Small Dollar Consumer Loans NONPROFIT LENDERS MAKING A DIFFERENCE

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1 Small Dollar Consumer Loans NONPROFIT LENDERS MAKING A DIFFERENCE Acknowledgments This research was funded by the Citi Foundation. We thank them for their support but acknowledge that the findings and conclusions presented in this report are those of the authors alone and do not necessarily reflect the opinions of the Foundation. We also thank all of the CBA member organizations and others who participated in our survey and our interviews. Their contributions were instrumental to the content of this paper: We thank them for their input and commitment to the field. Credit Builders Alliance (CBA) is an innovative, nonprofit social enterprise that empowers a diverse network of nonprofits and public entities to help low- and moderate-income individuals and families build strong credit and other financial assets. CBA s philosophy is that good credit is essential to achieving and maintaining financial stability. This is an elusive goal for millions of low-income and underserved individuals and families excluded from the credit mainstream. CBA believes that mission driven nonprofits are uniquely positioned to help these struggling households build credit as an asset. With demonstrated expertise in supporting hundreds of organizations to access electronic credit reports for financial counseling, responsibly report credit data, and increase organizational impact, CBA also provides innovative training and technical assistance to organizations so they may better serve their communities in this changing credit economy. For more information, visit or contact [email protected].

2 TABLE OF CONTENTS Executive Summary.3 Why Nonprofit SDL Lenders?...4 SDL Nonprofit Lender Implementation Issues..6 SDL Underwriting Models.12 Potential for Financial Capability Research..14 Conclusion and Recommendations...15 Appendix A: SDL Program Considerations Appendix B: Federal Laws & Regulations Applicable to SDLs...18 Appendix C: List of Nonprofit Survey Respondents.19 Appendix D: List of Nonprofit Interviewees..21 A Brief History of Small-Dollar Loans In the early part of the 20th Century, groups seeking to combat loan sharking of the day -- and wishing to legitimize the small-dollar consumer lending industry -- devised what became known as the model Uniform Small Loan Law. This model law capped interest rates for small dollar consumer installment loans (SDLs) at 36%. It was modified and adopted by 34 states by the early 1940s. By the 1970s, however, a number of events collided to drive non-banks and banks alike away from making otherwise regulated SDLs. These included deregulation and other market driven pressures, the rise of credit cards as an alternative form of personal credit, and the use of computer-generated data analytics to assess borrower risk. Banks began to nationalize and non-bank finance companies began to diversify their products towards larger, more profitable loans causing both to shift away from offering SDLs. For underserved consumers with no, thin or poor credit histories, relationship-based SDLs became hard to access. Recognizing a significant market opportunity, unregulated payday lenders stepped in. By the late 1990s, there were more payday loan shops across the country than Starbucks and McDonalds combined. 2

3 EXECUTIVE SUMMARY Many low-income households do not have access to personal savings, affordable credit, or the family and social safety nets necessary to weather economic challenges. Any unexpected expense or sudden loss of income can result in a downward spiral, leading to housing and employment instability, food insecurity and other living conditions that threaten peoples ability to meet their basic needs or access opportunities necessary to break the cycle of poverty. For individuals like Joanna, access to small-dollar credit options is critical to managing her finances. The rise of predatory short-term products like Joanna is a domestic violence survivor and dedicated mother of two toddlers who struggles under the burden of heavy garnishments of her paychecks. She took out a payday loan to cover a child-care bill that she hadn t paid in three months. What am I supposed to do? I cannot lose my job, my housing or my kids. payday loans over the last twenty years has kept pace with this need. However, until a household transitioning out of poverty has established a stable source and habit of savings, a reliance on payday loans to smooth basic consumption needs can push families into an unsustainable cycle of debt, dramatically decreasing future opportunities, including access to responsible financial products and services necessary to build assets. In the last several years, a number of nonprofit, non-depository lenders, including Community Development Financial Institution (CDFIs) loan funds, Community Action Programs (CAPs), United Ways, and others have begun to define and deliver small-dollar loans (SDLs) as a responsible alternative to payday loans. Unlike payday loans that must be repaid in one lump sum over a very short period of time, nonprofit SDL lenders prefer a product that can be repaid in installments over the course of at least six months. The reasonable monthly payments are not only more sustainable for already stretched households, but when reported to the credit bureaus 1 they also help low-income borrowers build credit and position themselves for greater financial stability in the long-term. Over the last several years there has been a notable uptick in the number of nonprofit lenders making or interested in making SDLs, including credit builder-specific loans. In 2012 CBA identified and surveyed over 100 such lenders, almost half of whom responded. Ten were also interviewed for more in-depth information. This paper explores some of the real and perceived opportunities, barriers and common issues nonprofit lenders face in offering (or considering) SDLs as they strive to achieve improved efficiency, risk management and scale in this space. 1 CBA s Reporter service offers nonprofit lenders technical assistance and a mechanism to report their borrowers loans to Experian and TransUnion. For more information visit 3

