This interview is part of Next Up: CDFI Leaders Thinking Ahead and Acting Now, an 8-part series exploring the Community Development Financial Institution industry.
Tim Ferguson: There is a perception that CDFIs have become too bank-like to fulfill their mission to provide capital and resources to underserved communities. Do you agree?
Joe Neri: I think it’s a much more complex question. The more superficial “are you bank-like or are you not” doesn’t really get at the particulars. In some ways, it’s fair to constantly challenge ourselves to say that we’re different from banks. In other ways, we have enormous pressure to comply like banks. That pressure tends to force us into managing ourselves more like banks; those pressures often manifest themselves in ways that make us appear like banks.
Banks often say to IFF “you should only make the loans that we won’t make.” And my response has been “what would that be today?” because banks are constantly evolving and changing their credit standards (up market, down market, side market), and it is not the job of CDFIs to constantly evaluate what banks will do today or tomorrow or yesterday. So, sometimes we do loans that look like what banks would have done, but in fact there’s so much more complication than that.
In that sense, every market is different. We certainly work across a large footprint in the Midwest. And we clearly see major differences in terms of nonprofits getting credit in a city like Chicago versus a city like St. Louis, where the banking community is more conservative, and the need for IFF could seem greater. That doesn’t mean that in 2009, or 2010 or 2011 that IFF wasn’t needed desperately in Chicago by nonprofits.
So that’s one answer.
The other answer, though, is that CDFIs have to constantly challenge themselves and ask the question: “are we too bank like?” Are our products, our covenants, our requirements, our credit standards (all things that a lot of banks will have) – are they all meeting the goals of our intended purpose – which is to be an alternative capital source, based on deep knowledge in the community development sector for providing capital and removing barriers for growth in low income communities. And if we’re not constantly asking that question, we’re not doing our jobs.
So, to conclude, do I think CDFIs have become too bank-like? No. But I do think there are areas where CDFIs have become more bank-like, and that they need to challenge themselves to make sure they really are pushing the envelope for getting credit out in a responsible way.
TF: I want to come back to the sources of funding question. But before we do that, I think that IFF has a very clear focus in terms of providing financing to community facilities, and nonprofits specifically. Can you talk a little bit about what differentiates you? Obviously there’s the geographic focus, but you also have a specific focus on the entities to which you’re providing financing, and often advice.
JN: There are a lot of CDFIs that have community facilities finance or community services finance as part of their suite of products, and I think that is well known. But if you dig deeper into that, what you’ll see is that frequently that means CDFIs that are serving only a handful of sectors, for example childcare, early education, charter schools, and affordable housing (which is not necessarily community facilities, but in the same bandwidth); and, in the last six years or so, a growing number have stepped into Federally Qualified Health Center (FQHC) financing space. So, I think that if you look at CDFIs in the country that say they do community facilities lending, they’re very much in those sectors.
Then there’s a smaller group, of which IFF is one, that defines a “community facility” as any facility that a nonprofit uses, owns, or develops to deliver on their mission. So in addition to the sectors I mentioned, IFF also provides financing to a very broad range of human services agencies that use facilities. That includes group homes for the mentally ill or developmentally disabled, senior community centers, other emergency service nonprofits like food pantries, homeless shelters, transitional housing, youth housing programs, arts and culture, substance abuse, and so on.
We view community facilities in a much broader way. IFF actually has three asset classes: The first is affordable housing, which is underwritten in a different way; it’s much more project focused finance. And then community facilities is an asset class, which again is very broad. All the various types of nonprofits I just described fall under that. And finally, our third, which came to be over the last seven years or so, are commercial, for-profit grocery stores, aimed at ending food deserts.
So, our marketplace is much broader than many other CDFIs. Charter schools, early education, and healthcare, along with housing, are our largest sectors in terms of our diversified portfolio. We of course are lending in that space, and have specialists on staff that are involved in advising, as well as public policy and, program initiatives to advance that work. But we are just as busy focusing on human service agencies, food pantries and emergency services underneath that banner.
