University of Southern California Dissertations and Theses

Bank community development coporation investments in community economic development

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Bank community development coporation investments in community economic development

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BANK COMMUNITY DEVELOPMENT COPORATION INVESTMENTS IN

COMMUNITY ECONOMIC DEVELOPMENT

by

Dwight J. Prevo

A Dissertation Presented to the
FACULTY OF THE SCHOOL OF POLICY, PLANNING,
AND DEVELOPMENT
UNIVERSITY OF SOUTHERN CALIFORNIA
In Partial Fulfillment of the
Requirements for the Degree
DOCTOR OF PLANNING, POLICY, AND DEVELOPMENT

May 2009

Copyright 2009 Dwight J. Prevo

ii
Table of Contents

List of Tables iv

List of Figures v

List of Abbreviations vi
Abstract viii

Introduction: National Bank Community Development Corporation 1
Investments in Community Economic Development
The Research Setting 5
Data Collection 6

Chapter 1: Government Regulatory Environment 7
Redlining 8
Community Reinvestment Act 10
History of the Office of the Comptroller of the Currency 15
CRA Performance 19
Bank Community Development Corporation Regulatory Policy 20
National Bank Community Development Corporations 25
Promote the Public Welfare Part 24 29
Community Renewal Tax Relief Act of 2000 34
Title I. New Markets Community Renewal Initiative 36
U.S. Treasury Department – 39
Community Development Financial Institutions Fund
Challenges of the Bottom Line 48

Chapter 2: Community Development 53
People or Place-based Community Development Strategies 57
Bank CDC Community Development Investments 63
Community Development Investment Vehicles 66
Community Development Venture Capital 67
Equity Equivalent Investments 83
New Market Tax Credit Program 91

Chapter 3: Case Study – Community Capital Development 112
Additional Background on Community Capital Development 127
Analysis of Community Capital’s Roles and Functions 131
Community Capital’s Relationship with Bank CDCs 134
iii
Contributions and Results 137
Additional Contributions and Results 143
Growth and Importance of Community Capital - 145
Increased CED Effectiveness
Conclusion 150

Chapter 4: General Summary, Lessons Learned, and Recommendations 156
Community Economic Development Outcomes 157
Government’s Role 158
The Double Bottom Line 161
Recommendations 162

Bibliography 171

iv
List of Tables

Table 1: Office of the Comptroller of the Currency Options for 22
Structuring a Bank CDC

Table 2: Promoting the Public Welfare: What Bank CDCs can do 31

Table 3: NMTC CDE Parent Type – Round 1 Allocatees 98

Table 4: NMTC Allocations Received by CDFIs Round 1 and 2 Allocatees 99

Table 5: NMTC CDE Parent Type – Round 2 Allocatees 107

Table 6: NMTC CDE Parent Type – Round 1 and 2 Allocatees 112

Table 7: Historical Timeline of Community Economic Development-related 159
Government Legislation and Public Policy

v
List of Figures

Figure 1: National Bank Part 24 – Community Development Investments 27

Figure 2: CDVC Funding Source by Industry Sector 71

Figure 3: Percent of NMVC Investments Located in Low Income 78
Communities 2003–2006

Figure 4: Cumulative NMVC Companies Investment Activity 2003–2006 79

Figure 5: New Market Tax Credit – How it Works Flowchart 92

Figure 6: U.S. Department of the Treasury – New Market Tax Credit 103
Allocation Phase

Figure 7: City of Seattle Map City of Seattle Office of Strategic Planning 118
(Selected Planning Related Areas)

Figure 8: Community Capital Development Organizational Structure 129

Figure 9: Community Capital Development Number of Businesses Assisted 133
(Number of Businesses Assisted 1998–2008)

Figure 10: Community Capital Development 137
(Dollar Amount of Loans 1998–2008)

Figure 11: Community Capital Development 138
(Number of Jobs Created/Sustained 1998–2008)

Figure 12: Community Capital Development 141
(Loans by Size Fiscal Year 2008)

Figure 13: Community Capital Development 149
(Loans by Demographic Fiscal Year 2008)

vi
List of Abbreviations

AMI – Area Media Income

Bank CDC – Community Development Corporation, structured as a business line or
subsidiary unit of a national bank.

BEA – Bank Enterprise Award

CDBG – Community Development Block Grant

CDC – Community Development Corporation, nonprofit community-based
organization.

CED – Community Economic Development

CDE – Community Development Entity

CDFI – Community Development Financial Institution

CDVC – Community Development Venture Capital

CRA – Community Reinvestment Act

EC – Enterprise Community

EZ – Empowerment Zone

EQ2 – Equity Equivalent Investment

HMDA – Home Mortgage Disclosure Act

HUD – Housing & Urban Development

LMI – Low to Moderate Income

LIHTC – Low-income Housing Tax Credit

LISC – Local Initiative Support Corporation

NMTC – New Market Tax Credit

vii
NMVC – New Market Venture Capital

NMVCC – New Market Venture Capital Company

OCC – Office of Comptroller of the Currency

SBA – Small Business Administration

SBIC – Small Business Investment Company

QEI – Qualified Equity Investment

QLIBI – Qualified Low-income Business Investment

QLICI – Qualified Low-income Census Tract

viii
Abstract
This dissertation analyzes best practices of bank-owned Community
Development Corporation (CDC) investments in Community Economic Development
(CED). Using documents from banking institutions, literature on community economic
development, and case study methods, I will identify and evaluate investment strategies
that have satisfied the double bottom line of such institutions. These banks have made
profit and expanded capacity while redeveloping urban communities and
neighborhoods.
In response to the landmark Community Reinvestment Act (CRA) of 1977,
banks created bank CDCs to comply with federal regulations and promote the public
welfare by lending to low-to-moderate-income populations and communities. At first
the banking community was concerned that the CRA would force banks to make bad
loans and incur losses. However, that was not borne out by experience. The research
demonstrates that over time banks have found ways to meet their regulatory and public
policy goals as well as the expectations of other stakeholders. The research objective
was to examine the existing literature and determine if bank CDC investments actually
make a positive contribution to neighborhood revitalization. Successful revitalization is
determined according to three basic criteria:
1) Does it meet public policy objectives for both federal and local
government?
2) Does it meet the objectives of community-based organizations? and
3) Does it meet the objectives of nonprofit economic development
organizations?
ix
A review of best practices at leading bank CDCs is provided, with a focus on
those considered effective in addressing these three sets of objectives. Finally, strategies
are outlined regarding future practices and public policies that merit further
consideration regarding how bank CDC investments can be used to forward CED
objectives.
1
Introduction: National Bank Community Development Corporation Investments

This section provides an overview and summary of the research project
completed on national bank CDCs, with a focus on investments in community
economic development CED in low-income and minority neighborhoods. My main
purpose was to determine the value of bank CDCs as participants in the process of
bringing credit, investments, and other economic development improvements to low-
income and distressed urban areas. The research included an analysis of the public
policy goals and objectives of national banks acting through their bank CDCs.
Investments made through these institutions are expected to meet a double bottom line
in their performance. In other words, bank CDC investments are expected both to be
profitable and to contribute socially beneficial improvements to the communities they
serve.

A case study provides an in-depth investigation of a leading Community
Development Financial Institution (CDFI) providing loans and technical assistance to
small businesses. As an economic development intermediary, the CDFI under
investigation views and makes use of bank CDC community development investment to
carry out its mission, extending small business loans and business education that targets
low-income populations, distressed communities, and women. The case study highlights
the importance of bank CDCs as the lead funders in certain types of economic
2
development projects. The research project concluded with an examination of best
practices used by bank CDCs to facilitate community economic development.

The background research and case study serve as a roadmap that the bank CDC
industry can use to improve its knowledge of community development investments. The
research brings clarity to the important role played by the national bank CDC as a tool
to realize positive community development outcomes and make an impact on low-
income populations and distressed communities through community development
investments.

Chapter 1 provides additional analysis of the regulatory environment in which
national bank CDCs operate with respect to community development investment
activity. Like other corporations, national banks and bank CDCs operate in a
government regulated environment. Within this environment, the Office of the
Comptroller of the Currency (OCC) serves as the regulating agency, with primary
oversight of national banks and bank CDCs. The dissertation reviewed the literature to
ascertain what the research has conveyed, what has been written, and what is known
about bank CDC community development investments. The dissertation also explored
the reality of the “double bottom line,” where banks must adhere to safe and sound
business principles while also striving to have a positive impact on low-income
communities and neighborhoods. Finally, it examined how challenges to the bottom line
3
impact the ability to develop a corporate culture that recognizes the business value of
bank CDC community development investments and the subsequent social benefits.

Chapter 2 examines of the experiences of national banks that have created bank
CDCs and have a demonstrated history of making community development investments
in CED. To identify lessons learned and best practices, the research focused on those
activities that had the greatest impact toward area revitalization and stabilization of low-
to-moderate-income (LMI) populations and communities. These high-impact activities
include Community Development Venture Capital (CDVC), Equity Equivalent
Investments (EQ2), and New Market Tax Credits (NMTC).

In Chapter 3, a case study is presented that examines a CDFI that has acted as an
economic development intermediary working in collaboration with national bank
CDCs. Using the case study as a model, the research project examined many factors that
contribute to the success or failure of CED, including the importance of collaboration
among public and private sector players in supporting the efforts of an economic
development intermediary such as a CDFI. Case study interviews took place from April
2007 through October 2008. The case study under investigation identified professionals
in government, CED practitioners, small business owners, and those in the bank CDC
field with experience in CED. Interviews with key informants served an important role
in the case study, helping to augment the documented record of investment strategies
4
and decisions by uncovering the interpersonal and political dynamics that encompasses
the investment process in financing CED.

The research paper paid special attention to bank CDC investment activities,
policies, and collaborative efforts that position selected national bank CDCs as industry
leaders. The objective was to analyze and examine successful bank CDC investment
strategies with an eye toward the identification of best practices. The research gave
particular focus to bank CDCs viewed as industry leaders in providing community
development investment in LMI neighborhoods and communities. The main research
questions that guided the study included the following:

1. What are the most important characteristics of CED strategies and what are
the requirements for effective CED investments?

2. Do bank CDC community development investments result in positive
economic development outcomes for low-income and minority communities and
residents?

3. Are bank CDC investments critical to the community redevelopment and
revitalization process replicable? If so, what should be the future role of bank
CDCs?

5
Data for the study was obtained from bank documents and other sources. Records and
reports of various phases of the project indicate clearly that all participants in successful
CED projects have an important role to play. Due to privacy issues, the case study
analysis had limited access to the documents of private sector investors engaged in
redevelopment projects. This was particularly true for bank CDCs, specific to financial
documents and the underwriting guidelines that are part of the CED process.

Chapter 4 of the dissertation concludes with recommendations on how bank
CDCs can use their role as private sector participants to employ investments as a
vehicle to move community development goals and objectives forward. The research
project was most interested in the bank CDC as a private sector mechanism that adds
value to CED strategies with a demonstrated positive impact toward the revitalization of
urban communities. This section will also provide an overview of the current financial
crisis, including the loss and consolidation of many major financial institutions, and the
potential impact on the CED field.

The Research Setting

The project examined the impact of bank CDC investments that occur in urban
communities. The urban environment serves as a living laboratory for practitioners to
determine if bank CDC investments represent sustainable practices that can be used to
6
facilitate the redevelopment of communities and neighborhoods. The research analyzed
bank CDC investments that occurred in major urban centers.
The analysis also determined if these activities represent an effective tool to facilitate
the urban redevelopment process.

Data Collection

The research project identified leading bank CDCs whose CED investment
practices served as the groundwork to design future practices, policies, and procedures
that can benefit urban redevelopment and revitalization. The primary source for the
literature review included journal articles; monographs; news bulletins; regulatory
documents from the Office of the Comptroller of Currency and various Federal Reserve
banks; and available reports from bank corporations. A review of the literature helped to
identify leading bank CDC investment and universally recognized best practices.
Interviews with key informants in local government, economic development
practitioners, and senior executives from leading bank CDCs were a key part of the data
collection.

7
Chapter 1: Government Regulatory Environment

Background information on the bank regulatory environment is needed in order
to understand its impact on national banks, their policies and their role in community
economic development. This chapter covers the most influential legislative act that has
shaped national bank policies and performance since the 1970s—the Community
Reinvestment Act (CRA) of 1977. In addition, major issues pertaining to national bank
investments and credit availability are discussed, issues such as redlining, and the
response of the banking community to those issues. The policy role of the OCC is also
presented, along with a number of pertinent regulations and investment practices that
guide national bank policies and performance.

The CRA set out to address decades of disinvestment in poor and minority
neighborhoods, where residents were often faced with the inability to access traditional
bank loans and other basic bank products and services important to everyday economic
life. In later years, revisions to the CRA served to encourage national banks to form
subsidiary bank CDCs as a way to respond to the regulations and effectively fulfill their
mission as a primary source of credit and investment in urban communities. Federal
Reserve Board Vice Chair Alice Rivlin (1997) maintains that, by their nature, financial
institutions are in the business of community development – taking deposits and making
loans and investments that create economic value and growth by financing businesses,
housing, and community facilities. In the main sections of this chapter, key topics
8
covered include redlining, the CRA and community development, and bank CDC
community development investments. It should be noted that the various practices
described are common to all areas of the financial services industry, not just banking.
However, their impact and visibility are more prominent in banking than other areas
because of the scope of the CRA and other regulations.

Redlining

During the 1970s community activists coined the term “redlining” to describe
the unwillingness among banks to make loans in geographically distinct areas, areas
where, more often than not, the residents represented low-income and minority
populations. Redlining as described by Ross and Tootell (2001) constitutes
discrimination against a neighborhood (spatial geography) as opposed to discrimination
against members of a specific racial or ethnic group. Redlining may depress property
values in vulnerable neighborhoods and limit the ability of minority and low-income
households to accumulate wealth. Rivlin (1997) characterized redlining banks as
“generally conservative, risk-averse institutions, banks that historically did not view
low- and moderate-income areas or people as profitable markets for their loans and
services.” As an initial response to the problem, Congress created the Home Mortgage
Disclosure Act (HMDA) to address the issue of redlining in the mortgage industry. The
Act defined redlining as the refusal to approve creditworthy loan applications for
9
housing in minority or low-income neighborhoods, and noted that such underwriting
policies served to restrict homeownership rates for minority and low-income households
who predominantly resided in redlined neighborhoods (Ross and Tootell, 2001). In
essence, the practice of redlining effectively served to limit the economic development
potential of low-income and black communities in urban areas throughout the U.S.

Redlining has also been characterized as the practice of arbitrarily denying or
limiting financial products and services to specific neighborhoods because their
residents were people of color, poor, or both. From a historical context, redlining
became a major issue after WW II, when suburban growth occurred in cities throughout
the U.S. and when there was a preference for residential investment in the form of home
mortgages. This suburban expansion generally happened at the expense of poor, inner
city, and minority communities. While the city of Chicago is the most famous and most
referenced example of redlining, in reality redlining was a phenomenon affecting most
black and low-income neighborhoods throughout the U.S. (Hunt, 2005), a phenomenon
exacerbated by a growing wave of middle-class whites making a massive exodus from
the central cities to the suburbs.

This exodus was due, in part, to the violent race riots that engulfed urban
America during the 1960s, shattering the notion that racial equality in the U.S. was
imminent (Sides, 2003). The physical deterioration of inner cities led to redlining,
inequality, and racial tension. This in turn led to riots, which hastened the pace of
10
“white flight” from the inner cities and increased the tendency of banks to redline these
communities. The prevalence of redlining in Chicago prompted community activists
there and across the country to put pressure on banks to change their policies, and this
pressure ultimately led to a Congressional mandate designed to require banks to lend
equitably to all residents of a given community.

The Community Reinvestment Act

In 1977, Congress implemented Regulation 12 CFR, part 25 (12 U.S.C. 2901),
entitled the Community Reinvestment Act and Interstate Deposit Production
Regulations, and generally known as the Community Reinvestment Act, or CRA.
Congress implemented the CRA as public policy to encourage lending institutions such
as banks, thrifts, and savings and loans to help meet the credit needs of all segments of
the communities in which they operate, with a particular focus on LMI neighborhoods
(FFIEC, 2007). The CRA was passed by Congress to counter proven and pervasive
racial discrimination by banks and savings and loans, institutions that had consistently
denied creditworthy customers, particularly African American and Latinos, access to
standard loans and mortgages (Bell, 2008). In the three decades since its passage, the
CRA and associated institutional changes have defined the regulatory environment for
national banks with respect to community credit and investment.

11
It is important to note that when the CRA was enacted in 1977, many financial
institutions bristled at the thought of additional regulatory oversight, particularly when
it would require the industry to consider extending credit to low-income people and
minority neighborhoods (Knowledge@Wharton, 2002). As with any law, policy or
regulatory provision, however, there are at least two schools of thought, or prevailing
viewpoints. From the very beginning the CRA had, and still does have, detractors.
Some critics maintain, for example, that the CRA forces banks to abide by lax
underwriting and lending guidelines and to extend credit to a segment of the population
(that is, blacks and Hispanics) who could not otherwise qualify for loans or financing.
Another argument against the CRA is that it forces banks to locate facilities or bank
branches in communities and neighborhoods where such branches are not financially
viable. However, former Comptroller of the Currency, Eugene Ludwig (2008), suggests
quite the opposite to be true. “Because of CRA, banks have had to make loans and
services that have transformed neighborhoods all over America for the better and, of
course, supported the overall economy,” Ludwig says.

The conservative viewpoint also maintains that government intervention through
regulation hinders the free market system. In contrast, the liberal perspective upholds
the view that government intervention is needed for the purpose of making an
occasional market correction or addressing social wrongs. In the case of the CRA, the
social wrong to be addressed is the lack of access to financial services for minority and
12
low-income communities. I believe what complicates the issue is the factor of race, and
denying people access to basic financial systems, based on the color of their skin.”

Antonakes (2001) finds that the CRA set out to address the issue of banks failing
to serve their entire communities by setting specific regulations which will ensure that
banks do serve low-income communities—in particular those with high percentages of
minority residents—to the same extent as communities with higher incomes and fewer
minority residents. Hopkins and Tellalian (2006) maintain that the CRA was
fundamentally a place-based legislation that drew the attention of bank regulators to
underserved geographic areas. It was also through the CRA that the federal government
set out to compel banks to make basic services, such as checking and savings accounts,
available to all income communities. The legislation aimed to connect targeted
communities with mainstream financial services and to concentrate more lending
activities in those communities (Hopkins and Tellalian, 2006). The regulation also set
out to reverse the inability of these low-income residents to secure homeownership,
build credit through mortgages, and gain access to lending and financing for new and
existing small businesses.

Through the CRA, Congress required each appropriate Federal financial
supervisory agency to assess a banking institution's record of helping to meet the credit
needs of the local communities in which the bank is chartered, consistent with the safe
and sound operation of the institution. The CRA’s implementing regulation (12 CFR 25,
13
et seq.) requires the federal regulator of financial institutions—in the case of national
banks, the Office of the OCC—to assess the record of each bank or thrift in meeting its
obligations to the target communities and populations. In addition to the OCC, other
federal regulatory agencies charged with overseeing banks, thrifts, and savings and
loans include the Board of Governors of the Federal Reserve System, the Federal
Deposit Insurance Corporation, and the Office of Thrift Supervision.

The CRA mandates that the relevant supervisory agency take into account a
bank’s CRA record when evaluating that bank’s application to establish new branches,
or when that bank seeks regulatory approval for a merger, acquisition, or other major,
federally regulated corporate activity. The CRA also provides a framework for
depository institutions and community-based organizations to work together to promote
the availability of credit and other banking services to underserved communities.
Because of the CRA, banks and thrifts have opened new branches; provided expanded
services; adopted more flexible credit underwriting standards; and made substantial
commitments to state and local governments and community development
organizations in order to increase lending to underserved segments of a local economy
and population (OCC, 2007). In the early years of the CRA, factors that limited its
effectiveness included the following:

1. failure of regulators to follow through on enforcement on banks with
substandard CRA performance
14
2. grade inflation, and
3. corruption of government regulators

Thomas (2002) simply states that “CRA was once the most hated law in banking,” with
the Federal Reserve itself originally coming out against it (Knowledge@Wharton,
2002). Evidence of this aversion: in 1996 alone regulators received 105,000
applications for new branches and mergers, with only 31 denials
(Knowledge@Wharton, 2002).

This is consistent with the research of Apgar and Duda (2003), who found that,
in its early years, the CRA lacked the enforcement mechanisms or tools to punish
underperforming banks. Apgar and Duda (2003) suggest that the CRA’s most important
tool was the ability for regulators to condition or deny a bank’s request to expand or to
merge its operations yet, as the research shows, this is a tool that was rarely if ever used.
The lax enforcement of the CRA was caused, at least in part, by the fact that both the
government and banking industry had reservations concerning the burden of the
regulation. Apgar and Duda (2003) found, in their review of the first twenty-five years
of CRA, that while the Regulation continues to provide significant benefits to LMI
households and communities, change is needed to ensure that financial service
providers continue to meet the needs of low-income people and minority communities.

15
Calls from community activists, who seek to keep the banking industry
accountable to minority and low-income communities, have prompted a look back over
the past thirty-plus years since the CRA’s adoption into law. Viewed by many as one of
the most successful effective community revitalization programs, the CRA has
expanded credit availability and has served as a value-add for bank lending and
community economic development. According to the National Community
Reinvestment Coalition, in the past thirty years the CRA has encouraged lenders to
invest more than $4.5 trillion in minority and low-income areas (New York Times,
2008). This money has helped to remake urban neighborhoods throughout the U.S. by
extending financing for the construction of new housing and small businesses
development. The CRA has also helped provide essential services to these
neighborhoods, including medical centers and housing for the elderly and disabled.
These are community development projects that the private sector has too often refused
to finance.

History of the Office of the Comptroller of Currency

Congress established the national banking system as a vehicle to finance the
Civil War (OCC, 2007). In 1861, the U.S. Congress established a system of federally
chartered national banks, each with the power to issue standard national bank notes.
With the passage of the 1863 National Currency Act, Congress also created the OCC as
16
the federal agency with regulatory oversight of the newly created system of national
banks. A national bank is a financial institution that receives its charter from the OCC.
While national banks no longer issue currency, they continue to play a prominent role in
the nation's economic life.

With its origins dating back to 1863, the OCC is the oldest federal regulatory
agency, and is led by a chief administrator, who is known as the Comptroller of the
Currency (Comptroller). As a subagency of the Treasury Department, the OCC has the
authority to charter, regulate, and supervise all national banks and agencies of foreign
banks. Headquartered in Washington D.C., the OCC has four district offices located
throughout the U.S. The agency also maintains an office in London to supervise the
activities of foreign banks with operations in the U.S. (OCC, 2007). Stiller (1994)
characterized the OCC as an unusual federal agency, in that it has two unique attributes.

First, in order to shield the agency from the vagaries of the political
environment, Congress determined that the Comptroller would serve a five-year term
that would overlap presidential administrations. Second, in order guarantee it a
dependable source of operating revenue, Congress stipulated that the OCC would be
funded by the system of national banks it oversees. While this arrangement effectively
insulates the OCC from politics and provides it with greater freedom (Stiller, 1994), it
would seem to increase the opportunity for conflicts of interest between the OCC, as the
regulator, and the industry it is assigned to regulate.
17
The National Bank Act authorized the Comptroller to hire a staff of examiners
and provided the OCC with the “broad authority to make a thorough examination into
all the affairs of all national banks” (OCC, 2007). Moreover, the OCC has the authority
to regulate the lending and investment activities of national banks, with the prime
directive to ensure that the U.S. national bank system is safe and sound for all
Americans. To carry out this directive, OCC examiners regularly conduct an analysis of
each bank’s loan and investment portfolio; its risk profile, liquidity and profitability; its
compliance with consumer banking laws; and its internal controls and management
ability.

