CDFIs at a crossroads: A conversation with Mark Pinsky of National Community Capital Association

Community Development Financial Institutions, or CDFIs, are specialized entities that provide lending, investments and other financial services in economically distressed communities. The CDFI industry includes banks, credit unions, loan funds, venture capital funds and microenterprise development loan funds. CDFIs are certified and, in part, supported by the CDFI Fund, a program of the U.S. Treasury. According to the Philadelphia-based National Community Capital Association (NCCA), a CDFI membership network, there are currently 800 to 1,000 CDFIs operating in the United States.

CDFIs experienced explosive organizational and asset growth during the 1990s. Now a number of structural and systemic barriers threaten to limit their future growth, creating a strategic challenge for the industry. In the words of NCCA President Mark Pinsky, the challenge is to "grow, change or die." Community Dividend spoke with Pinsky to learn more about the trials that CDFIs currently face.

Community Dividend: You've spoken recently about important changes in the community development finance industry. Could you describe those changes and how they've influenced your work at NCCA?

Mark Pinsky: In late 2001, we started taking a hard look at where the CDFI industry was. We asked ourselves some tough questions. What was working? What wasn't working? What external changes and forces were affecting us? We saw a few things. First, we saw that the pattern that started with the Reagan Revolution was continuing. Resources for community development, broadly defined—for antipoverty strategies, for economic development in general—that came out of government were diminishing. The policy environment changed and so did the resources that went along with it. We viewed the shift as permanent, especially when the current President Bush's tax cuts went into effect, the war on terrorism broadened and the deficit grew. A real tidal shift had occurred. Traditional resources were not going to be there—not just for the next few years, but for at least a decade.

Second, we saw the "go-go" growth stage of CDFIs in the 1990s. Prior to the 1990s, CDFIs had spent close to 20 years figuring out how to succeed at financing community development. At the same time, the creation of the CDFI Fund in 1994 and the changes to the Community Reinvestment Act in 1995 had made it easier for banks to invest with us, which enhanced the work of CDFIs. By the early 1990s, we were able to seize on developments around us and went through a booming growth period. Our industry grew at a rate of almost 40 percent per year in assets and about 40 percent per year in financing outstanding. It was phenomenal. That happened to correspond with one of the greatest boom economies in the history of the world.

We looked at those two things, plus a host of other changes, such as demographics. We concluded that the traditional community development finance model, which relied heavily on federal financial support and grew through fully integrated organizations, had just about run its course. At the same time, we were discovering that for a variety of reasons, things were also changing internally, within the businesses that are CDFIs. We had reached a level of sophistication, but reaching that level had required a cultural shift in many organizations. So, we began asking the question: Is there a future for CDFIs? And our answer was that there is a future for these institutions, whether you call them CDFIs or not, but the future looks very, very different from the past.

CD: Is that when you began to use the phrase "grow, change or die" in describing the future of CDFIs and the community development finance industry?

MP: Yes. "Grow, change or die" was an old phrase that we used when we talked about strategic planning and the strategic choices we make. I think "grow, change or die" should be an everyday process in every business throughout the country, because businesses must make strategic choices all the time.

We opened our annual conference last year in New York with a session called "Grow, Change or Die" and gave a fairly unvarnished presentation of what we had found and what it meant. It was a little bit of shock treatment for some of the attendees. It reverberated beyond our expectations and got people to focus on taking a tougher strategic look at what their options were, what the factors influencing them were and how they were going to continue their work. It captured all of that. We're thrilled that it's gotten people to focus on long-term strategic thinking.

Some CDFIs will continue to succeed and even excel, but many CDFIs will struggle. Some won't make it. We're seeing that happen now, and we'll see more of it. Some CDFIs that have embraced "grow, change or die" are changing their fundamental business models. Instead of being vertically integrated business units that raise their own capital and do their own lending and servicing, they've begun to pick out one or two of those functions to specialize in. Then they're contracting out some of the other functions. For example, in your region we've had conversations with a group of microlenders who were all working in a similar area and realized they could get more bang for their buck if they distributed their business line functions among all the different players. This same sort of disaggregation of functions occurred in the financial services industry from the 1970s to the 1990s.