We have also really focused on the Midwest. In recent conversations our Board called us out and said “we don’t need to geographically expand anymore.” For example, we don’t need to go south even though there are donors that have offered to pay for us to do so. We see ourselves as very deeply focused on the Midwest. To that end, we’ve opened a number of offices throughout the Midwest to serve a large number of the big metropolitan areas in the Midwest.
TF: You mentioned the three asset classes, and I hear you saying that you believe it’s not just about the financing; it’s also about providing solutions to entities that are serving a group of people you want to see services provided to. Could you give examples?
JN: You know, it’s interesting, because the whole use of the term “asset class” (which is very much a banking term), reflects back to your first question: are we becoming too bank-like? The process of defining each sector under the community facilities banner as an asset class is part of the problem, frankly. Because then we are very focused on creating a product that is very specific to a sector or even a sub-sector (not health care, but FQHC). And I believe that tends to create much smaller credit boxes than are intended, which then again drags us back to your initial question of being more bank-like.
When we talk about community facilities, our fundamental focus on our underwriting has not really changed much since we started almost 30 years ago, which was to be absolute experts on understanding the revenue models of the nonprofits we’re serving. Obviously the revenue model of charter schools is different than the revenue model of childcare, or health clinics, or a group home, but that does not change the asset.
In many ways we talk about how we’re a business lender but lending for real estate. In other words, we’re “cash flow lenders on real estate.” We look at revenue and the expenses of the nonprofit that we serve, and are looking at that as the repayment for the loan that they’re making, which of course is to buy real estate. But the real estate is essential to them providing their service or to running their business. So that is how we have focused on thinking about the asset class of community facilities. I know that some of my colleagues do a very similar thing, and we certainly have benchmarks for how we view charter schools versus, say, childcare. And we’re obsessed with the public policy environment that affects those sectors, just as we are if we’re doing a group home or senior center or some other type of nonprofit lending. So when we talk about being “solutions oriented,” I mean we are crafting our terms around the needs for nonprofits. And we pride ourselves on that.
When we started, we set out to create products with the nonprofit in mind from start to finish. Versus trying to create a commercial product built for other types of businesses. When we call them “solutions,” I mean we are looking to make loans that are collateralized by what we’re lending on vs blanket liens. We make loans that don’t have prepayment penalties, because every nonprofit is always fundraising and often gets checks in the mail that allow them to pay down their debts, or they’ll conclude a successful capital campaign that allows them to pay down their debt. We understand that they need to purchase and rehab their facilities, so we’re not creating construction loans that have fees when they transition to permanent loans. We’re trying to craft solutions for them so that they’re in interest-only periods that convert when they get leased up in the case of housing, or fill their slots in the case of childcare centers, or get their first funding in the case of a charter school. And we really look at “what is this sector, how does it make its money, and how do we craft the loan to assist them in the future?”
TF: From the perspective of the borrower- the benefit of working with you is that you have a deep understanding of the challenges that they face, and are able to customize the particular loans to reflect what it is they have in terms of collateral, etc. And from perspective of funders to IFF, they appreciate that, based on your track record, you have a deep understanding of the risks in the sector that they wouldn’t necessarily have. Would you agree?
JN: That is absolutely fair. It’s kind of the bedrock of what we are attempting to do. We say to investors all the time “it’s very different for you to assemble a portfolio as diverse as what IFF does” because it does require understanding of public policy across different sectors, and those nuances.
When we expanded to serve the Midwest, that was part of diversification of our portfolio that took us out of just being in Illinois. We have to fundamentally understand these nuances. For example, if the State of Illinois announces they are cutting nonprofit contracts, often the first questions from our Board are around how it will affect our portfolio. And we know exactly how it will, because we know what dollars are “state discretion,” what dollars coming from the federal government are pass-through, what dollars are court mandated, and so on. So if the State makes cuts, we know when to expect to hear the next day that a judge has overruled it and reinstated the funds. So since this is our only business and these are our only customers it’s very difficult for a traditional financial institution to replicate that in the way we can do it. So our relationship with our funders is very much one built on trust built over 30 years, and selling an expertise that would lead most funders to say they’re getting a great deal.
TF: That’s where you’re lending to other community partners, nonprofits. But you also do some of your own development. I’m thinking of…I’ve forgotten the name, but it was around housing for people with disabilities.
