Future of Community Development Investments
from a panel discussion )
2003 Federal Reserve System's Community Affairs Officers' Conference
Dallas, Texas, May 21, 2003
On May 21, 2003, the Officers, Managers and selected
staff of the Community Affairs Offices of the Federal Reserve System held
a conference on community development issues which included a panel entitled
"The Future of Community Development Investments." Panelists
included Bob Taylor, Senior Vice President at Wells Fargo Bank and President
of the Wells Fargo Bank Community Development Corporation, Dan Sheehy,
President of Impact Community Capital, Frank Altman, President of the
Community Reinvestment Fund, and Jim Reid, President of the Texas Mezzanine
Fund. The panel was moderated by John Olson, Community Investment Specialist,
Community Affairs Office of the San Francisco Federal Reserve Bank.
John Olson: To explore the issue of
"the future of community development investments," we invited
four distinguished panelists to offer their unique perspectives: Bob Taylor
of Wells Fargo, to cover the perspective of a CRA-motivated investor,
Dan Sheehy from Impact Community Capital, to cover the perspective of
community development investors who are not motivated by the CRA, Frank
Altman from the Community Reinvestment Fund, to share his views as a secondary
market practitioner, and finally Jim Reid from the Texas Mezzanine Fund,
to give us an understanding of the "other side" as a CDFI recipient
of community development investment. My thanks to each of you for participating
today. I'd like to start with a broad overview from each of you on your
role in the industry and trends that you're seeingwhat are your
reactions to some of the current issues we've been discussing today, such
as possible changes to the CRA regulation and the impact of the proposed
elimination of the tax on dividends.
Bob Taylor: I work for Wells Fargo and centrally
manage community development investment activity for the bank in 23 states.
The investments are centralized at Wells Fargo for a variety of reasons,
but opportunities are identified within a decentralized management structure.
We have a portfolio of $1 billion, roughly $500 million in Low Income
Housing Tax Credits, $125 million in housing-related bonds, $125 million
in real estate, and $150 million in equity equivalent investments. Our
2003 investment budget is $325 million, roughly the annual commitment
in place since 1996. Prior to that, we had not done much investing, and
at that timewhen the new regulations came into effectthe industry
didn't really know how much investing was going to be enough.
Over the last seven to nine years things have changed
a lot. There's been an amazing increase in efficiency in the capital markets,
not just nationally but internationally, and with that has come certain
standards. People now put money at risk and expect a return; previously
these activities had been thought of as "give-aways"doing
what we had been taught not to do in banking school. We have a staff of
50 on the ground, folks in cities and in rural markets to say what's going
on and we try to address needs that are uncovered. Before, people said
that this is CRA investing, just do it. Now, you must make investments
that make good business sensea whole financial discussion with both
pricing and loss estimates. CRA's the right thing to do and it's growingan
emerging market with groups seeking opportunities. Benevolence is rewarded
with cross-selling opportunities for the bank. Especially considering
competition from brokerage houses and others, it's a very competitive
world. The motivation for an outstanding rating is still there, although
it doesn't buy a safe harbor from protests in mergers.
If CRA went away and/or the investment test were
scaled back, we would continue with Low Income Housing Tax Credits as
we'd still get the tax relief as well as the potential for lending associated
with the projects. We would still do intermediary-type lending as we have
an active small business franchise and these firms also have needs for
checking accounts and other banking services. As for the impact of the
elimination of the tax on dividends, the result is more up in the air.
We pay some $3 billion in taxes, and there would be some impact as a result
of the change. But we do have profits needing offsets, so it's unlikely
we would get out of the tax credit business.
It's an interesting business to be in. I continue
to be amazed that there are still people in the bank who don't know what
we do in the community development investment area. I'm proud to do it!
You have to pick partners like Frank Altman or Jim Reid; people you can
trust, so you don't have to spend a lot of time "underwriting"
the people involved. If you give people money, you have to be able to
trust them to re-loan it appropriately, to utilize it efficiently in real
estate development, etc. It comes back to deals and pricing.
