Products, Programs and Progress: Are CDFIs the Future for Credit Unions?

[00:00] Shirley: I think one area that we all could level ourselves up on to understand that we don’t need to look at other credit unions or other banks as our competitors to a point. If you’ve got a small credit union that does just consumer lending, doesn’t do business lending, doesn’t do mortgages, but then you’ve got a bank over here, and they’ve got the expertise in doing the business lending and the mortgages but not in consumer lending. This is where banks and credit unions can work so well together because they’re meeting their own needs, but they can also cross-reference to make sure that someone in their community is getting everything that they need.

[00:41] Narrator: Welcome to 22 Minutes in Lending, your go-to podcast for insights on all things lending, from lending practices, regulatory updates, how to enhance lending efforts, and more. In each episode, Vince Passione connects with industry leaders to discuss the latest trends and happenings around the lending industry. Let’s dive into the latest in lending.

[01:04] Vince: Welcome everyone to 22 Minutes in Lending. I’m your host, Vince Passione, and today, I’m excited to welcome Shirley Senn, the chief consulting officer at CU Strategic Planning. Shirley has over 30 years of experience in financial services, having worked at Merrill Lynch and Prudential Securities before moving over to the credit union industry.

[01:21] Vince: Her experience spans investment management, risk assessment, and community development. Shirley joined CU Strategic Planning in 2015, working directly with credit unions on CDFI certification, grant applications, and field of membership expansions. She has an impressive track record, which includes a near 100% approval rating on over 110 field of membership and charter applications. Shirley, welcome to the podcast, and thank you for joining us today.

[01:47] Shirley: Well, thanks, Vince, for asking me to be here today. I am so passionate about CDFIs and especially CDFI credit unions. My entire mission in terms of what I do with working with credit unions has been to help provide those outlets for financial empowerment, and this is just a really good way for credit unions to do that. So thanks for the opportunity to express a little bit of that passion as well as opportunities for CDFIs and credit unions to become CDFIs.

[02:17] Vince: Oh, fantastic. Welcome. I thought what we would do today for our listeners is just start off with what is a CDFI. And actually, what help me is how does that differ from low-income designation.

[02:33] Shirley: So the CDFI… Being a CDFI actually is a designation that comes through the CDFI Fund, and CDFI stands for Community Development Financial Institution. So the primary difference is that a CDFI designation is not just credit union-centric. So banks, venture capital funds, and loan funds can also apply. And the most significant difference in terms of how you obtain that designation, whereas on the low-income designated side, it basically has to be 50% plus one of your current members you’re serving as well as potential.

[03:13] Shirley: And that’s based on your field of membership as a credit union. On the CDFI side, it’s not based necessarily on your field of membership per se but the activities of those members in particular loans. So the CDFI provides its designation. They’re changing it now. But most commonly, it used to be 60% of all the loans that you did in a target market. And so this is where it can get complicated.

[03:45] Shirley: In the past, the target market was basically if you did at least 60% of your loan activities to low-income targeted populations, which the acronym LITP is used in the CDFI space, or if you did loans in investment areas, which on the credit union side, we typically call those underserved census checks or other targeted populations. And this is a term that is specific to the Office of Management and Budget.

[04:13] Shirley: So it includes only the following groups, African American, Native American, Hispanic, Native Hawaiian, Native Alaskan, and they have extended out Asian American to include Korean… No, Vietnamese, and Filipino. I’ll have to verify those. But if we’re looking at other groups that may be low income, if they don’t fit one of those specific designations and also including Pacific Islander, then they’re not considered other targeted populations or OTP.

[04:49] Shirley: So what happens is that when you’re… in the past, when you were certified, you would look at where all those addresses of those loans were. And then, you would determine, based on looking at the individual’s income or where the loan was actually originated, to determine if one of those, or a combination of one of those three, brought your activities to at least 60%. And it used to be that it was 60% of the dollar amount as well as 60% of the number of loans.

[05:24] Vince: Got it.