As of September 2006, the OCC had regulatory oversight for more than 1,750
national banks, and 50 federal branches of foreign banks with operations in the U.S.
This accounts for approximately $6.5 trillion, or more than 67 percent of total assets for
all U.S. commercial banks (OCC Community Affairs, 2007). As the bank regulator, the
OCC’s primary role is to evaluate and rate banks against the “CAMELS” rating process
for safety and soundness. The basis of the CAMELS evaluation is to review a bank’s
Capital Adequacy, Asset Quality, Management, Earnings, Liquidity, and Sensitivity to
market risk (Wides, 2007). The OCC also evaluates national banks for compliance with
consumer protection and civil rights statues under the Uniform Interagency Consumer
Compliance Rating System.

18
Most important to the research project is the OCC’s regulatory role as it relates
to the CRA. When conducting a CRA examination, the OCC is focused on the
following regulatory activities:

• approving or denying applications for new charters, new branch operations,
capital, or other changes in the corporate or banking structure;

• taking supervisory actions against banks that do not comply with the laws and
regulations, or otherwise engage in unsound banking practices; and

• issuing rules and regulations that govern bank lending, investments, and other
practices (OCC Community Affairs, 2007).

The OCC’s primary goal is to ensure that the national system of banks is both safe and
sound. Second, the agency looks to foster competition within the industry by allowing
financial institutions to develop and offer new products and services. Third, the agency
works to improve its efficiency and effectiveness regarding its supervisory role over
national banks by reducing any unnecessary regulatory burden placed upon national
banks. Fourth, as a regulator, the OCC looks to ensure that all Americans, particularly
low-income and minority Americans, have fair and equal access to the banking system
that offers safe and sound financial products and services (OCC, 2007).

19
CRA Performance

As a regulator, the OCC has the responsibility to oversee the CRA directive and
regulatory compliance for national banks. Pursuant to Section 12 CFR, Part 25, on a
periodic basis (usually every three years), the agency is required to assess each bank’s
record of helping to meet the credit needs of its community, including low-income
neighborhoods and geographies. In 1995, the OCC implemented a new method to
measure and evaluate the performance of national banks with respect to compliance
with CRA objectives. Known as the CRA Performance Evaluation, the exam is an
assessment of a bank’s performance in three key categories: lending, investments, and
services. Based upon the examination findings, the OCC will assign a rating or grade,
which is intended to summarize a bank’s success or failure at meeting CRA objectives
in the communities that comprise its assessment areas. The assessment area is defined
as the geographical area within which the OCC will measure a national bank’s
performance in helping to meet the lending needs of its entire community, with a
special emphasis on LMI communities. A bank’s performance within its assessment
area is characterized by one of the following ratings: Outstanding, Satisfactory, Needs
to Improve, or Substantial Noncompliance—according to its performance under each of
the three key categories listed above.

Using an instrument known as the Lending Test, the OCC evaluates a bank’s
record of meeting the credit needs of its assessment area through a review of its lending
20
activities. The Lending Test focuses mainly on the bank’s performance regarding the
provision of home mortgages and lending to small business and small farms, but it also
considers a bank’s community development lending activity. Another instrument used
by the OCC to measure a bank’s CRA performance is known as the Investment Test,
which gauges a bank’s record of meeting the credit needs of its assessment area through
the provision of qualified investments. To score well on this test, a bank must
demonstrate that its investments benefit a specific geographic area or a broader
statewide or regional geography that encompasses the bank’s assessment area. Finally,
the Service Test evaluates a bank’s record at meeting the credit needs of a specific
geography by analyzing both the availability and effectiveness of a bank's systems for
delivering retail bank services—better known as branch distribution—within that area
(OCC, 2007).

Bank CDC Regulatory Policy

The following section provides a review of the regulatory policy and compliance
issues that guide a national bank in the creation of a bank CDC. A national bank
chartered with the OCC as its regulator must meet a number of criteria in order to
establish a bank CDC. Eligibility is contingent upon the bank’s ability to demonstrate
that it is well-capitalized, maintains a composite rating of 1 or 2 under the Uniform
Financial Institutions Rating System, and has received a CRA rating of "Outstanding"
21
or "Satisfactory" at its last performance evaluation. In addition, at the time of
application, the bank cannot be subject to a cease and desist order or a consent order,
nor can it be under a formal written agreement or corrective action directive by its
regulator (see 12 CFR part 6, subpart B).

There are two commonly used organizational structures that national banks use
to establish a bank CDC. The first structure involves establishing the bank CDC as an
affiliate through a holding company of the bank. Under this scenario, the bank holding
company (in other words, the bank) holds a controlling interest in the bank CDC. The
second structure involves establishing the bank CDC as an operating subsidiary with a
separate corporation or LLC, where the national bank maintains a 50 percent or greater
share of voting stock or a similar type of controlling interest. As a subsidiary
corporation, the bank also holds a majority interest of stock shares. This option provides
the bank with the ability to exercise management control over the bank CDC, including
the ability to share in any earnings generated by the bank CDC’s investment activity.
Also, if the bank decides to dissolve the subsidiary corporation, it receives any residual
proceeds realized from the liquidation of assets. A national bank CDC must also operate
in a manner that does not expose the bank to any liabilities greater than the bank’s
investment in the CDC.

22
Table 1: Structuring a Bank CDC
(OCC Community Developments, Winter2004/2005)

A national bank investing in a CDC must also file the necessary legal documents
to certify that its investments with the OCC’s regulatory requirements as described
under 12 CFR 24 and to satisfy the certification requirements of the public welfare
investment regulation. National banks tend to prefer structuring bank CDCs as chartered
subsidiary corporations that operate separately from the banks themselves. There is no
indication that the OCC has a preferred standard or model when it comes to how
national banks structure their CDC charters, or the articles of incorporation that banks
must adhere to. Some bank CDCs choose to make the “purpose” section of their articles
23
of incorporation broad, to provide themselves with the latitude to engage in a variety of
investments. Such broad purpose statements provide bank CDCs with the flexibility to
engage in investments consistent with the public welfare objective 12 USC 24
(Eleventh). Other banks have chosen to adopt more narrow language, going so far as to
identify the specific type of community development activities that they will engage in,
as outlined in the list of qualified public welfare investments 12 CFR 24.6. Whether
structuring their CDC through a holding company or as a subsidiary, national banks
must weigh a number of factors when working out the details. If the bank CDC is
structured through a holding company, for example, the following considerations apply:

• Capital – If the bank funds the CDC through the holding company, the capital
contribution used by the bank to form the CDC will reduce the bank’s own
capital.

• Dividend Capacity – If the bank funds the CDC through the holding company,
the funds contributed by the bank will also reduce the bank’s future dividend-
paying capacity.

When structuring the CDC as a subsidiary, the bank, as the corporate entity, can
avoid any obligations, such as debts or liabilities that the bank CDC may incur. As a
matter of practice, the operations of the bank CDC should include a periodic
compliance or internal performance review, to ensure that it maintains a separate
24
corporate identity. Failure by the subsidiary CDC to maintain its separateness can cause
the parent bank to become liable for the bank CDC’s debts and obligations, can subject
the bank to litigation, or both. Factors that determine separateness include corporate
procedures, financing, business purpose, and disclosure of information. Steps the bank
can implement to maintain separation from bank CDC operations including maintaining
a separate office and making sure that, at a minimum, at least one director of the
subsidiary bank CDC is not also an employee of the bank. The bank and subsidiary
bank CDC should also conduct separate board of directors meetings, with separate
meeting minutes, and ensure that all resolutions authorizing the subsidiary CDCs
actions are made by the subsidiary itself, and not the parent bank. Separate corporate
records and books should also be maintained, and steps should be taken to ensure that
funds of the bank and the bank CDC are not co-mingled. The bank must also maintain
adequate capitalization of the bank CDC and provide adequate disclosure of the
subsidiary bank CDC’s activities in any stock offerings, circulars, prospectuses, or
public announcements.

Financial institutions have increasingly recognized the value of bank CDCs as a
vehicle to meet CRA objectives while increasing business opportunities. National banks
continue to recognize community development investing as a way to remain financially
responsive to their customers, while being socially responsive to their communities.
Banks have found that community development investments, instead of being a
liability, are a value-add to the bottom line. These investments can also serve as an
25
avenue by which the bank can expand its market reach, support the development of new
products, and leverage funds from other sources (OCC Community Development
Resources, Summer 2004). In today’s economy, large financial conglomerates have a
stake in CED that goes beyond the need to satisfy CRA obligations, or to pave the way
for future mergers and acquisitions (Brown, 1999). The research project will advance
the bank CDC as a private sector tool that can have a positive impact on efforts to
revitalize and redevelop urban communities.

An important update to the CRA Regulation occurred in 1995, when the OCC
began to recognize bank CDC investments in CDFIs as ‘Qualified Investments’. In this
way the OCC used its regulatory authority to attract additional bank CDC investment
dollars in the pursuit of community development objectives. Not only did the change in
regulation provide banks with valuable CRA credit, Cooch and Kramer (2007) found
that the action resulted in a substantial infusion of capital into community development
from commercial and national banks acting through a bank CDC.

National Bank Community Development Corporations

One of a bank CDC’s value-adds to its national bank partner is the ability to
undertake community development investing and lending activities that impact low-
income communities and minority populations, including activities outside the bank’s
26
geographic assessment area, as prescribed by the CRA (Tucker, 2004/2005). As early as
1989, the Federal Reserve issued a joint statement on behalf of all federal bank
regulators regarding CRA enforcement. This statement encouraged national banks to
establish CDCs as vehicles to undertake community development investments and
lending programs (Brown, 1999). A 2005, Press Release issued by Julie L. Williams,
then Acting Comptroller of the Currency, noted that a bank CDC provides a bank with
an innovative way of financing a wide range of community and economic development
initiatives. Ms. Williams also noted that more than 50 national banks have formed bank
CDCs as a way to support a variety of affordable housing and commercial
redevelopment activities (OCC Community Affairs, 2007).

The research has set out to advance the bank CDC as a private sector tool that
represents a positive contribution to the community revitalization and redevelopment
process. Federal Reserve Governor Barry Wides (2003) declared that during the past
decade, national bank CDC investments in low- and moderate-income neighborhoods
had exceeded $15 billion in equity investments under the public welfare investment
authority (Wides, 2003).

27
Figure 1: National Bank Part 24 Community Development Investments
(OCC Community Development Investments Winter 2004/2005)

National banks establish bank CDCs for a variety of reasons. First, a bank CDC
represents a mechanism to address ongoing community development needs and
provides the bank with the ability to undertake a number of community development
projects over a sustained period of time. Second, the bank CDC allows the bank
maximum flexibility to make community development investments, including the
ability to respond to emerging community needs and opportunities (OCC Community
Development Investments, Winter 2004/2005). Third, a bank CDC serves as an
organizational focal point, from which the financial institution can develop a
coordinated and holistic approach to its community development efforts and
investments. Hopkins and Tellalian (2006) disagree with this view, however, and
suggest that what bank CDCs have created are actually loan and investment portfolios
that lack any specific focus or comprehensive strategy. Community development
28
investments are “deal by deal” in nature, they argue, and are spread thinly throughout
the bank’s retail footprint, thus diluting the potential for any substantial community
development impact on a specific neighborhood or community.

Finally, because of the increased level of risks associated with community
development investments, a bank CDC enables a national bank to leverage its capital
for community development purposes: this provides a safeguard that limits any direct
exposure the bank might encounter when making direct investments in economically
distressed neighborhoods. In spite of their criticisms of bank CDCs’ lack of focus,
Hopkins and Tellalian (2006) still support the role of banks in community development
generally. They suggest that no other institution, public or private, possesses a bank’s
capacity to alter the economic trajectories of low-income communities. This is
consistent with Rivlin (1997), who argues that, by their very nature, financial
institutions are in the business of community development – taking deposits and
reinvesting money in projects that create economic value and growth by financing
businesses, housing, and community facilities.
29
Promote the Public Welfare Part 24

In September 2003, the OCC published a final rule amending the Code of
Federal Regulations Section 12, Part 24, relating to community development
corporations, community development projects, and other public welfare investments.
In this section of the code the OCC authorized national banks to make investments with
the intent of promoting the public welfare. Public welfare investments are defined as
community and economic development activities that primarily benefit low- and
moderate-income individuals, or low- and moderate-income geographic areas. This is
extended to areas targeted for redevelopment by local, state, tribal or federal
government. The public welfare policy is intended to encourage national banks to make
investments that produce affordable housing, services, and jobs that benefit target
populations and geographies. With the creation of the public welfare policy, the OCC
envisioned the opportunity to attract bank CDC investments to community
development. Finally, the OCC recognizes national banks that establish bank CDCs,
and encourages those banks to pursue a variety of investments to pursue community and
economic development under their CRA obligation. Specifically, the policy directs
national banks to make investments in community and economic development entities
(CEDEs) and community development projects (CD Projects).

The term CEDE encompasses a variety of legal and organizational structures. In
addition to the bank CDC, which is the focus of this research paper, CEDEs also
30
include limited liability companies or partnerships; community development financial
institutions; community development venture capital funds; and community
development loan funds (OCC Community Development Fact Sheet, 2006). A bank
investment in any of the identified organizational structures qualifies as a public welfare
investment and promotes bank CDC involvement in addressing both people- and place-
based community and economic development objectives.
31
Table 2: Promoting the Public Welfare: What bank CDCs can do
(OCC Community Development Investments, Winter 2004/2005)

Bank CDCs can undertake many activities that promote the public welfare by primarily
benefiting low- and moderate-income persons and communities. Investments meeting
this standard can include those that provide or support any of the objectives on the left-
hand column of the table below:
Public Welfare Objective Method
Affordable housing,
community services, or
permanent jobs
• Finance, acquire, develop, rehabilitate, manage,
sell or rent affordable housing
• Develop and operate an assisted living facility
for the elderly
• Develop and operate a special needs project,
such as transitional housing for the homeless
• Develop and operate a medical or mental
health facility
• Develop and operate a community services facility
• Provide credit counseling and job training
• Conduct community development research
• Invest in federal low-income housing tax credits
• Invest in historic rehabilitation tax credits
• Generate or retain permanent jobs
Equity or debt financing
for small business
• Provide equity and loan financing and/or technical
assistance for small businesses and micro
enterprises
• Invest in a community development entity that
provides financing for small businesses
• Invest in federal new markets tax credits
Area revitalization or
stabilization
• Develop and operate a commercial
or industrial property
• Develop and operate a business incubator
• Form a community development financial
institution (CDFI) or community development
focus bank
• Form and operate an agricultural cooperative

Because they target a specific geographic area – for example, a designated
distressed community – bank CDC investments in CD projects are primarily place-
based community development investments that support such endeavors as the
production of affordable housing and other activities that foster the revitalization and
stabilization of low- and moderate-income areas. People-based community development
32
investments, conversely, encompass the provision of equity or debt financing to support
small businesses that are located in targeted geographic areas, or community
development investments that produce or retain permanent jobs that directly benefit
low- and moderate-income persons (OCC Community Development Investments,
Winter 2004/2005).

The OCC uses the public welfare policy as a means to insure that bank CDC
investments are focused on activities that revitalize or stabilize urban neighborhoods.
As mentioned, bank CDC public welfare investments are focused on both people- and
place-based community development objectives. People-based investments must
demonstrate direct benefit to low-income populations, defined as those with annual
incomes at or below 80% of Area Median Income (AMI). In contrast, a qualified public
welfare investment that is place-based is characterized within a geographical or spatial
context, where the census tracts included are at, or below 80% of AMI. To accomplish
both people- and place-based community development objectives in a single project, a
bank CDC investment might finance the construction of affordable housing, for
example, or might provide equity or debt financing to support and sustain a small
business lending program. Other efforts might be focused specifically on area
revitalization or stabilization (a project such as the conversion of a historic building into
a community center, for instance), or other activities, services, or facilities that benefit
LMI populations and communities (OCC Community Affairs, 2007).
33
Under the public welfare provision, a bank must also demonstrate non-bank
community support for its CED activities. The non-bank community support
requirement is satisfied by a bank investment in a nonprofit community development
corporation (CDC), or the participation of non-bank community representatives with
relevant experience that serve on the CDC’s board of directors. A bank can also
demonstrate community support through a direct investment in a federal low-income
housing tax credit (LIHTC) loan pool that finances the construction of affordable
housing.

Prior to the 1990s, the public welfare provision went largely unobserved by
national banks. The provision gained popularity beginning in 1995, when the OCC
revised the CRA performance criteria used to examine national banks. Under the
Investment Test of the CRA exam, a bank CDC community development investment
must develop and operate a commercial or industrial property; develop and operate a
business incubator; form a Community Development Financial Institution; charter and
fund a bank with community development as its primary focus; or form and operate an
agricultural cooperative. In return for making community development investments, a
national bank can benefit from the public welfare policy in a number of ways. Because
these are for-profit investments, if successful the investor can expect a market rate
return on principal invested, achieve a double bottom line outcome (doing well while
doing good), and receive CRA credit under the Investment Test of the OCC
34
performance evaluation. However, as with any investment, there are associated risks;
investors might realize losses on principle invested.

Community Renewal Tax Relief Act Of 2000

In December 2000, President Clinton implemented the New Markets -
Revitalizing America’s Underserved Communities Initiative, known as the New
Markets Initiative. The White House later summarized this landmark legislation as
follows:
Passage of this historic bi-partisan legislation represented a significant
commitment to the community development field. Through the
Initiative, the Clinton Administration’s goal was to attract private
sector equity investment to underserved and distressed communities
throughout the U.S. As redistributive economic policy, the New
Markets Initiative represented a significant effort in the use of public
policy as a means to bring private sector capital to address the
revitalization of distressed communities. The Initiative was
implemented with the goal to ensure that all Americans would share in
the economic prosperity that was currently sweeping the nation.

(Summary of Provisions Contained in H.R. 5662, The Community
Renewal Tax Relief Act Of 2000. December 2000; The White House,
2000).

The Initiative set out to improve access to basic, safe, and affordable financial services
and products—including credit and investment capital—to promote the economic health
of low-income communities. As a place-based community development strategy, the
Initiative was designed to help real estate developers finance the redevelopment of
35
existing infrastructure by constructing affordable new housing, commercial
development projects, and community facilities. The Initiative was designed to attract
capital to support local small businesses and entrepreneurs in need of start-up funding,
and help existing small businesses to promote continued growth. Community
development investments produced by the Initiative were also used to capitalize safe
and affordable local community development banks, where neighborhood residents
could maintain accounts, build assets, and create wealth (Benjamin, Rubin, Sass, 2004).

The research project focused on the first three provisions contained in the New
Markets Initiative (Community Renewal, Empowerment Zone, New Market Tax
Credit), each provision being intended to facilitate the redevelopment and revitalization
of urban neighborhoods and communities. Starting on January 1, 2002, and continuing
through December 31, 2009, the New Markets Initiative has provided and will provide
tax incentives to investors willing to commit capital with the long-term objective of
spurring development in targeted economically distressed areas (Fiore, 2001). The
short-term objective has been to attract private sector capital to distressed communities
as a means of stimulating business investment and growth and creating additional jobs
which would be filled by low-income individuals (Fiore, 2001). Fiore (2001) also
characterizes the policy objective of the Initiative as one that has encouraged businesses
to locate in distressed rural and urban areas and hire residents who had not prospered
from recent economic expansion in other areas around the country.
36
Title I. New Markets Community Renewal Initiative

Section A: Community Renewal Provision

The renewal communities provision designated 40 urban and 12 rural
communities as renewal communities. These communities were identified by their
respective state and local governments on the basis of their long-term poverty rates, area
median incomes, and levels of persistent poverty. Businesses located in designated
renewal communities are entitled to a number of tax concessions meant to encourage
existing business to remain and to attract new businesses to a target community.
Renewal community businesses can also take advantage of federal employer wage
credits for full-time employees, an expanded expense deduction for tangible assets, and
accelerated commercial revitalization deductions. Other examples of how Community
Renewal Provision Title I - Section A tax incentives can benefit a business entity
include:
1) a zero percent rate for capital gains realized from the sale of qualifying
assets

2) a fifteen percent wage credit to employers for the first $10,000 of qualified
employee wages, and

37
3) commercial revitalization deductions that allow a taxpayer to either:
(a) deduct 50 percent of qualified expenditures for the taxable
year in which a qualified building is placed into service, or
(b) spread the tax for qualified expenditures over a 10-year
period, beginning with the month the qualified commercial
real estate is placed into service and available for occupancy.
(c) deduct an additional $35,000 of section 179 expensing for
qualified real estate/property

4) expansion of the Worker Opportunity Tax Credit, applied to renewal
community residents.

Section B: Empowerment Zone Provisions

Enacted by Congress and signed into law by President Clinton, the
Empowerment Zone Program was originally part of the 1993 Omnibus Budget
Reconciliation Act. The 1993 legislation designated 104 Empowerment Zones (EZ) and
Enterprise Communities (EC) located throughout the U.S. In supporting the legislation,
President Clinton intended to use federal policy to “empower people at the local level to
make the most of their own lives by solving their own problems,” where federal
government acts as a facilitator of change, rather than being an obstacle to it
38
(Liebschutz, 1995). Section B of the 2000 Renewal Communities Provision authorized
the creation of additional empowerment zone communities by offering an expanded
array of tax incentives to continue past efforts to attract private sector business
operations to target communities and neighborhoods.

The 2000 Renewal Communities Provision extends the designations and
associated tax incentives originally set forth in the 1993 legislation through December
2009. Under the extension, businesses in the newly designated renewal communities are
eligible for the same tax incentives as those contained in the 1993 legislation, and
communities which were previously designated as EZs can apply for a Renewal
Community Designation. Specific incentives under the 2002 Community Renewal EZ
Provisions include a 20 percent wage credit for firms located within empowerment
zones and employing EZ residents; the ability to expense $35,000 for a qualified
commercial property located in the EZ – provided it is placed in service and operated by
a qualified zone business; and eligibility for additional tax-exempt bonds for certain
businesses with operations in existing EZs. Like the CED program, the EZ/EC program
represents public policy directed at assisting localities with job creation and other
efforts to stimulate future economic development opportunities, opportunities that
Liebschutz (1995) maintains will benefit low-income communities and create a better
future as a result of the partnership between federal, state, and local government, and
the private sector.
39
Section C: New Market Tax Credit

The New Market Tax Credit (NMTC) Program has been touted as one of the
most innovative community revitalization programs to come along in the past 20 years.
The NMTC Program, which will be discussed at length in a later section, is a form of
community development investment widely used by bank CDCs to impact community
development. A primary objective of the NMTC Program is to stimulate private equity
investment in underserved communities by allowing taxpayers to receive a credit
against their federal income tax in exchange for making a qualified equity investment
(QEI) in a Community Development Entity (CDE). The CDE is then required to use a
substantial percentage of the equity to provide community investments in low-income
neighborhoods. With this tax credit as a funding mechanism, the NMTC Program, at its
inception, was projected to stimulate $15 billion in private equity investments over a
seven-year period. The NMTC represents an invaluable new tool to spur new
investment dollars to redevelop underserved and distressed communities.