JN: You’re thinking of our subsidiary, HomeFirst, which I’m happy to talk about.
But before I answer that, specifically, I want to say that one of the challenges that is IFF’s ultimate mission is to make change. We believe that nonprofits, when they get stronger, expand their services. They make more change. And we started out as a CDFI who helped them find the capital to do that. But we also discovered in our early years that those same nonprofits had technical challenges in terms of their development, which impeded their ability to expand their services and change the world. So we got into the real estate consulting business to help those agencies better conceive, plan, and execute on their facilities projects. We help non-profits to do those pieces. It’s not that they come to us with the perfect purchase or rehab loan application; instead, they say “we need to move” or “we need to expand” and they need help thinking about how to do that. So through that process, we created our real estate consulting group of over 30 people who have developed over 3 million square feet. And that isn’t in a few hundred thousand square feet buildings; that’s in 15,000 square foot buildings. That has made us a very different kind of CDFI. We call that Development Services; and most CDFIs provide some of this, but we take it to a whole new level – we help them get their facilities executed.
Frankly, we’ve always known that a nonprofit’s core mission has nothing to do with real estate; they need facilities, but they don’t need to get into the business of real estate development or become experts, since they’re only doing it every 5-10 years.
Where I’m going with this, is that this evolution put us into the professional role of doing facilities development. One of our clients – Access Living, which is a center for independent living in Chicago, had been working for a very long time trying to expand accessible housing opportunities for persons with disabilities coming out of institutions. The State of Illinois, at the time, had one of the highest percentages of persons with disabilities living in institutions. Our client, in partnership with us, saw the opportunity to move beyond that. But Access Living understood that they were an advocacy and services organization, not a housing developer. But, how would we get this housing built? So, in partnership, we created HomeFirst Illinois, specifically around developing housing for people with disabilities coming out of institutions. We’re talking about the poorest people in our society; they’re unable to work because of their disabilities; their entire income comes from their SSI check, which puts them at 16% of median income and unable to afford housing. So Illinois had been just putting them in nursing homes.
This subsidiary was focused on really solving a facilities challenge, but in a different way: IFF would develop and own the housing, as one aspect of using our development consulting services. And we’re really solving a societal challenge in Illinois. Now we’re getting requests from other cities to explore the possibility of doing the same in Missouri and Michigan.
TF: How do you think about your impact?
JN: I do think that impact is a more complex conversation than one that is simply about ‘what are you outputs and outcomes’. When I say it’s more complex, I mean we measure in multiple ways.
First, our ultimate goal is stronger nonprofits. Part of our impact is that we are creating stronger nonprofits, and there are different measures of that. We have done a number of studies looking at the financial health of our nonprofits – they’re not all success stories, but the vast majority are. And this is grounded simply in the idea that financially stronger nonprofits are more able to provide their services either in larger quantities or at a higher quality. The only nonprofits we serve are those that serve low income communities, and they have lasting impact. So our measure is “are we creating stronger institutions that are charged with changing the world?” When we look at the work our nonprofits do, and often in cases of the facilities that we’re helping finance, which help expand their services, we’ll drill down into our sectors and look at what are the outputs to those sectors. For example, in early education we’re looking at how many child care seats in low income communities we’re creating; in healthcare we’re looking at how many exam rooms are created or patients served; in charter schools we’re looking at how many seats in higher quality schools are being created. But we don’t confuse ourselves – we’re measuring outputs there.
We look at both short term and long term. In the short term we look at the outputs. We know of the various studies that talk about longitudinal success of childcare in terms of payback to society. So we obviously talk about the outcomes for a child that comes out of high quality childcare; we create change in the short term by adding high quality care in communities. Same with the trajectory of kids that graduate high school and go on to college; lots of studies talk about how kids who are at grade level and who successfully matriculate from high school, that changes the trajectory of their lives. So when we provide seats in high quality schools and look at graduation rates, we can measure the difference between graduation rates of schools we supported, versus other schools in the neighborhood, which will predict outcomes that we don’t see for 18 years. Let’s be clear, these are longitudinal studies that we can’t perform on every loan, but we can use these studies to ground the outputs that we do control in the short run.