4 WHY NONPROFIT SDL LENDERS? Nonprofit, non-depository lenders are uniquely positioned to offer productive, credit building SDLs to low-income and underserved individuals and families. Some banks and credit unions offer affordable SDLs, but these are not available to those without bank accounts and are not always actively marketed to those who do have access. 2 For-profit retail consumer finance companies may be more accessible to consumers but, with some interesting exceptions, can trap customers in an unsustainable cycle of borrowing. 3 By definition, nonprofit lenders are filling unmet credit needs in underserved communities. Many have built their programs in direct response to the realities, needs, and gaps that exist in the low-income communities they serve. A nonprofit lender s success is directly linked to the success of its clients. Thus, those that offer SDLs strive to do so in ways that help their clients reach their goals. Furthermore, nonprofits have the potential of serving a much Responsible SDLs Matter As the cost of living increases and the economy continues to lag, Americans are struggling. According to the most recent U.S. census, one in seven Americans 14.3% of the population -- now lives in poverty. Those living with no family or social safety net or who lack access to responsible forms of small-dollar credit are especially dependent on fringe non-bank financial service providers to manage their cash flow and pay unexpected expenses. According to the Brookings Institute, high-cost non-bank financial services, which include payday lenders and check cashers, is nationally a $100 billion industry. Recent research by the Pew Charitable Trust reveals that 5.5% of adults nationwide used a payday loan in the past five years, spending approximately $7.4 billion annually in interest and fees. Seventy-five percent of respondents took loans from storefront lenders, averaging eight a year. Almost 70% use these loans to pay for a recurring expense, like rent, a mortgage, utilities, credit card payments or food. 2 The rise of the predatory payday and short-term retail installment loan market over the last two decades has prompted consumer advocacy groups, federal agencies, and other interested stakeholders across the country to search for more responsible alternatives to the undeniable need for credit in low-income communities. In response, some banks and credit unions, with encouragement from the FDIC and the National Credit Union Administration (NCUA), have developed or reinvigorated SDL programs that adhere to criteria designed to protect borrowers from loan products that they cannot afford at terms that they cannot meet. The contribution of traditional financial institutions to the market for SDLs has been and will continue to be important to the evolution of credit products designed to meet the needs of an increasing number of American households. However financial institutions offering SDLs are still limited to the degree that unbanked consumers, especially those with poor banking or credit histories are often unable to access loans because they are precluded from the formal banking system altogether. Furthermore, consumers are not always aware of responsible SDL options if they are not actively marketed due to lack of profitability or likelihood of higher loss rates. 3 For-profit retail consumer finance companies offer SDL options, particularly for un- and under-banked consumers. While they may offer rates that are significantly lower than payday loan companies, consumers often get trapped in a cycle of repetitive borrowing. This can undermine a household s ability to save or develop long term financial security. In some cases, payday lenders have also begun to circumvent state-level regulations that restrict payday loan fees and interest rates by taking on the mantel of consumer finance companies: converting and repackaging their payday loans as installment SDLs but not changing their predatory marketing or other lending practices. Consumers may be encouraged to continue borrowing, becoming locked in a cycle of debt, without the benefits of building credit or relationships with traditional financial institutions. There are a growing handful of socially conscious for-profit retail lenders, particularly in the online space. Although not covered here, groups like the Center for Financial Services Innovation (CFSI) are diligently tracking and assessing many of these companies to ensure that consumers have access to highquality financial products. 4

5 wider community of people who are in need of responsible credit, in particular those who are unable to access products because they are not eligible for or do not wish to open a bank account. Driven by their missions to put client welfare before financial gain, nonprofit lenders may offer affordable SDLs both as a critical alternative to predatory credit products and to proactively improve their low-income clients financial wellbeing. SDLs therefore serve as a steppingstone to responsible, conventional credit options offered by traditional financial institutions for those currently without access. Finally nonprofit lenders may use SDLs, combined with timely and relevant financial education, as a powerful financial capability tool to help borrowers achieve, maintain, and build financial security. It [SDL program] provides low cost access to capital that individuals and small business owners do not have access to. It helps provide people with food to eat at the end of the month, medicines, and money to pay bills. Greater Newark Enterprises Corporation, Newark, NJ In our area, banks don't report credit activity so it is a major benefit to our low income clients to begin to build credit histories/identities. Four Bands Community Fund, Eagle Butte, SD We've conducted research which shows that over half of residents of key neighborhoods have credit scores lower than 620. As our mission is to serve the low-wealth residents of Hartford, it is important for us to figure out how to serve this significant low-wealth credit-underserved population. Providing small, credit building consumer loans paired with credit counseling and financial education seems a logical entry point for us. Hartford Community Loan Fund, Hartford, CT 5