US Treasury Department – Community Development Financial Institutions Fund

Established by Congress in 1994 as part of the Riegle Community Development
and Regulatory Improvement Act, the CDFI Fund is managed by the U.S. Department
of the Treasury (CDFI Fund, 2007). The Act created the CDFI Fund as a vehicle to
40
expand the availability of credit, investment capital, and financial services in distressed
neighborhoods and communities nationwide (Kaplan, 2007). The primary mission of
CDFIs is to improve the economic conditions of low-income individuals and
communities by providing a range of financial products and services that are often not
accessible through mainstream lenders (Benjamin, Rubin, and Sass 2004).

Formation of the CDFI Fund led to a proliferation of CDFIs operating
throughout the U.S., with the CDFI Fund committing some $850 million, the single
largest source of funding for the CDFI network (Cooch and Kramer 2007). Following
the formation of the CDFI Fund in 1995, the OCC incorporated the Investment Test as
part of the examination of a bank’s CRA performance. This established bank CDC
loans and investments in CDFIs as a qualified community development activity. The
creation of the Investment Test also increased bank CDC investments in CDFI’s,
provided banks with positive CRA credit for qualified investments, and served to
increase bank CDC engagement in CDFIs generally.

The changes implemented by the OCC led many financial institutions, usually
acting through an intermediary such as a bank CDC, to increase the level of direct
community development investments in CDFIs. These direct investments also allowed
banks to receive CRA credit and cash rewards under the CDFI Fund Bank Enterprise
Award (BEA) Program (CDFI Fund, 2007). The regulatory policy led to increased bank
CDC participation and investments to assist CDFIs to address community economic
41
development in low-income communities. The public welfare provision led to increased
bank CDC investments in CDFIs, through such vehicles as the Equity Equivalent
Investment, the New Market Tax Credit, and Community Development Venture
Capital. The ability for CDFIs to access these community development investment
vehicles led bank CDCs to represent leading CDFI investors and serve a critical role in
the ability of CDFIs to raise the mandatory private sector matching funds.

As an economic development intermediary, a CDFI also serves an important
role as a buffer between its bank partners and the community activists who agitate for
economic development on behalf of low-income communities and who look to hold
financial institutions accountable to these communities. Cooch and Kramer (2007)
maintain that CDFIs serve a market niche that has gone unserved by traditional
financing institutions—a situation one could easily attribute to the practice of redlining.
CDFIs serve low-income and minority communities where the population is composed
of at least 69% low-income residents, at least 58% minorities, and at least 52% women.

The history of the modern CDFI has its origins in the 1880s, with the advent of
minority-owned banks that were created with the sole purpose of serving low-income
areas. The 1930s and ‘40s witnessed the emergence of accountholder-owned “credit
unions,” many of which were located in the rural south, that were established expressly
to serve the needs of a poor and largely African-American population. By the 1960s,
Community-based Development Corporations, or contemporary CDCs, were being
42
created to address the financing shortage for small business growth and development.
These early CDCs were the key to a broader urban economic development strategy. The
1980s witnessed the emergence of nonprofit loan funds established with the intent of
helping to create multi-family affordable housing and spur small business development.
With leading national organizations such as the Local Initiative Support Corporation
(LISC) and the Enterprise Foundation taking the lead, these organizations began
systematically targeting low-income and minority communities for redevelopment
(Benjamin, Rubin, Sass. 2004).

Today certified CDFIs serve low-income populations in distressed urban and
rural communities throughout the U.S. CDFIs are market-driven, locally-controlled,
community-based organizations that measure success by focusing on the “double
bottom line.” [Note: The term “double bottom line” refers to the combination of two
measures of an institution’s success. The first bottom line is the financial one: Is the
bank making a profit for its customers and stockholders? The second bottom line is the
social one: Is the bank truly serving the community?] The goal of CDFIs is to mind both
bottom lines by making sound economic decisions while supporting responsible home
ownership for neighborhood residents, assisting locally owned businesses that provide
needed products and services, developing community facilities, and providing financial
services and products that enable people to save and build wealth. In many low-income
and distressed communities, CDFIs serve a pivotal role in bringing the targeted
43
populations into the economic mainstream. The CDFI Fund achieves its mission and
objectives through four key initiatives:

• Community Development Financial Institutions – By capitalizing CDFIs, the
CDFI Fund provides direct investments, technical assistance, and training to
CDFIs. These CDFIs in turn provide loans, make investments, and provide
financial services and technical assistance to underserved populations and
communities.

• The New Markets Tax Credit Program – Annual allocation to Community
Development Entities is used as a tool to attract private sector capital to address
the revitalization of LMI communities.

• The Bank Enterprise Award Program – This program provides banks with a cash
incentive to invest in their communities and to make investments in certified
CDFIs.

• The Native American Initiative – This program is focused solely on Native
Communities and encompasses Native American, Alaska Native, and Native
Hawaiian communities (collectively known as Native Communities). The
Native Communities Initiative provides training, technical assistance, and
financial resources to a network of Native CDFIs. The Initiative’s goal is to
44
overcome the barriers that have historically limited or prevented Native
Communities from gaining equal and fair access to credit, capital, and financial
services. Through the Initiative, the CDFI Fund provides direct monetary awards
and technical assistance, using private sector contractors to increase the number
and capacity of Native CDFIs addressing the community economic development
needs of Native Communities.

The CDFI Fund provides resources and support to certified CDFIs that have a
demonstrated record of success, and to organizations seeking CDFI Fund certification.
Through Financial Assistance (FA) awards, the CDFI invests in certified CDFIs with
adequate financial and managerial capacity and a proven track record of providing
affordable and appropriate financial products and services to their communities.
Recipients must be established and viable financial institutions that will effectively
leverage CDFI Fund dollars with private sector capital. Financial assistance is available
in the form of grants and investments, and, depending on the specific CDFI’s mission,
FA support to capitalize a loan fund. An example of this would be a nonprofit
affordable housing developer who uses FA to support a pre-development fund, or a
small business lending program that makes loans to low-income and minority business
owners.

Additionally, the CDFI Fund provides CDFIs with Technical Assistance (TA)
awards. TA awards are directed at both start-up and existing CDFIs with the objective
45
of assisting those CDFIs to build and grow their organizational capacity. TA awards are
provided by the CDFI Fund in the form of grants; CDFIs use the TA awards to serve
their target markets through the acquisition of goods and services such as consulting
services, technology purchases, and staff or board training. The record of success
established by urban and rural CDFIs working throughout the U.S. has served to
validate the CDFI industry and to increase the level of confidence among existing and
potential investors. This success has attracted new investors, support, and funding,
which further aids CDFIs in carrying out their mission. Of equal importance to the basic
operations of the CDFI Program is the success CDFIs have had in leveraging private
sector resources that support community development activities. CDFIs attract funds
from a variety of public and private sector sources: corporations, banks and bank CDCs,
private foundations, religious institutions, and individuals. However, the CDFI Fund
will only fund certified CDFIs that have demonstrated their ability to secure, at a
minimum, a 1:1 match of federal to non-federal funds. Kaplan (2007) finds that the
CDFI Fund has developed into an important government entity that promotes economic
growth and access to capital in low-income communities through monetary awards to
CDFIs and the allocation of tax credits to CDEs.

The Coalition of Community Development Financial Institutions provides a
comprehensive assessment of the origin, function, and work of the CDFI industry and
its mission to serve low-income populations, communities, and neighborhoods. The
coalition represents some 1000 CDFIs in operation throughout the U.S. (CDFI
46
Coalition, 2007). CDFIs are focused on efforts to support entrepreneurs, to create and
grow small businesses, to build affordable housing and community facilities, and to
engage in other projects critical to revitalization. To address these tasks, CDFIs have
developed into a variety of organizational structures such as micro-enterprise funds or
community development loan funds, community development corporation-based
lenders and investors, and community development venture funds. The CDFI Fund uses
these organizations to further important community development objectives that include
job creation, business development, and commercial real estate development.

CDFIs also serve a critical role in meeting the basic banking needs of low-
income individuals and families by sponsoring community development banks and
credit unions that provide basic banking services (such as checking and savings
accounts) to underserved communities. These resources are important to the financial
livelihood of low-income and minority individuals and families, and CDFIs try to
rebuild disinvested communities one customer at a time, by making loans to people with
limited or poor credit histories. Unlike standard commercial banks, CDFIs have the
flexibility to adapt lending guidelines to meet the needs of borrowers within the target
population. This flexibility includes the ability to accept unconventional collateral for
loans, to offer non-conforming mortgages, to provide financial literacy and education
programs for borrowers, and to provide individualized assistance to potential borrowers
(CDFI Coalition, 2007). An example of an unconventionally collateralized loan would
be one where the lender accepted a second or third lien position on real estate, publicly
47
traded stock, or an automobile. For the first time homebuyer, a history of timely utility
payments, a clean rental history, or a completed auto loan might be accepted as proof of
the homebuyer’s ability to repay a loan on time.

While CDFIs differ greatly from mainstream financial institutions, their success
and survival is still contingent upon the existence of mainstream banks, so CDFIs try to
establish mutually beneficial relationships with mainstream banks whenever possible.
CDFIs and banks work in partnership to develop innovative ways to deliver loans,
investments, and financial services to low-income and distressed communities. An
important aspect of this partnership is a CDFI’s ability to jointly underwrite brick-and-
mortar community development projects along with banks. In a typical venture of this
kind, the CDFI would assume the more risky, subordinate debt. Many redevelopment
projects would not come to fruition in the absence of such joint funding by a bank and a
CDFI. Examples of such redevelopment projects include office space that will house
nonprofit organizations, community health centers, business incubators, community
event centers, and other facilities generally owned and operated by nonprofit
organizations. Typically, for these projects the bank will take a first position on any
collateral and assets, while the CDFI provides an unsecured loan and takes a
subordinate position on the real estate as collateral.

The premise of the CDFI Funds program is that the federal government should
use its resources to build the capacity of the network of CDFIs located throughout the
48
U.S. In this view, the purpose of government is to promote economic revitalization and
community development through investments, technical assistance, and training to the
network of CDFIs serving low-income populations and communities. The CDFI’s
vision is an America where all citizens have equal access to affordable credit and
capital. To make this vision a reality, CDFIs strive to expand the capacity of financial
institutions to provide credit, affordable capital, and financial services and products to
underserved populations and communities (CDFI Fund, 2007).

Challenges of the Bottom Line

According to Lee Winslett, Vice President and Investment Manager with the
Wells Fargo Bank CDC, investing in community development venture capital funds has
allowed national banks to earn meaningful economic and social returns on community
development investments while also helping to fulfill the banks’ CRA obligations
(OCC, Community Developments, Spring 2007). Winslett also maintains that
investments in community development serve a higher purpose by providing needed
growth capital in communities where portfolio companies and ordinary, low-income
people have a common vision of shared prosperity. Elizabeth Ferguson, Executive Vice
President and Managing Director of the Bay Area Fund, suggests that community
development investments assists bank investors to realize more than just CRA credit:
49
the Fund also generates a return on investments that mirrors private equity markets
(Federal Reserve Bank - San Francisco, 2003).

Sustainable community development strategies must first satisfy a corporation’s
primary interest: generating profits and revenue. Only then will the corporation consider
engaging in efforts to facilitate the redevelopment and revitalization of urban
communities. Corporations are linked to cities and urban areas with respect to business
growth, workforce, education, politics, and the environment. More importantly,
corporations are dependent on the urban environment and its inhabitants as markets in
which to sell their products and services. Porter and Kramer (2006) assert that
successful corporations require a healthy society and that education, health care, and
equal opportunity are essential to a productive workforce.

The multiple bottom line, commonly referred to as the double or triple bottom
line, is founded on the premise that the private or corporate sector can simultaneously
serve larger societal goals while also producing a return on investment (ROI) (Davis,
2005). As it applies to community development, the double bottom line refers to a
scenario in which the investor wants to further a social good and is fully aware of the
need for capital to facilitate the revitalization of distressed low-income communities.
The investor also recognizes the challenges of investing in such areas and the risks
associated with community development investments, recognizing that in many cases
50
an investment in such an area will produce at best a market rate or less than market rate
return (Waddock, 2000).

The San Francisco Bay Area Family of Funds, a community development
venture capital fund, secured corporate participation by offering pension funds,
insurance companies, investment and financial institutions (bank CDCs) an opportunity
to invest and obtain a positive return for the company’s bottom line, as well as social
returns for the community. Major investors in the Fund include Bank of America,
Bechtel, Wells Fargo Bank, Pacific Gas and Electric, and the Fireman’s Fund. Davis
(2005) characterizes what the Bay Area Fund has set out to achieve as the “triple
bottom line,” which he describes as investment which is designed to serve social and
environmental goals, while producing a profit (Davis, 2005). As a triple bottom line
fund, the Bay Area Fund provides a venue for the corporate sector to invest in three
different sub-funds, each with a different objective. First is the Smart Growth Fund,
which is focused on the production of mixed use, mixed income smart growth real
estate development. Second is the California Environmental Fund, which provides loans
and lines of credit to finance environmental cleanup. Finally, there is the Bay Area
Equity Fund, a venture capital fund that targets job creation by investing in companies
in the consumer products, high technology, and health care sectors. The Bay Area Fund
addresses issues that have historically impacted distressed low-income communities
(OCC Community Developments, Summer 2005).

51
Since its establishment in 2002, the Fund has attracted more than $175 million,
with $100 million invested in projects and businesses (Office of the Comptroller of the
Currency. Community Developments. Summer 2005. Investment Intermediaries:
Helping Banks Achieve a Double Bottom Line). Through the Fund, corporate investors,
largely financial institutions, can invest money in projects that will produce economic,
social, and environmental benefits to the community (OCC, Community Developments,
Summer 2005). While shareholder value must always serve as a critical measure of
business success, the efficient and sustainable provision of goods and services that
society as a whole wants should represent the corporation’s long-term or ultimate
purpose (Davis, 2005). In the context of community and urban economic development,
a corporation must address the needs of the total marketplace, and this includes
providing goods and services at fair market value to all communities, including
minority and low-income ones.

As with the Bay Area Fund, the goal of the New York City Investment Fund is
to mobilize corporate and financial community resources to facilitate urban economic
development. The New York City Investment Fund’s managers characterize it as one
of the nation’s few “corporate civic investment funds.” Its investors consist largely of
Wall Street CEOs who serve on the Fund’s board of directors. Since its establishment
in 1999, the Fund has secured $100 million in capital under management, with $50
million invested in 47 projects, producing an estimated 2,750 jobs over a five-year
period (Wylde and Plastrik, 2001). The New York Fund mirrors similar funds
52
established by business leaders in other major urban centers (Cincinnati, Cleveland,
Detroit, Pittsburgh) throughout the U.S. In each case, the city fund’s directors recognize
that corporate participation in community development is critical to a city’s prospects
for future economic development.
53
Chapter 2: Community Development

Introduction

Before the research paper turns its attention to an analysis of the specific types
of community development investment vehicles used by bank CDCs to pursue
community economic development objectives, it is important to clarify the meaning of
the term “community development.” The objective is to examine how each investment
vehicle forwards the community development agenda. As previously discussed, the
research project was most interested in community economic development, defined as
the revitalization and redevelopment of low-income neighborhoods, inclusive of
geographic approaches, and tax incentives (Sviridoff, 1994). Meyers (1997) found that
in 1977, the year CRA was passed, the concept of community development was limited
to the development of community infrastructure, encompassing building projects such
as street improvements, water and sewer projects, and recreational facilities.

Where Yellen (2007) found that early efforts at urban renewal, undertaken some
30 years ago, were funded largely by federal grants, today community development
projects are more likely to be financed by a combination of public and private dollars.
Andranovich, Moddarres, and Riposa (2005) suggest that two major needs are
addressed through modern community development public policy. First is the need to
54
provide access to development capital for people who otherwise would not have such
access. Second is the need for poor and low-income populations to leverage economic
success into broader forms of self- and community-empowerment. It took a decades-
long struggle by the community investment movement, combined with legislation such
as the HMDA and the CRA, to finally empower community-based organizations,
residents, and businesses to gain access to capital investment in their own
neighborhoods (Vidal and Keating, 2004).

When it comes to community development strategies, there are two prevailing
philosophies, or schools of thought: a conservative school and a liberal school. Both
schools recognize that urban decay and poverty exist. According to the conservative
position, however, minority and low-income communities don’t merit any special
consideration when it comes to investment, since there is little that government can (or
should) do for inner-city communities and their inhabitants (Sviridoff, 1994). In
essence, this view holds that African-American, minority, and low-income residents
should be left to fend for themselves in contained geographic areas. In contrast, the
liberal perspective asserts that what is required is a resolute and sustained economic
commitment to poor people and to poor places: a commitment to invest money in these
places, with a focus on reindustrialization and livable wage employment, quality
education, health care, drug treatment, and more generous welfare supports.

55
The researcher subscribes to the doctrine that community development, in its
truest form, recognizes that access to affordable housing is only one piece of the
community development pie. What is needed is a holistic community and economic
development approach that recognizes the need to focus on rebuilding shattered
communities both socially, physically, and economically (Sviridoff, 1994). Economic
development at the community level helps build infrastructure while improving the
lives of the community and its inhabitants. This translates into a better quality of life for
the low-income and minority people living in distressed communities. Community
economic development equates to more living-wage jobs, increased homeownership
rates, lower crime rates, and higher education rates. As articulated by Vidal and Keating
(2004), community development is about asset creation that improves the quality of life
for residents in low-income neighborhoods. Yellen (2007), President and CEO of the
Federal Reserve, describes community development as development which improves
the well-being of low-income and minority communities by employing a range of
innovative strategies and programs to produce lasting change.

The research project maintains that community development is consistent with
the traditional view of economic development, where the focus is on how to attract new
business to a community and to retain existing industries and commercial businesses
that generate and export goods and services. Community development is measured by
the same economic indicators as economic development—indicators such as job
creation and retention, and new investment that benefits low-income neighborhoods and
56
populations (Andranovich, Moddarres, and Riposa, 2005). Using the term “community
development” has the advantage of clarifying the relationship among community
development, economic development, and community economic development—terms
that are often used interchangeably, with confusing results. Economic development, in
the economist’s definition, can take place on many geographic scales; hence one finds
references in the literature to national, state, regional, and local (commonly meaning
city) economic development policy, while community development takes place on a
smaller geographic scale, in a neighborhood or a group of neighborhoods, for example,
and may occur along any of the dimensions of community (economic, social, physical,
etc.). Community economic development connotes the intersection of the two—that is,
economic development at the community scale (Vidal, 1995).

According to Crandall and Manville (2008), one of the longest-standing debates
within the community economic development field has been how to produce
community economic development outcomes that benefit low-income and minority
individuals and communities. Historically, there have been two approaches to
community development: people-based development and placed based development, so
the crux of the debate is whether to focus community development resources on places
(in other words on the physical redevelopment of distressed urban communities) or
whether to focus these resources on people: poor and minority individuals who will
benefit from the revitalization of the distressed neighborhoods in which they reside.

57
The task at hand, then, is to determine which is the more effective community
economic development strategy for community development: a people- or place-based
approach. Should resources be directed in such a way as to improve people’s
livelihoods through various types of intervention, such as workforce development, job
training, education, cash allotments, and vouchers? Or should community development
strategies pursue a place-based approach, where resources are focused on the physical
redevelopment of distressed and older urban neighborhoods, through such measures as
construction of affordable housing, mixed-use development, and so forth?

People or Place-based Community Development Strategies

In reviewing the two approaches, a legitimate starting point would be to clarify
the target population—that is, the people—who are served by people-oriented
community economic development policies, programs, and strategies. The people in
question are best characterized as poor and low-income individuals and families, adults
and children, most likely people of color, who reside in economically distressed
communities and neighborhoods. These are neighborhoods that have suffered from
decades of disinvestment that has led to crumbling infrastructure, boarded-up windows,
and graffiti-covered buildings. For Sviridoff (1994), who supports a people-based
approach, the continued existence of distressed inner-city, neighborhoods, populated
largely by poor minorities, demonstrates that physical and economic development is not
58
likely to be effective without social stability. What is needed are community
development strategies that have as their primary focus the improvement of the
economic, educational, and day-to-day physical environment for the low-income
individuals or families living in the target community. The desired outcome of a people-
based strategy is to create economic opportunity for the individual, who over time will
be enabled to accumulate assets and grow personal wealth.

For example, a people-based approach will assist entrepreneurs to create new
businesses and support existing businesses with business education, lending, and
financing. This strategy will support business development and growth and will provide
the opportunity to generate additional business income, revenue, and profits. In turn, the
benefited businesses will be able to employ neighborhood residents, bring much need
goods and services to the community, and recycle dollars within the neighborhood.
Politicians, policymakers, philanthropists, academics, corporate heads, and community
activists generally agree that minority business development has proven itself as an
effective strategy to address urban poverty (Shuman, 1997).

To see this type of community economic development at work, one can look to
Community Development Venture Capital, whose focus is to grow businesses located in
distressed neighborhoods, and employ neighborhood residents, many of whom have
little formal work experience. Community Development Venture Capital invests in
businesses that provide employees with health insurance, a retirement plan, ownership
59
in the company, tuition reimbursement, and job training needed to advance. The
rewards are twofold: in their simplest form CDVCs reach individual people through
education and relevant job training skills that provide access to quality, livable-wage
jobs. By extension this helps local businesses. Whether a low-income or minority
business owner is able to repay a business loan to some degree depends on the success
of nearby businesses and a vibrant business district.

A healthy business environment is one in which community, commercial, and
mixed-use business districts coexist with healthy residential neighborhoods, where
there’s a greater sense of pride of ownership by the stakeholders, who are low-income
residents (Hopkins and Tellalian, 2006). These places are communities and
neighborhoods that lack small businesses that provide basic goods and services. They
are neighborhoods where the only store is quite often a liquor or corner convenience
store at best, neighborhoods where there is no grocery store for families to purchase
basic staples. An example is the North Kenwood-Oakland community located on the
south side Chicago, which recently welcomed the development of a $9.1 million,
78,000-square-foot shopping center. This shopping center was the first such
development in the community in 50 years, and was made possible by community
development organizations working through public and private collaboration (Meyer,
1997).

60
Place-based strategies seek the most effective method to define community in
terms of a geographic neighborhood. Whether defined as a single neighborhood or as a
large section of a metropolitan center, the places in question are typically plagued by
low-incomes, high social service demands, deteriorating housing stock, high
unemployment rates, inadequate services, failing schools, and a lack of jobs for area
residents. Place-based strategies focus on the physical redevelopment of low-income
communities and neighborhoods through such measures as the renovation of existing, or
the construction of new commercial, mixed-use, multi-family housing development.
Crandall and Manville (2008) found that the most favored community development
programs rely on place-based economic development strategies that include such
initiatives as enterprise zones, redevelopment projects, tax increment finance districts
(which target investments), job training subsidies, and tax breaks to industries and
residents that locate in specific neighborhoods.

According to Vidal (1995), public policy development and analysis have
historically been very inconsistent in their attention to the importance of location, and
policies specifically intended to help places, rather than people have tended to fall in
and out of favor throughout the postwar period. When it comes to financial institutions,
Hopkins and Tellalian (2006) argue that in order to accomplish community
revitalization, community development lenders must return to the place-based thinking
that originally inspired the CRA. They suggest that what is needed to help low-income
communities thrive economically is a sustained and focused effort by banks, who must
61
utilize all of their product lines to make an impact (Hopkins and Tellalian, 2006).
Financial institutions must rethink their current approach to low-income and minority
communities, and view these communities as markets that represent true business
opportunity, rather than viewing them simply as a regulatory burden (Yellen, 2007).
This will in turn result in opportunities to add new customers and depositors.

