How has CDFIs’ cost of debt changed over time, and what might the future hold in a rising interest rate environment?
CDFI Loan Funds Trends Report, July 2023
An analysis of CDFI loan fund capitalization data from the past decade and a half shows that CDFIs have demonstrated a remarkable ability to maintain a relatively stable cost of debt, despite ups and downs in the prime rate. This stability is in part reflective of CDFIs’ ability to blend capital from a variety of sources, and in turn, enables them to offer low interest rates that are consistent with their missions and that can be successfully borne by their borrowers. Below are some of the highlights from a longer look at interest rate trends in Aeris’ CDFI loan fund data set.
The number of CDFIs in the data set has grown dramatically during the analysis period. For CYE 2006, Aeris had data on only 50 rated CDFIs. For CYE 2016, after Aeris launched its Aeris Cloud data platform and began collecting data on non-Aeris-rated CDFIs, the data set had grown to 130 CDFIs. More recently Aeris has ramped up data collection efforts, and by 2022 the data set had grown to approximately 150 CDFIs.
This analysis covers 120 reporting CDFIs that have completed submitting their data for CYE 2022 and Q1 2023, enabling a full review as of this writing. The data set includes CDFIs with a range of asset sizes, as well as CDFIs from each of the three most prominent primary lending types (Community Facilities/Commercial Real Estate, Affordable Housing, and Small Business/Micro Lenders), as well as CDFIs that primarily lend to other CDFIs (intermediary lenders), mortgage borrowers, and consumers. Concentrations within quartiles are noted where applicable.
CDFI HISTORICAL COST OF DEBT
Prime Rate and Interest Expense/Average Total Debt
This graph tracks the movement of the prime rate and the average CDFI cost of debt at the same points in time. Data are presented by quartiles, with the median being the midpoint between the second and third quartiles. While the average cost of debt for the top quartile of CDFIs started at just over 4.0% in CYE 2006, it has been remarkably stable around 3.0% since CYE 2009. The median and bottom quartiles have shown a very slight decreasing pattern within a 1% range. Of the total number of real estate lenders in the data set, a higher percentage is in the top quartile. Of the total number of small business lenders in the data set, a higher percentage is in the bottom quartile.
Loan Interest Earned/Average Loans Outstanding
Average Net Interest Margin
Over time, the average interest earned on CDFIs’ portfolios and average net interest margins (NIMs) have decreased slightly, but have remained within a range of 100-200 basis points since 2009. In the two graphs above, small business lenders are most concentrated in the top quartiles for portfolio interest rates and average NIM. This reflects the higher inherent cost and risk of small business lending, compared with real estate lending – in this case, real estate lenders in the data set are most concentrated in the bottom quartiles. These trends are consistent with financial market norms.
CDFIs of all types have provided relatively stable rates to their borrowers and have built business models around relatively stable NIMs—all supported by CDFIs’ stable average cost of debt.
Why is CDFI cost of debt so stable? One reason can be found in CDFIs’ ability to blend capital from a wide range of sources. Using the data set for the Aeris CDFI Loan Funds Trends Report for Q3 2022, bank debt made up a median 44.0% of CDFIs’ total debt. Bank debt can often be highly sensitive to market rates, although this too can vary depending on each bank’s institutional goals, such as expansion into new markets or specific Community Reinvestment Act objectives. Another source of CDFI debt, Wall Street-rated Investor Notes, is also sensitive to market rates, but these notes have only been used by a very small number of large CDFIs, and only in the last few years. In addition to these capital sources, CDFIs carry significant debt from alternative sources, including government entities, private foundations, intermediaries, and faith-based organizations. Many of these are highly driven by program and impact objectives, and as a result are not as sensitive to market rates.
CDFI COST OF DEBT AT 3/31/2023
We analyzed interest rate changes from CYE 2021 to 3/31/2023, when the Federal Reserve was increasing its target range for the federal funds rate. Prime rate at CYE 2021 was 3.25% and increased 475 bps to 8.0% at 3/31/2023. For CDFIs, the top quartile average interest rate and median increased by only 10 bps to 2.8% and 2.2%, respectively, and the bottom quartile held steady at 1.7%. Although the average interest rate increases for CDFIs are modest and fall within historical ranges for the quartiles, a closer look reveals creeping increases among individual CDFIs.
|Cost of Debt Changes from 12/31/21 to 3/31/23
|| % of CDFIs in the Data Set
|>0.3% increase in average interest rate
|between 0% and 0.3% increase in average interest rate
|0% and up to 0.3% decrease in average interest rate
|>0.3% decrease in average interest rate
Nearly 60% of CDFIs in the data set have experienced an increase in their average interest rate since CYE 2021, with 31.7% experiencing an increase of more than 30 bps. This could be an indication of CDFIs taking on higher priced debt.
Aeris examined whether a relationship existed between high on-balance-sheet deployment rates (Loans Outstanding / (Debt + UNA + NA for Financing)) and interest rate increases. One might expect that CDFIs with greater deployment would be more inclined to assume higher interest rate debt. While this may be true for some CDFIs, no correlation existed between high deployment and increased average cost of debt. Based on Aeris’ experience, while the deployment ratio is informative, it does not fully capture a CDFI’s liquidity capacity and need for capital. For example, many CDFIs can sell their loans or participate out a portion of their loans. Other CDFIs regularly develop programs with philanthropy or local government agencies who then provide product capital at negotiated low rates.
Another factor that may contribute to the increase in average interest rates is the repayment of very low priced debt that supported pandemic efforts. In addition to the Federal Reserve’s facility to bridge Payment Protection Program (PPP) lending, numerous private foundations and local municipalities also provided low-cost debt (and grants) to CDFIs that supported small businesses and low-income renters. As of 3/31/2023, most of this pandemic-related debt had been repaid.
OUTLOOK FOR CDFI CAPITAL DEMAND
The biggest factor driving capital demand is loan growth and anticipated loan growth.
*Excludes PPP and forgivable loans, but includes other pandemic support loans.
For this graph, real estate lenders in the data set are most highly concentrated in the top quartile, while small business lenders are most highly concentrated in the bottom quartile. On first look, the median and bottom quartiles for loan growth appear to have flattened as of 3/31/2023. However, this only reflects one fiscal quarter of activity and individual CDFI loan portfolios tell a different story, with nearly 70% of the CDFIs in the data set reporting some portfolio growth.
There are other reasons to expect increasing capital demand by CDFIs. CDFIs seem to be anticipating loan growth. As reported in Aeris’ CYE 2022 analysis, CDFIs have invested heavily in staffing in CY 2022, likely to prepare for the growth. Second, when looking at total loans outstanding, a decrease in special programmatic loans related to the pandemic could be masking “core” loan portfolio growth. This would be most applicable for small business lenders. Finally, the data set does not capture off-balance-sheet funds, which also require capital and continue to be formed to address specific program objectives, and with a narrower credit box than CDFI on-balance-sheet lending.
Aeris will continue to closely follow and report on CDFI interest rate and capital trends as 2023 progresses and CDFIs take on the challenge of supporting marginalized communities in a slowing economy.
This is the 12th in a series of CDFI trend reports tracking CDFI performance. Access the archive of Aeris CDFI loan fund trends reports.
Are you an investor with questions about the performance of your own CDFI portfolio? We are eager to hear from you. Contact us if you would like to discuss your portfolio, ask questions, or hear more about what we are seeing through our CDFI ratings and data collection work. Are you a CDFI loan fund that would like to participate in our database? Let us know.