So it’s a very nuanced conversation when we start talking about impact – because there are short, middle, and long term impacts of our work.
TF: I want to revert back to question of ‘bank-like’ which is also nuanced response. Do you think it’s fair to say that most CDFI funding comes from either CRA lenders and commercial banks, or the government, particularly at the federal level?
JN: The answer to that is a resounding yes. Most of the debt that CDFIs have is coming from CRA banks. Government, particularly at the federal level, is not providing a lot of debt; though the CDFI bond guarantee program was a large initiative to try to get lower cost capital into CDFIs. The government has certainly been the most important source of equity for CDFIs, which they need to be able to take on the CRA debt from banks. So yes, certainly banks, and certainly for IFF, CRA institutions are the largest source of our capital for lending. Without it, IFF would be tiny. Government has been the largest source of net assets in order to leverage that debt.
TF: Do you think to some extent that leads to the perception that there’s conservatism in terms of how they view the risk that is being taken?
JN: So, yes and no. I think that banks have gotten more sophisticated in how they view CDFIs. Part of it is that we’ve built long track records. For example, IFF has a 30-year track record. In the early days when we were looking at investment from banks, they would see that we don’t require appraisals for our loans, and that was big red flag for them; it put many of them off. But after 30 years of not requiring appraisals, but proving that our underwriting is completely focused on risk management with nonprofits, I think that’s loosened up. So yes, when we talk to new investors eyebrows go up around the appraisal issue, but they come back down when they realize that we fundamentally understand their role and use them, but they’re not that useful in our kind of lending.
Ultimately we have to pay the banks back, and therefore we have to be very good stewards of that money; and that may make us less willing to take on risk in our lending. But I’m not so certain that if we didn’t have to pay it back, we’d be willing to lose it. When talking to our loan officers, the first thing that comes out of our mouth in terms of risk mitigation should not be “we could lose this money,” though of course that matters.
We view it like this: if we don’t get paid back on a loan, we haven’t met our mission. Because our mission is making a stronger nonprofit so they can change the world. If they don’t pay us back, something went wrong in that equation. It tends to mean they’ve either gone bankrupt in some form, or have failed significantly. We certainly work with borrowers to work out issues over time, but when they’ve utterly failed is the only time we don’t get paid back. So if we’re really pursuing our mission, and the money has no recourse, which of course it does, we still want it back because it means we were right in our underwriting, we were right in crafting a solution for that nonprofit so that they’re changing the world.
So yes, banks are more conservative, but part of it is that they often don’t understand the credits as well we do. And that’s the value proposition that we’re bringing to the table. I always say, we underwrite just like banks; we use all the same measures, ratios, and so forth. We come to different conclusions based on better information and our experiences of doing this for 30 years. It’s not like we throw that out the window because we either do or do not have to pay banks back. We still want to be a financially sustainable institution ourselves. So I don’t think it’s that that bank debt makes us more conservative. For CDFIs that have been around a long time, banks are not in the weeds of what we do, they are out telling us how to do our business.
The final thing I’ll say on this is: there’s a little bit of a difference between a lot of CDFIs that work on the coasts and those in the Midwest. In the Midwest, we’ve tried to avoid creating funds where banks insist on having a lot to do with forming that credit box, in order for them to provide capital into a fund. IFF has never worked that way – we don’t create funds where banks craft the credit box. We maintain that they invest into the larger IFF, and we provide the capital into the communities and nonprofits based on our analysis of the needs within our community. And that goes back to our founding, because we were started by the Chicago Community Trust, which is a community foundation. The very principle of community foundations is that instead of creating their own foundation, wealthy individuals in the city put money into the Trust, which was their foundation to evaluate the challenges of communities and make investments in order to improve them at a macro level. So being born out of the Trust, we’ve positioned our CDFI very much in that way—invest in IFF and we will get money to the nonprofits with needs within our community, with deep analysis. We make a pretty good case after all these years that we’re still a good investment on the whole, and that we’ll balance those risks through multiple nonprofits, versus single asset class funds. I think it’s a differentiated way than creating a lot of very specific funds, in order to get capital to very specific asset classes, which often I think handcuffs the CDFIs flexibility to work with their customers.