Ladd (1991) describes a pure people-oriented strategy as one that assists people
regardless of whether they live in a distressed community or not, and focuses on human
capital and mobility. Consistent with Ladd, Dawson-Munoz (1996) argues that place
alone does not account for the varying economic and educational profiles of racial
groups in poor areas. Addressing the problems of a geographically defined place
through redevelopment seems as straightforward as constructing or renovating existing
facilities. Regarding place-based development, however, community economic
development actually means far more than just building a new neighborhood or
commercial retail development project.

This research paper supports the principle that what is needed are public policy
and government community economic development strategies that incorporate both
people-based and place-based strategies, with an emphasis on ensuring that low-income
and minority resident’s benefit from the physical redevelopment and revitalization
strategies implemented in their communities. One such example is found in subsequent
revisions to the CRA regulations, which have expanded the definition and scope of
62
community development, resulting in a focused and expanded scope of community
development investment activities that target the revitalization or stabilization of
designated areas as an outcome. The focus of community development is to address the
needs of people caught in the grip of generational poverty, where the norm is an
inadequate or inferior public education system, high rates of teen pregnancy, drugs, and
gangs.

The community development investments used by national bank CDCs consist
of both people and place-based efforts. Bank CDCs have investments that target the
redevelopment of existing infrastructure and support the construction of new mixed-use
projects, commercial projects, and affordable housing. In spite of the obvious benefits
of redevelopment to a community, it appears that all too often in today’s environment,
low-income and minority populations are too often priced out of the neighborhood by
redevelopment, and with the rebirth of the many urban areas and inner-city
neighborhoods comes gentrification, a phenomenon whereby the original residents
leave a neighborhood and are replaced by a “whiter” and more upwardly mobile
population. The original residents (minority and low-income individuals and their
families) will then relocate to cheaper, first ring suburbs, and the cycle of urban decay
begins anew.

Whether people-based or place-based development is taken as the model, what
the research project has set out to demonstrate is the positive impact that bank CDC
63
community development investments can have on the day-to-day lives of low-income
and minority populations, and on the distressed neighborhoods and communities where
they reside. The positive externalities attributed to community development are
numerous. However, the research used to justify place-based strategy has a propensity
to select place alone as the basis for the allocation of social policy funds and often does
not take into account the racial diversity of impoverished neighborhoods and
communities. This in turn diminishes the ability of development to benefit minority
populations.

Bank CDC Community Development Investments

The research project examined national bank CDCs community development
investments to explore their contributions to redevelopment and revitalization of urban
communities. An additional goal was to identify bank CDC investments in CED that
represent best practices. Julie Williams, Acting Comptroller of the Currency (OCC,
2005) expressed the sentiment that CDCs provide banks with an innovative way of
financing a wide range of community and economic development initiatives. The
successful identification of best practices resulted in a comprehensive set of strategies
regarding the use of bank CDCs to advance CED outcomes. In 2003, the OCC
implemented revisions to 12 CFR (Part 24). The subsequent public policy and
regulatory changes recognized the value attributed to national bank investments in the
64
New Market Tax Credit Program as qualified public welfare investments (OCC, 2004.
Community Development Investments, New Market Tax Credits-Bridging Finance
Gaps). Under the normal course of the CRA, a national bank is required to demonstrate
that its lending and services benefit a specific assessment area, usually the communities
and neighborhoods in close proximity to a main bank or one of the bank’s branches.
This differs greatly from the expanded set of economic development and investment
activities that bank CDCs can engage in under the public welfare authority in Part 24,
which include activities designed to reach LMI areas and individuals that fall outside a
given bank’s assessment area, or activities designed to address a broader statewide or
regional area inclusive of the bank’s assessment area (Tucker, 2004/2005).

The primary objective of the research was to examine bank CDC community
development investment vehicles and their ability to impact CED and urban
revitalization. Under Part 24, the OCC, in its oversight capacity of national bank CDCs,
has identified a number of approved community development lending and investment
vehicles. These represent community development investments that are largely limited
to activities that only a bank CDC can engage in. These community development
investment vehicles encompass buying; selling; developing and managing of real estate
or real property; making equity investments; forming limited partnerships and joint
ventures; making high-risk loans; and providing technical assistance and counseling
services. This research project focused on Community Development Venture Capital,
Equity Equivalent Investments, and the New Market Tax Credit Program as the
65
community development investment vehicles with the greatest chance to impact CED
outcomes. Based on the literature review, the objectives of Small Business Investment
Companies are consistent with the activities and outcomes pursued through CDVC. As
such, the research focused its attention on the CDVC as the preferred investment
vehicle.

The scope of the project included bank CDC community development activities
that promote, stabilize, and revitalize communities. The OCC has identified the
following activities as mechanisms used to attain the objectives:

• Development and operation of commercial or industrial property,

• Development and operation of a business incubator,

• Formation of a community development financial institution (CDFI) or
community development bank, and

• Formation and operation of an agricultural cooperative (OCC, 2004)

To satisfy the OCC’s public welfare objective, these investments must benefit LMI
populations, geographies, or specific target areas identified by the federal government
for redevelopment. In contrast, under Part 25 of the CFR, CRA qualified investment
66
activity is subject to a more strict interpretation, which mandates that a bank must
benefit its immediate assessment area. The distinction is that Part 25 of the CRA
regulation is subject to geographic restrictions whereas Part 24, as described under the
public welfare investment authority, gives national bank CDCs the latitude to address a
broader set of public policy and community economic development objectives.

Community Development Investment Vehicles

The following three sections of the research project provide an in-depth
examination and analysis of community development investment vehicles that
demonstrate the greatest opportunity to contribute to the revitalization, redevelopment,
and overall economic development of distressed and underutilized communities. The
examination of the identified investment vehicles provides the reader with a working
knowledge of each vehicle and how it is employed by bank CDCs to accomplish CED
outcomes. First, the research will explore Community Development Venture Capital.
The research will then turn its attention to the Equity Equivalent Investment. The
section concludes with a review of the New Market Tax Credit Program. Each of these
community development investment vehicles is a relative newcomer to the CED field,
with the NMTC being the most recent to come on the scene.

67
The research placed a particular focus on community development investment
vehicles where job creation and retention, wealth building, and expanded
entrepreneurial capacity demonstrate a direct benefit to LMI populations and distressed
communities. The remaining community development investment vehicles: Mortgage
Bonds, Real Estate Investment Trusts, and Low-income Housing Tax Credits have as
their primary focus the production of rental multi-family affordable housing (Federal
Reserve Board - San Francisco, 2007). While important to the CED field, this research
project determined that other mechanisms, such as pooled investments, securities, and
bonds, were primarily a function of Wall Street and should therefore not be considered
here.

Community Development Venture Capital

The origin of venture capital (VC) as a community development investment vehicle can
be traced to 1993, with the founding of the Community Development Venture Capital
Alliance (CDVCA). The Alliance is the industry association that consists of both
“domestic and international” community development venture capital (CDVC)
companies. These companies employ venture capital funds as a community
development investment vehicle. Kerwin Tesdell (2007), President of the CDVCA,
maintains that CDVC Funds represent an effective vehicle to direct equity financing to
businesses in underserved communities in ways that promote entrepreneurship, wealth,
68
and job creation. While the CDVC industry adopts traditional venture capital strategies,
community development is reflected in CDVC’s double bottom-line objectives (OCC
Community Development Investments, Fall 2006).

This is consistent with the view of Rubin (2000), who identifies the primary
objective of CDVC as job creation, increased entrepreneurial capacity, and wealth
building that directly benefits low-income people and distressed communities. For
example, Pacific Coast Ventures (PCV), a CDVC fund with portfolio investments
throughout the state of California, pursues CED outcomes similar to those of its
industry peers. These outcomes include helping companies to grow profitably; adding
quality living-wage jobs with health benefits; developing job skills; and creating wealth
for the whole community by building wealth for the individuals who live there.
Recognizing the importance of “brick and mortar” small business enterprises as
significant employers and job creators, PCV pursues an investment strategy that focuses
on businesses that have demonstrated the ability to spur economic growth in
California’s lower-income communities (Pacific Community Ventures, 2007). In other
words, PCV provides resources and capital to businesses that have the potential to bring
significant economic gains to low-to-moderate-income communities.

For bank CDCs, CDVC investments are eligible CRA investments under the 12
CFR of the public welfare authority, as long as these investments directly or indirectly
benefit LMI communities and families by addressing the need for affordable housing,
69
supplying vital services, or creating jobs (OCC Community Development Investments,
Fall 2006). Lee Winslett of Wells Fargo Bank CDC—a bank CDC which is responsible
for portfolio investments in numerous states (i.e., California, New Mexico, and
Montana) — maintains that his institution considers investing only in CDVC projects
where CDVC fund managers can demonstrate the ability to earn competitive returns
while simultaneously pursuing a second set of social bottom line objectives (OCC
Community Development Investments, Fall 2006). The common requirement for all
entrepreneurs, regardless of the type of financing they use, is access to debt and equity
instruments as a means to start a new business or growing an existing one. It was the
search for new ways to accomplish CED objectives that led to the creation of the CDVC
industry and the use of venture capital as a community development investment vehicle.

The Bank of America California Community Venture Fund, LLC; Wells Fargo
Community Development Corporation; Merrill Lynch Community Development
Company; and First Regional Bank are some of the financial institutions and national
bank CDCs that invest in CDVC funds. In addition to providing small business
enterprises with much needed growth capital, CDVC investments have a higher
purpose, a vision of shared prosperity for low-income workers and economically
distressed communities. CDVC provides equity capital for businesses located in
underinvested markets and pursues strong financial returns as well as the creation of
good jobs, wealth, and entrepreneurial capacity for LMI residents. Small business
enterprises served by CDVC are generally located in low-income or underserved areas.
70
This is consistent with the mission of the Wells Fargo bank CDC, for example, where
CDVC investment decisions are based not only upon a fund’s ability to deliver
economic returns to shareholders, but also on its ability to revitalize neighborhoods,
eliminate blight, and create employment opportunities (Taylor, 2007).

According to Tesdell (2007), financial institutions and bank CDCs have found
that CDVC funds can serve as a profitable investment vehicle that also enables a bank
to fulfill its CRA regulatory requirements. Equally important, CDVC investments help
bank investors build future market opportunities for traditional lending products and
services. As the use of VC as a community development investment vehicle has
witnessed growth during the last ten years, bank CDCs and financial institutions have
come to represent the dominant investors in CDVC Funds. The CDVCA reports that,
by 2003, banks had invested an estimated 42 percent of the total capital under
management in CDVC funds (Tesdell, 2007). In fact, the percentage of participation by
banks is far greater than any other single category of investor. When the data is
examined with regard to new capital committed during the same period, it suggests that
banks and bank CDCs alone accounted for 48 percent of total capital commitments
(Figure 2). During this period, banks and bank CDCs accounted for 80 percent of total
new commitments (Tesdell, 2007).

71
Figure 2: CDVC Funding Source by Industry Sector
(Community Development Venture Capital Alliance, 2006)

As an economic development intermediary, a CDVC fund serves a number of
important roles in CED. On one hand, a CDVC fund has a relationship with its investors
(largely banks and bank CDCs) that is designed to create and employ a pool of investor
capital. On the other hand, the CDVC fund uses its equity capital to invest in business
enterprises that meet CDVC investment criteria. While the most important investment
criterion is a return on principal invested, a CDVC fund has a competing interest to
make portfolio investments that produce tangible social benefits. These double bottom
line objectives include characteristics such as creating quality employment
opportunities; promoting progressive management practices; producing socially
beneficial products and services; and enriching distressed communities and their
residents. Founded in Maine in 1994 and focusing on investing in businesses throughout
the northeastern U.S., Coastal Enterprises Inc., is capitalized with total commitments of
Capital Committed During 2003
Bank
48%
Corporation
2%
Non-
depository
Financial
32%
Foundation
11%
Other
4%
Federal
Government
3%
2003 Aggregate Capital
Bank
42%
State/Local
Gov't
8%
Other
13%
Federal
Government
7%
Non-
depository
Financial
14%
Foundation
14%
Corporation
2%
72
$25 million from national banks and bank CDCs, and manages two socially responsible
venture capital funds that make equity investments in businesses (CEI Maine).

Through its investment model, CEI Ventures has demonstrated its ability to
invest in companies that produce a positive rate of return. CEI manages a balanced
equity portfolio that is diversified by geography, industry, stage of business
development, and specific double bottom line objectives. Historically, CEI has invested
in its portfolio companies over multiple cycles of financing, where investments can
range from $1 million to $4 million. CEI invests in innovative and emerging companies
that exhibit the possibility of rapid growth and dynamic transformation (CEI Ventures).
CEI Ventures portfolio companies offer competitive advantages through proprietary
technology, intellectual property rights, and specialized distributions systems, and
pursue broad ranging social benefits as a part of their normal business activities.

Traditional VC is defined as a source of “patient equity” or capital that provides
critical early stage financing for a start-up company, or money to fund the expansion of
a rapidly growing business with a promising product or service (Hoopengardner, 2003).
With traditional VC, the primary objective is to invest in expanding new industry
sectors and companies that will maximize the investor’s return on the principal
investment. In contrast, the CDVC investment strategy tends to focus exclusively on
existing businesses where a VC infusion will take a company’s operations to the next
level, resulting in increased production capacity, which in turn will facilitate a growth in
73
revenue and profits. Consider Cal-Organic Farms, for example, which is owned by
Grimmway Farms and located in the premier agricultural region of California’s San
Joaquin Valley. Grimmway Farms is a portfolio company in the Pacific Community
Ventures Fund; the Pacific Community Ventures Fund provides CDVC investment to
support the operations of Grimmway Farms because this company meets the Fund’s
community development investment criteria (Wides, 2007).

Over the past 20 years, traditional VC corporations have invested predominantly
in the high technology, life sciences, and biotechnology industry sectors, due to the
potential for rapid growth and maximum return on the investment (Hoopengardner,
2003). An entrepreneur will typically seek venture capital only after exhausting his/her
personal resources but prior to turning to commercial banks that offer conventional
financial lending products. Hoopengardner (2003) maintains that under the traditional
VC model the individual or institutional investor provides capital and in return gains a
share of ownership in the business. Venture capital often represents the sole source of
capital for an entrepreneur to start up a new business venture. This capital also
represents an important source of equity necessary to move an existing business to the
next stage in production capacity, or to finance the implementation of a restructuring
plan that leads to greater efficiencies and revenue growth.

Another illustration of a successful CDVC Fund at work is the case of Pacific
Community Ventures (PCV). PCV’s investment strategy is focused on small- and
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medium-sized “brick and mortar” businesses that it views as critical to the development
of underserved communities in California (Pacific Community Ventures, 2007). PCV
defines “brick and mortar” businesses as non-technology-driven businesses, such as
manufacturing, service, and food companies with a workforce of 10 to 100 employees
and annual revenues between $500,000 and $30 million (Pacific Community Ventures,
April 2007). For example, PCV will invest only in existing businesses that are located
within California’s underserved communities, businesses with the proven ability to
produce both competitive financial returns and significant social returns (PCV web
site). When underwriting a potential investment, PCV measures the applicant’s financial
success by its internal rate of return. At the same time, PCV is equally concerned with
the social return on its investments, defined as the number and quality of jobs created by
the investment that will directly benefit low-income communities and populations
(Pacific Community Ventures, 2006).

According to Winslett (2007), the Wells Fargo bank CDC’s strategy is to spread
its CDVC investment activity across a broad spectrum of funds that meet the demands
of emerging businesses while diversifying risk. The OCC recognizes CDVC as a
maturing community development investment vehicle for bank CDC investments in
CED, a trend that will only continue as the community development field continues to
increasingly adopt venture capital strategies. The Bay Area Equity Fund (BAEF) serves
as another example of a successful CDVC fund at work. As the venture capital arm of
the Bay Area Family of Funds, the BAEF works to ensure that its portfolio investments
75
meet the social bottom line, in addition to producing market rate returns. Citibank and
other bank CDCs have chosen to invest in the BAEF because of its holistic approach to
addressing the economic development needs of underserved communities (OCC
Community Development, Summer 2005). To ensure that LMI communities are
benefited by the jobs created by each of its portfolio investments, the BAEF provides its
portfolio companies with access to human resources and additional support to ensure
that there is a direct connection between money invested and jobs created (OCC
Community Development, Summer 2005).

This is another key distinction between CDVC and traditional VC. Unlike
CDVC, the VC model does not base investment decisions on job creation, since any
jobs created by traditional venture capital investments typically require a highly skilled
workforce with a high degree of technical skill and knowledge. CEI finds that there are
compelling investment opportunities in a range of markets that are underserved by the
traditional financing community. In pursuit of the double bottom line, CEI strives,
through its investments, to create quality employment opportunities, particularly for
people with low to moderate incomes. CEI’s portfolio companies also promote
progressive management practices that support socially beneficial products and
services, enrich distressed communities, and foster environmental sustainability.

In 2004, the CDVCA estimates that there were more than 80 community
development venture capital funds (either active or in formation) operating throughout
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the U.S., with an estimated $870 million under management. The Alliance maintains
that investments made from these funds have led to the creation of some 24,000 new
jobs in underinvested communities and neighborhoods throughout the U.S. (CDVCA,
2008). Former chairman of the Federal Reserve Board Alan Greenspan regards venture
capital investments as an essential part of the financial foundation for the dynamic
young enterprises that are central to the wealth-creating process. Greenspan finds this to
be “especially true for lower income communities [where] the continued need to
develop markets for private equity investments will be rewarded by innovative and
productive businesses” (CDVCA, 2008). In a 2001, article produced by the Brookings
Institution titled “Equity with a Twist: The Changing Needs of the Community
Development Field,” Nancy Andrews refers to community development venture capital
as the newest entrant into the rich agenda of programs, talent, and expertise.

Clearly an industry leader among national bank CDCs, Wells Fargo began
investing in CDVC funds in 1999 and to date has committed more than $10 million in
four CDVC funds that consist of three different sponsors (Winslett, 2007). As part of its
underwriting criteria, BAEF will only invest in companies that are willing to provide
jobs (primarily entry level positions) to LMI community residents. In keeping with this
philosophy, the BAEF has focused its investments in such industry sectors as consumer
products and services, technology, and the health care field—each one representing a
key industry sector for the San Francisco Bay area economy (OCC Community
Development, 2005). Unlike traditional VC, CDVC places a premium on double bottom
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line goals that reflect general community development objectives (OCC Community
Development Investments, Fall 2006).

An additional value-add of the Bay Area Family of Funds for bank CDCs is the
pooled investment approach, which minimizes risk by spreading it among multiple
investors. An example of CDVC at work is a BAEF investment in the Elephant
Pharmacy. This flourishing retail business located in the Bay Area sells pharmaceutical
and “complimentary” products (e.g., food, flowers) and services targeted at health
conscious consumers. The $2.2 million CDVC investment in Elephant Pharmacy met
the BAEF’s double bottom line objectives because the store is located in a LMI
community and the majority of new jobs created at the pharmacy benefited community
residents. The majority of these positions were entry level ones, but paid wages that
exceeded the city government livable wage ordinances for the municipalities of
Berkeley, Oakland, and San Francisco. Employee benefits include health care, equity
sharing, and job training (OCC Community Development, Summer 2005)—all features
that are more typical of higher-paying white collar jobs.

Further evidence concerning the viability of VC as a community development
investment vehicle was evident in a public policy implemented in 2000, under President
Clinton’s New Markets Initiative (NMI). The New Markets Venture Capital (NMVC)
Program was designed to increase access to VC for small businesses operating in low-
income communities (Figure 3). The programmatic objective pursued by the NMVC
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Program is to encourage VC investments in low-income communities as a way to create
jobs and increase entrepreneurial capacity in areas where traditional venture capital had
historically been non-existent (CDVCA, 2006).

Figure 3: Percent of NMVC Investments Located in
Low Income Communities 2003-2006
(Community Development Venture Capital Alliances, 2006)

Percent of NMVC Investments Located in Low-income Areas as of 3/31/06

Low-
income
92%
Other
8%

The New Markets Program recognizes the value of expert guidance—or what
the policy refers to as “operational assistance”—to small businesses in receipt of VC
investments. The SBA allocated $30 million to fund the provision of expert guidance
(technical assistance) to small businesses in receipt of NMVC investments. The
program would accomplish its objectives through direct federal assistance to improve
local economies and to address the unmet equity needs of low-income urban and rural
communities (CDVCA, 2006). To realize these programmatic objectives, the legislation
proposed the creation of New Market Venture Capital Companies (NMVCCs) as
intermediaries that would direct venture capital investments into small firms operating
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in targeted low-income areas (Figure 4). It was estimated that the program had the
potential to stimulate $15 billion in new private sector investments in low-income areas
with high concentrations of poverty (The White House, December 2000).

Figure 4: Cumulative NMVC Companies Investment Activity 2003-2006
Program Impacts: Financing, Jobs, and Growth for
Low-Income Communities
(Community Development Venture Capital Alliances, 2006)

As of March 31, 2006, the six NMVCCs had invested approximately $32.2 million into
75 companies, 69 of which (92%) are located in low-income areas.

The same legislation gave the federal Small Business Administration (SBA)
oversight authority for the NMVC Program. According to the OCC Community
Developments (2007), the SBA’s role mirrors the functions it serves under the Small
Business Investments Company (SBIC) Program. Like the SBIC, the SBA selects firms
to participate in the NMVC program, provides funding to capitalize the NMVCC’s
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investment pool, provides operational assistance, and regulates the NMVCC’s
operations to ensure compliance with public policy objectives. Under the policy, the
SBA had the authority to guarantee up to $150 million in loans to match the $100
million in private equity raised by NMVCCs (for a total of $250 million) to capitalize
the program. Bank CDCs and other institutional investors are the primary source of the
private sector capital that NMVCCs raise.

Under the guidance of the SBA, NMVCCs act as for-profit entities and are required
to raise a minimum of $5 million in private capital from sources other than the federal
government. Once an NMVCC fulfills the private sector capital requirement it is
eligible for 2:1 federal matching dollars. In exchange for the federal 2:1 match, the SBA
requires the NMVCC to invest in smaller businesses located in LMI communities,
where the average venture capital investment ranges from $50,000 to $300,000. The
SBA also provides participating NMVCCs with two types of assistance:

• Debenture guarantees. The NMVCC receives cash proceeds of SBA-backed
debenture financing equivalent to the amount of private capital raised.
Debentures are repayable according to a ten-year schedule, with no interest due
during the first five years of the term and interest-only payments during the last
five.

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• Operational Assistance Grants. These are used to provide technical assistance
to portfolio companies and companies in the investment pipeline. NMVCCs
identify promising LMI area businesses that require specific help to ensure the
viability of business operations and then make operational assistance money
available to them.

Bates (2002) characterizes the New Market Venture Capital proposal as the
recycling of a bad idea. Some elements of the New Markets Initiative do appear to be
ideas that failed to work when originally implemented in the 1970s through the U.S.
Small Business Administration. However, the CDVCA (2006) argues that the NMVC
Program differs significantly from the SBA-administered SBIC Program, since the
SBIC Program is primarily a form of debt financing as opposed to the CDVC, which is
equity financing. Licensed and regulated by the US SBA, SBICs are privately owned
and managed investment firms that provide venture capital and start-up financing to
support the development of small business enterprises. The 2006 CDVCA report
concludes that while the NMVC Program is modeled in some respects after the SBIC
program, NMVC comes with a number of programmatic improvements. Speaking to the
apparent success of the CDVC industry, a 2006 Alliance report shows that six
NMVCCs were formed during the 2003–2004 period, with operations in, and a focus
on, underinvested low-income urban and rural areas throughout the U.S. As of March
2006, the combined efforts of the six NMVCCs produced the following outcomes:

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• Investment of more than $48 million in 75 companies with operations located in
poor and underinvested communities.