6 SDL NONPROFIT LENDER IMPLEMENTATION ISSUES In 2012 CBA identified over 100 nonprofits making or interested in making SDLs, including a number of credit builder-specific loans. Forty-four organizations responded to our 2012 survey, and ten participated in follow up interviews to identify opportunities and challenges associated with offering SDLs. Ninety-eight percent of respondents provide services to low-income households with over half focusing on populations with poor or no credit. Many of these households are also un- or under-banked. Thirty-nine percent of respondents serve culture-specific populations including Native communities, immigrants, refugees, survivors of domestic violence, persons with disabilities, etc. Fifty-four percent of the respondents were already providing an SDL product in 2012, and 46% were either considering doing so or had recently decided not to. Respondents of CBA s 2012 survey identified the following uses of the SDLs they offer: HOW DO SDL PRODUCTS MEET CLIENT NEEDS?* *RESPONDENTS CAN SELECT MULTIPLE ANSWERS AS A PAYDAY LOAN ALTERNATIVE TO HELP WITH A STRATEGIC PURCHASE (APPLIANCE, CAR, ETC.) TO HELP BUILD CREDIT TO ADDRESS A SPECIFIC NEED (E.G. COVER IMMIGRATION COSTS, ETC.) TO ADDRESS A SPECIFIC UNDERSERVED TARGET MARKET Figure 1: Uses of SDLs among current SDL providers (some providers offer SDLs that serve multiple purposes) Credit Types A majority of survey respondents offer or consider offering small-dollar installment loans. Eighty-three percent of current providers and 91% of prospective providers 4 offer or plan to offer an installment SDL. Other products offered include single repayment alternative payday advance loans, lines of credit and secured credit cards (in partnership with traditional financial institutions or credit issuers). It is important to nonprofits that any SDL offered allow consumers to build credit and meet other financial and household needs with sustainable monthly repayments. Lending Models Of those surveyed, some see the product as an add-on to their existing lending portfolio (mortgage, small business, etc.) while others view them as a primary tool, if not actual necessity, to help their clients avoid predatory products in their markets, address unmet needs and begin to build credit and other assets. Some respondents prefer to partner with traditional financial We also have a captive clientele that is well suited to this [installment SDL] product. This product will be used to build credit to then qualify for a microloan. -- Iowa MicroLoan, Boone, IA 4 This figure includes those who have ultimately decided not to offer SDLs.

7 institutions that can play a critical role in the administration of the programs by providing upfront capital or performing the backroom operations necessary to acquire and service loans. The vast majority of current (96%) and the majority of prospective (67%) SDL providers, however, are or wish to be direct lenders. Direct lending status is important to these nonprofit lenders because it allows them to: Control the underwriting criteria according to the needs of their particular client market(s); Design and deliver SDLs according to their own pricing needs and risk threshold determinations (which vary depending on their motivation for providing the loans, the risk associated with the loans, the availability of loan capital and loan loss reserves, and their particular lending philosophy); and Meet Community Development Financial Institution (CDFI) Fund 5 certification requirements. Nonprofit lenders seek to augment the impact of their SDLs by enlisting the services of traditional financial institutions. These partnerships provide clients with a pathway to the mainstream credit system as they graduate into responsible products offered by the financial institutions that help them continue to build credit and other financial assets. We serve as an honest broker between mainstream financial institutions and households that have long been locked out of this system. As such, we create channels for our clients to gain or regain access to banks and credit unions, while also helping to inform the appropriateness and accessibility of the products and services offered by these traditional institutions. --Innovative Changes, Portland, OR Key Barriers Although survey respondents and interviewees raised a number of concerns and issues, three consistent key challenges rose to the forefront. These include: Staff capacity devoted to loan applications, origination and servicing, and collections Forty-five percent of respondents see lack of staff time as a barrier to project implementation, and are concerned with the time staff spend or would spend on servicing and collecting loan payments. Balancing staff workloads is often a barrier for nonprofit lenders of all sizes, but especially smaller ones where staff may be spread across multiple functions. 5 Created by Congress in 1994, the CDFI Fund's mission is to increase economic opportunity and promote community development investments for underserved populations and in distressed communities in the United States. In order to become and remain a certified CDFI, an entity must be a financing entity. This criterion is met when the organization can demonstrate that its predominant business activity is the provision of arms-length transactions, financial products and/or other similar financing, and development services. This means that the entity must demonstrate that it: Has begun to use its own capital to provide financial products (evidenced primarily by any loans receivable from lending activities on the balance sheet). Engages in direct financing activity as reflected on its financial statements and/or executed notes. Dedicates More than 50% - or a preponderance of its assets to financial products, development services and/or other financing. Dedicates more than 50% of its staff time to financial products, development services and/or other financing. Maintains sufficient capital to continue financing activities for at least three months. 7