[05:25] Shirley :So that’s the big thing that separates this is that on the CDFI side, we talk about target markets. On the LID side, we’re still talking about low-income people, but based on fields of membership. And then, of course, CDFI Fund had to go and just completely blow that out of the water and has a whole new certification process. So we’re all getting our feet wet on that, but it still is based on what we call a target market.

[05:53] Vince: Got it. What’s the fundamental value to a credit union of getting certification?

[05:58] Shirley: So what it does is a lot of the credit unions or others that could qualify as a CDFI do it for a couple of reasons. One, there are obviously grants involved, and there’s a multitude of grant programs through the CDFI Fund. The ones that credit unions most often use are what we call financial assistance programs. So those grants can be used to beef up your loan loss reserves. Capital reserves can be used to increase or implement development services, which are like financial counseling, financial coaching.

[06:37] Shirley: You can invest it in what we call financial products, which is basically anything with lending. So if you needed to hire a new lending officer because you were going to increase capacity of your target market lending, and then we have financial products. So, in those cases, those grant funds obviously can help a credit union mitigate some of the risks that may occur with losses getting into a new market or a new product or serving a new community.

[07:07] Shirley: Other outside of just simply applying for a grant through the CDFI Fund, there are nonprofits out there like the Chase Foundation or Wells Fargo and other entities that also leverage their funds to invest in social impact programs. So because the CDFI’s mission is to empower communities, underserved communities, by aligning those funds directly with CDFIs, they can also fulfill their own mission. So there’s also opportunities for CDFIs to have access to other resources, not just grant funds, but technical assistance and things of that nature that may not be available all the time to just credit unions.

[07:57] Vince: Just grants, right. There is [inaudible 00:07:59] programs. How does the credit unions operations… Do they have to change the way they operate their credit union?

[08:06] Shirley: Not necessarily. So I think sometimes individuals or credit unions themselves may think that becoming a CDFI means that you’re more risky, and it’s not necessarily because I think there’s kind of a common theme in the CDFI movement that it’s not necessarily what you do, but who you are. It’s in your DNA. So if you’re a credit union that has consistently worked in low-income or underserved underrepresented communities, you probably are already utilizing the tools, measurements, compliance, and so forth that you need for your operation. So having the CDFI funding for a credit union like that would just help leverage the impacts they can make.

[08:54] Shirley: For other credit unions that may not have that as a full function of who they are, I would say, operation… operationally, it could potentially change. There could be more, if you want to call it, handholding in terms of working one-on-one with individuals or with businesses that may not necessarily be approachable through automation. There is a part of being a CDFI that there is reporting and compliance that has to be done every year, and especially if you’ve won grants, there’s grant reporting. So, to me, that would be the primary area is probably compliance and reporting under the CDFI Fund standards. And there’s a lot of reporting that goes in under that.

[09:47] Vince: Yeah. No, I imagine it would be, and especially in the grant process, right?

[09:50] Shirley: Yes.

[09:50] Vince: And staying compliant. So Shirley, in looking at the numbers, it looks like the number of CDFI credit unions doubled since 2020. Now, why is that? It had something to do with the pandemic, or was it just coincidental?

[10:04] Shirley: No, I think it has to do with a collaborative direction of CDFIs, in particular, in the credit union space.

[10:13] Vince: Mm-hmm.

[10:14] Shirley: So there was a big effort, in particular, for credit unions and cooperativas in Puerto Rico, and so that has led to a majority of the cooperativas down there being certified as CDFIs. So that was a big part of it. Second is that as credit unions and credit union boards and managers and NCUA, even in state regulators understood more about what the CDFI movement entailed and the impacts.

[10:50] Shirley: It became aware that more credit unions could probably qualify as a CDFI, and we’re doing the work anyway. So getting the certification just helped them leverage resources and funding that was already there. So it definitely became a certification that was much more palatable for credit unions during that time. And then, of course, everything pretty much shut down in 2022 because they were looking to redo the whole certification process, and it’s taken them a whole year.
[11:28] Vince: So I was going to ask that. So now those applications, if you file, those applications will be looked at. They’re no longer in hold. There’s no backlog.