John: Thanks, Bob. To press further, there
are various pressures at play in the investment decision-making process.
It seems that CRA's not quite the same motivating force that it once was.
How have community-based organizations responded to that shift? Have they
had to reform the way in which they propose things to you?
Bob: Jim will have to answer part of that.
To share an interesting analogy, my father was a 'beat cop' at one time
and whenever he was accused of trying to meet a quota in writing someone
a ticket, he always responded "no, I can write as many tickets as
I want." The point is that we will occasionally stretch or bend things,
but ultimately we want to make a difference in a community. Before, there
was a big hammer over our head, but now there's some rationality in how
we respond. In part it's because there are now fewer banks and even more
cooperation in our responses.
John: Jim, let's turn to you to follow up
on this. Have you had to approach banks differently than before?
Jim Reid: First, from our perspective, at
the very start we developed a strategic plan for self-sufficiency. We
set our own performance objectives before the CDFI Fund specifically required
it of us. We welcome standards and accountability and we respond to trends
in financing. There seems to be a tendency in the CDFI industry to say
"more is better," with, for example, the number of certified
CDFIs growing to some 637 now. However, as we've seen in the CHODO and
SBIC industries, more is not necessarily better. We need to aggregate
in certain markets in order to serve them more effectively.
Secondly, although the CDFI Fund has given us two
awards, which we've appreciated, in the end this money is "chump
change." The fact is that if there were as much priority in Washington
placed on community developments as on tax breaks, then we'd have major
funding for these activities. We need a national focus on community and
economic development. The jury's still out on the New Markets Tax Credit
(NMTC); certainly more players are brought to the table because of it.
Moreover, if you look at the world of community development organizations
around the country who have been slugging it out since the 1960's, none
of them received credit allocations. And in terms of whether the NMTC
will benefit communities, I went to the first NMTC conference last year
and saw none of the usual faces. I saw people from investment houses,
attorneys, and tax credit professionals. It made me wonder how much of
this money goes to those organizations that need it.
Third, in thinking about community development, we
have a tendency to think only in terms of actual places, specifically
bank assessment areas. However, while our fund targets incomes, specifically
below 60% of area median, we also target minorities. National studies
have shown that minority businesses have less collateral, less access
to capital, yet the CDFI Fund said we needed a special Texas study to
prove this. In thinking about the future of community development, there
is a tendency to think about places like low-income communities. We also
try to target African-American and Hispanic businesses and are still arguing
with the CDFI Fund about the importance of this. We've even used a recent
Milken Institute study to try to explain. Given that we will be a majority-minority
country, how can we ignore the minority community?
John: To follow up just a bit, Jim, a couple
of times in this conference people have mentioned some fear on the part
of CDFIs of working with institutional investors. What's your take on
Jim: I have no fear. We don't just take money
because it's available. We only do if the earnings objectives and the
other objectives of the investors are in line with the mission of our
organizationeven without CRA as a motivation. We want more players
at the tableespecially players looking at business needs not related
to the CRA. For example, we're looking at setting up a business fund for
minority contractors here in Dallas.
John: Now let's bring Dan into the discussion.
You're a relatively new player, representing insurance companies through
your organization, Impact Community Capital. What's motivating insurance
companies to do this without a regulatory requirement?
Dan: I first want to say that I've been quite
stimulated by the conversation thus far and, to a certain extent, the
issues we're discussing are a prime example of why Impact's in the community
investing business. For example, Bob says that he doesn't need CRA to
motivate much of his community investment work. Impact and its insurance
company investors don't need a form of CRA inducement either.. Impact's
first deal in 2000 was a $40 million transaction. We now have direct investments
or firm investment commitments at the $750 million level. Impact was formed
by three nationally-focused insurance companies; they have been joined
by seven others, all interested in demonstrating that there is a way to
engage in community investing profitably and without regulation. However,
insurance companies have felt perhaps a hint of the possibility of the
imposition of some CRA-type mandate. And, of course, there are 50 different
state insurance regulators. Pure altruism? Not necessarily, but the companies
have a strong desire to create a connection between our community investment
initiatives and the communities in which these companies write policies.