8 STAFF CAPACITY ISSUES AS PERCEIVED BARRIERS TO SDL PROGRAMS 53% 53% 33% 42% 58% 33% [ON LOAN ORIGINATION/CREDIT APPLICATION FACILITATION] [ON SERVICING LOANS/CREDIT] Prospective Providers Current Providers [ON COLLECTIONS] Figure 2: Degree to which prospective and current SDL providers perceive staff time devoted to loan origination/credit application facilitation, servicing loans/credit and on collections to be program barriers. Interest rates and fees are not enough to cover the cost of SDLs and the risk involved in providing them Sustainability is a genuine concern for nonprofit financial service providers. A faltering economy has created increased demand for their services and products while grant funding sources are less abundant. Although almost all of those surveyed and interviewed do not define sustainable as generating a profit on their SDL products, nonprofit lenders are concerned about interest rates covering the cost and risk of the product. 83 % OF SURVEY RESPONDENTS ARE CONCERNED THAT THE INTEREST RATES THEY CHARGE OR PLAN TO CHARGE ARE OR WILL NOT BE ENOUGH TO COVER THE COST OF THE LOAN PRODUCT 80 % OF SURVEY RESPONDENTS ARE CONCERNED THAT THE INTEREST RATES THEY CHARGE OR PLAN TO CHARGE ARE OR WILL NOT BE ENOUGH TO COVER THE RISK OF LOAN LOSSES Figure 3: Concerns about sustainable lending Follow-up interviews with several current providers emphasized that default rates and other costs are forcing increases in fees and interest rates. Few of those surveyed are concerned, however, that their interest rates and fees are perceived as high by consumers, advocates, or other members of the nonprofit community. Taken together, concern around covering costs with interest rates and/or fees and confidence that interest rates are low by consumer and field standards suggests that nonprofit lenders still self-regulate their prices to benefit the consumer at the expense of product profit. Delinquency and loan loss rates All respondents are concerned about delinquency and loan loss rates in the current economy. Prospective SDL providers, however, view them as more of a program barrier than do current providers. This gap suggests a perceived entry barrier to which established programs adapt. 8

9 DELINQUENCY AND LOAN LOSS RATES AS PERCEIVED BARRIERS TO SDL PROGRAMS 53% 33% 53% 33% Prospective Providers Current Providers DELINQUENCY RATES LOAN LOSS RATES Figure 4: Degree to which prospective and current SDL providers perceive delinquency and loan loss rates to be program barriers. Other Implementation Issues Respondents were asked to consider issues of pricing, capital, staff capacity, technology, risk and the regulatory environment in relation to their current or anticipated SDL lending practices. Respondents rated issues by their importance as well as the degree to which they perceived each issue as a barrier to offering these products. Technological Capacity Nonprofit lenders see technological capacity as important to underwriting and originating SDLs and especially for achieving scale. However less than half in each group see it as a barrier. The importance of personal touch and relationships with borrowers is a high priority for respondents, some of whom place it above the need to scale. IMPLEMENTATION ISSUE: TECHNOLOGICAL CAPACITY Currently offering SDLs Considering offering SDLs % 90.00% 80.00% 70.00% 65.22% 77.78% 82.61% 83.33% 86.96% 66.67% 60.00% 50.00% 40.00% 39.13% 33.33% 43.48% 33.33% 34.78% 33.33% 30.00% 20.00% 10.00% 0.00% IMPORTANCE BARRIER IMPORTANCE BARRIER IMPORTANCE BARRIER EFFECTIVELY UNDERWRITES EFFECTIVELY ORIGINATES/FACILITATES LOANS/CREDIT MEETS NEEDS FOR ACHIEVING SCALE Figure 5: Degree to which current and prospective SDL providers perceive issues of technological capacity in terms of importance and as program barriers. 9

10 Regulations and Licensing Requirements CBA conducted a regulatory scan of state statutes across the country that govern non-bank financial institutions, including nonprofit lenders making SDLs. We identified and reviewed: Each state s licensing requirements The regulating entity (if any) The Finance Charges permitted including, for comparison s sake, the maximum effective APR allowed in each state for a 12 month, $1000 loan The SDL term parameters The maximum loan principal amounts allowed STATE CONSUMER LOAN LICENSE REQUIREMENTS Require license over state usory rate 86% No License Requirement 8% Conditional License 6% Interestingly CBA s research revealed that Figure 6: State consumer Loan License Requirements survey respondents do not see state licensing and regulation as much of a barrier to their small dollar lending programs. Current providers have either designed their programs to avoid the need for licensure (i.e. they charge interest under the usury rate allowed by state law) or they have successfully navigated the licensing process. Prospective providers are more likely to see licensing requirements as a barrier. However in many cases CBA also noted that they are either unaware of licensing requirements or do not believe that they are applicable. In follow up surveys only two organizations indicated that licensing is a real barrier to their current operations, and one additional organization noted that it would be a barrier only in scaling its program beyond state borders. 53% REGULATORY ISSUES AS PERCEIVED BARRIERS TO SDL PROGRAMS 47% 33% 17% 9% 32% 32% 9% Prospective Providers Current Providers PROCESS OF OBTAINING STATE LICENSE COMPLIANCE WITH STATE LENDING REGULATIONS KEEPING UP TO DATE WITH REGULATION CHANGES COST OF COMPLYING WITH STATE REGULATIONS Figure 7: Degree to which prospective and current SDL providers perceive regulatory issues to be program barriers. 10

