More Than Lending: The Business Model of CDFI Loan Funds

CDFI Loan Funds Trends Report for Q3 2023

While on-balance-sheet lending is always a leading focus for CDFI loan funds, other activities are critical to achieve impact and earn revenue. Investors need to understand a CDFI’s full business model.

CDFI loan funds are by definition lenders, therefore it is reasonable to assume that lending is always their most significant strategy to achieve mission and earn revenue. However, their activities are usually much broader than lending, and their lending is usually priced to achieve success for the borrower rather than to maximize revenue.

In reality, based on this review of 68 Aeris-rated CDFIs, loan portfolio revenue – including loan revenue, loan application and closing fees, and earnings on idle funds – made up a median 39% of all earned revenue while non-portfolio revenue made up the larger 61% of earned revenue. Although portfolio revenue is a smaller percentage of total earned revenue, it is steady and ongoing. On the other hand, non-portfolio revenue can come from a large variery of sources, and may fluctuate from period to period.

We found the following common types of non-portfolio activities among the CDFIs reviewed.

MANAGING/SERVICING OFF-BALANCE-SHEET ASSETS

Roughly 56% of the CDFIs reviewed manage or service assets that are not on their balance sheets, thereby increasing their impact and earning fees, without adding risk to their balance sheets. The asset sizes of CDFIs managing or servicing off-balance-sheet assets varied greatly, ranging from $25.3 million to $1.0 billion, demonstrating that CDFIs do not have to reach a certain asset size in order to engage in off-balance-sheet activities.

New Market Tax Credit (NMTC) Transactions

The most common type of off-balance-sheet assets is New Market Tax Credit (NMTC) facilities:

  • Of the CDFIs with off-balance-sheet activities, 68% managed NMTC facilities; and
  • It was the only off-balance-sheet activity for 40% of CDFIs with off-balance-sheet activities.

CDFIs involved in NMTC transactions typically generate NMTC syndication and management fees, thus benefiting both the CDFI’s impact creation and fee revenue. However, the awards program is competitive and cannot be relied on as a stable resource. Therefore most CDFIs, even those that have succeeded in obtaining awards, prudently do not budget for new awards. Once a CDFI successfully places the allocation and creates a NMTC facility, the related management fees are assured for the seven-year compliance period.

Servicing Loans or Participations Sold

For some CDFIs, off-balance-sheet transactions are integral to their business models. One example is a CDFI that lends to resident-owned manufactured-home parks and seeks to sell participations in most of the loans it makes. Other examples are CDFIs selling into secondary markets their single-family mortgages that meet Fannie Mae standards, or the guaranteed portions of their SBA 7(a) loans.

There are also CDFIs that sell loans and loan participations less regularly, mainly to manage liquidity, but also to reduce risk exposure, and/or strengthen investor relationships.

For almost all loan sales, the CDFI maintains the primary servicing responsibilities, and receives fees, in addition to acquiring new capital which the CDFI can deploy into its target markets.

Other Non-portfolio Activities Involving Off-Balance-Sheet Assets

CDFIs also generate non-portfolio revenue and increase impact through various other off-balance-sheet activities, including:

  • Originating and managing state tax credit transactions,
  • Originating and managing loan portfolios housed in off-balance-sheet special purpose vehicles for investor partners.
  • Servicing loan portfolios for other mission lenders, such as smaller CDFIs, community foundations, or government loan funds.

To understand the significance of non-portfolio assets to the CDFIs reviewed, we compared the size of off-balance-sheet assets to on-balance-sheet loan portfolios. This ranged widely, but for 58% of the CDFIs with off-balance-sheet assets, these assets were bigger than their on-balance-sheet loan portfolios; the median ratio of off-balance-sheet assets to on-balance-sheet loans was 1.6.

NON-PORTFOLIO REVENUE SOURCES INDEPENDENT OF OFF-BALANCE-SHEET ASSETS

Types of non-portfolio revenue not involving off-balance-sheet assets included the following:

  • Fees from government contracts, to provide services such as home buyer education or borrower technical assistance;
  • Consulting practices with contract revenue;
  • Real estate sales or rental revenues via developing and managing real estate.

These sources of non-portfolio revenue are significant for many CDFIs. Current financial statement presentation of such revenues varies, making it difficult for Aeris to accurately break them out and quantify them in a more granular way. The sources of such revenue that are easier to identify relate to government contracts, such as programs under the USDA and SBA.

In conclusion, the vast majority of CDFI loan funds (and all those reviewed for this report) have diverse sources of earned revenue from multiple activities. In the group of 68 CDFIs reviewed, there was no discernable difference in the median level of non-portfolio revenue between those with off-balance-sheet management activities and those without.

Despite robust and diverse earned revenue sources, for the vast majority of CDFI loan funds, contributed revenue is also necessary to fully cover core lending and the broader set of activities to achieve mission. The median self-sufficiency (calculated as “earned revenue/expenses”) for all CDFIs in our review was 82.9%.

Even for the CDFI loan funds that consistently achieve near or greater-than 100% self-sufficiency, contributed revenue is important to cover certain activities that earn no revenue, such as research and policy work, and to accelerate the pace of building net assets, which supports additional debt to fuel portfolio growth and enables the CDFI to expand impact creation.

The 68 CDFI loans funds in this review include the most recently rated organizations with total assets ranging from $18.1 million to $1.0 billion; the aggregate total assets of the group amounted to $10.9 billion. Those reviewed engage in the full gamut of CDFI lending, including loans for affordable housing, community facilities, homeownership, and small businesses.

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.

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