The Impact companies have a necessary focus on risk-based
capital requirements and risk-adjusted investment returns. Their community
investment dollars are sourced from each company's investment account,
not from a charitable giving budget line. Insurance regulators look at
safety and soundness of a company and its investments to ensure that,
for policyholder protection, invested assets are safe and liquid. So,
Impact's investment strategies needs to be consistent with those requirements
and regulator attitudes. Some $600 million of our $750 million total funded
and committed investments is or will be securitized with a significant
portion of the resulting securities receiving investment grade ratings.
In a typical transaction, each single loan purchased (one-off investments)
will be pooled and securitized; Impact's investors will include these
rated certificates on their balance sheets, and Impact will hold the non
investment grade piece. Credit enhancement (or the "securitization
subsidy") is provided by the insurance companies via their funding
of Impact's purchase of the non investment grade portion of the securitization.
We seek ways to purchase assets (mortgages) from
CDFIs and from organizations like Frank's that work with CDFIs. We also
rely on the banking community. For example, we're talking to Bob regarding
a novel way of financing health care centers. In this situation, Wells
would originate and service the loans and Impact would provide the permanent
John: Isn't it hard to buy a bunch of loans
made by CDFIs; aren't they one-off, "story" loans? How do you
bundle and securitize them?
Dan: You're correct; it's very difficult,
at times. It is difficult for an investor to purchase 'one-off' community
loans, in general, and that degree of difficulty varies among asset types.
Community development loans and asset or loan types are more likely than
not to exhibit aspects such as insufficient historical performance track
record, poor credit history, high leverage, etc. However, once these loans,
and asset classes, prove themselves, they can then be more readily pooled
and sold to institutional investors. It's a process; it doesn't just happen.
And there are a variety of reasons. Chief among them is the community
development originators themselves, and specifically, the degree to which
each possesses the capacity to produce investments palatable to the investment
community. The community development world's undergoing significant change.
John: Now's a good time to turn to Frank,
the guru of secondary markets for community development lending.
Frank Altman: Since I last spoke to this group,
we (the Community Reinvestment Fund, or CRF), had done maybe $10 million.
Now, we're growing rapidly and are pleased to have many good partners.
For example, Wells Fargo has been a major investor. What we do, basically,
is aggregate loans, "onesies" and "twosies," from
CDFIs, purchase them, and create a financial product that can be purchased
by organizations like banks and insurance companies. Secondary market
intermediaries match community demand with capital, but also mediate between
different kinds of institutions seeking to diversify. On the one hand,
it's balancing areas with capital with areas that need capital. And on
the other hand, it's intermediating between different kinds of institutions
such as retail and commercial finance companies. We seek CDFIs and others
with community development missions, then we work with them to think about
their unique competency, then find other organizations to assist them
with what they do well.
While I do feel it's important to keep the regulation,
I think that in the future, we'll be moving from an industry driven by
regulation to a market approach where market mechanisms start approaching
capital. The issue is segmentationfinding the right role for different
investors. CRF is national, with a charter to support non-depository lenders
such as CDFIs, public agencies, etc. with little access to capital. They
depend on dollars from the CDFI Fund, USDA and others, which are dwindling
and therefore they must make better use of these funds. These organizations
are not competing with banks, but rather are complementary. There is a
role for philanthropypurely social motivationbut we want to
find a product that works as an investment vehicle.
Secondly, socially-motivated investors want their
principal back, and some interest, but they also want a social return.
Such investors include socially-motivated mutual funds, religious organizations,
and banks with an appetite for EQ2s (equity equivalent investments). We
raised 15% of our capital from such organizations, which in turn attracted
the other 85% from other banks, pension funds and life insurance companies
in a range of sizes. The largest pension fund investor is the United Methodist
Church, which has provided $100 million thus far. It's not the easiest
product, but we're working to make it easier. So, we see the future of
the community development investment industry as moving from regulations
to markets, from funding to financing, and groups such as established
CDFIs will have to learn how to finance themselves using market mechanisms.