11 State consumer loan statutes vary greatly and are designed with the intent of regulating retail consumer finance companies. Although nonprofit lenders are not exempt they are unique. While some state regulators may not fully understand their mission-driven approach to SDL lending, most are likely to embrace them once they do. Our state has embraced our desire to compete with predatory lenders. They have bent over backwards to accommodate our questions and work with us on our license application. Montana Community Loan Fund, Missoula, MT The Commonwealth of Virginia does not require a Consumer Lending License to entities loaning Small Dollar Loans if the interest and fees that are charged do not exceed the State Usury Threshold People, Inc., Abingdon, VA Regulators have been a significant impediment to expanding operations. It has been difficult to get them to grant us a consumer finance lending license and they have even been extremely strict on the wording of educational materials, marketing materials, and signage, often causing long delays in material distribution. Community Development Finance, San Francisco, CA Obtaining a federal status (as non-depository) that allows nationwide lending without the meddling by 50 state legislatures would be helpful. Ways to Work, Milwaukee, WI 11

12 SDL UNDERWRITING MODELS Lending to low-income communities has historically been considered risky. Although most nonprofit lenders emphasize a distinction in striving for sustainability rather than profitability, few are interested in losing loans or clients to charge offs. Lenders of all types use various underwriting solutions and models to mitigate risk. In the nonprofit lending world in particular, underwriting has morphed into many diverse attempts to balance the needs of clients/customers and the risk tolerances of lenders. The groups surveyed by CBA use a variety of underwriting models and technological platforms and many still struggle with balancing sustainability with client impact. The biggest challenge, especially at the local level, is funding. We work in a service gap with high human costs that customers cannot afford to pay for. If we can lower our risk enough to cover our cost of loans, we will be successful. The rest we expect to raise through private and government grants and other funding streams. Innovative Changes, Portland, OR Although many nonprofit lenders would embrace loan underwriting and delivery efficiencies, the range of underwriting criteria, lending philosophies, organizational cultures and diverse target markets make it difficult to identify one existing model or platform that would meet most nonprofit lenders needs without significant additional research and testing. Furthermore, in follow up interviews, nonprofit lenders emphasized the importance of being able to make customized and flexible lending decisions and their commitment to working with the software solutions in which they have already invested much time and money. In reviewing literature and interviewing prospective platform partners for this study, CBA identified three different models -- none mutually exclusive -- that do or could meet the underwriting needs of nonprofit lenders, depending on their cultures and preferences as well as their capacity, financial realities and desire to achieve scale. Data Analytics The goal of data analytics is to highlight useful information in order to draw conclusions to make decisions. In the for-profit space consumer lending is a volume based business with millions of small loans and transactions handled on a daily basis with thin profit margins. Loan officers depend on data analytics to control risk-returns statistically. Using powerful statistical software, credit and other data (financial and otherwise) are crunched to develop models that provide the probability of consumer default at the time of application. Retail finance companies such as ZestFinance, for example, employ sophisticated data analytics to assess and mitigate risk. ZestFinance is a for-profit social enterprise dedicated to re-inventing underwriting in order to make more credit available to underbanked and underserved consumers. This model pulls tens of thousands of data bits from different sources and draws relationships out of them using data analytics. By combining traditional data with alternative data, credit decision-making platforms such as ZestFinance s use a more complex logic to evaluate consumers and assess risk. 12

13 While many still value a personal relationship with the borrower and an understanding of their motivations, nonprofit lenders are also using data to provide broader access to safe and affordable credit. In the last five years for example, CBA has helped its nonprofit members use credit reports as part of their underwriting, although most still focus more on the content of a consumer s report than the score. However many nonprofit lenders do not have the capacity, resources or intention to use data analytics as a sole tool for underwriting. There has long been an inherent tension between high-touch service and scalable automation. As more nonprofit lenders contemplate going to scale, however, there is greater appreciation for the value of analytics and scoring. Social Relationships Social relationships have always played a critical role in lending. Nonprofit lenders in particular have long offered high touch services along with financial products in order to achieve impact. By design the high touch model involves establishing and maintaining relationships with clients who are committed to moving along the economic mobility trajectory. Many nonprofit lenders also incorporate social relationships into their lending decisions basing the extension of credit on the strength of relationships with individual borrowers or on the relationships between the borrowers themselves. For example, Innovative Changes (IC$), makes unsecured loans only to borrowers who have been referred by its network of 47 nonprofit partners in Portland, Oregon. IC$ was founded in 2009 to offer responsible, affordable loans combined with financial education and credit building in order to help its borrowers achieve and maintain household stability. Referring partners include affordable housing, social service, and asset building nonprofit practitioners who serve as character collateral for the SDL applicants they refer. In its orientation and follow up with referring partners IC$ emphasizes the importance of setting those referred up for success. IC$ partners are expected to identify prospective applicants whom they are reasonably confident have both the capacity and commitment to repay an SDL from IC$, but also the desire to maximize the opportunity to overcome barriers to stable and healthy financial lives in the long-term. Others, like Mission Asset Fund (MAF), use a peer-based model to make social loans. MAF is a San Francisco based nonprofit that has facilitated well over 2 million dollars in loans over the last five years using its Lending Circle or Cestas model. Through lending circles, every participant is actively involved in a group that determines the terms, amount, and order of who gets the loan. The [social element and] level of involvement is not only critical - it allows folks to exercise power over their finances. MAF is merely the facilitator, recorder and guarantor of the social loans. Mission Asset Fund, San Francisco, CA Whether it is a peer-to-peer or a borrower-to-lender, social relationships are critical to most nonprofit lenders. By creating the foundation for and fostering relationships with their borrowers nonprofit lenders are able to simultaneously deepen their impact and mitigate risk. Psychometrics A psychometric approach to underwriting is one that attempts to assess risk by understanding the motivations of a borrower. Psychometric analysis is built into underwriting platforms to assess consistent, accurate predictors of character to help determine the likelihood that a borrower will repay his or her loan. This methodology is often used by microlenders to measure the entrepreneurial potential of the entrepreneurs 13