[11:36] Shirley: Right. So what they did before they released the new CDFI certification regulation last December is they approved most of those. If they were approved, they were approved under the old regulation or certification regulation. But what’s going to have to happen is the whole slate is being wiped clean. And so every CDFI, whether you were just recently certified or have been certified, has to go through this new process. And so it is a little bit more laborious.

[12:12] Shirley: It is a little bit more… There’s a lot of gray area in the past that has been simplified in terms of knowing this side or that side in terms of interpretation that I think will make things more aligned going forward in terms of those credit unions, banks, venture capital funds, and loan funds that want to continue to be CDFI. “These are your do’s. These are your don’ts.” And actually, what it does, though, is it brings a lot of clarity to be able to say, “Okay, is this something that would be of use or of need in a low-income area or to underserved populations?” And so, now there’s some specific guidelines on what those products and services look like.

[13:02] Vince: So let’s drill a little bit further into programming. So we had Tanya Sturgeon on, and she’s the CEO of Guadalupe Credit Union, New Mexico.

[13:11] Shirley: Mm-hmm.

[13:11] Vince: And it was very interesting. She has a program. She’s doing ITIN lending.

[13:16] Shirley: Right.

[13:17] Vince: So we talked a bit about that. So is part of your role helping the credit union actually figure out the kind of program? Is that up to them? And then how does she use the funds? Is she using the funds that she’s getting to actually lend, or is she using the funds to sit back and help her reserves?

[13:35] Shirley: So that could be the situation. I don’t know particularly for that credit union. But to answer your first question, one of the big things about the CDFI Fund is they want to ensure that you have a community development mission, and this is slightly different than your credit union’s overall mission statement, vision statement because this is particularly focused on community development.

[13:58] Shirley: And then, within that realm, as we’re working with credit unions, we help identify needs and challenges in their communities that they may not have even known that were there. In the case of Guadalupe, doing the ITIN lending is something definitely a lot of credit unions, in particular CDFI credit unions, are looking to get into that space, but it also comes with a level of risk.

[14:20] Vince: Right.

[14:21] Shirley: And so with the ITIN lending for credit unions that we’ve worked with that are getting into that space or increasing their impacts, typically, we’ll use those funds for loan loss reserves or capital reserves depending on what their capital level already is. But most of the time, even if you look at the overall basis of how the awards are used, a majority of it is used in loan loss reserves.

[14:45] Vince: That’s great. Now we talked about capital. Last 18 months have been pretty challenging for credit unions from a liquidity perspective, and the end of the year, somewhere around 86 in… 86% loan to share. So pretty tight historically. Is that also true for CDFI credit unions, or does some of this funding help their liquidity?

[15:07] Shirley: No, I would say that for a lot of CDFI credit unions, because most of them continue to do a heavy amount of lending in their target markets, that liquidity has been just as much, if maybe not more, of an issue. I’d have to say that we’re walking into another year that’s going to, I think, be very challenging for credit unions from the standpoint of the liquidity space as well as how do you balance that with continuing to lend to these communities.

[15:38] Vince: Now, that makes an awful lot of sense. Obviously, it was interesting listening to Guadalupe dealing with ITIN lending has to present some pretty interesting challenges when it comes to underwriting and creditworthiness. Now, are there firms that you introduce that help credit unions deal with some of the concerns about [inaudible 00:15:58] file or someone who’s not a citizen, and how do I figure out their creditworthiness, or is that really left up to them?

[16:04] Shirley: It’s really left up to them. I think what we… what our role is in that capacity when we’re working with them is just to provide advice and options of what we’re seeing as best practices because of the amount of credit unions that we worked with over the last 15 years. I think one of the advantages that we have is we… through the collection of data policies, underwriting processes, and so forth, it gives us access to a lot of information of best practices.

[16:31] Shirley: So I think it’s important for our credit unions, as well as ourselves that are helping CDFI credit unions, to know what tools are out there, what companies are out there that can help them in this process to make even more impact. So a lot of the customized AI underwriting that’s out there, or certain non-traditional customized matrix, for example, are really helping credit unions dig deeper into their communities for underwriting purposes and helping those that normally wouldn’t have an option for financing.