• Leveraging of approximately $136 million in additional equity investments from
other sources, including angel investors and other venture capital funds, with an
average leverage ratio of 4:1.

• The provision of operational or technical assistance valued at $6 million to 63
companies. Operational assistance funds such efforts as business planning,
marketing, and consultant services.

• The retention of 1,626 jobs and the creation of 368 new ones in the communities
where the NMVCC maintained operations.

The CDVCA points to this data as validation that the NMVC is a successful double
bottom line model that provides bank CDCs the potential to invest in strong, high-
growth companies, limiting risk and producing market-rate returns for investors, while
simultaneously fostering economic growth and the creation of good jobs in distressed
urban and rural communities.

Unfortunately, continued federal government funding for the NMVC Program
eventually fell victim to the political vagaries of congressional and presidential politics.
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As of 2003, which was the end of the first round NMVC funding, the SBA had
approved six NMVCCs, four of which were located in rural communities. However,
there have been no second or third round congressional allocations to fund continued
NMVC Program operations, and the NMVC Program was deleted from the 2003 Fiscal
Year Omnibus Appropriations Bill. Since 2003, no additional funds have been allocated
(OCC Community Investments, 2007). In spite of the political issues that limit the
viability of this government sponsored program, the CDVC development projects that
were already begun have been successful.

Equity Equivalent Investments

In 1996, the Ford Foundation, Citibank, and The National Community Capital
Association (NCCA), working in partnership, identified the need within the community
development field for a product or mechanism that could expand the sources of capital
to support the work of nonprofit community development and lending organizations
(Toups, Honor, and Kolluri, 2007). Out of this effort came the first ever Equity
Equivalent Investment, commonly referred to as an EQ2. The EQ2 was seeded by a
$1million investment from Citibank that capitalized the NCCA Central Fund. The
$1million Central Fund served as a mechanism by which NCCA could use the Citibank
investment to attract and generate additional community development investments and
grants to benefit its CDFI members (Haag, 2000). Lipson (2002) views the EQ2 as a
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financial tool that allows CDFIs to strengthen their capital structures and leverage
additional debt capital that would in turn put the CDFI in a position to increase CED
lending and investment activity in distressed or underserved communities.

Community and neighborhood-based CDFIs looked to the Central Fund as a
source of low-interest, long-term, patient capital that supports their ability to carry out
CED-related activities. The EQ2 is the foundation that CDFIs use to fund the operation
of micro-loan and small business loan programs. These programs extend loans to small
business enterprises that are located in distressed communities—particularly those that
are minority-owned or employ LMI individuals. The EQ2 is an important tool that
facilitates the creation and growth of community-based small businesses. If small
business is the backbone of the U.S. economy, it is also the cornerstone of
neighborhood and community revitalization. CDFIs also use EQ2 equity investments to
pursue commercial and mixed-use development and affordable housing (both single-
and multi-family) construction. Under this scenario, the EQ2 can support the pre-
development activity necessary to real estate development.

As a membership-based organization that represents community-based CDFI
lenders and real estate developers, NCCA established early on that a feasible investment
product must build and enhance the expertise, capacity, and financial strength of CDFIs
in order to help them undertake complex and catalytic community development activity.
In developing a product for this market, the NCCA recognized that any equity-based
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product must possess two important features in order to attract and satisfy bank
investors. First, the product must satisfy the bank’s CRA and community development
obligations; that is, it must direct resources to LMI communities within the bank’s
footprint or assessment area. Second, participating banks must be able to justify their
equity investments by realizing a good return on those investments. The EQ2 satisfies
both requirements: by providing CDFIs with an alternative source of capital and by
providing financial institutions with a vehicle for CRA credit under the Investment Test
(Haag, 2000). For example, a priority for Bank of America is to use the EQ2 as a
mechanism to help nonprofits build financial strength and the internal expertise needed
to undertake and complete community development objectives (OCC Community
Development, Winter 2000/2001).

By taking advantage of the EQ2’s low interest rate, bank CDCs are able to offer
capital to community development lending organizations, CDFIs, and other qualified
nonprofits, thereby enabling these organizations to work closely with the end-user, for
example, an entrepreneur seeking a small business loan. This kind of customer support
is considered critical for riskier entrepreneurial business enterprises and has proven to
result in lower than average default rates among borrowers (Randolph, Allyson. 1997)
(Toups, Honor, Kolluri, 2007). EQ2 capital also makes it easier for CDFIs to offer more
responsive financing products with longer terms, with the size and term of loans varying
according to the borrowing organization’s mission. The Chicago Community Loan
Fund (CCLF) serves as an example. CCLF uses EQ2 proceeds to spur urban
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revitalization through the provision of development capital and technical assistance for
projects considered too risky by traditional banks. Another example is the Cascadia
Revolving Fund, a Seattle-based CDFI that operates a micro-loan fund in the states of
Washington and Oregon. Cascadia employs EQ2 proceeds to provide small business
enterprises with capital and technical assistance.

The EQ2 differs from ordinary subordinated debt in several ways:

1. Unlike ordinary debt, the EQ2 is carried as an investment on the investor’s
balance sheet in accordance with Generally Accepted Accounting Principles
(GAAP).

2. An EQ2 investment is a general obligation of the nonprofit lender (investee); the
loan acts like equity in that repayment of the EQ2 is not secured by any of the
nonprofit recipient’s assets. In other words, it is an unsecured investment, like
an investment in the stock market.

3. The investment is fully subordinated to the right of repayment of the nonprofit
lender’s other creditors. Should the nonprofit lender experience a financial loss,
the investor is the last to be repaid.

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4. The investor, in this case a bank CDC, is not able to accelerate payment of the
EQ2, unless the nonprofit lender ceases its normal operations or changes its line
of business. This provides the nonprofit with the comfort of knowing that the
investor will not recall its investment in the short term. This enables the
nonprofit to re-lend the capital for longer periods of time.

5. The EQ2 interest rate is fixed, and bears no relation to the nonprofit’s revenue
generation. No matter how much revenue the nonprofit is able to generate from
the investment, the interest rate and terms remain fixed.

6. A rolling term with an indeterminate maturity date further supports the
nonprofit’s ability to re-lend the money for longer time-periods.

Toups, Honor, Kolluri, (2007) found that the community development industry
experienced a constant and growing need for a greater breadth of sources and access to
capital in order to support nonprofit community development and lending organizations.
The EQ2 represents a new generation of community development financial instruments
that is part equity and part debt. The EQ2’s private (or for-profit) component is
convertible preferred stock on which the investor is able to realize a dividend. The EQ2
is also a flexible capital investment in that bank CDCs can deploy it in a variety of ways
under Part 24 of the public welfare authority. As a community development investment
vehicle, the EQ2 is consistent with the broad authority granted to national banks by the
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OCC under the Regulation (12 CFR Part 24), meeting the objective to produce
innovative and complex bank CDC investments in CED.

Bank CDCs quickly recognized the value of the EQ2 as a community
development investment vehicle that expands the sources of capital available to
nonprofit community and lending organizations. Randolph, Allyson, (1997) and Toups,
Honor, Kolluri (2007) estimate that in the first five years of the EQ2’s existence, from
1996–2002, approximately 25 bank and non-bank sources, led by such notable national
banks as Citibank, Washington Mutual, U.S. Bank, Wells Fargo, Northern Trust, and
Bank One, contributed in excess of $70 million in EQ2 investments. This is consistent
with the research of Lipson (2002), who found that the EQ2 is an increasingly popular
product with significant benefits for bank investors.

Lipson (2002) finds that a strong permanent capital base is critical for CDFIs,
and that once it was in place, the EQ2 increased the CDFIs’ risk tolerance and lending
flexibility, while lowering the cost of capital and protecting lenders by providing a
cushion against losses in excess of loan loss reserves. The EQ2 provides CDFIs with the
flexibility necessary to meet the needs of their markets by allowing longer-term and
riskier lending. While the EQ2 possesses a variety of favorable characteristics for
CDFIs, the most important is that it allows these nonprofit organizations to grow and
solidify their long-term operations.

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As a community development investment vehicle, the EQ2 has also made it
easier for CDFIs to offer more attractive financial products to their customer base
(Lipson, 2002). For example, the EQ2’s low-interest ten-year term enables the Chicago
Community Loan Fund (CCLF) to pass these favorable terms on to its customers. In
some cases, CCLF allows for automatic rollover clauses that can lead to a twenty-year
loan term. This type of “patient” capital can prove key to the success of small business
enterprises. Another example of an EQ2 success story is the Cascadia Revolving Fund.
This Seattle-based CDFI, uses the EQ2 as a source of capital for its quasi-equity
financing and long-term real estate-based lending. Another well-established fund,
Boston Community Capital, also finds the terms of the EQ2 flexible enough to help
capitalize its venture fund.

Consistent with the introduction of the EQ2 as an investment vehicle used by
banks and bank CDCs, in 1996 and 1997 the four federal bank regulatory agencies
(OCC, Federal Deposit Insurance Corporation, Office of Thrift Supervision, and the
Federal Reserve Board) issued a joint interpretation declaring that financial institutions
would receive favorable consideration under CRA regulations for EQ2 investments.
The interpretation stated that equity equivalents would be qualified investments under
the Investment Test, or alternatively, under the Lending Test. The regulatory
interpretation has had significant implications for banks interested in collaborating with
nonprofit CDFIs because it entitles them to receive leveraged credit under the CRA
Lending Test. When a bank CDC makes an EQ2 investment in a CDFI loan fund,
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capital that the CDFI then loans out to small business is considered a direct benefit to
the investing bank’s assessment area, or a broader statewide or regional area.

The bank EQ2 investor can then claim a pro rata share of the incremental
community development loans made by the CDFI. Lipson (2002) offers the following
scenario:

A nonprofit CDFI has “equity” of $2 million, $1 million of which is in the form
of permanent capital and $1 million in EQ2 provided by a commercial bank. The
bank’s portion of the CDFIs “equity” is fifty percent. Assuming that the CDFI
uses the $2 million to borrow $8 million in senior debt, bringing the total to $10
million under management. The CDFI makes $7 million in community
development loans over a two-year period. The bank is then entitled to claim its
pro rata share of the loans originated by the CDFI at 50 percent, or $3.5 million
in lending credit, over the two- year period.

As this investment vehicle becomes more commonplace, it provides for very favorable
cost of capital, with interest rates in the two to four percent range, and standardized
documentation for investments. The Citibank EQ2 to NCC served as a model or
prototype that could be replicated (Lipson 2002). In addition to the financial return, the
favorable CRA treatment that banks receive under this scenario provides another form
of non-monetary return on investment. Lipson (2002) suggests that this is a motivating
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factor for many banks that make EQ2 investments, and Lipson (2002) finds that the
EQ2 is a step in the right direction in developing investment vehicles that support the
growth of CDFIs, the nonprofits they support, and community redevelopment.

New Market Tax Credits

Enacted as part of the Community Renewal Tax Relief Act of 2000, and viewed
as the cornerstone of then President Clinton’s 2000 New Markets Initiative, the New
Market Tax Credit (NMTC) Program has as its chief objective to stimulate private
investment in underserved communities. The NMTC program achieves this objective by
securing private sector investors to invest in the funds of certain financial intermediaries
called Community Development Entities (CDE) (Figure 5).
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Figure 5: How New Market Tax Credits Work
(0CC Community Developments, 2002)

Passed by Congress with bipartisan support in December 2000, the NMTC program was
viewed as the most significant federal subsidy for economic development in distressed
communities in the past thirty years (Armistead, 2005). Community development
practitioners, including CDCs, nonprofit financial intermediaries, and banks, have come
to appreciate the NMTC program as important to the overall community development
strategies needed to support their efforts to achieve community economic development
outcomes.

Andrea James (2008), a Seattle P-I reporter, describes the NMTC as a tax break,
provided by the federal government, that gives businesses a lower tax bill, through
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credits, in return for development in LMI neighborhoods which is aimed at reducing
blight and spurring new construction. The NMTC program was implemented by the
federal government as an incentive to attract private sector and corporate investment,
including investment by bank CDCs, in the effort to stimulate and support community
economic development. Viewed as an innovative new investment vehicle, the NMTC
Program was highly anticipated by community economic development practitioners and
investors. In 2001 the Enterprise Foundation touted the NMTC as a promising new tool
for community revitalization (Williams, 2001), and CEOs for Cities (2004)
characterized the NMTC program as a much needed catalyst for community economic
development. The NMTC Program is jointly administered by the Treasury
Department’s Community Development Financial Institutions Fund (CDFI Fund), and
the Internal Revenue Service, through Section 45 D of the Internal Revenue Code (OCC
Community Development Insights, 2007).

The New Markets Initiative legislation that authorized the NMTC Program also
formed the previously discussed Community Development Financial Institutions
(CDFI) Fund, and the New Market Venture Capital Program. Through the NMTC
program, the federal government has leveraged capital from private investors to spur
economic development in targeted urban and rural low-income communities (OCC,
Community Development Insights, 2007). Early on, the NMTC program proved itself
as an attractive community development investment vehicle for bank CDCs and other
institutional investors. Evidence of the program’s early success: in 2003, the CDFI Fund
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completed two rounds of allocations, issuing a total of $4 billion in NMTCs. In these
first two rounds, 31 depository financial institutions were awarded $1.2 billion of the
total $4 billion in allocations (Wides, Barry. Summer 2004. New Market Tax Credits-
Bridging the Finance Gaps. Community Developments). Armistead (2005) found that
by 2005 CDEs had successfully attracted investors to commit over $700 million in QEI
(capital), and to invest the majority of those funds in qualified projects.

Rubin and Stankiewicz (2005) report that the NMTC is an effective method of
poverty alleviation, since it is aimed at bettering the lives of residents of distressed
communities and not merely at addressing broad economic development objectives. In
a 2001 article titled “The NMTC: A Promising New Tool for Community
Revitalization” Williams (2001) portrayed the NMTC program as an investment vehicle
that could facilitate the redevelopment and creation of:

• neighborhood retail centers
• small businesses
• manufacturing facilities
• office space
• childcare centers
• charter schools
• health care facilities, and
• mixed-use projects.
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Early programmatic success was evident in 2004, when the Local Initiative Support
Corporation, working through its local affiliate, Impact Capital, provided $10.9 million
in NMTCs to facilitate the redevelopment of Albers Mill, a historic property and former
superfund site located in a designated Federal Renewal Community in the city of
Tacoma, Washington. US Bancorp served as the project’s qualified equity investor
(Armistead, 2005), providing capital in exchange for the tax credits to US Bancorp
Community Development Corporation (USB CDC). The parent company, US Bank,
provided a construction loan to the project that was taken out by the NMTC financing
through its own affiliated CDE (CEO’s for Cities, 2004).

The $12 million Albers Mill redevelopment, a mixed-use residential and retail
project in close proximity to Tacoma’s Thea Foss Waterway, was a community
economic development catalyst for the city’s larger redevelopment plan.
Redevelopment of the previously contaminated five-story building led to the creation of
10,000 square feet of ground floor commercial space and the addition of 36 market-rate
loft apartments on the building’s top four floors. As part of its larger redevelopment
plan, the City of Tacoma created 1.5 miles of waterfront walkway, public plazas,
marinas, shops, and a cultural center (CEOs for Cities, 2004). This is consistent with
Chamberlain’s (2006) research, which found that the NMTC is the only federal tax
program for commercial projects in low-income areas. NMTC encompasses projects
large and small and helps to create jobs and revitalize streets and even entire
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downtowns. Financial specialists agree that many of these projects would not come to
fruition without the existence of a tax break or some other incentive to attract private
sector investors (Chamberlain, 2006). Tax benefits to NMTC investors are spread over a
seven-year period, starting on the date when the equity investment is made to a CDE,
and on each subsequent anniversary. The NMTC Program permits taxpayers to receive
a credit against federal income taxes for making Qualified Equity Investments (QEI) in
designated CDEs. Investors realize a tax credit worth more than 30 percent (in present
value terms) of the amount invested, receiving a five percent credit for the first three
years of the investment, and six percent for each of the final four years, totaling thirty
percent over a seven-year credit allowance period. Investors may not redeem their
investments in CDE’s prior to the conclusion of the seven-year period.

Like the Low Income Housing Tax Credit, the NMTC program uses tax credits
(instead of the more common direct government funding) as the mechanism by which to
spur neighborhood revitalization (Rubin and Stankiewicz, 2005). Implemented in 1987,
the LIHTC has facilitated the construction of 80,000 to 100,000 low-income rental
apartments per year, creating about 70,000 jobs, $1.8 billion in wages and $700 million
in tax revenues annually. This has resulted in the leveraging of over $12 billion in
corporate investments, the majority from corporations that had not previously invested
in the creation of affordable housing (Armistead, 2005). Rubin and Stankiewicz (2005)
suggest that tax credits are more palatable to taxpayers than other kinds of incentives,
and are easier to enact politically, because tax credits are not accounted for as direct
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government budget expenditure. Forgoing the collection of a tax represents only an
opportunity cost for the federal government, as compared with the “real” cost of taxes
that are used to redistribute income in the forms of grants and other social service-
related activities. From a public policy perspective, the NMTC program is accurately
characterized as a “Third Way” policy, one that uses market forces to better people’s
lives (Rubin and Stankiewicz, 2005). The NMTC program effectively addresses the
lack of private capital in distressed communities. For these communities the program is
the missing ingredient.

From the onset, the NMTC program was expected to spur economic
development in distressed communities through the issuance of $15 billion in tax credits
over a seven-year period, from 2001–2007. Starting in 2002, the first round allocation
was $2.5 billon; with $1.5 billion in 2003; $2 billon in both 2004 and 2005; and ending
with a $3.5 billon allocations in 2006 and 2007.
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Table 3: NMTC CDE Parent Type – Round 1 Allocatees
(Armistead, 2005)

This much-needed equity was projected to stimulate business growth in LMI
communities throughout the United States (PL&C Policy Analysis, 2004). To realize
the NMTC’s ambitious goal, the Treasury Department implemented a competitive
process whereby both nonprofit and for-profit organizations could apply to the CDFI
Fund for Community Development Entity (CDE) certification (Table 3). A CDE is a
domestic corporation or partnership that serves as an intermediary and has community
development as its primary mission. CDEs serve low-income communities and are
accountable to the residents through community representation on a governing or
advisory board.

Because of their pre-existing relationship with the CDFI Fund, CDFIs are
automatically eligible for CDE designation (Table 4) (OCC Community Development
Insights, 2007). Like CDFIs, Specialized Small Business Investment Companies also
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receive an automatic CDE designation. Both entities are required to complete an
abbreviated certification process.

Table 4: NMTC Allocations Received by CDFIs
Round 1 and 2 Allocatees
(Armistead, 2005)

Investors are of two types driven by the bank’s appetite, interest, and need to control its
own portfolio of NMTC investments. Banks participating in the NMTC program are
typically motivated by a number of factors including: attractive economic rates of return
on investments; prospects to generate significant impacts in LMI areas; opportunities to
diversify into other credit products and services; and the ability to receive favorable
CRA consideration (OCC Community Development Investments, January 2007).

Bank CDC investments are of two types. The first type, known as the third party
model, is when the bank CDC acts solely as an investor, making a Qualified Equity
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Investment (QEI) in a CDE where there is no legal relationship between the bank CDC
and the CDE. An example of this model is Washington Mutual’s (WAMU’s)
participation in the redevelopment of the Wonder Bread Bakery site in Seattle,
Washington’s LMI “Central District” community. In this example, WAMU made a
$4.87 million QEI in the project, and received $6 million in federal tax credits in
exchange. In this case, WAMU purchased the tax credits from Enterprise Social
Investment Corporation, the CDE. As the QEI, WAMU probably negotiated the deal
contingent to its role as QEI, with the parent bank WAMU providing an $8.3 million
loan finance project construction (James, 2001). The OCC (2007) refers to this as the
third party model, where the bank or bank CDC prefers more limited participation and
minimal exposure. When the bank CDC’s participation is limited to making a QEI, the
bank CDC must have extreme confidence in its community development partner, the
CDE.

Critical elements for the bank CDC to consider when selecting a CDE to partner
with include such factors as: the importance of the people involved, underwriting the
people involved in the project, the value of existing relationships, and the ability to
create partnerships that must span both good times and bad. Finally there is the project’s
financial structure. Managers at the Wells Fargo bank CDC, which has acted solely as
an equity investor (QEI), have determined that once you get past the standard
underwriting process for NMTC projects, the next most important task is to focus on the
purpose of the investment or project. Taylor (2007) recognizes that in addition to
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satisfying shareholders, NMTC programmatic objectives are to revitalize
neighborhoods, eliminate blight, and create employment opportunities.

A second option is when a bank-affiliated bank CDC that has community
development as its focus creates its own CDE. In this case, the bank CDC has decided
to establish and make a QEI into its own CDE. To create a CDE, the bank uses a
subsidiary, most often a bank CDC, to create a Limited Liability Corporation (LLC) as
the vehicle to obtain certified CDE status through the CDFI fund, and make application
for a NMTC allocation. Acting as both a CDE and QEI provides the bank CDC with
added control and oversight over future investments. For example, Key Bank’s
subsidiary, Key Bank Community Development Corporation (KCDC) created the Key
Community Development New Markets LLC, a subsidiary of the KCDC. The Key
Community Development New Markets LLC used NMTCs in combination with
Historic Tax Credits to finance the redevelopment of Cadillac Hotel in Seattle’s historic
Pioneer Square District (OCC Community Development Investments. Winter
2004/2005). Growing Markets with Bank CDC). Originally constructed as a hotel in
1889, the building was successfully converted into modern office space as a result of
this innovative project.

As an extension of the bank CDC, the CDE is able to offer tax credits to
investors that likely will include the bank CDC (Brown, 2002). US Bank’s bank CDC
has been one of the more active in the NMTC industry. In 2005 alone, US Bank closed
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more than 50 deals involving NMTCs (Chamberlain, 2006). US Bank thus acts as an
investor itself— receiving NMTC in exchange for a QEI and applying the tax credits
against the corporation’s federal income taxes—and through its CDE provides the
opportunity to offer interest bearing loans or investments in QLICs to other investors.
A bank or bank CDC combined with a CDE provides for increased opportunities for
banks to participate in the NMTC program. Through a variety of business lines and
affiliated companies, a bank CDC can act as an equity investor, receive tax credit
benefits, and finance project construction, just to name a few examples.