14 they serve. For example, ACCION Texas Microloan Management Services (MMS ), a comprehensive solution for business loan origination used by a number of nonprofit lenders offering microloans in over a dozen different states combines data analytics with psychometrics. This system incorporates an entrepreneur character assessment into its underwriting procedures for prospective borrowers who are not automatically preapproved by its proprietary scoring engine (which includes credit-related criteria and nontraditional socioeconomic criteria). Psychometric underwriting can be achieved through the selection of a series of questions. For example, Progresso Financiero, a socially responsible for-profit lender, has made hundreds of thousands of SDLs using an innovative underwriting platform to assess credit risk among Hispanic consumers that lack FICO scores, credit histories, and traditional banking relationships. Loan officers ask prospective borrowers a number of questions during the application process. These questions have been designed and honed by Progresso Financiero to assess what the company calls moral collateral a demonstration of moral character and commitment to obligations that it believes translate into high credit worthiness. POTENTIAL FOR FINANCIAL CAPABILITY RESEARCH The financial education field has long worked to equip Americans with useful financial knowledge. However, the traditional financial education approach may need to be revisited in this volatile environment. Organizations in the field are adopting the broader framework of financial capability, extending their efforts beyond the classroom. They are pairing access to financial products with education to help people more directly translate financial knowledge and guidance into better financial behavior in their everyday lives. This pairing is a key component of the financial capability framework and mission-driven nonprofit lenders who look to link products for their clients with guidance on using them. According to CFSI, a leader in the financial capability field, interventions that most effectively impact behavior are: Relevant, addressing participants specific concerns and financial situations Timely, coinciding with key life events or moments of decision; Actionable, enabling consumers to put newly gained knowledge into action right away; and Ongoing, developing long-term relationships to provide support and accountability. SDLs are ideal financial capability tools. CGF provides financial coaching for borrowers and Coaching Loans for loan applicants who do not qualify for loan products. Coaching Loan participants build credit and receive financial education in order to prepare to be a successful borrower in the future. Capital Good Fund, Providence, RI We can tie financial education to loans, helping people build their financial skills. Wind River Development Fund, Ft. Washakie, WY 14

15 CONCLUSION & RECOMMENDATIONS Nonprofit lenders are in a unique position to provide responsible SDLs CBA s research shows that there is both a need for and demand among nonprofit lenders to operate in the SDL space. By employing a variety of strategies to meet the needs and address the concerns of their particular constituencies, SDL programs can play a significant role in confronting the problems plaguing low-income and underserved individuals and families with thin/no and poor credit histories. The combination of the loan product and complementary features and services offers individuals an opportunity to improve their credit profile while receiving a high level of support. Nonprofit lenders will and should continue to embrace and expand the provision of innovative and affordable SDLs in their communities to: Meet the short-term credit needs of their clients; Provide a responsible alternative for underserved households without access to other SDL options; Leverage as a powerful financial capability tool; and Help households build credit and other financial assets. Nonprofit SDL providers face barriers to entry, and in the sustainable provision, of SDLs Currently nonprofit lenders use various underwriting solutions and models to mitigate the risk of making SDLs. The three greatest challenges for nonprofit lenders are related to underwriting, servicing efficiency, and effectiveness. Although many nonprofit lenders seek to improve their underwriting efficiencies, the range of organizational cultures, lending policies and diverse target markets make it difficult to propose one SDL platform that would meet most of their needs without additional research, testing and investment. Those considering entering the SDL space may first wish to explore the viability of partnering with current SDL providers in their areas if there are any, including local community credit unions, or look to national options, such as Mission Asset Fund s Lending Circles or Ways to Work s vehicle purchase program for working parents. Although outside this paper s scope, nonprofits may also explore the cost/benefit of partnering with or referring clients to small dollar loan products offered by responsible for-profit social enterprise lenders. The development of a turnkey small dollar loan platform similar to Accion MMS s for entrepreneurs could also enable nonprofit lenders to efficiently review applications and make approval decisions that would increase loan cost recovery by reducing the risk of delinquencies and losses. Funders, policy makers and intermediaries can and should support nonprofit SDL lenders Currently nonprofit lenders use various underwriting solutions and models to mitigate the risk of making SDLs. As more nonprofit lenders enter and expand the SDL space, however, CBA encourages and expects to participate in additional research. We recommend that: Funders offer grants to cover staff time, overhead, and other operating costs as well as grants or forgivable loans to help bolster loan capital needs and loan loss reserves. Policy makers advocate for funding 12 US Code Grants to establish loan-loss reserve funds, authorized by the Dodd Frank Act in 2011 but currently unfunded, to help certified CDFIs defray the costs of operating small dollar loan programs. Intermediaries like CBA should create and promote forums for nonprofit lenders to help identify and share lessons learned and best practices in the small dollar loan space. 15

