============================================================================== Center for Community Economic Development University of Wisconsin-Extension Community Economics Newsletter No. 262 August 1998 ============================================================================== A Newsletter from the Center for Community Economic Development; Community, Natural Resource and Economic Development Programs, and University of Wisconsin-Extension ============================================================================== Bank CDCs: Building Partnerships for Community Development* Although there are costs and risks associated with a bank CDC, this type of organization can offer many benefits to a community with unmet credit and investment needs. For example, the bank CDC structure allows banks and holding companies to make equity investments in community development projects. These equity investments are subject to limits specified by the bank's regulator. Bank CDCs can also develop innovative debt instruments or provide near-equity investments tailored to the development needs of the community as well as to the financial and marketing needs of the bank. Banks with an interest in new opportunities for community development lending and with resources to invest should consider involvement in a bank CDC. Bank CDC investors can begin with debt-financing or equity-investment instruments, depending on the needs of CDC partners and the goals of the organization. Many bank CDCs offer a combination of debt and equity instruments to balance risk and return, as well as to meet the needs of the prospective clients. Banks, communities, and local businesses have several reasons to work together to form a bank CDC. One of the most important reasons is that it is good business. There have been many success stories of profitable and effective bank CDCs in the areas of housing, small business creation, and economic development. For many investor banks, the bank CDC is an important component of their obligation to address unmet community credit needs under CRA. Bank CDC lending and investments in low- and moderate-income geographies are viewed favorably under CRA, especially to the extent that the investments are complex or innovative in addressing the credit needs of the target businesses and communities. Although investors should not enter into a bank CDC for the sole purpose of obtaining CRA credit, bank CDC investments can serve as evidence of the bank's commitment to meeting its obligation under CRA. Investment in a bank CDC also offers banks a unique opportunity to highlight their commitment to the community and attract new customers. The marketing benefits of CDC participation can be significant. Bank investors are often positively associated with community development, and new customers may be attracted to the participating banks. Increased visibility in low- and moderate-income areas may result in penetration into new markets and an expanded customer base. Bank CDCs may be structured in a variety of ways, depending on the needs of the investors and communities they serve. Items potential investors consider include start-up and operational costs, amount of control over loans and investments, level of risk and expected return. A CDC may be structured as a parent bank holding company. A bank CDC can be wholly owned by a single bank or it can be structured as a multi-bank CDC with several bank investors. Like MCDC, it can also be structured as a multi-investor bank CDC, which brings utility companies, governmental entities, local corporations and others in partnership with lending institutions. Creating a consortium of investors in a multi-investor or multi-bank CDC can be an effective strategy for smaller banks or communities. This organizational form allows all investors to share the costs of establishing and staffing the CDC, and the CDC will have access to more resources than if it had been funded by only one investor. Although CDCs can create positive opportunities for lenders and communities, there are costs and challenges that should be carefully considered before beginning a CDC. Starting and operating a CDC can be time- and resource-intensive. If the CDC will be involved in purchasing tax credits, legal and tax advisors must be hired, which can be quite expensive. Staffing the CDC can be another substantial expense, even if the costs are shared among several investors. Some CDCs are run by a volunteer board to reduce staff and operating expenses, but the board members may lack time to meet all the needs of the organization. Begin the process with an assessment of your area's economic and community development needs as well as the demand for loans and equity investments in local projects. Talk with the local economic development association, small-business owners and your customers about needs and opportunities in the community. Consider the loan requests that have crossed your desk that could not be approved under traditional underwriting standards, but which you believe have a community development purpose and good potential for success. Analyze your relative interest in making equity investments versus offering debt financing and the levels of risk and return you expect. If you are interested in forming a CDC but would like partners, talk with other bankers, utility companies, local corporations, and other potential investors in your community about getting involved. Finally, discuss your plans with you federal banking regulator to be certain your activities will meet regulatory guidelines. The common thread among all bank CDCs is that their investments must have community development purpose. Requirements for meeting this standard vary somewhat by regulator, but all regulators require some type of public, civic, community, or economic development purpose before the CDC will be permitted under banking laws and regulations. Common eligible purposes include the creation of jobs and affordable housing for low- and moderate-income individuals and lending and investment for small business creation and expansion. Recognize that a CDC can be an important new source of funding to address unmet credit and investment needs in your community. To show the potential value of a CDC to the community, develop an assessment of the area's financial needs from the perspectives of a wide range of community members. Gather bankers to discuss the CDC and why you think it would work in your community. Make an effort to commit some resources to get the project started. Economic development association support, especially technical assistance, during the initial phases of the project can be a valuable contribution to the success of the bank CDC. Finally, consider ongoing involvement in the CDC, depending on the needs of the investors. Bank CDCs offer communities and banks an important opportunity to build partnerships and use scarce resources for local development more effectively. Although it is not a solution for all community development needs, a bank CDC is worth investigation for those bankers and other partners committed to improving their communities through increased access to lending and investment. Ron Shaffer Community Development Specialist * Drawn from Federal Reserve Bank Minneapolis, Community Dividend, Fall/Winter, 1997. 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