership.
“It becomes a real jigsaw puzzle if they have to be an executive of that organization,” Altman says. “It’s going to make it very difficult to build strong boards when everybody’s looking for exactly the same four or three titles from each organization to serve on their board.”