16 APPENDIX A: SDL PROGRAM CONSIDERATIONS CBA has identified four key areas of consideration for nonprofit lenders interested in implementing an SDL program. Below is an outline of these issues and some of the questions nonprofit lenders or prospective lenders may wish to ask prior to implementing a program. These considerations and questions are not meant to capture every issue, variable, or circumstance that any given nonprofit may need or wish to address. Rather they are meant to spur ideas and more questions and are not intended and should not be construed as legal advice. Programmatic Articulate the need, but also the demand What is the problem? Who is the target market? Are there other responsible options such as community credit unions? What is your competitive edge over easy to access payday or online lenders? How will you market your SDL to prospective borrowers? Will you receive referrals from partner organizations? Cultivate allies Has there been or is there currently a local policy debate around short-term credit products, particularly payday and/or title loans? Who are the key stakeholders in this debate? Consumer advocates? Consumers? State Regulatory Authorities? Social Service and other Community Based Organization providers? AG s office? To what data do they have access? # s of short-term loans made at city, county or state level? Average dollar amount? Average number of rollovers? Average amount of fees paid? How could/will they support your efforts? If you re going to charge interest and/or fees, is there any reputational risk or do you need to educate allies and consumers about your efforts? Design a good product What is the loan purpose? The term? What will or do you have to charge in interest and fees to break even? How will you underwrite? Are there other models you can replicate? Are there other nonprofit lenders locally or nationally with whom you could partner? What are some of the best practices that exist around the type of SDL you wish to offer? For example: Are you reporting the loans to the credit bureaus to help borrowers build credit? Will you require financial education? How will the SDL promote financial capability? Are they a stepping stone for asset building opportunities? Does your SDL program also include savings options? Can you use text messaging to send payment reminders and/or tips? Is there a graduation strategy in place for successful borrowers? By offering SDLs nonprofit lenders are meeting borrowers CURRENT needs. By REPORTING SDLs nonprofit lenders are helping borrowers with their other CURRENT and their FUTURE needs. Develop a business plan How will you raise capital for loans? Loan loss reserves? How will you price? Do you need to break even? 16

17 How much risk can you incur? How will you mitigate that risk? Measure success How do you define success? For borrowers? For your organization? For the community? How will you track and communicate outcomes? Operational Staff for success Do you have the expertise and capacity on staff to make the loans? Can they also provide in-touch education along with the loan servicing if desired? Be consistent but flexible Do you have loan policies and procedures in place to ensure compliance and consistency? Can you build in loan modification options to help borrowers experiencing and communicating their repayment challenges? Use technology to your advantage Do you have the technology/loan management platform sufficient to comply with loan disclosure rules like the Truth in Lending Act (TILA)? How will you disburse the loan proceeds? Check? Cash? Electronic deposit? Prepaid Card? How will you collect loan payments? Checks? Cash? Automatic withdrawal from bank accounts? Online through PayPal or another platform? Manage data carefully Do you have physical and electronic information security policies and procedures in place to protect sensitive data? Collect correctly How will you follow up with folks who pay late or default altogether? Regulatory Know your state s lending licensing and other rules Do you need a license? A bond? Are there other requirements or parameters around SDL lending? If not, do you want to cultivate a relationship with your state s regulatory agency? Comply with federal laws 6 Financial Budget adequately Do you need to pay annual licensing fees? Bonding? State examinations if license required? Insurance (including increased Directors & Officers)? Legal Fees? Technological upgrades? Staff training? 6 See Appendix B for examples of laws and regulations that are applicable to SDLs 17

