By taking a conservative lending approach with a traditionally riskier client base, community development financial institutions seem to be weathering the nation’s financial storm when many conventional banks are in crisis.
Officials in the industry say they are certainly feeling the effects of the credit crunch and the slowing economy. But community development credit unions, banks and loan funds have not suffered the severe losses of conventional banks, many of whom are hurting from a collapse in the value of their loan assets.
“Our portfolios remain healthy,” says Mark Pinsky, president of Opportunity Finance Network, an association of community development financial institutions (CDFIs) based in Philadelphia. “We’re seeing a little distress but nothing causing losses to investors. Demand is up and our biggest concern now is maintaining liquidity so we can meet demand.”
Community development financial institutions provide capital to promote home ownership and small business development in low-income communities. Their borrowers are typically people who do not have the assets or the credit history necessary to qualify for a loan from conventional banks. The industry averages about $5 billion per year in financing, according to Pinsky.
As the nation’s financial crisis has intensified, more lending institutions have been destabilized. More than a dozen banks have failed and others are looking to the federal government for help. But while giants such as Washington Mutual Bank with $307 billion in total assets and IndyMac Bank with $32 billion in assets have been toppled, smaller community banks are fairing better.
Saurabh Narain, chief fund advisor for the National Community Investment Fund, a Chicago-based nonprofit private equity fund that invests in CDFIs, says that asset quality at most of those institutions has deteriorated, but more because of the general recession in the economy and not because of bad loans.
“The good thing is that CDFIs were not part of the problem,” he says. “They didn’t originate these toxic waste loans. CDFIs have historically demonstrated the ability to work out their loans well, so we are hopeful that they will ride this crisis also.”
Ironically, though they typically loan money to people who can’t qualify at conventional banks, CDFIs may be doing relatively well because of their loan practice. Because they are community-oriented, CDFIs know their neighborhoods well and take the time to insure the borrower is ready for a loan.
“They do more relationship lending,” says Narain. “Given that they’re in the communities that they serve they understand the dynamics of the community so it’s more prudent risk and risk management.”
David Beck, director of public policy with Self Help Credit Union in Durham, N.C., says that even though CDFIs loan to people others will not, they still follow sound business practices. He says that Self Help has a strong position because its loans are “extremely well underwritten.”
“I think that’s generally true across the CDFI field,” he says. “We push the envelope on loans, but we don’t bust it and throw it out the window, which is what happened with a lack of underwriting.”
“Old fashion lending seems to be working,” adds Pinsky. “I often say that CDFIs are tortoises compared to the hares. When we underwrite loans we really know how much people are earning.”
If CDFIs are generally secure, they could be in a position to expand their business by moving into a space vacated by conventional lenders. During the past three to six months, many conventional banks have stopped providing loans for a segment of their market they now consider below standard. But that group – which includes home mortgages as well as loans to small businesses and non-profits – is actually “up-market” or above the typical CDFI borrower in terms of risk, according to Pinsky.
“Banks in general are moving away from this market,” he says. “There are people who are perceived as less risky, who may have higher credit scores than we were already lending to. They want to borrow.”
Even without going up-market Beck expects greater demand at community development financial institutions. During the past decade larger mortgage lenders expanded more aggressively in to the traditional CDFI market. Now that they have pulled back, he expects local lenders to move back in to their historic space.
“There effectively is no subprime market anymore,” he says. “While a lot of those loans probably never should have been made, there is a significant swath of society that needs, merits, access to credit. That is the sweet spot that CDFIs seek to serve.”