Both nonprofit and for-profit CDEs are eligible to apply for an NMTC
allocation, but the legislation mandates that in order for a nonprofit to qualify as a CDE
it must either create a new for-profit subsidiary or submit plans to transfer its entire
allocation to an existing for-profit subsidiary. An allocation is also contingent upon
CDFI Fund review and approval of a business plan that effectively addresses the CDE’s
management capacity and anticipated community impact, including a business and
capitalization strategy (CDFI Fund, 2004).
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Figure 6: US Dept. of the Treasury CDFI Fund Source
NMTC Allocation Phase
(Armistead, 2005)

Armistead (2005) characterizes NMTC activity as a three phase process
(Figure 6). First, the CDFI Fund allocates credits through a competitive process to
financial intermediaries—in other words, CDEs. Second, financial intermediaries
(CDEs) exchange NMTCs for capital from qualified equity investors. Third, CDEs
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select, close, and monitor investments in projects or businesses located in target areas.
Through its business plan, a CDE must demonstrate a primary mission of serving or
providing investment capital to a Qualified Low-Income Community (QLIC) or its
residents, and must also be accountable to the residents of the community it serves. The
CDFI Fund defines a QLIC as census tracts with a twenty percent or greater poverty
rate, or census tracts where the median family income is 80 percent or less of the area
median income. CDEs are classified into three distinct groups:

• For-profit entities, such as banks, bank CDCs, and investment banks—refer
to previous examples, Key Bank, US Bank, and WAMU.

• Mission-driven organizations, including nonprofit CDCs and
intermediaries, and CDFIs. Organizations that fall into this category include
the Local Initiative Support Corporation, Shorebank Enterprise Pacific,
Enterprise Social Investment Corporation. LISC, the nation’s largest
community development financial intermediary, received a $65 million first
round NMTC allocation. LISC CEO Michael Rubinger maintains that LISC
uses the NMTCs as a new arsenal to further the intermediary’s community
development mission, and to support strategies LISC is already using to do
business. An example of this is the previously discussed Albers Mill project
in Tacoma. In that case the LISC, acting as the CDE, provided a $10.9
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million NMTC allocation, and US Bancorp served as the equity investor.
(Armistead, 2005)

• Government entities, such as a housing finance agencies and public
economic development agencies.

The recipient of the largest first round allocation was a for-profit subsidiary
created by the City of Phoenix, the Phoenix Community Development and
Investment Corporation which received a $170 million allocation. Through
the CDE, the City of Phoenix planned to pursue revitalization activity that
focused solely on its LMI communities that lie within the city limits,
including commercial real estate investments in distressed neighborhoods.
The city expected to produce such outcomes as job creation for residents and
persons below the poverty level in designated areas of the city and increased
wages and benefits for residents already working but living below the
poverty level (Armistead, 2005). This is consistent with NMTC
programmatic objectives to provide capital and liquidity to benefit LMI
persons, communities, and local businesses (Williams, 2001).

Upon receipt of an NMTC allocation, a CDE must then seek and secure
investors willing to make a QEI. In other words, investors willing to exchange equity
for tax credits. Once the CDE has sold its pool of tax credits to investors, the CDE has
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12 months to apply a minimum of 85 percent of investor equity toward make Qualified
Low-Income Community Investments (QLICIs). QLICIs are characterized as:

• investments in, or loans to, businesses, considered to be Qualified Active
Low-Income Community Businesses (QALICB),
• investments in,or loans to, other CDEs,
• loans purchased from CDEs,
• a means to provide financial counseling and other services (FCOS) to
eligible businesses, including nonprofit organizations, to assist with business
plan development, financial analysis, financing, and similar activities (OCC
Community Developments Insights, Feb. 2007). New Markets Tax Credits:
Unlocking Investment Potential; Community Reinvestment Fund, March
2004).

Qualifying activities that CDEs can undertake include: commercial real estate
development projects in LMI communities; loans to, or investments in, qualified
businesses that operate in LMI communities; loans or investments in other CDEs; and
the purchase of qualifying business loans from other CDEs (secondary market
purchases). For example, Key Bank planned to use its NMTCs as a partial guarantee,
primarily to extend small business loans to QALICB. This represents loans and
investments that would otherwise not be extended to small businesses due to the credit
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risk presented by the targeted business enterprises (Wides, Summer 2004. New Market
Tax Credits-Bridging the Finance Gaps. Community Developments).

During the inaugural round of allocation in 2002, the CDFI awarded $2.5 billion
in NMTCs. The CDFI received 345 first-round applications, representing total requests
of $26 billion. The average first round allocation was $38 million, with a range in
allocations between $500,000 and $170 million. Of the $2.5 billion awarded by the
CDFI Fund, six CDEs received allocations that exceeded $100 million (Table 5). A
2007 OCC report found that bank-affiliated CDCs and community development banks
are a common venue through which banks actively participate in the NMTC program.

Table 5: NMTC CDE Parent Type – Round 2 Allocatees
(Armistead, 2005)

The NMTC program has proven extremely popular with the financial services
industry. However, a major constraint for the communities it seeks to impact, as well as
the investors and the CDEs looking to make an impact from day one, is the competition
for a scarce commodity: the NMTC. There has been much competition for allocations
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from a limited fund source. In the originally appropriated four rounds of allocations,
CDE applicants have requested in excess of $107 billion in credit allocations, or $95
billion more than the $12 billion authorized by the 2000 legislation. The request for
NMTCs is thus seriously oversubscribed, with requests outpacing availability by almost
nine times (OCC, Community Development Insights, 2007). Through the first four
allocations rounds, from 2001–2007, $12.1 billion of tax credit allocations was awarded
to 233 CDEs. During the first three rounds, 170 CDEs received an allocation. Of these
170 CDEs, 51 or approximately 30 percent were CDFIs or CDFI affiliates that received
$1.8 billion of the total $8 billion in NMTCs allocated.

Armistead (2005) has found that community development practitioners,
including CDCs, nonprofit financial intermediaries, and banks, view the NMTC
program as very important to the overall set of available community development
investment vehicles. These same practitioners also agree that the NMTC has allowed
them to achieve community economic development objectives that would otherwise not
come to fruition. According to Armistead (2005), there are promising signs that the
program is successfully stimulating the flow of new investment capital into capital-
starved areas and that the deployment of this capital is generating increased economic
activity in targeted areas. The NMTC program represents a crafted solution that forms
new public-private partnerships to overcome barriers to investing in potentially
lucrative new markets existing in the U.S. (Rubin and Stankiewicz, 2005). Bob Taylor,
President of the Wells Fargo Community Development Corporation, finds that the
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NMTC program has served as an effective tool for community and neighborhood
revitalization, job creation, and redevelopment (Federal Reserve Bank – San Francisco,
2003).

Given the popularity of the NMTC program and the competitive environment
that surrounds allocations, the CDFI Fund has directed applicants to submit proposals
that focus on strong business capitalization and demonstrated community impact. The
NMTC program has proven itself an important community development investment
vehicle, and banks have embraced it to promote economic development and
revitalization strategies in LMI communities and neighborhoods. Through the first four
rounds of NMTC allocations, the financial services industry, banks and bank holding
companies have represented 75 to 80 percent of the institutional investors participating
in the NMTC program, and approximately 23 percent of all NMTC allocates.

While early assessments of the NMTC program acknowledged that the program
successfully met programmatic objectives to spur community and economic
development in low income communities, the program was not without its detractors.
Early on, the NMTC program faced criticism regarding what many viewed as
programmatic shortfalls and limitations. The NMTC program represented a new tool for
the community development field, and its practitioners, many of whom are familiar with
and knowledgeable of the LIHTC, expected the mechanics of the NMTC to work in a
like fashion. To the contrary, however, the NMTC program’s newness presented a
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variety of challenges and complexities. One of the early issues to arise for CDEs
seeking a NMTC award, was the start-up costs that had to be incurred to establish the
necessary organizational infrastructure and appropriate structures critical to submitting
a successful NMTC application. For CDEs that submitted a successful application and
received an NMTC award/allocation, the next challenge was for the CDE to identify
potential investors who would provide Qualified Equity Investments (QEI), a project
pipeline that met programmatic criteria, and the capacity to adhere to mandatory CDFI
Fund compliance. Early assessments provided every indication that preparing an NMTC
application was too costly or cost prohibitive for smaller CDEs. Instead, smaller CDEs
would do better to adopt a strategy that is centered on developing partnerships and
collaborative relationships with larger CDEs. This is based upon the premise that larger
CDEs possess the organizational capacity, infrastructure, and financial resources
necessary to complete the application process (Armistead, 2004).

A second concern expressed by community development practitioners was that,
with the NMTC program, most of the early deals were real estate-centric, with the
preferred CDE investment being some type of real estate project. In an early evaluation
of the NMTC program, Armistead (2004) studied real estate investments according to
the CDFI fund report. A review of second round award allocations intended to use two-
thirds, approximately $2.3 billion. The expectation was that the program would also
serve as a stimulus for equity investments and loans for small businesses.
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However, the program’s real estate focus leads one to regard the program as supporting
place-based community development strategies.

A third concern is the question of distribution, specifically the geographic
distribution, of tax credits: urban versus rural areas. Early indications signal that urban
areas are the preferred geography.

A fourth concern involves the distribution of allocations between for-profit
entities (commonly banks and bank CDCs) versus organizations that are mission-
driven, such as not-for-profit organization (e.g., community development corporation,
CDFI, community development intermediary) and public entities such as city
governments or state government economic development authorities (Table 6). Is a for-
profit just that, a business decision, driven by the need to maximize the return on the
principle investment. Many for-profits will only participate in CED projects where there
are ancillary business opportunities. Mission-driven organizations, conversely, are
motivated primarily by community development, inclusive of people-based and place-
based community development principles. While the NMTC is said to be widely
available on a competitive basis to qualified CDEs, a point of contention with first
round allocations is that a significant number (25 percent) of allocatees were financial
or depository institutions (CDFI Fund, March 2004).

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Table 6: NMTC CDE Parent Type – Round 1 and 2 Allocatees
(Armistead, 2005)

Finally is the question of whether, absent the NMTC, the community
development activity would happen at all. If not for the tax credits, many borderline
projects would not come to fruition. Is the NMTC essential to the process? –or is it
merely a convenient way to sweeten a deal that would move forward irrespective of the
tax credit?

Chapter 3: Case Study – Community Capital Development

As market-driven, locally controlled, community-based organizations, CDFIs
measure success by focusing on the double bottom line. They are expected to produce
economic gains for low-income and minority communities and neighborhoods as well
as making social contributions to them (CDFI Coalition). Through the CDFI Program,
Congress’s intent was to create a vehicle to address the historical lack of credit
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financing and access to capital in low-income and minority communities. Congress
viewed the CDFI Program as a vehicle to promote both economic and social
development, and the CDFI Program’s primary objective is to expand the availability of
credit, investment capital, and financial services in low-income, minority, and distressed
communities nationwide (Kaplan, 2007).

By 2005, there were an estimated 1000 community-based CDFIs in operation,
working to create economic development in low-income communities and
neighborhoods throughout the U.S. (Baue, 2006). According to Baue’s 2006 research, a
2004 nationwide survey found that some 517 CDFIs possessed assets in excess of $18
billion. If we were to extrapolate the assets of the 1000 CDFIs currently in operation,
the total dollar amount would be between $32 to $38 billion. This means that, on
average, each of the 1000 CDFIs controls between $3.2 and $3.8 million.

This chapter presents a case study of one such institution: Community Capital
Development Corporation (Community Capital) of Seattle, Washington. This high-
performing CDFI represents an exemplary economic development and financial
intermediary. In 2007, Community Capital had assets in excess of $14 million, and
$4.2 million in outstanding loans. The purpose of this section is to introduce
Community Capital, a uniquely successful and effective CDFI, in order to identify the
characteristics, factors, and qualities that make the organization effective in addressing
community development objectives in low-income and minority communities. As the
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reader examines the case study, the following sections will provide an in-depth analysis
of Community Capital’s operations, its successful business model, and best practices
that the CDFI industry as a whole should seek to replicate.

To begin, the organization has a unique operating structure: Community Capital
represents the umbrella organization for three sister 501(c)(3) non-profit entities, each
with its own board of directors. Each of the three entities is legally distinct, but for
reasons of efficiency, productivity, and economies of scale, the entities share staff,
operate in the same office space, and work in collaboration under the trade name
“Community Capital Development.” In this organizational setting, Jim Thomas, serves
as the Executive Director for each of the three entities and serves as CEO of the
umbrella organization as well.

Thomas sees community development as a way for socially conscious financial
institutions to help women and low-income and minority populations build viable and
productive small business enterprises. In turn, these small businesses will facilitate the
economic development process through the redevelopment and revitalization that helps
to build strong neighborhoods and communities. Bryant Concrete, Inc., serves as one
example of an established small business that Community Capital has worked with. Ron
Bryant, owner of Ryan Concrete, became a union member in the trade at a very early
age. After a stint in the U.S. Navy, Bryant relocated to Seattle and began work as a
concrete journeyman with one of the region’s larger construction firms. During this
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time Bryant was able to refine his skills in the trade, and by 1996 he had established his
own business venture: Bryant Concrete, Inc. Once again the trend rings true: an
individual with years of industry experience decides to venture into entrepreneurialism,
relying on his industry know-how as his primary asset.

Through its programs, Community Capital is able to support fledgling
entrepreneurs who might not otherwise have the opportunity to pursue business
ownership and is able to help existing businesses grow their operations. Community
Capital takes a people-based approach to community development and envisions the
primary mission of the non-profit community development organization and certified
CDFI as providing access to capital and business assistance to people operating
businesses in distressed and underserved communities. Community Capital’s approach
to poverty alleviation is to help low-income people pursue self-sufficiency through
entrepreneurialism (Community Capital Development, 2008). Using this approach,
Community Capital looks to create opportunities for low-income women and minority-
owned businesses by producing livable-wage jobs that help workers develop life-long,
transferable skills.

Community Capital’s core functions and scope of services are focused on
business education and training and small business lending. With over twenty years of
commercial banking experience, the organization has developed several unique
attributes that allow it to flourish in the CED sector. One of these attributes is the
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industry knowledge possessed by its CEO, Jim Thomas, who early on recognized that
access to capital is not the sole requirement for an entrepreneur or small business owner
to succeed. Thomas knows the importance of business education and technical
assistance, particularly when it comes to the success of inner-city entrepreneurs and
businesses. As the product of an inner-city himself, with roots in Detroit, Thomas is
clearly aware of the challenges faced by urban economic development.

As an outgrowth of the City of Seattle Loan Program, Community Capital
adheres to a place-based approach to community economic development, an approach
that originally focused on serving five distressed Seattle communities (Figure 7). These
communities include the Central Area, Delridge, downtown Seattle, the Duwamish river
corridor, the International District/Chinatown, and Southeast Seattle. Together, these
communities comprised an area the city designated 1997 Enterprise Community (EC),
per the criteria defined by the federal Department of Housing Urban Development
(HUD). Each of the five communities included in the Seattle EC has historically been
inhabited by a high proportion of minority and low-income residents (See Figure 8).
During WW II, these communities saw a large in-migration of black Americans who
came to work in the naval yards and Boeing plants. Later, in the mid-1970s, a second
wave of immigrants arrived—this time from Southeast Asia. In addition to outright
discrimination, residents of each of the areas in the designated EC have suffered from a
decades-long history of disinvestment, neglected, and decaying public housing
complexes, urban blight, and a history of redlining by area banks. Longtime Central
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Area business owner and client of Community Capital since 2004, Paul Bascomb,
knows all too well the history of the EC communities and questions why place-based
development during the past 10 to 15 years has failed to benefit community residents
and business owners, who are largely African-American.
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Figure 7: City of Seattle Map
Selected Planning Related Areas
(City of Seattle Office of Strategic Planning, 2007)

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Today, Community Capital has expanded its geographic scope to encompass 23
counties throughout Washington State and has moved well beyond its original mission
as a small business loan program addressing the needs of three Seattle-area
communities. Community Capital now manages an expanded set of programs that
address the training and lending needs of small business enterprises and entrepreneurs
and maintains relationships not only with the private sector but with the public and not-
for-profit sectors as well. Community Capital maintains performance and outcome-
based agreements with many of its funders as a way to ensure that the organization
maintains efficient operations.

Throughout its existence, Community Capital has garnered the support of
investors representing a variety of industry sectors that include public, private, and
philanthropic funders. Most important to Community Capital are the relationships it has
established with the national banks and their subsidiary bank CDCs. Community
Capital is accountable to both its public and private sector funders, and in order to
preserve its programs and associated funding streams the company has maintained
efficient, effective, and successful operations. Community Capital’s CEO is proactive in
identifying new sources of equity and patient capital it needs to sustain the
organization’s ability to meet the business education and lending needs of entrepreneurs
and small businesses operating in both urban and rural communities. The recipients of
Community Capital’s services include entrepreneurs and existing small business
enterprises that are owned and operated by low-income and minority men and women.
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These are individuals deemed unbankable by traditional banks, due to their bad or
nonexistent credit history, or lack of experience in operating a small business.

Entrepreneur and restaurant-owner Martha Villega has worked with Community
Capital since July 2008. She plans to open the doors of her new business, an authentic
Puerto Rican restaurant called El Pilon, in Seattle’s Rainier Valley community in
February of 2009. A native of Puerto Rico, Ms. Villega has a passion for the culinary
arts and already has some experience owning and operating a business. While El Pilon
certainly won’t be Villega’s first venture as a small business owner-operator, she still
needed support to help her launch her own restaurant. For this project she was able to
secure working capital from Community Capital to pay for tenant improvements and an
interior build-out remodel, as well as the cost of a professional services architect. A
major hurdle often faced by prospective restaurant owners like Villega is the permitting
process required by the local health department, in this case the Seattle-King County
Department of Public Health. This process needed to be completed, with all permits in
place, prior to the opening of the business. The loan from Community Capital was
essential in ensuring that permitting delays would not sink the El Pilon project.

Community Capital’s ability to maintain a portfolio with a below-industry-
average loan default rate and a high percentage of performing loans speaks directly to
the effectiveness and capacity of the organization, its leadership and employees. It is
also a reflection of the quality of business education and technical assistance the
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organization provides its clients. Community Capital sees business and technical
expertise as prerequisites for any business applying for a small business loan and
supplies them to all loan candidates accordingly. Michael Verchot is director of the
Business & Economic Development Center for the Foster School of Business at the
University of Washington, and a longtime Community Capital Board Member. Mr.
Verchot stated that very few businesses that Community Capital counts among its
clients have gone out of business or failed to repay their creditors. Why is this so? Short
answer: Community Capital’s business financing and technical assistance. Long
answer: Community Capital’s assistance with cash flow management and the ability to
work with clients one-on-one.

Because of its business model, Community Capital can provide a level of
business assistance that even includes working with a business owner to revise a
business model or develop a “workout plan.” (A workout plan is designed to help a
struggling business operate more effectively and to identify an “exit strategy” for
satisfying the obligation of a loan and allowing a business owner to close the door with
a clean slate.) Mr. Verchot believes that business assistance, as important as it is to any
fledgling business, is not the only prerequisite to success. Although Community Capital
differs from traditional investment capital in some ways, in other ways the organization
takes an old-fashioned approach to investing and wants to ensure that business owners
have a personal stake or investment in the business’s success or failure—what many
refer to as “skin in the game.” Forms of unconventional sources of collateral include a
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third position on real estate, publicly traded stock, certificates of deposit, and
automobile titles.

In using case study methodology, I have followed the model of Feagin, Orum, &
Sjoberg (1991), who suggest that qualitative methodology represents the most suitable
research strategy when the research question or problem involves cities and
communities. The case study illustrates how Community Capital can be so effective in
collaborating with bank CDCs. The case study also illustrates Community Capital’s
effective use of community development investment vehicles such as equity
investments, community development venture capital, and new market tax credits.
Through these investments Community Capital has pursued economic development
outcomes that achieve the double bottom line, benefiting low-income neighborhoods,
communities, and residents. The case study relied on primary sources of information
(Tellis, 1997), including archival records, interviews, direct observation, participant
observation, public policy and government documents, and annual reports. This
material was included to give the reader a specific and in-depth view of how, when,
where, and why Community Capital and bank CDCs use community development
investments to accomplish CED objectives.

Through the case study, the qualitative research methodology effectively
characterizes the important role played by CDFIs in achieving community economic
development. The following example highlights the qualitative value of the case study
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regarding Community Capital’s work with assisting small business that are critical to
community economic development: Thanks to the assistance of long-time Community
Capital Board member George Staggers, CEO of the Central Area Development
Association (CADA), a community-based community development corporation (CDC).
CADA under George’s direction has completed the construction of a number of major
community development projects in Seattle’s Central Area. Bryant Concrete, Inc.
served as a subcontractor on the Welch’s Plaza mixed-use development project,
including, where CADA acted as the project developer. This project created affordable
rental apartments targeting individuals and families and also contained ground floor
commercial space.

Bryant was introduced to Community Capital by George Staggers of CADA.
Bryant Concrete had served as subcontractor to a larger general contractor on the
Welch’s Plaza project developed by CADA. The particular general contractor, like
most, took from 45 to 60 days to reimburse subcontractors for work performed, where
Bryant typically finished its portion of the work and submitted invoices in 30 days. As
many in the construction industry are acutely aware, an invoice backlog of a few weeks
can be a death sentence for a small business, particularly for a subcontractor who
operates in the narrow margins of profitability. Consistent with the mission of CADA,
Staggers fully understands and values the importance of providing small and minority
contractors—particularly businesses owned and operated by African-Americans—the
opportunity to work on large-scale commercial development projects. As CADA moved
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forward with a project that consisted of rental apartments and ground floor commercial
space, Staggers wanted to ensure that Bryant Concrete had the opportunity to bid on the
contract for the development. Bryant conveyed his concerns to Staggers regarding the
payment process under the previous project and quickly identified two issues: the
existing general contractor’s insensitivity to the cash flow needs of subcontractors and
the need for Bryant Concrete to have access to patient capital in the form of a business
loan line of credit. For the project, Staggers decided to go with a different general
contractor and introduced Bryant to Jim Thomas at Community Capital. Once again, the
access to capital that Community Capital affords to small businesses proved critical,
but, like other Community Capital clients, Bryant Concrete certainly didn’t get a free
ride. To ensure that he had “skin in the game,” Bryant had to put up a piece of
residential real estate he owned as collateral.

Ms. Villega, also a client of Community Capital has worked with a business
coach. At some future time, she hopes to take advantage of business classes offered by
Community Capital, with a focus on the business’s backroom operations (accounting,
bookkeeping, financial planning, marketing), keeping up with payroll, and making sure
that all federal, state, and local tax obligations are met on time. In addition to the owner,
the restaurant will provide jobs for two or three employees, and Villega anticipates that
at some point in the future the business will allow her to develop a training program for
youth as a way to provide them with some engagement, direction, opportunity, and a
modest income. Consistent with her devotion to her community, Villega plans to donate
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restaurant proceeds from one day each month to an area nonprofit organization. As a
board member of the People of Color Against Aids Network (POCAAN), she has first-
hand experience with social service organizations.

Consistent with its mission, Community Capital and its bank CDC partners
jointly pursue shared goals and objectives that deliver credit, investments, and other
improvements to low-income and disadvantaged urban communities. The case study
also examined the relationships that Community Capital has developed with local,
federal, and state government, and with community development policies and politics
that exist in government at all levels.

The main purpose of the case study was to conduct an analysis of Community
Capital and the relationships it has developed with bank CDCs. Additionally, the case
study considered the community development investment vehicles employed by both
entities to accomplish community development outcomes. The case study research
highlighted Community Capital’s work and its importance as an economic development
and financial intermediary working in collaboration with bank CDCs. From a broader
perspective, the research highlights Community Capital as a model CDFI. As the case
study found, Community Capital represents best practices and lessons learned by the
CDFI industry as a whole. Equally important was the opportunity to examine whether
Community Capital’s activities are replicable in other urban and rural communities
(Stake, 1995). During its 12-year history, Community Capital has developed best
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practices in the provision of business assistance, small business financing, and lending.
The organization’s leadership has played a large role in its early and continued
successes.