The third area I want to touch on is CRF's work on
advance commitments. With support from the Rockefeller Foundation, we
are working to standardize documentation. Volume is growing significantly.
The New Markets Tax Credit (NMTC) represents a recognition of what was
going on, specifically what tax incentives can do. The NMTC will provide
$15 billion in private investment over ten years, bringing a huge opportunity
and I hope everyone will embrace it in a positive way. We think the credit
will result in long-term loans and equity with a real exit strategy.
Audience question: Usually when securitization
is done, it's a byproduct. With community development loans, what kind
of portfolio mix is used: is it by different type of loan such as housing
or small business, or by loan quality?
Dan: By loan or asset type. A bona fide cost
effective, price efficient capital markets type securitization, is accomplished
with one asset class. For example, loans to community development entities
(CDEs), residential mortgages and small business loans van be separately
pooled, but not cominglrd. However, there are less formal ways of achieving
asset aggregations. They are commonly referred to as pools or participations,
but are not, in the capital markets sense, securitizations. Frank has
mentioned a successful approach to pooling which combined different asset
Frank: We do mix assets in pools because we
have investors willing to buy them. It's a process of introducing an investment
product that meets the requirements and builds scale. You want diversification
in other ways rather than just using the same asset class, and that's
usually achieved geographically or by using risk profiles. Dan's aimed
at getting a rated security and there you can't mix the asset classes.
Our securities are privately placed. Nevertheless, we are doing a fair
amount of work educating the rating agencies about what we do.
Audience question: Regarding the previous
point about a difficult loan needing time to season, who's problem is
this, the Mezzanine Fund's or the investors'?
Dan: I believe the problem resides with the
originator and the mezzanine lender, so it's their responsibility to nurture
out of that mode to the next phase.
Jim: At the Mezzanine Fund, the big issue
is getting deals done. There are lots of CDFIs who don't want to sell
their portfolios because they don't have the tools to access additional
Audience question: Without CRA, or with a
de-emphasis of the investment test, will there be a scaling back of this
activity and in relationship lending, too?
Bob: While it's hard for me to say, exactly,
I think the answer is no, not on relationship lending or potential relationships.
I think we'd continue to invest, especially where there's a clear need.
John: What could we in Community Affairs at
the Federal Reserve do to assist?
Bob: We try to understand our markets, work
with organizations to help quantify demand. Activists always say we're
not doing enough, but how much is enough? We see lots and lots of organizations
looking for good quality loans. What markets aren't being filled? The
Fed would be a logical place to explore these questions.
Jim: CRA's helped show that there's money
to be made in community development investing and in working with emerging
John: What can we do to help with the growth
of the industry?
Dan: The community development industry needs
leadership, a focal point, a rallying point, a forum to discuss and devise
ways to recast itself. And for those of us who are seeking to make community
investments in scale, we would encourage this leadership. Without prodding
and absent any CRA type mandate, Impact formed a community development
entity (CDE) and received a $40 million New Markets tax credit allocation.
The investments will be structured differently than our affordable housing
investments. They'll be a little more return sensitive, and focused in
areas such as health and child care rather than commercial real estate.
Frank: Most people look at CRA geographically.
However, since CRF works because of its pooling, we then have to assign
certain loans in order to get the geographic focus desired by the CRA-driven
investors. Even still, we get lots of questions on whether these banks
will in fact get CRA credit. There's three areas where we could use help.
First, there's not liquidity in the securities, even though they've demonstrated
that they're good credit risks, with less than half a percent in losses.
Secondly, the portfolio's doing well, but the next step is getting a rated
institution to put up a letter of credit to allow it. Finally, there's
not a liquid marketplace. Banks could be a liquidity backstop. Wells Fargo
has done a little bit of thismaking a market in securities they
John: Well, I know we could keep talking for
hours on these subjectsthere's so much to discuss, but our allotted
time is coming to a close. We hope that the new Center for Community Development
Investments can serve as one of the focal points for the discussion as
it continues. Please join me in thanking our panelists, Dan Sheehy, Bob
Taylor, Jim Reid, and Frank Altman.