CDFI Small Business Lenders: Succeeding in the Margins by Blending Capital and Know-How

As mission-driven financial institutions, CDFIs provide financial services to markets and communities that are not adequately served by commercial lenders. CDFIs intentionally operate in communities that, due to their smaller scale and a perception of outsized risk, mainstream lenders often avoid. And within those communities, small businesses can be some of the most challenging borrowers to serve.

One might expect CDFIs that primarily lend to small businesses in economically distressed markets to exhibit poor financial performance, as compared to commercial lenders. Yet over nearly three decades, CDFIs have demonstrated an ability to successfully operate small business lending programs, and to prudently steward investor capital. Currently, each of the 28 Aeris-rated CDFIs with small business as a primary lending type has a “sound” financial rating and nine are rated AA- or higher.

The Aeris Cloud database includes about 150 CDFI loan funds, encompassing both rated- and non-rated CDFIs, and representing about 80% of total assets among all US Treasury-certified loan funds. This analysis focuses on the 55 rated and reporting CDFIs with small business lending as their primary lending type. As we have reported in our previous Quarterly Trend Reports, loan delinquency rates in CDFI small business portfolios have trended downward during the pandemic. This was primarily due to both public and private emergency relief support, which has since ended. Nonetheless, as of 3/31/2022 delinquencies were still very low: the median greater-than-90-day loan delinquency for CDFI small business lenders was 0.9% and the median greater-than-30-day loan delinquency rate was 2.2%.

How are CDFIs able to successfully serve small businesses in challenging markets? One of the answers lies in CDFIs’ ability to bring resources beyond capital—such as technical assistance (TA) and coaching—to small business owners. In addition to giving small business owners tools for success, TA keeps CDFIs close to their borrowers so they can identify and address issues when they arise. In addition to managing risk by improving small business outcomes, CDFIs manage their risk exposure by accessing public and private subsidies, with many grant, loss sharing, and credit guarantee programs available to CDFIs serving small businesses.

These resources enable small business CDFIs to operate with narrower net interest margins (NIM) than would be prudent if earned revenue was needed to absorb losses and cover TA expenses. During the Covid pandemic, median NIM for CDFI small business lenders ranged around 4.0%. CDFIs’ use of external resources is also reflected in their self-sufficiency ratios (i.e., earned revenues divided by total expenses), which are commonly less than 100%. Historically, the median self-sufficiency ratio for CDFI small business lenders has been under 70%, although unique opportunities during the pandemic pushed this to 77% for fiscal year 2021. During the crisis, CDFIs often partnered with government, earning fees to execute public policy goals around small business survival. Due to the extraordinary and temporary nature of many of these programs, the higher-than-normal self-sufficiency ratios among small business lenders may not persist in the long term.

Because of the core characteristics of small business lenders’ operations, while small business lenders may become more efficient, they typically cannot grow their way out of the need for contributions that support TA and cushion losses. Fortunately, CDFI small business lenders have demonstrated a consistent ability to attract grants and other resources to support their operations, resulting in net surpluses and continued asset growth. Historically, small business lenders earned median surpluses between $100,000 and $500,000, including during the Great Recession of 2008-2009. The average median surplus from 2005 to 2019 was $300,000 with an average median return on assets (surplus/total assets) of 2.0% and average median net profit margin (surplus/total revenues) of 12.5%. More recently, CDFI small business lenders used the spotlight on the industry during the pandemic to leverage greater earned and contributed revenues, resulting in record median surpluses of $1.3 million and $3.4 million for fiscal years 2020 and 2021, respectively. For the last two years, the return on assets was 3.5% and 7.7%, and the net profit margin was 22.7% and 47.1%.

Among CDFI small business lenders, median asset size was $41.2 million as of 3/31/2022, a significant increase from 12/31/2019, when the median asset size was $27.9 million. This pace of growth may slow, as much of the recent growth was fueled by CDFIs providing Paycheck Protection Program (PPP) loans and administering small business loan programs for local municipalities. While the remarkable pace of CDFI growth may slow, the longer history shows steady growth over time: the median total asset size for business lenders at FYE 2008 was less than $10.0 million.

Lending to small businesses in communities not served by commercial lenders is a challenging undertaking. But tackling these challenges is what CDFIs were created to do. And the data show that, by and large, CDFI small business lenders navigate these challenges successfully, responsibly managing toward a positive bottom line, and being good stewards of lenders’ and investors’ capital.

This is the eighth in a series of CDFI trend reports tracking CDFI performance during the Covid pandemic. Reports for Q4 2021, Q3 2021, Q2 2021, Q1 2021, Q4 2020, Q3 2020, and Q2 2020 are also available.