[17:05] Vince: Now, you talked about programming again, and internally, you’d have to build out staff for some of this program, and then you have to build partnerships. Now, can you use some of the funding for staffing? I mean, if you go for a grant-

[17:17 Shirley: [inaudible 00:17:18].

[17:17] Vince: … can you build out an ITIN underwriting organization or a solo lending group?

[17:23] Shirley: Yes. So again, there’s different categories from the grant perspective.

[17:28] Vince: Mm-hmm.

[17:29] Shirley: And so, let’s use, for example, your example of the ITIN lending. So under financial products is an opportunity that you could utilize some of the funds to be directed towards a loan officer or an underwriter that would be specific to loans in that target market. So they would specialize maybe just in the ITIN lending, or maybe they’re bilingual or so forth.

[17:56] Shirley: Same thing goes with financial counseling. Using a category called development services, you can hire a financial counselor or a financial coach, anything that’s going to help develop an individual into being a credit-worthy borrower, and also everything else that goes with that, savings, and so forth. So yes, you can use those funds to be pretty creative in alignment with what you’re trying to leverage for increasing those impacts.

[18:32] Vince: Now, are there restrictions on interest rate? Obviously, credit unions have that user limit per state, but you’re dealing with a pretty risky part of the population. So are there guidelines that say you can’t charge interest that’s as high as the user rate in your state, or is it you manage just like any other part of your credit portfolio?

[18:51] Shirley: So again, it would be based on whether you’re federal or state-chartered. So, obviously, if-

[18:57] Vince: [inaudible 00:18:57].

[18:57] Shirley: … you’re state-chartered, you’re going to go by the guidelines in the state. Federal is just a flat 18% unless you’re using the PALs program. In the CDFI space under the new certification, there are some restrictions on rates because, again, loan funds are not regulated. And so there are some loan funds that have charged upwards of 36% APR, and that’s the max.

[19:27] Shirley: So basically, what the CDFI Fund has done is they have taken what’s called the military annual percentage rate as a base to say, “You cannot charge any more than 36% MAPR, which includes fees, whether they were wrapped up into the loan or not,” to say, “This is your maximum.” And I do know of some CDFI Funds out there that charge like 35.99. Credit unions, I believe, are definitely much more conservative and responsive to the needs of the individuals and communities they’re serving.

[20:04] Shirley: So while I know a majority of the credit unions we work with use risk-based lending, their credit scores, for example, are only used to help with determining pricing, not necessarily whether they qualify for the loan or not because they use a multitude of other factors. But I think this is where CDFI credit unions really shine is because they really look at… they want to cover their risk, obviously mitigating their risk but not excessively.

[20:34] Vince: So on the… I just want to go back on these interest rates because, usually, you start… I was looking at the ITIN lending after we met with Guadalupe, and usually, it seems like you start with auto lending first, where rates can get pretty high. So programming, I guess, to help people with that is more around education, I guess. I mean, would they directly subvent a rate with the funding?

[21:03] Shirley: So they can’t use the… If this is what you’re meaning. They can’t use the funds directly to buy down rate because-

[21:11] Vince: Oh, so they turn up. Okay.

[21:15] Shirley: No. But the funds obviously can be used to offset the risk. So, for example, if you were appropriately pricing your different tiers, obviously taking into consideration everything that needs to be done there so that we’re fair lending on everything, and you were a shop that said your maximum rate was 15% regardless where everybody else was doing 18%, you may have a certain loan loss ratio that you’re assigning to that particular rate.

[21:47] Shirley: And if you do, then you can utilize a portion of the funds to offset that. So if you feel like you’re going to have a higher percentage of losses, but you’re wanting to keep the rate lower, then, obviously, you can use the funds to offset those losses in your reserves.