Recognizing the critical importance of attracting private sector resources, capital
and, investments to pursue its mission, Community Capital has collaborated
successfully with national bank CDCs. Although Seattle is not a major American
banking center, it is the home of Washington Mutual Bank—the nation’s largest thrift—
which Community Capital has effectively leveraged to its advantage. The case study
research has demonstrated how equally adept and efficient Community Capital has
proven in building relationships with large national banks and bank CDCs, like US
Bank, Bank of America, Key Bank, and Wells Fargo Bank. In its collaboration with
banks and bank CDCs, Community Capital’s lending activities accomplish double
bottom line objectives for the organization and its bank partners. Community Capital
serves a number of important functions for its bank CDC investors, which include
providing CRA credit under the Investment Test, offering an equitable return on cost of
capital, and assuring 100 percent return on principal investment (which addresses a
major concern of banks regarding operations in the inner city). Finally, as an economic
development intermediary, the organization acts as a buffer between large national
financial services companies and the community of any given city where the bank has
operations.

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Additional Background on Community Capital

Established in 1977 by Mayor Charles Royer, the City of Seattle Loan Fund was
created in response to accusations of redlining made by black small business owners
from Seattle’s largely African-American Central Area community. In response to these
accusations, the City established a loan program with a geographic focus on five target
communities. These five communities were populated by high percentages of minority
and low-income individuals. Housed in the City’s Department of Community
Development (DCD), the loan fund operated for 20 years, from 1977 to 1997. During
this period, the City made loans to businesses in the form of debt financing, with
maximum loan amounts of $25,000. Chuck Depew, former Finance and Economic
Development Director of the DCD, later to serve as Deputy Director for the Seattle
Office of Economic Development, said that during its existence, the loan fund was
plagued by internal mismanagement, inadequate infrastructure or “backroom
operations,” lack of accountability, failure to repay by borrowers, the City’s failure to
collect, and high rates of non-performing loans. According to Community Capital CEO
Jim Thomas, borrowers consistently failed to repay their obligations and many came to
view the City’s small business loans as grants, not repayable loans.

In 1996, the federal Housing and Urban Development (HUD) agency conducted
an audit that sealed the fate of the City-operated loan program. The audit identified
multiple negative findings and compliance issues with the program, and after reviewing
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the results of the audit, newly elected Mayor Norm Rice determined that the city should
not be in the business of making small business loans. In 1997, the City of Seattle
decided to privatize the loan fund and initiated a public bidding process to solicit bids
from private contractors. After prevailing in the bidding process, Community Capital
was awarded the contract to operate the fund; the loan fund was then capitalized
through the City’s federal Community Development Block Grant (CDBG) allocation,
and Community Capital raised additional funds through private contributions to provide
business assistance in conjunction with its loans (Community Capital, 2008).

When Community Capital assumed operation of the City’s loan portfolio, the
fund totaled $5.2 million; with $1.8 million in cash; $3.4 million in performing loans;
and $2.8 million in non-performing loans. After assuming the City’s portfolio,
Community Capital negotiated collections of the non-performing loans, with the net
amount collected to be used to seed a retirement fund account for Community Capital’s
employees. Since taking over the City loan fund, the organization has experienced a
successful recapture rate, collecting 50 percent of outstanding loan proceeds. In 1998,
Community Capital comprised a staff of nine, including three lenders, three business
and technical assistance counselors, and three administrative support positions. By
2007, the organization's structure had grown to a total staff of twenty-five, including
four lenders, seven administrative workers, and seventeen business and technical
assistance counselors (Figure 8). The seven administrative positions support the
business and technical assistance counselors.
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Figure 8: Community Capital Development Organizational Structure
(Community Capital Development, 2008)

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The experience of Seattle’s Community Capital Development echoes the
research of Andranovich, Moddarres, and Riposa (2005), whose observations focused
on a similar microfinance program in Los Angeles. In Los Angeles, community
organizations had complained that a lack of technical assistance for borrowers and
lengthy delays in loan approval had hindered the program’s effectiveness. Today,
Community Capital’s business model continues to adhere to a philosophy that sees
technical assistance as a vital part of what it provides to customers. As a result,
Community Capital has established itself as one of the industry’s leading CDFIs in the
business of providing technical assistance and financing to small businesses in minority
communities. Community Capital has a geographical presence that spans counties
throughout Washington State, and serves low-income, female, and minority
entrepreneurs and small businesses in distressed and underserved urban and rural
communities.

When receiving a loan from Community Capital the business owner has the
same obligation to repay as if they had borrowed from a traditional lender. Michael
Verchot of UW’s Foster School of Business describes Community Capital’s
methodology with borrowers as a classic “carrot-and-stick” on, where the carrot is the
business assistance, and the stick is the investment equity represented by the business
loan. If the business owner fails to honor his/her debt, Community Capital has the right
to take legal action, including the right to seize business equipment and machinery, or
even the personal property of the business owner.
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Analysis of Community Capital’s Roles and Functions

Community Capital’s approach to community economic development is to
alleviate poverty by encouraging self-sufficiency through entrepreneurial efforts. This is
clearly a people-based approach to community development and one that is consistent
with Shuman’s (1999) article titled “Community Entrepreneurship.” As such, it
emphasizes an economic development strategy that directly benefits low-income
individuals. Community Capital is an umbrella organization that is made up of three
sister 501(c)(3) non-profit entities, each with its own board of directors. Each of the
three entities is legally distinct, but for reasons of efficiency, productivity, and
economies of scale, the entities share staff, operate in the same office space, and work
in collaboration under a common trade name: Community Capital Development. Jim
Thomas, is the Executive Director for the three entities, and serves as CEO of the
umbrella organization, Community Capital Development.

The first of the three sister entities is the Seattle Economic Development
Association (SEDA), which represents the strategic planning arm of Community
Capital and is chiefly responsible for the day-to-day administrative oversight of the
organization. SEDA is the business arm responsible for the organization’s backroom
operations and administrative functions. These include such functions as human
resources, quality control, file documentation, board of director’s insurance, and
fundraising. The second sister entity is the Seattle Economic Development Fund
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(SEDF), a certified Community Development Financial Institution (CDFI). Treasury
Department certified since 1998, the SEDF administers a $6 million loan fund through
numerous financing and lending programs and is charged with promoting lending and
economic opportunities to underserved populations and areas. The third of Community
Capital’s sister entities, called the Seattle Business Assistance Center (SBAC), fills
what many view to be the organization’s most important function. Through the SBAC,
Community Capital provides entrepreneurs and small business owners with general
business counseling, education, and training, and also operates three specialized
Women's Business Centers, which are geographically dispersed throughout Western
Washington (Figure 9).
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Figure 9: Community Capital Development Number of Businesses Assisted
Number of Businesses Assisted 1998 – 2008
(Community Capital Development, 2008)
Number of Businesses Assisted
365
262
385
600
1,000
1,200
1,500
1,600
1,961
2,094
2,556
0
1000
2000
3000
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

The SBAC is partially funded by the U.S. Department of Defense and is part of
the network of Procurement and Technical Assistance Center (PTAC) located
throughout the state. The purpose of PTAC is to assist businesses in identifying and
conducting business with federal, state, and local governments. Finally, the SBAC
operates the Washington Statewide Minority Business Enterprise Center (MBEC).
Funded through U.S. Department of Commerce, the MBEC is part of a network of such
Centers operating across the U.S. Through the Center, Community Capital is able to
provide professional expertise in all aspects of business, with a focus in management,
finance, marketing, and accounting.
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Excelsior travel, a CCD client since 1997, has benefited from CCD’s expertise in
several areas, including business assistance, business planning, financial planning,
bookkeeping and accounting.

Community Capital’s Relationships with Banks CDCs

The public policy revisions to CRA regulations implemented by Congress in
1995 created the framework whereby financial institutions could lend to CDFIs as a
qualified community development activity. These political and regulatory changes
prompted financial institutions to provide direct community development investments
to CDFIs. For a CDFI like Community Capital, which has an interest in increasing
access to private sector capital, this was welcome news. To assure the continued
capitalization of its loan fund, Community Capital had to develop strong relationships
with other financial institutions and bank CDCs. The EQ2 is an example of one such
institution; EQ2 is an important source of working capital and a fundamental
community development investment vehicle for both Community Capital and the Bank
CDC.

Community Capital received its first EQ2 in March 2001, from the Wells Fargo
Bank CDC, in the amount $250,000. This was followed by Community Capital’s single
largest EQ2 of $1.5 million, from the Bank of America Bank CDC, which was followed
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in turn by an EQ2 from Wells Fargo Bank CDC with investments totaling $725,000.
Lipson (2002) views the EQ2 as a financial tool that allows CDFIs to strengthen their
capital structures and leverage additional debt capital that in turn puts the CDFIs in a
position to increase CED lending and investment activity in distressed and underserved
communities. For example, Community Capital uses the capital it raises from the EQ2
to capitalize a revolving fund loan pool which then makes loans to small businesses,
with interest rates set at between eight and ten percent. Thus, Community Capital can
extend capital, services, and business assistance to its borrowers, while earning a
competitive return on the revolving loan fund.

In its work with Key Bank CDC, Community Capital has also gained first-hand
experience with the federal New Market Tax Credit Program by using the tax credits to
acquire commercial real estate. In 2004 for example, Community Capital, working with
the Key Bank CDC, used the NMTCs to purchase the commercial building in which the
organization’s headquarters were housed. Under the Bank CDE model, the Key Bank
NMTC LLC (the CDE) and Key Bank CDC financed Community Capital’s acquisition
of the commercial real estate. This is an example of when a national bank acts both in
the capacity of a CDE (by using its NMTC allocation) and also as a QEI (by making an
investment through bank CDC).

The cost of the commercial building was $1,975,000, of which Community
Capital provided $375,000 in equity. Community Capital found the process expensive,
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with the greatest costs attributable to fees paid for accounting and legal counsel needed
to maneuver through the bureaucratic process. Under the NMTC Program, the
participating bank can incorporate its legal fees into the financing structure of the deal,
passing those fees on to the customer, in this case, Community Capital. This meant
Community Capital was responsible for Key Bank’s legal fees, which amounted to
approximately $50,000. According to Jim Thomas, “the fees were horrendous.”
However, in spite of the excessive legal fees, Thomas found that the NMTC still made
the deal bankable. The current interest rate is 2.34%, with an outstanding principal
balance of $1,448,000.

In its capacity as a Treasury Department-certified CDFI, Community Capital
applied for, and received, Community Development Entity (CDE) certification under
the NMTC Program. As a CDE, Community Capital was then eligible to apply for an
NMTC award. As one of the City of Seattle’s most effective CDFIs, Community
Capital earned the respect and trust of city managers. On two occasions, in 2005 and
2006, the City and Community Capital jointly submitted a request for an NMTC
allocation.

Although there was ultimately no award for either submission, the partnership is a
testament to the importance of public and nonprofit collaboration in pursuing
community and urban economic development objectives (Takahashi, 2008).

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Contribution and Results

According to Liz Feldman (2008), a consultant to the Calvert Foundation,
Community Capital maintains a loan fund with a delinquency rate of ten percent, where
the industry averages are sixteen percent and five percent respectively. Since 1997,
Community Capital has provided loans totaling over $24 million to 562 otherwise
unbankable small businesses.

Figure 10: Community Capital Development
Dollar Amount of Loans 1998 – 2008
(Community Capital Development, 2008)
Dollar Amount of Loans [in millions]
1.9mm
1.9mm
1.2mm
1.8mm
3.2mm
0.9mm
1.9mm
1.1mm
2.5mm
3 mm
4.5mm
0.00
1.00
2.00
3.00
4.00
5.00
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

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These businesses were responsible for creating or sustaining some 1200 jobs, more than
60 percent of which went to individuals with low to moderate incomes (Community
Capital, 2008).

Figure 11: Community Capital Development
Number of Jobs Created/Sustained 1998 - 2008
(Community Capital Development, 2008)
Number of Jobs Created & Sustained
59
260
203 205
197
200
123
366
184
132
290
0
50
100
150
200
250
300
350
400
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

An example of one such business is Bryant Concrete. Owner Ron Bryant noted that, as
a subcontractor specializing in flatwork (e.g., sidewalks, floors, steps, patios), his
“sweet spot” is not found in having the winning bid on a large commercial or public
works project but rather in the small residential jobs that are completed in one day and
pay from $800 to $1200. In contrast to the general contractor, Bryant Concrete’s
fortunes do not depend entirely on any one job. However, as a small business, Bryant
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Concrete is subjected to the whims of the general contractor, and loses a great deal of
financial autonomy in the process.

Community Capital has effectively expanded its geographic presence far beyond
its origins as the City of Seattle Loan Fund. Today the organization works to meet the
lending and financing needs of entrepreneurs and small business enterprises in 23
counties throughout Washington State. Community Capital’s “Access to Capital”
programs are focused on providing financing to businesses in operation for six months
or less (in other words, start-up businesses); businesses in operation less than two years,
but not yet bankable; and established businesses which have been in operation more
than two years, but which are facing new challenges. As an entity that must adhere to
traditional “Safe and Sound” business principles, Community Capital is regulated by the
Washington State Department of Financial Institutions, which gives it an annual
examination. At this examination, Community Capital’s loan portfolio is evaluated
according to the CAMEL rating, where 1 is excellent and 5 is failing. Community
Capital has consistently received a 2 rating from the state bank regulator; in order to
maintain this above-average rating, Community Capital sticks to traditional safe-and-
sound lending criteria, including the “5 C's of Financing”:

• Character – as demonstrated by the entrepreneur’s credit score, which is
based on an official credit report.

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• Capacity – the owner's ability to succeed with the business. Capacity is
demonstrated by a well-executed business plan, well-thought-out business
model, experience in the industry, and solid financial statements.

• Capital – the owner’s personal contribution must be at least 20 percent of the
requested financing amount.

• Collateral – the business must have sufficient collateral to back the loan in
case of default.

• Cash Flow – the business must be able to pay its owner and employees and
service its debt, with enough cash left over to fund all other operations.

Since 1998, Community Capital has served as a financial intermediary for the
Small Business Administration’s (SBA’s) Pre-Qualification 7(a) Loan Program, as well
as its Micro-loan Program. Acting as the SBA’s intermediary, Community Capital also
administers the SBA Minority and Women’s Pre-Qualification Loan Program. In 1999,
the SBA and the Washington State Banking Superintendent approved Community
Capital as a certified SBA 7(a) Lender for the State of Washington. Community Capital
successfully lobbied the U.S. Department of the Treasury’s CDFI Fund for the funds
necessary to capitalize the 7(a) Program. In 2002, Community Capital became the
administrator of the SBA’s Micro-loan Fund, which it administers throughout a 23
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county footprint in Washington State. Entrepreneurs can borrow up to $35,000 from this
fund for the start up of a new business (Community Capital Development, 2008).

Figure 12: Community Capital Development
Loans by Size Fiscal Year 2008
(Community Capital Development, 2008)
Loans by Size FY 2008
MicroLoans
(<35,000)
64%
Other
Loans
(>35,000)
36%

Martha Villega of El Pilon Restaurant has been a client of Community Capital’s
since June 2008; her business is an example of typical small Community Capital
project. Villega turned to the organization only after her personal resources were
exhausted. Community Capital provided Villega with a start-up $25,000 loan to assist in
the cost of starting a new venture, and Villega collateralized the loan with a
condominium she owns in the Seattle area. The terms and conditions of the loan were
such that Villega will pay interest only on the principal amount for the first 12 months.
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This will give the business the opportunity to open its doors for business and establish
the customer base needed to generate a revenue stream that will be sufficient to service
the debt (both principal and interest) and generate operating funds.

As a CDFI, Community Capital is able to utilize various programs to assist
small businesses that do not satisfy traditional banking requirements due to the small
loan amount requested, limited credit history, or limited business experience.
Community Capital adheres to the SBA’s determination for loan categories, where
micro-loans are categorized as having a range of $5,000 to $35,000, and small business
loans are those from $35,000 to $100,000. Community Capital also offers non-SBA
term loans that range from $5,000 to $100,000. Through an SBA 7(a) guaranteed-term
loan, Community Capital’s small business clients can access up to $250,000 in capital.

In 2002, Community Capital also became an administrator for the U.S.
Department of Agriculture’s Intermediary Relending Program (IRP). The purpose of the
IRP is to finance business facilities and community development projects in rural areas.
This program provides loans not to exceed 75 percent (or $250,000) of community
development project financing in six counties throughout Washington State (U.S.
Department of Agriculture, 2008). Through the IRP, Community Capital has effectively
leveraged government resources to establish a revolving loan fund. Financial assistance
from the intermediary to the ultimate recipient must be designated for community
development projects that (a) establish new businesses or expand existing ones and (b)
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create or retain jobs. The IRP offers small business more favorable rates than traditional
banks and represents a local source of credit for eligible small businesses or community
projects.

Through its various loan programs, Community Capital is able to deliver to the
entrepreneur and the small business enterprise financing and lending options that cover
a wide breadth of business needs, ranging from start-up costs to full-scale business
expansion. The loans may be used to: purchase or lease machinery and equipment;
renovate a business; provide short-term working capital to support business operations;
finance the acquisition of commercial or mixed-use real estate; acquire a franchise; or
restructure cash flow and debt.

Additional Contributions and Results

Since 2002, Community Capital has worked with the Ewing and Marion
Kauffman Foundation, a leading foundation recognized as the foremost authority in the
field of entrepreneurship expertise and guidance. Headquartered in Kansas City,
Missouri, the Kauffman Foundation has a vision to “foster a society of economically
independent individuals who are engaged citizens, contributing to the improvement of
their communities" (Kauffman Foundation, 2008). In pursuit of this vision, the
Foundation focuses its grant-making and operations on two areas: advancing
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entrepreneurship and improving the education of children and youth. In the area of
entrepreneurship, the Kauffman Foundation works nationwide to catalyze an
entrepreneurial society in which job creation, innovation, and the economy flourish. The
Foundation engages leading educators, researchers, and other partners in order to
further understanding of the powerful economic impact of entrepreneurship on society.
More specifically, the Foundation works to train the nation’s next generation of
entrepreneurial leaders to develop and disseminate programs that enhance
entrepreneurial skills and abilities, and to improve the environment in which
entrepreneurs start and grow businesses (Kauffman Foundation, 2008). The
Foundation’s objectives mirror those of Community Capital; this has led the two
organizations to work toward the pursuit of common goals and objectives.

In 2000, the Denali Initiative, a program offered by Carnegie Mellon
University’s Heinz School of Public Policy and Management, conferred a Certificate of
Completion upon Jim Thomas. Carnegie Mellon awarded Thomas a Denali Fellowship
based on his proven leadership ability as CEO of a small business lender and technical
assistance provider. Funded in large part by the Kauffman and Ford Foundations,
Denali Fellowships allow members to participate in a three-year program dedicated to
developing the next generation of social entrepreneurs, from small to mid-size
community-based, not-for-profit organizations across the nation (The Denali Initiative).
Mr. Thomas’s selection as a Denali Fellow is evidence of his expertise and
effectiveness in leading a premiere CDFI.
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The Denali Initiative’s mission is to improve the quality of life in communities
and to promote a standard of excellence in a variety of social sectors by identifying
leaders who demonstrate entrepreneurial potential and possess high ethical standards.
With its inaugural class in the spring of 1999, the Initiative set out to develop the next
generation of social entrepreneurs from small to mid-size community-based, not-for-
profit organizations across the nation. During the course of the program, Denali Fellows
are introduced to a premier educational curriculum that includes the use of peer support
and technical assistance. Fellows are then guided through a rigorous and action-oriented
development program with the objective of maximizing the effectiveness of leaders
(The Denali Initiative).

Growth and Importance of Community Capital - Increased CED Effectiveness

In the continued pursuit of its mission, Community Capital has tirelessly sought
new ways to collaborate with the private sector and partner with the public sector to
create opportunities that benefit entrepreneurs and small businesses in distressed
communities. The expectation is that through access to capital financing and micro-
loans, women and minority business owners can create livable-wage jobs and develop
lifelong transferable skills for themselves and their employees. In pursuit of these
outcomes, Community Capital has been involved in the following initiatives:

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• With funding from the Washington State Department of Commerce,
Trade, and Economic Development and the Department of Social and
Health Services, Community Capital administers a State-funded micro-
loan program that targets in-home childcare providers and childcare
centers in six Washington counties. Loans are used for start-up costs,
expansion, equipment and supplies, and operating expenses.

• Using capital from a local community bank (Whidbey Island Bank),
Community Capital established the Latino, Women, and Minority Loan
Fund (LWM Fund). Through the LWM Fund, Community Capital
provides small business loans up to $35,000. These loans target the
Latino business community, women business owners, the Native
American community, and other minority business owners.

Recognizing the benefits of private equity and patient capital (the cornerstones
of which are low interest rates and a long-term repayment schedule), Community
Capital has increasingly pursued these sources as a means to capitalize the
organization’s loan fund. After considering whether Community Development Venture
Capital could help the organization meets its mission, Community Capital determined
that bank CDC funds were too expensive as a source of a capital to support a CDVC
Fund. However, Community Capital did identify some Foundation Program-related
Investments (PRIs) as a potential source of capitalization for a CDVC Fund. As a result,
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Community Capital is actively working with a national foundation that has
demonstrated an interest in providing a PRI to capitalize a CDVC Fund. Additional
equity initiatives that Community Capital’s CEO Jim Thomas has explored in this area
include:

• The USDA’s Rural Investment Committee. As part of its initiative to
bring social venture capital to Washington State’s rural and underserved
areas, the Rural Investment Committee has hired staff who are
knowledgeable in equity investing as a tool for economic development.

• Equity fund pilot programs for start-ups. Depending on the level of
success its client businesses have in securing start-up capital,
Community Capital will explore establishing a larger fund that will serve
rural and underserved areas. Early project support has come from the
CDFI.

• The Clean Energy Equity Fund. This fund is in the early stages of
research to determine feasibility. If it is deemed feasible, there is the
potential to pilot the venture capital fund with targeted investments in
underserved businesses, including those that may have received technical
assistance through the RBEG program. Community Capital anticipates
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that equity investments will complement debt financing instruments,
including those available through the USDA IRP.

Andranovich, Moddarres, and Riposa (2005) maintain that microfinance is of growing
importance to the field of community development, where access to credit is seen a
means to empower LMI neighborhoods and populations. One measure of Community
Capital’s contribution to community and economic development is the number of
women-owned businesses that look to CDFI for financing and technical assistance.
Community Capital’s CEO Jim Thomas noted that from 2006 to 2007 the number of
women entrepreneurs and small business owners surpassed the number of male
entrepreneurs and owners by 20 percent.
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Figure 13: Community Capital Development
Loans by Demographic Fiscal Year 2008
(Community Capital Development, 2008)
Loans by Demographic FY 2008
Loans to
Women &
Minorities
60%
Loans to
Others
40%

Excelsior Travel/Ms. Rosales is an example of the increasing number of women
using Community Capital’s products and services. Ms. Rosales, the owner of Excelsior
Travel has twenty years’ experience in the international travel industry, as a participant
in Lufthansa Airline’s training program, and has several years of experience as a
shipping scheduler in the Mexican Maritime Industry. When Ms. Rosales began
searching for financing for her travel business, she was in arrears with the Internal
Revenue Service, a fact which many potential lenders would consider a deal breaker. In
addition, personal credit issues had an adverse impact on Excelsior’s ability to establish
a business account with a traditional financial services company. In spite of these
challenges, CCD has been able to offer Ms. Rosales a high level of financial and
technical service as she nurtures her business. The company’s willingness to take a
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chance on Ms. Rosales when others wouldn’t has made all the difference for her ability
to run a business.