TF: That’s a really good segue. Let’s assume that the banks continue to fund CDFIs, and you get some form of financial help from government. What do you see as the future of funding?
JN: I do think that well-established CDFIs can position themselves to expand their relationships with financial institutions, in order to help those institutions do the kind of lending that they can’t do within their own house. I think it’s a partner relationship, versus a compliance relationship. Now don’t get me wrong, if CRA were completely rescinded, I don’t think financial institutions would necessarily want to partner. But I think that even under CRA enforcement “light,” the smarter financial institutions are partnering with well capitalized, experienced CDFIs to get capital onto the streets as they can’t necessarily do, or can’t do as cost effectively. That’s the kind of relationship we’ve struck with financial institutions, and I fundamentally believe that will continue.
But, I think the future of funding is about how we get other institutions, and possibly high net worth individuals (though that will come last), to begin to partner with CDFIs to have the impact they want to see. I think that this gets back to the diversification of how CDFIs will fund themselves; it’s not that we’ll replace CRA, it’s that we’ll add on to it.
There are still possibilities with government, beyond what the CDFI fund does. For example, in Indiana, they wanted to assist charter schools with charter school financing. They could have created a financing program themselves (though frankly I don’t think the government should be in the day-to-day activities of financing nonprofits), but they saw that they could partner with IFF and provide us with the net assets to create a charter school loan fund for the State of Indiana, which has been a very good deal for them. They had about $3 million dollars; we’ve subsequently lent over $20M, using those assets and then leveraging. There are more opportunities like this; as government thinks about how to leverage their resources in a smart way, CDFIs are a good partner. Just like CRA banks look to us to partner on projects they’re challenged to do, government can do the same thing. It’s the same sources, thinking differently, and being more flexible.
And to the extent that we can, we should consider other institutions. Only .1% of capital markets are putting their dollars into impact investing, however you want to define that, but that is a significant amount of money. If we can ready ourselves to be both able to take those dollars, and able to report and comply in a smart way, those dollars can start to flow too. I don’t have illusions that this will replace CRA lending, but I think we can open ourselves up to receive more of those dollars.
TF: Do you believe CDFIs have been doing impact investing all along?
JN: Yes, absolutely. It’s kind of a joke in impact investing circles – CDFIs say “we’re the original impact investors, so give us all the money.” But all joking aside, the claim isn’t false. We have been doing impact investing all along, particularly in the community development space. But many people have made a good case for the fact that not all impact investors understand community development per se, or have an interest in that. The idea that CDFIs should receive all impact investing dollars is kind of silly. So, I do believe that CDFIs have to earn the right to say “we’re the original impact investors, we’ve been doing it since day one,” but we have to understand that we have to earn the attention of this growing movement to invest in the things that we have been investing in. Because it is a sub-market of what impact investing is trying to do.
TF: You’ve been able to innovate and evolve based on who you’re funding, and where you’re receiving funding from. With regards to your last statement on impact investing, what are you doing to persuade those more traditional investors to invest in your work?
JN: There is a challenge in that, because we’re not set up to talk to 100+ investors on a retail basis. We don’t have the resources to go meet with and convince individuals that we are worthy of that investment. Part of the solution is looking to other aggregators of that, to the extent that’s possible in a disaggregation focused world. But it’s really different for CDFIs to go out and find those 100 investors at a significant dollar value, just in terms of the cost benefit in that space. Right now, what IFF is doing is looking at some of the movement in the aggregator space, like a Benefit Chicago, which is looking at how to aggregate some of those; and others will come about.
On another level, I think that we are going to have to better understand each of our marketplaces. I think it’ll be hard to aggregate that kind of capital on a Midwest basis, because, from what my limited conversations have been, people are really concerned about the space they’re in – where they’ve made their money, where their business is located- this is the place they care about most. So even though IFF has worked hard to expand to serve a pretty large geography, we also have to think about how we focus locally. That local focus will allow us to offer opportunities and solutions that are interesting to High Net Worth Individuals and institutions that are “in place.” That’s the second way we’re looking at this.