[22:05] Vince: Oh, excellent. No, that’s helpful. No, it makes a lot of sense. Makes a lot of sense. So if we think about the system itself, and we talked about subordinated debt, the other thing I heard and was able to find out when I was reading is that if you, by obtaining the CDFI designation, you now become capable of taking municipal deposits. Can you explain that to me? I was trying to understand the connection between these two.

[22:32] Shirley: Yeah.

[22:32] Vince: The designation and municipal deposits.

[22:35] Shirley: So again, I think that’s one of those areas where credit unions have, if they’re in it, kind of tiptoe into it because a lot of that is driven by… could be driven by state law. And there’s quite a few states that actually don’t allow credit unions. I think they’re a little bit behind the curve.

[22:52] Shirley: I know two states in particular that have been trying to get this law changed are Arkansas and Florida because the laws allow the banks to take municipal deposits, but they don’t allow credit unions because it says banks only. It doesn’t say credit unions.

[23:04] Vince: [inaudible 00:23:06].

[23:06] Shirley: But with that being said, it seems to be a very small portion of the sources of funding that a lot of credit unions will consider. I think one just because it’s new and just something that is not normally looked at. But again, I think as credit unions are having to look outside the norm of a line of credit or increasing cost of funds on their CDs to bring in more deposits, I think the opportunity to look at, if you want to call them more non-traditional sources of liquidity funding, is going to be something that’s probably going to be on the radar.

[23:44] Shirley: I know that that’s a part of the priorities for examinations this year is looking at that liquidity and your contingency funding plans and so forth, which, again, are very critical to all credit unions, but in particular CDFI credit unions, whether that’s looking at how do they underwrite loans and then can those loans be offset by selling them, participating them out to continue to have that liquidity?

[24:11] Vince: No, I’ve heard it, and we can understand why, given the liquidity issues that are out there, and as you pointed out, right, needing to be creative to find these pockets of deposits. These are large deposits, right. Can you imagine working with that local municipality and dealing with things like taking their funding, running payroll for the municipality, and it also feels like there’s great connectivity, right, between the community and the-

[24:35] Shirley: There is.

[24:37] Vince: It’s sort of what you talked about, right. It should be reciprocal. So I think it’s a logical spot for credit unions to find themselves in. Now, they just have to make sure they have the services, right, to provide the municipality. But it did stand out to me as a way when I was trying to connect the liquidity and the value proposition for the credit union.

[24:57] Shirley: It’s the one thing I think that’s a critical component to all of this is the partnerships because I think credit unions need to understand that having partnerships on the CDFI side is different than it is in most realms of what we’re used to. These partnerships are developed too, like we were talking about, to really meet those needs and challenges beyond just the volunteer and the sponsorship.

[25:23] Shirley: So when we’re looking at partners, community partners, it’s not just the nonprofits, it’s just not the municipalities. It actually is other CDFIs. It could actually be other banks. And this is, I think, one area that we all could level ourselves up on to understand that we don’t need to look at other credit unions or other banks as our competitors to a point, especially if we’re talking about community banks. We’re all in the same space a lot of times, trying to serve certain niches.

[25:57] Shirley: And I think this is where partnerships can align very well is if you bought a small credit union that does just consumer lending, doesn’t do business lending, doesn’t do mortgages, but then you’ve got a bank over here, a bank and trust or first mortgage bank of whatever, and they’ve got the expertise in doing the business lending and the mortgages but not in consumer lending. This is where banks and credit unions can work so well together because they’re meeting their own needs, but they can also cross-reference to make sure that someone in their community is getting everything that they need.

[26:33] Vince: Great work, great program. So thanks for sharing-

[26:38] Shirley: Sure.

[26:38] Vince: … the story of CDFIs with us today. Really do appreciate your time. Thanks to our listeners for tuning in, and make sure you subscribe so you can hear future episodes of 22 Minutes in Lending, and I’ll see you back here at our next podcast.

[26:49] Narrator: Thank you for listening to the 22 Minutes in Lending podcast. We hope you enjoyed today’s episode. You’ll find links to any resources mentioned in the show notes. If you’re enjoying our show, be sure to subscribe and leave us a five-star review.