A Path to Conventional Equity for CDFIs

Development Financial Institution (CDFI) is approaching its maximum leverage covenant and needs equity in order to make new loans. It decides to obtain equity from a new equity fund designed specifically for CDFIs. The CDFI can obtain equity by selling any amount of its old or new loans to a for-profit subsidiary which it owns and manages. The equity fund for CDFIs invests equity in the for-profit subsidiary which is upstreamed to the CDFI. Key features are:

• The subsidiary is 100% owned by the CDFI, the loans remain on the consolidated CDFI balance sheet, and the loans are administered by the CDFI.
• The subsidiary is capitalized in part by issuing preferred equity which is purchased by the equity fund. The equity fund provides the preferred equity at a rate of 20 cents on the dollar per CDFI loan sold to the subsidiary. The Fund is capitalized from common and preferred equity from outside investors.
• The CDFI has delegated authority to select the loans it sells to its subsidiary, so there is no time lapse or paperwork burden associated with equity fund or investor approval.
• When the CDFI sells its loans to the subsidiary, it upstreams the proceeds from the fund to the CDFI.
• The CDFI sells loans to its subsidiary and receives the cash and equity at the end of each quarter.
• The CDFI uses equity cash from its subsidiary to capitalize the origination of new loans.

The CDFI receives the proceeds from the preferred stock investors through the equity fund. The fund is a platform shared with other CDFIs. However, each CDFI’s relationship to the equity fund is direct and discreet. There are no joint and several obligations with other participating CDFIs, no pledge of collateral, and no claim on the CDFI assets. While there are financial constraints on the subsidiary, there are no constraints imposed on the CDFI. The process increases liquidity and decreases consolidated leverage for the CDFI, which enables it to accelerate the growth of lending and services to the communities it serves.