The 2013 Interagency Minority Depository Institution and CDFI Bank Conference

Plenary Sessions
The Investor Perspective

Overview 

The panel discussed perspectives of socially responsible investors, private equity and the capital markets on how to attract capital, debt, deposits and grants to CDFI and MDI banks. Panelists explored: how banks can prepare themselves to attract these sources of funding; changes to business models to create scale and efficiencies thereby attracting investors; and how to generate interest by communicating the social performance impact that separates Minority and CDFI Banks from others.

General Discussion

Socially responsible investors support mission oriented banks in a variety of ways, including liquidity deposits,  equity capital investments, purchase or sale of loan portfolios, or engaging in financial literacy partnerships.  The capital markets are currently open.  Traditional merger and acquisition activity is below historic levels due to the substantial consolidation of the banking industry that has occurred since 2000.  While M&A activity is lower so far this year, it will probably start to pick up again.  Strong 2013 equity performance has supported healthy capital markets.  Equity capital market activity will continue to be driven by acquisition finance, monetization by private equity and for TARP repayment by those institutions required to raise equity.  Private investors have purchased TARP through the Treasury auction process.  Debt and equity capital are available for smaller banks ($10 billion and under); common stock is the main source of capital for these banks.

Bank earnings will continue to be challenged due to net interest margin compression.  One panel member suggested that the growth in earnings per share is estimated to be 7 percent in 2013 and 5 percent in 2014.  Loan growth is expected to be moderate due to low rates and a very competitive environment.  To maintain or boost earnings, industry research suggests that banks will need to shift to focus on expense initiatives.

MDI and CDFI CEOs can prepare themselves to attract funding in this climate by showing effective leadership, including knowing the goals of their constituencies (shareholders, board, regulators, management); knowing where their sources of capital are (institutional investors, retail investors, friends and family, Board of Directors, family office, private equity); knowing what their investors are looking for (capital appreciation, dividend income, time horizon, social impact); and knowing and communicating their stories.  On the financial side, the value proposition includes earnings growth, asset growth, valuation, and appropriate exits – while value on the social return side includes year-over-year change in the impact of the banks on their communities.

Strengthening balance sheets is essential for MDI and CDFI banks to attract investors.  It is important to keep capital up, as the implications for falling below “well capitalized” are dividend restrictions, management compensation and share repurchase limitations.   Scale is also important.  For MDI and CDFI banks, the trend toward a little bigger is better, in part due to more diverse sources of earnings.  MDIs and CDFIs may need to modify their business model by working collaboratively to achieve scale.  Possible models could include independent shared service platforms or mutually owned shared service platforms for back office and capital raising, a multi-bank holding company or “Franchise Model,” or full bank consolidation.   Other ways to achieve scale might include developing a common liquidity vehicle or fund to hold investments.  The CDFI Fund’s New Markets Tax Credit (NMTC) program, the CDFI Fund Bond Guarantee Program, or Small Business Administration Small Business Investment Company (SBIC) structures are possible options for supporting increases in scale. 

MDIs and CDFIs can generate additional investor interest by communicating the social performance impact that highlights their mission.   To tell their story, successful MDIs and CDFIs will be able to communicate their impact on low- or moderate-income (LMI) communities.  The National Community Investment Fund (NCIF) is a socially responsible private equity fund established in 1996.¹  NCIF developed social performance metrics which show the success of MDI and CDFI banks that consistently operate in LMI communities.  For example, the median Development Lending Intensity of banks participating in the NCIF’s social performance metrics project, as measured by home-lending activity (using Home Mortgage Disclosure Act, or HMDA data) in these communities, has remained between 40 and 55 percent over time.  This is three times the lending of all bank peers in LMI communities.  The median Development Deposit Intensity of NCIF banks, as measured by deposits in their branches located in LMI neighborhoods, has remained between 50 and 70 percent.  This is three to four times that of all bank peers.  Together, these indicators show that MDI and CDFI banks have consistently outperformed all banks in home lending and branch presence in LMI communities over a 15 year period.  Moreover, apart from lending, these institutions are often the only source of non-predatory financial services in LMI areas.

Conclusion

MDI and CDFI banks will be successful in raising capital if they exhibit strong earnings potential through relatively high margins.  Measured growth, though not at the expense of profitability, is vital to making these banks attractive to new investors.  Managing credit costs and quality will improve profitability and will increase access to the capital markets.  MDIs and CDFI banks might consider partnering with a local advisor who has the same interest in serving the community long-term.  CEOs must know and communicate effectively what creates value (predictable earnings growth, balance sheet integrity, eventual prospect of paying a dividend, market share, impact on the community).