Partners (Number 2, 2007)

Complexities of Community Development Finance

Juan Sanchez In theory, the concept "community development finance" suggests a broad set of activities that usually includes innovative, flexible financial products designed to channel investments into disadvantaged communities where markets don't function well on their own.

How the concept plays out in practice varies widely depending on the needs of the community and the resources available. Some practitioners view community development finance through a lens of affordable housing, while others think more in terms of small business enterprise development. But regardless of the perspective, development and finance organizations must join forces to address risks and challenges.

One of the most important things I've learned in my years of community development experience is that the risks and challenges differ—sometimes greatly—even among similar deals. It is therefore extremely important to understand the potential problems and benefits of a particular project when approaching finance. A combination of financing products that complement each other helps to mitigate the level of risk and improve the long term viability of each project.

Renewing brownfield sites seems to be one of the most challenging community development activities. According to the Environmental Protection Agency (EPA), a brownfield is 'real property, the expansion, redevelopment, or reuse of which may be complicated by the presence or potential presence of a hazardous substance, pollutant, or contaminant.' The U.S. has approximately 450,000 brownfields, many of which are located in or near industrial parks.

The large number of sites and the potential for redevelopment present financial institutions with great opportunities. But banks must be acutely aware of the immediate and inherent risks associated with these types of deals. In addition to applying standard bank underwriting principles such as analysis of cash flow, debt service coverage and maximum loan-to-value guidelines, lenders must also address nontraditional factors to mitigate the level of risk of each brownfield project.

When using different layers of financing, it is important to understand the guidelines of each product including terms, conditions and limitations of guarantee. It is also critical to determine the level and class of contaminants found in a specific site through site and/or soil sample assessments prior to consummating a deal. Furthermore, lenders should mitigate their liability by complying with specific criteria that protect them from the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA).

The EPA has taken a proactive role to inform lenders of the steps required to establish exemption from CERCLA liability. The Federal Reserve Bank of Atlanta recently held a forum with the EPA and industry professionals in our New Orleans Branch to help educate the local banking community. Other forums of this type are planned throughout the country.

The Atlanta Fed encourages financial institutions to participate in such training programs to gain a deeper understanding of both the opportunities and the complexities associated with unique community development finance deals. This type of training will enable banks to set up strong programs that ensure proper due diligence in assessing and mitigating lender risk.

Juan C. Sanchez
Community Affairs Officer