Nina Röhrbein finds out how the Minneapolis-based Community Reinvestment Fund is helping to funnel capital into distressed urban communities

When it comes to environmental, social and governance factors, the ‘social’ often appears to be the most neglected. However, some investors have been paying attention to the social pillar for not only years, but decades.

The idea for the Minneapolis-based Community Reinvestment Fund (CRF) was born in the early 1980s when the US was just emerging from a significant recession.

Government spending cuts had led to sharply reduced resources for community and economic development across the country, which gave impetus to the development of CRF, officially launched in 1988.

“We wanted to sell loans, get the cash and move the capital into areas where it does not easily flow so that these communities could become less dependent on scarce public resources,” says Frank Altman, president and chief executive officer of CRF.

“At the same time, though, we wanted to remain supportive of the efforts of development lending and public sector organisations. Our goal was to create jobs in low-income areas and distressed urban communities. A couple of large philanthropic foundations backed the idea and the first transaction with five communities in Minnesota took place soon after. In the early 1990s we began expanding the organisation into a national platform.”

At present CRF has issued loans in 47 US states, including Hawaii and Alaska, and in more than 750 communities ranging from the centre of Harlem in New York to the Hoopa tribe’s Indian reservation in Northern California. About 80% of the portfolio focuses on business loans that create or retain jobs, while the rest consists of affordable, multi-family housing aimed at low-income families.

So far CRF has led to the creation or retention of more than 40,000 jobs.

“Local non-profit or governmental organisations originate small business loans for sale to us and when these are ready to close, we buy them,” says Altman. “We fund the loans at the table, the borrowers get the financing they need and then we aggregate those individual loans into a portfolio. When that portfolio reaches the right size and sufficient diversification, we take it to the capital markets and transform it into an asset-backed security that is sold in various S&P-rated tranches, ranging from AAA down to B. By holding the highest risk piece in the portfolio, we take the risk of first loss in these transactions, which should enable more charitable resources to access the capital markets and leverage their limited resources. Generally we have issued these securities to institutional investors, including pension funds, life insurance companies and banks, about once every 18 months.”

CRF differs from traditional micro-finance in that the loans are not small in scale; they are loans issued to small and medium-sized, mainly privately held or family enterprises, which have higher debt requirements than micro-finance can provide. The average loan size in the CRF portfolio is $700,000 (€587,000), but can range up to $2.5m as many are financing the acquisition and expansion of facilities in which the businesses are operating. This real estate component is also absent in micro-lending.

CRF screens and analyses its local lending partners - such as non-profit development corporations, municipal development agencies or housing authorities - before deciding whether it can support them. “Many of the local loan sellers have very specific missions,” says Altman. “Some of them focus on women and minority entrepreneurship or a specific segment, such as green products, while others concentrate on specific geographic areas or blighted communities. We have a joint under-rating process, where the local lending partner puts the loan together after identifying the particular need of the borrower through its own channels. It then submits the loan to us. If it meets our criteria, we issue a commitment and the lending partner can issue the commitment back to its borrower for the loan to be funded and ultimately closed. We are the master servicer for all these loans on behalf of our investors.

“However, in many cases we sub-contract back to the local groups to be the primary servicers so they can retain the relationship they have developed with the borrower and remain close to the collateral.”

The default risk to senior investments is very low, says Altman, with more than 70% of CRF’s senior notes rated AAA and life-to-date losses of less than 2%. “Of course we have experienced a significant increase in delinquencies in the underlying loans of our portfolios during the credit cruncg. Our current 30-day loan delinquency rate is approximately 6.9% but all of the securities rated investment grade by S&P continue to perform as scheduled,” he says.

Investors in CRF are global and include insurers such as AXA, Prudential and Metropolitan Life, as well as banks such as HSBC, Citibank, Merrill Lynch Bank of America, Wells Fargo and a number of other large US banks. On the pension fund side, corporate or religious-based US institutions dominate, including the Pension Fund of the United Methodist Church, the Evangelical-Lutheran Church in America Pension Fund, the pension fund of Mennonite Mutual Aid and the Milwaukee County Pension Fund.
Although Altman admits that some large institutions are under pressure to find ways of investing in emerging domestic markets and communities, their primary motivation is to generate a good market return.

“But at the higher risk end of our transactions, investors are generally less concerned about the market and more concerned about the social returns,” he says. “The returns are yield-driven and based on the risks associated with those particular securities. All loans price off the AAA or other respective spreads against the LIBOR curve, the swap curve or whatever the particular tranche is the investor wants to purchase.”

As there is no active secondary market, investors hold their individual tranches until they are paid off. AAA tranches pay off quickly in between one and three years, with the next tranche paying down over the next three to five years. The further down investors go in tranching the longer they hold the securities. “As these are sequential pay securities the investor at the top of the waterfall gets principal interest and other investors get interest-only payments until the senior investor has been paid off,” says Altman. “Then it starts to amortise the next tranche until all those tranches are paid off.”

Altman says CRF has never been involved in sub-prime lending. However, many of the neighbourhoods that CRF works with have been decimated by the consequences of sub-prime lending, with a spin-off effect on local businesses.

“Since the financial crisis hit, our mission to transform community finance in the US has become much more challenging,” Altman continues. “Five of our major pre-crisis investors, for example, are no longer in business or have merged with other banks. The asset securitisation market has frozen-up so that we are not currently issuing asset-backed securities. But we continue to watch the capital markets and expect the market to re-open for asset-backed securities over the next 18 to 24 months. In the meantime, we use other tools to keep the liquidity for these organisations moving. We are about to obtain a US SBA7A licence, which will enable us to get insurance on these loans and attract investors that would not necessarily invest in uninsured transactions.

“We also have a credit against US federal income tax - called the federal new markets tax credit - which has been very helpful in attracting capital from a number of banks and corporations for investments in low-income communities. Between those two sources of capital, the asset-backed securities and issuance of new markets tax credits we have funded about $1bn in loans and are going to close with about $200m in loans at the end of this fiscal year in June.”

Altman adds that CRF will continue to increase loan servicing. “We use the servicing platform - which has also been rated by S&P - on behalf of other, less sophisticated organisations and work with their borrowers to get the payments back. Currently we service about $650m in loans but have a goal of more than doubling that amount by the end of 2012.”