The third way is by becoming larger, and investing in IT and data systems, so that we can be worthy of receiving larger amounts of money when it is available Midwest- wide. This might come from insurance companies or other non-CRA investors who want to move money in larger amounts, but also report back that we are good stewards of the money. We can get it out in larger volume (which is why we’ve worked on becoming bigger) but also report on the impact we’re having. That’s the other piece of this puzzle.
The answer, like all my answers, is that it’s complex. We have to work hyper-locally with certain kinds of investors, which in some ways makes us very small. And then we have to work with larger institutions and be able to move larger amounts of money, which will make us very big.
TF: Is there anything you’re doing internally to make this happen?
JN: We just hired a new CFO who was at Goldman Sachs and understands big volumes of money. We also recently created two President positions. The first will focus on capital on the CDFI side, and really focus on making sure we’re really asking for every dollar in the CDFI space. Then at the same time, there’s the President of a new division called the Social Impact Accelerator. This includes our research capacity, evaluation, development, and what we call Vital Services, which is comprised of sector experts that work across our various core business solutions in lending and real estate consulting, but on a very local basis. The Accelerator group is very focused on working on opportunities to have greater impact, but in a very local way, they will be providing opportunities for investment that have high local impact.
So, the CDFI is going to focus at the Midwest level, getting all of the financial institution CRA money that we can, positioning us as a partner for deploying volumes of dollars at large levels, a la insurance or pensions funds. And the Accelerator group is focused on hyperlocal solutions, programmatic ways to enhance creating higher quality child care, charter schools, health clinics, and so on, which will attract more hyper local investors.
TF: That’s really interesting, and it borrows a little from the capital markets.
JN: Well then the final piece of our new strategic plan is to create a position, and eventually a group, which we’ll call Market Maker. That person will look at what the relationships are with the investor world, both at a macro level, and also at a micro, hyperlocal level. They’ll also have an understanding of the financial needs of our borrowers, of projects our borrowers are doing, or projects we’re doing on behalf of our borrowers, and will make those connections for development. That’s our vision over the next 5 years; we have a lot of work to do to build that out. By no means have we figured it all out, but that’s where we’re headed.
TF: I have two final questions. The first is, if you weren’t a CDFI what would you call yourself?
JN: Haha, well I don’t have an answer…this is something I’ve been struggling with. It’s easy to call ourselves a CDFI because certainly at the federal level, as well as at the local level, the term CDFI has a cache in terms of people understanding what we do, which is provide capital to projects and organizations that need it. We’re proud to be a CDFI, but certainly we’re much more than that.
We’ve always felt that in order to help our customers make the change we want to see, we can’t only accept the perfect loan application; we have to be very involved in the policy environment, the technical assistance, and the real estate consulting side to help them perfect their application for capital. In some fields we have to be an accelerator that thinks “in this community with no childcare, how do we bring our client child care providers to think about this neighborhood differently and remove barriers to expansion.”
I don’t know what the ‘noun’ is, but I’m working on it. But that’s how we think of ourselves: not just a capital provider, but an entity that is proactively thinking about how our clients and communities get healthier and create change.
TF: Final question: you talked about a shift in strategic direction. What’s the most important thing to ensure success in terms of execution? What’s the one thing you feel is critical to succeeding in 4-5 years’ time?
JN: I think that the most critical thing in terms of execution is going to be rallying my Board and staff to understand that our ultimate goal is strengthening nonprofits and the communities they serve. In order to do that, it’s not just getting capital out the door, but it’s the whole package: capital mixed with expertise and knowledge; those things need to come together.
I do think my Board fundamentally understands this. As with all organizations, the staff get caught up in the department they live in. What we’re challenging them to understand and implement is the fact that they’re only as good as the solution they craft that pulls from all of strengths of the organization. That’s going to be critical.
TF: At end of the day, does it come down to the passion of people?
JN: That’s always the case. But this passion challenges them to step out of their narrow expertise, to understand that they’re on a very large team that pulls all of these pieces together. That becomes the ultimate expression of their passion, because it’s about the goal and outcome, not just their own expertise and passion.