Conclusions

Using Community Capital as a case study, the research project has demonstrated
how the results provided by one company are transferable to other companies and how
cross-generalizations can be applied to similar situations. The case study served to
confirm the researcher’s hypothesis regarding the important role and contributions that
bank CDC investments play in furthering both people- and place-based community
development objectives. By increasing the capacity and effectiveness of economic
development and financial intermediaries, these investments give low-income, minority,
and women entrepreneurs much greater access to business assistance and small business
lending than they would otherwise have. The case study also suggests that without the
products and services made available by Community Capital these businesses would
probably not exist. What rang true repeatedly throughout the conversations and research
regarding Community Capital’s clients is the importance of “access to capital.” The
interviews with small business owners left the impression that Community Capital was
generally considered “the place to go” for working capital needed to cover operating
expenses, purchase of equipment, and technology.

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As a grassroots CED-focused organization, Community Capital’s mission is to
benefit low-income and minority communities. In addition to a basic entrepreneurial
spirit, some consistent themes conveyed during interviews with Community Capital’s
small business clients were that:

− Community Capital’s clients tended to be very small businesses (if number of
employees is used to define the size of business)

− personal industry experience (i.e., passion, knowledge) was the primary
determinant of the type of business an entrepreneur would choose to start

− businesses were often used to mentor and create jobs for low-income
community residents

− there was a general adherence to the double bottom line philosophy by the
businesses

− business and technical assistance, while important, were secondary to financial
assistance

− time pressures associated with operating a small business can be prohibitive

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The beneficiaries of Community Capital’s activities include hundreds of small
businesses that occupy commercial space, provide access to goods and services, create
employment opportunities, and create wealth in distressed urban and rural areas
throughout Washington. As an economic development intermediary, Community
Capital also plays another important role in that its CEO has the presence and industry
knowledge necessary to secure investments from bank CDCs and other institutional
investors. Much of Community Capital’s long-term success as a promoter of
community economic development is due to its positive track record as a CDFI.
Building on this historical success, Community Capital gathers investment capital from
various sources. It then deploys this capital in the form of loans to low-income and
minority business enterprises. Further evidence of Community Capital’s success as an
economic development intermediary is its ability to use the NMTC Program to finance
the acquisition of a commercial facility.

With the Seattle loan program as its origin, Community Capital has survived and
grown its operations for more than ten years. During this time, the organization has
expanded its capital position, which in turn has help it expand the small business
lending, financing, and business assistance that it can offer entrepreneurs and small
businesses operating in distressed communities. The case study demonstrated that
Community Capital is a model CDFI that has realized great success by collaborating
with local government. This collaboration enables the organization to effectively pursue
its mission of helping potential and existing small business owners to create healthy
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neighborhoods. Much of Community Capital’s success has been due to its ability to
develop partnerships with the public sector as well, most importantly the U.S. Small
Business Administration and the USDA. Community Capital has also worked
effectively with state government through a number of state agencies. Geographically,
Community Capital has expanded its scope of work to reach rural communities in
Washington State.

Through the CDFI Program and associated regulation, the federal government
has addressed redlining and the continued failure by financial institutions to serve low-
income and minority communities. Following the government’s determined lead, many
financial institutions have demonstrated their social responsibility by investing in
intermediaries that are working on a daily basis to address the issue.

In closing, the notion of the double bottom line is not something that is limited
to the financial institutions and bank CDCs which serve as the investors. The practice of
doing well by doing good permeates the community development industry at all levels.
While double bottom line objectives appear to be intrinsic to Community Capital’s own
mission, the organization also helps others pursue these objectives by employing
investment capital provided by investors to provide loans to small businesses of all
kinds. Community Capital’s business model allows the organization to assist would-be
entrepreneurs and existing business enterprises, while also generating revenue on
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capital loaned. The double bottom line does not end there, however. The majority of
Community Capital clients interviewed as part of this study also do well by doing good.

The preponderance of these business owners talk openly about the need to give
back to a community that has provided them with so much. This includes using their
small businesses to provide employment and training opportunities for others. In many
cases, the business owner is actively engaged in some capacity with local nonprofit
organizations. One example is Ms. Villega, owner of El Pilon Restaurant, who intends
to donate a portion of proceeds from her business operations to a designated nonprofit.
Another example of a Community Capital client carrying forward the double bottom
line principle is the community-based Excelsior Travel, which supports the not-for-
profit organization El Centro De La Raza by locating in El Centro’s offices in Seattle’s
Beacon Hill neighborhood. (El Centro is a community resource center providing the
Latino and Chicano population with educational, cultural, and social services.)
Excelsior Travel supports El Centro by renting office space. El Centro in turn supports
Excelsior by connecting the travel business with a largely Spanish speaking population
that represents a pool of potential customers.

What the interviews with clients of Community Capital have definitely
conveyed is that it is the access to capital that brings value to the organization’s
business model in working with small business enterprises. I suspect that while the
technical assistance and business education are of value to would-be and existing
155
businesses, they are definitely secondary to access to capital. CCD helps people and
businesses that are considered unbankable (in other words: too risky) by many
mainstream banks. As Ms. Morales put it: “Large financial institutions lack the heart to
take a chance on the small business owner. I was ready to close my doors, but with the
help of Community Capital, I was able to stay open for business.”

156
Chapter 4: General Summary, Lessons Learned, and Recommendations

Conclusion

The research paper has advanced the knowledge and current understanding of
bank CDCs as investment vehicles that can effectively deliver community and
economic development money to minority and low-income communities. The origin of
a bank participation in community development stems from a government mandate set
forth in the Community Reinvestment Act. Today, however, 30 years after the CRA
was passed, financial institutions have come to realize that their participation in
community and economic development makes sense not just from a legal standpoint but
from an ethical one as well. Beyond providing a return on investment that in many cases
is equal to or better than that of traditional investments, CED investments offer banks
the opportunity to achieve double bottom line objectives by doing good for the larger
communities in which they operate.

The OCC estimates that during the past decade national banks have invested
more than $2.6 billion in bank-owned community development corporations
(Community Development Investments). This represents an important private sector
contribution toward the redevelopment and revitalization of urban communities. The
beneficiaries of community development investments include entrepreneurs in need of
157
start-up capital, existing small businesses that need financing to grow their operations,
employees who benefit from the creation of livable wage jobs, and other businesses that
benefit from the cash injected into low income and minority communities.

Community and Economic Development Outcomes

From the outset, the research paper identified as a fundamental goal of
community development the need to bring about positive change in the lives of
indigenous—most often low-income and minority—populations, through the
revitalization and redevelopment of the urban neighborhoods and communities where
people live, work, and play. With this in mind, the research paper examined several
community development vehicles that broadly represent the innovative products and
programs available to community development practitioners, financial institutions, and
businesses. The research paper examined the question of how best to ensure that bank
CDC community development investments address the economic and social needs of
the low-income and minority people living in both urban and rural communities. The
paper’s conclusions echo the view of Bob Taylor, President of the Wells Fargo
Community Development Corporation, who noted that the objective of CED is to fund
investments or projects that not only deliver economic returns to investors and
shareholders, but also help to revitalize neighborhoods, eliminate blight, and create
employment opportunities (Taylor, 2005).
158
Throughout, the research paper has articulated the value of the bank CDC to the
community development industry. By its very nature, the bank CDC can and should
serve as the focal point, both internal and external, to its bank partner, by marshalling
capital, expertise, and other bank resources to produce effective and sustainable
community development investments. Bank of America for example, has taken
advantage of the authority granted to national bank CDCs under the government
regulatory policy as a means to pursue several innovative community development
projects (OCC Community Development Resources, Winter 2004/2005 (Tassan, Winter
2000/2001). Tassan (2001) also observes that the Bank of America CDC is able to more
efficiently address the investment needs of low-income communities because of the
public welfare investment authority. The investment tools available to national banks
under the regulations enable communities to benefit not only from traditional banking
services, but also from the patient capital that can be provided by financial institutions
like Bank of America (OCC, Winter 2000/2001).

Government’s Role

The research paper has clearly articulated the important role of government
regulation and public policy in guiding bank CDCs and related institutions as they
invest in community and economic development. Based on the important role it has
played to date, government will most likely have a continued role in updating existing
159
regulations, offering tax credits and articulating new public policies that will encourage
banks to invest in CED (Table 7).

Table 7: Historical Timeline of Community Economic Development-related
Government Legislation and Public Policy

It is important to note that the federal government has increasingly attempted to
privatize economic development, particularly when it comes to funding the
redevelopment of urban neighborhoods and communities. In today’s environment,
federal policies have increasingly incorporated a partnership approach, one that is more
inclusive of community members as stakeholders, In contrast to investors of previous
decades, today’s CED investors are more likely to be connected to the communities in
which they operate through professional, residential, or even personal ties
(Andranovich, Moddarres, and Riposa, 2005). This situation coincides with an
increasing reliance by investors on community-based organizations to implement public
Year

Legislation/Public Policy
1975 Home Mortgage Disclosure Act
1976 Low Income Housing Tax Credit
1977 Community Reinvestment Act
1994
Interstate Banking and Branch Efficiency
Act, known as Riegle-Neal Act
1995 Public Welfare Authority
1995
Updated CRA Exam Performance
Evaluation – Lending , Investment, and
Service Test
1999

Gramm-Leach-Bliley Financial
Modernization Act
2001 New Market Tax Credit
160
policy, due to these organizations’ perceived effectiveness at facilitating local needs and
mobilizing local residents (Andranovich, Moddarres, and Riposa, 2005).

Government agencies like the OCC and the Treasury Department must continue
to play a key role in regulatory oversight and must take an innovative and proactive
approach in updating the regulations to promote private sector participation in CED.
Examples of proactive efforts include the CDFI Fund and the New Markets Tax Credit
Program, both of which act as rewards for good behavior on the part of financial
institutions. Both the LIHTC and the NMTC serve as evidence of the value of using the
federal tax code as a motivator to spur business to act. The success of the LIHTC
demonstrates that a tax credit can be a very effective tool with which to promote
community development and should therefore be expanded (Steinbach, 1998).

With their increasing emphasis on voluntarism and the private sector, the
LIHTC, NMTC, and CDVC all reflect a paradigm shift in the federal government’s
approach to how it views its role in the redevelopment of urban communities. Tax
credits have proven themselves as a particularly effective measure with which to engage
the private sector and offset risk (Yellen, 2007) Future programs must therefore
continue to encourage private sector investment using this method. Steinbach’s (1998)
research finds that tax credits are effective at engaging the private sector directly in
community building, since tax credits projects are subject to private sector discipline
and sponsoring organizations are held accountable for results (Steinbach, 1998).
161
The Double Bottom Line

The research set out to address the question, Do bank CDC community
development investments result in positive CED outcomes for LMI communities and
residents? The answer is yes—bank CDC investments are an effective mechanism to
bring private sector capital to CED. Equally important is the opportunity these
investments give lenders to leverage public sector resources. Financial institutions have
increasingly recognized that bank CDCs have a value that goes well beyond their ability
to fulfill CRA objectives and create business opportunities. A bank CDC also affords
financial institutions the chance to pursue the double bottom line objective: doing well
by doing good. This is consistent with Davis (2005), who maintains that the corporate
sector needs to articulate its broader contributions to society and needs to define its
ultimate purpose in a way that is more subtle than the commonly held view that ”the
business of business is business.” An unexpected finding of the research was that there
is an assumption in the mainstream investment community that double bottom line is a
practice to which big business only gives lip service. But in fact, as the research also
demonstrated, double bottom investing is something that big business can and does
practice, with great sincerity.

Community Investment is a strategy of Corporate Social Responsibility (CSR),
where investments are focused on such areas as small businesses, affordable housing,
community facilities, and nonprofits (Cochran 2007). For the financial institution, the
162
activities in which the bank CDC is involved consistently produce new business
opportunities. It’s important to recognize that corporations are dependent upon cities
and urban areas with respect to business growth, workforce, education, politics, and the
environment. More importantly, corporations are dependent on cities and their
inhabitants for markets in which to sell their products and services. While shareholder
value will always represent the critical measure of business success, it is important to
characterize the ultimate purpose of business as the efficient provision of goods and
services that society wants (Davis, 2005).

Recommendations

The paper recommends continued and increased efforts at innovation by bank
CDCs who recognize an unmet need or see the opportunity to develop and implement
products that address community development needs. For example, in January 2006, the
Wells Fargo Bank CDC unveiled its new community development initiative: the Green
Equity Equivalent Investment (Corporate Social Responsibility Wire, 2006). As a
source of capital, the Green EQ2 will target nonprofit organizations using
environmentally sustainable and responsible practices in low-to-moderate-income
communities. A few of the likely target projects include: sustainable and affordable
housing development; brownfield reclamation and redevelopment; development of
renewable energy resources; organic farming; and natural resource conservation.
163
Over ten years ago, in 1997, The Brookings Institution (1997), under the
auspices of Community Capitalism Forum, convened a coalition of 65 business and
community leaders and government official. Leaders at the forum argued for a market-
driven initiative to renew America’s distressed urban neighborhoods and suggested that
the time is ripe for a new wave of private sector capital investment in urban areas. They
also encouraged businesses to work with nonprofit organizations, community groups,
organized labor, and government to harness the underdeveloped economic potential of
urban neighborhoods. The research paper agrees with the conclusions of the Forum and
would encourage investment corporations in general to adhere to the recommendations
and strategies as articulated in the summary paper. In summary, these recommendations
were that business and the public sector should work together to:

• improve access to equity capital and early-stage capital for urban
entrepreneurs
• support a greater breadth of fair lending activity
• increase private sector participation in workforce development
• transfer relevant federal resources to local government
• assemble developable tracts of urban land for redevelopment
• remove municipal regulatory barriers that serve to hinder redevelopment
• focus the philanthropic community on providing sources of investment
capital for economic development, and
164
• create investment guidelines that address institutional racism, economic
segregation, public safety concerns, and public education.

In addition to having a strong commitment to develop an economic agenda for
the community and to create economic equality for minority and low income
individuals and neighborhoods, a model bank CDC should demonstrate a willingness to
engage in long-term and ongoing investments that spur the revitalization of
neighborhoods and communities. A model bank CDC should also serve as an
organizational focal point for both internal and external customers, and demonstrate the
flexibility to employ community development investments in a manner that responds to
local needs as they arise. Bank CDCs must also engage with project stakeholders (local
businesses, property owners, community residents) and be involved early on in the
planning process comprised of local businesses, property owners, long-time community
residents. An example of the level of commitment needed is the strategy employed by
the Bank of America CDC’s Block-by Block program, which has enabled the bank to
target selected neighborhoods for multiple investments over the long term, working
with public agencies and neighborhood groups to address revitalization efforts (OCC,
Winter 2004/2005). Under this innovative grassroots program, new neighborhood
customers, developers, and other investors are engaged in the redevelopment efforts
(OCC Community Development Investments, Winter 2004/2005).

165
Community development must be inclusive and must take into account political,
economic, and cultural factors if it is to succeed at empowering people and eliminating
poverty (Andranovich, Moddarres, and Riposa, 2005). Continued success will depend
on good and frequent communication among banks, local government agencies, and
community organizations. Ultimately, this collaboration will need to extend to a variety
of other groups as well, including organized labor, religious organizations, and
educators (Rivlin, 1997). A solid community foundation must be constructed for each
CED project, a collaboration in which each entity plays a specialized role and function.
When all the pieces of puzzle are put together, positive CED outcomes result, benefiting
LMI populations and the communities in which they reside. More than ever, there is a
continued need and critical role for community activists. Activists must continue to be
proactive in the demand for change, and set out to establish productive working
relationships between banks and the communities in which they are located.
Rivlin (1997) encourages community organizations to do everything they can to
facilitate this type of communication.

Increased private sector participation—beyond that of national banks and
financial institutions—is needed to contribute more resources to the cause. Porter and
Kramer (2006) assert that successful corporations require a healthy society, where
education, health care, and equal opportunity are essential to a productive workforce.
As such, all corporations (and not just financial institutions) have a vested interest in
implementing strategies that can positively affect the communities in which they
166
conduct business. Toward this end, the research paper recommends that CRA
regulations in some form be extended to other industry sectors. These regulations might
encourage a higher profile for community activists, for instance, with a renewed focus
on change, and higher levels of social accountability, not just for financial services but
for other industry sectors as well. Ludwig (2008) points to several insurance companies
that have voluntarily adopted CRA-like programs that have improved LMI geographies.
Acting as role models for the rest of the business community, these insurance
companies encourage their peers in the business world to serve their communities in a
fair and equitable manner. More important, each corporation should be required to self-
report its level of involvement in CED (investments, contributions) to a government-
maintained and publicly transparent database that any citizen can review. Citizens could
then determine for themselves what investments, if any, a given corporation is making
to low-income communities (Ludwig, 2008). This database will serve both citizens,
who need to know what corporations are doing for their communities, and investors,
who don’t merely want a return on their investment, but also want some assurance that
their money will be invested in accordance with their principles.

A natural next step for the community development field is the advent of the
green economy as an emerging industry sector. Community development practitioners
throughout the country should begin to champion this sector of the economy as the next
logical step and a growth opportunity for the community and economic development
industry. Increased focus should be placed on what government can do to further green
167
development at the federal, state, and local levels. Government, the foundation and
philanthropic communities, the private sector, and community activists should join in
creating and championing a green economy vision statement that is consistent with the
objectives of the community economic development field. Community development
stakeholders can take comfort in knowing that at least one financial institution that has
served as a leader in community economic development, Wells Fargo Bank CDC, has
already begun to shift in this direction with the advent of the previously discussed
Green EQ2 investment vehicle. In recent years the “green economy” has emerged as a
growth industry, creating thousands of new jobs and business ventures. The CDFI
featured in the Case Study, Community Capital, with its involvement in the Clean
Energy Equity Fund, also serves as an example for the community development
industry. The Fund has been successful at expanding the employment base and
workforce, creating new jobs that are filled by low income and minority individuals.

For the longer term, the implications of the current and unprecedented turmoil
roiling the financial services industry, must be considered along with such trends as the
creation and consolidation of megabanks. A recent article discussed how the financial
services industry has come to be dominated by three megabanks, each exceeding the
federal government’s rule regarding ten percent market share. Bank of America for
example has taken over mortgage giant Countrywide, and investment giant Merrill
Lynch; JP Morgan/Chase has acquired mortgage and retail giant, Washington Mutual;
and Wells Fargo, with the acquisition of Wachovia, has expanded its retail presence east
168
of the Mississippi river. In addition to the historic changes that have faced Wall Street,
these changes have forever altered the nature and landscape of CED. Whether these
developments will ultimately be to the benefit or detriment of society is still
undetermined. In the short term, the rise of the megabanks has contributed to an
economic crisis that eventually led to an almost unimaginable three-quarters-of-a-
trillion dollar federal bailout.

The community development industry will be forever changed by the amount of
consolidation and sheer loss of larger financial institutions and investment companies
that found their demise at the hands of Wall Street. The affordable housing industry has
already began to suffer from these developments, with no need for investors to offset
earnings there is no market for LIHTC. It is unknown what impact this will have five or
ten years from now. In the short term, a number of investors who would have been
attracted to tax credits no longer have the need. The basic fact is that these private
sector investors have no revenue or profits to shelter, which they have historically offset
through use tax credits. One can only anticipate that with the loss of so many major
financial services companies there will be a precipitous decline in the volume of dollars
made available for community development investments. And since this decline is of
historic proportions, prospects for the future are anemic at best. Simply put, the future
does not look good.

169
On November 18, 2008, Comptroller Dugan set out to refute the notion held by
the CRA’s most staunch critics, those who have attempted to establish a connection
between the principle of government-sponsored CED and a crisis that has shaken the
very foundation of the financial services industry. These people maintain that the
CRA’s requirement that banks lend to minority-owned businesses and LMI
communities is somehow responsible for the sub-prime meltdown. In essence, the
critics argue, the CRA instigated the problem by forcing banks to make risky loans to
low income and minority applicants who could not afford the payments. Dugan,
however, finds to the contrary—that in fact only six percent of high cost or sub-prime
loans to low-income borrowers underwritten by national banks were regulated (or in
other words, mandated) by the OCC. Instead, Dugan maintains that most of the loans in
default were underwritten by entities not subject to the CRA. In fact, Dugan argues that
in the last ten years the CRA led to double the lending to small business and farms to
more than $2.6 trillion, and tripled community development lending to $371 billion.
This level of CED activity includes the ability to leverage additional investments both
public and private that created jobs and affordable housing.

In spite of the financial catastrophe that has taken place in the U.S and the world
markets during 2008, it is important to maintain confidence in the resilience of the
American economy and the American people. In the words of former Vice President Al
Gore, the greatest untapped markets in the world are right here at home, in our
distressed communities (The Brookings Institution, 2007). Despite the crisis, there is
170
reason for guarded optimism following the historic 2008 Presidential election. This
event has instilled a renewed sense of hope in all Americans, but especially among
minorities and low-income people, with good reason. The latter group whose ranks will
surely grow in the next decades have high hopes for what Barack Obama’s presidency
will bring to America and the world. If capitalism is to survive, it will probably not do
so in the form we currently know, but rather in one that attaches more importance to fair
trade and an environmentally sustainable business model. With this shift away from an
exclusive focus on the profit motive will come an associated change in political will or
ideals.

The words of Hugh L. McColl, Jr., CEO of NationsBank, sum up the situation
nicely. “Community development is more than just the right thing to do,” McColl says,
“it is essential to our [NationsBank’s] success.” I believe that what is true for
NationsBank holds true for the economy, indeed, for the nation as a whole. After the
smoke from the current battle has cleared, the basic principle upon which this society is
founded—the principle of fairness—will remain.

171
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Abstract (if available)

Abstract This dissertation analyzes best practices of bank-owned Community Development Corporation (CDC) investments in Community Economic Development (CED). Using documents from banking institutions, literature on community economic development, and case study methods, I will identify and evaluate investment strategies that have satisfied the double bottom line of such institutions. These banks have made profit and expanded capacity while redeveloping urban communities and neighborhoods.

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Asset Metadata

Creator Prevo, Dwight J. (author)

Core Title Bank community development coporation investments in community economic development

School School of Policy, Planning, and Development

Degree Doctor of Planning and Development Studies

Degree Program Policy, Planning, and Development

Publication Date 04/10/2009

Defense Date 10/06/2008

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Development,economic,OAI-PMH Harvest,policy,private,public,Urban

Language English

Contributor Electronically uploaded by the author (provenance)

Advisor Richardson, Harry W. (committee chair), Banerjee, Tridib (committee member), Borak, Michalle Mor (committee member), Winslett, Lee (committee member)

Creator Email d_prevo@hotmail.com,prevo@usc.edu

Permanent Link (DOI) https://doi.org/10.25549/usctheses-m2075

Unique identifier UC1134926

Identifier etd-Prevo-2608 (filename),usctheses-m40 (legacy collection record id),usctheses-c127-209494 (legacy record id),usctheses-m2075 (legacy record id)

Legacy Identifier etd-Prevo-2608.pdf

Dmrecord 209494

Document Type Dissertation

Rights Prevo, Dwight J.

Type texts

Source University of Southern California (contributing entity), University of Southern California Dissertations and Theses (collection)

Repository Name Libraries, University of Southern California

Repository Location Los Angeles, California

Repository Email cisadmin@lib.usc.edu