CD: In your estimation, who will survive and who will go out of business in the new system?

MP: The CDFIs with the best chance of succeeding are those that take a brutally honest look around and make hard strategic choices. The CDFIs that won't succeed are the ones that refuse to face the facts. Having said that, I think that many of the smaller CDFIs in this country—in particular, some of the microlenders in rural communities—will continue to succeed because they're providing a needed function and a large-scale operation wouldn't work for them. Those CDFIs are operating at such a small scale that they'll find a way to keep going.

At the other end of the spectrum, most of the big industry leaders—the ones that have created a critical mass of momentum—are not going to have difficulty, but it would still be easy for them to trip up if they make bad strategic choices.

Some of the CDFIs that lie in between these two extremes—those with roughly $2 million to $50 million in assets—are struggling, because their business models aren't as strong or as proven and aren't at a level of sophistication that's commensurate with the organizational and funding challenges they're facing. It's in that middle tier where we'll see most of the assets shaking out in one way or another. At that level, CDFIs will be transforming themselves and getting business done in different ways. For those that do survive and prosper, smart management and strategic thinking will lead them. We think that times of duress put a premium on leadership and strategy, and that's what we're seeing.

CD: Given the increased activity of mainstream lending institutions in the area traditionally dominated by CDFIs, do you think that CDFIs have worn out their niche in trying to meet the needs of low-income communities?

MP: I wish that we had worn out the niche. It's a success for us if mainstream financial institutions step in, and do so in a big way. That's a good thing, and it's what we're here for. We often talk about CDFIs working just outside the margins of conventional finance. When those margins move, we need to move with them. When conventional financial institutions move down-market, we ought to welcome them and make sure they're in securely. Then we need to find some other market to serve. If the conventional financial institutions move back out, which they do, we need to be able to move back in to serve that underserved market.

We saw that in practice in 1997 and 1998, when banks and other financial institutions moved down-market as the economy improved and their perception of risk changed. Many banks were making small business loans in markets where it hadn't been cost-effective for them to lend before. When that happened, CDFIs began moving into new areas, like financing child care, health care and charter schools. When the economy turned in 2001, banks retreated from many of those markets. They quit financing small businesses altogether, and quit some of their financing of affordable housing. After that happened, some CDFIs questioned if they should move back upstream to serve the communities that were formerly served by banks. Most of them did, because it fit their mission to serve these communities.

CD: In your opinion, what have CDFIs done well since they were created? What have they done poorly?

MP: The thing CDFIs have done best is to stick to their purpose of demonstrating that it's possible to lend or invest money in markets that mainstream financial institutions perceive as risky. By working in these markets, CDFIs show that if you lend or invest wisely, it's possible to provide a solid return to your investors and manage capital responsibly while connecting nonconforming customers to the economic mainstream.

What we've done poorly concerns our lack of business ambition. We haven't recognized the need to commit ourselves to growing at a level that's commensurate with the demand for what we provide. We've helped spur growth and demand, but we haven't yet figured out how to leverage the supply of capital into those markets. In the process, we've created market opportunities for predatory lenders who are stealing wealth from the very people we're trying to help. We didn't have the business ambition, or what I call "institutional ego," to realize that we had to stop loving ourselves as vertically integrated small business units and start thinking more systemically about how to provide capital that's commensurate with demand. That's exactly the problem that NCCA is focused on now.

CD: What can organizations like the Federal Reserve do to assist NCCA and other community development organizations in the future?

MP: The Federal Reserve has been really committed to helping us figure out how we should move forward. The Fed has two important tools that no other organization has. First, it has the ability to convene. When the Fed calls a meeting, people come, especially from our constituency. That's a powerful tool. The Federal Reserve should continue to convene meetings while focusing on a wider variety of issues that impact community development. The role of education in community development is one example.

The second tool is the research capacity of the Federal Reserve. The Fed has the largest concentration of research economists in the world. When the CDFI industry can find research topics for the collective brain power of the Federal Reserve to work on, to help us better understand what does or doesn't work and where the opportunities are, it's valuable to all of the players in the community development industry.