18 APPENDIX B: FEDERAL LAWS & REGULATIONS APPLICABLE TO SDLS The Truth in Lending Act (TILA), Regulation Z Lenders are required to disclose loan terms and Annual Percentage Rates. Regulation Z also requires lenders to provide advertising disclosures, credit payments properly, process credit balances in accordance with its requirements, and provide periodic disclosures. The Equal Credit Opportunity Act (ECOA), Regulation B Sets forth requirements for accepting applications and providing notice of any adverse action, and prohibits discrimination against any borrower with respect to any aspect of a credit transaction: On the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract); Because all or part of the applicant s income derives from any public assistance program; or Because the applicant has in good faith exercised any right under the Consumer Credit Protection Act. The Gramm-Leach-Bliley Act (GLBA) Prevents financial institutions from impermissibly sharing a consumer s nonpublic personal information with third parties, and requires that financial institutions disclose their privacy policies. The Electronic Fund Transfer Act (EFTA), Regulation E Electronic Fund Transfer Act (EFTA) and its implementing regulation, Regulation E, protects consumers engaging in electronic fund transfers. Among other things, Regulation E prohibits lenders from requiring, as a condition of loan approval, a customer s authorization for loan repayment through a recurring electronic funds transfer (EFT), except in limited circumstances. The Fair Credit Reporting Act (FCRA) Requires that furnishers of information to consumer reporting agencies ensure the accuracy and integrity of the data they report. Additionally, the FCRA prohibits the use of consumer reports for impermissible purposes, and requires users of consumer reports to provide certain disclosures to consumers. The FCRA also limits certain information sharing between affiliated companies. The Fair Debt Collection Practices Act (FDCPA) Governs collection activities conducted by: (1) third-party collection agencies collecting on behalf of lenders; (2) lenders collecting their own debt using an assumed name, to suggest that a third person is collecting or attempting to collect such debt; and (3) any collection agency that acquires the debt if the collector acquired the debt when it already was in default. 18

19 APPENDIX C: LIST OF SURVEY RESPONDENTS As of March 2012 Organization Name Offer SDLs Considering ACCION Texas No No Appalachian Community Enterprises, Inc. No No BiG Austin Black Hills Community Loan Fund, Inc. No Business Center for New Americans Butte County Self Sufficiency Loan Fund CASA of Oregon No No Champlain Valley Office of Economic Opportunity No Central Vermont Community Action Council No Citizen Potawatomi Community Development Corp Citizen Potawatomi Community Development Corporation Community Action of Northeast Indiana Community Development Finance ECDC Enterprise Development Group First Nations Community Financial Four Bands Community Fund Greater Newark Enterprises Corporation Greater Southwest Development Organization No Hartford Community Loan Fund Innovative Changes International Institute CDC No Iowa Able Foundation Iowa Microloan No 19

20 As of March 2012 Organization Name Offer SDLs Considering Just In Time for Foster Youth No No Justine PETERSEN Kansas Assistive Technology Cooperative No Kentucky Domestic Violence Association META Mountain States Group Mission Asset Fund Montana Community Development Corporation No North County Lifeline No North Side Community Federal CU NYC Dept. of Consumer Affairs Office of Financial Empowerment No Office of Rural and Farmworker Housing No Salt River Financial Services Institution No The Capital Good Fund Transitional Living Communities No No UCEDC No No Ways to Work WECO Fund Inc. West End Neighborhood House Wind River Development Fund No Women's Economic Ventures No No Women's Opportunities Resource Center 20

21 Organization: Greater Newark Enterprises Corporation Status: Considering SDL Program APPENDIX D: LIST OF INTERVIEWEES Summary: Greater Newark Enterprises Corporation (GNEC) is a CDFI providing loans and technical assistance to small business owners in 7 counties in New Jersey. GNEC is interested in expanding to provide small-dollar consumer loans because they see the intrinsic consumer component to small-business and microenterprise lending. GNEC is most concerned with how to develop and manage underwriting in order to reduce risk in a consumer lending platform. GNEC expects dramatic portfolio growth in coming years, and is concerned about having affordable and available capital to keep up with the growth. GNEC is also concerned about their capacity to develop a whole new platform for consumer lending, when they are already providing a lot of TA programming for small-business owners. Organization: Hartford Community Loan Fund Status: Current SDL Provider Summary: Hartford Community Loan Fund (HCLF) is a non-profit CDFI that provides construction loans and smalldollar consumer credit. HCLF currently offers unsecured Credit Builder Loans to individuals and is piloting small-dollar consumer loans to finance the costs associated with becoming a citizen. HCLF has conducted research into the need for building credit in the greater Hartford area. HCLF is interested in exploring ways to make underwriting and servicing of these loans more efficient HCLF is interested in exploring best practices for providing credit and budgeting related technical assistance along with consumer credit HCLF is interested in continuing to study other small-dollar consumer credit models and possibly providing a secured credit card. Organization: Kansas Assistive Technology Status: Current SDL Provider Summary: Kansas Assistive Technology Cooperative (KATCO) is an alternative financial institution provides financial products to Kansans with disabilities in order to acquire specialty equipment and assistive technology. KATCO covers a wide arena of assistive technology items from modified vehicles to front loaded washers; KATCO recently funded a surgery for a service dog. KATCO is concerned with long-term sustainability and access to capability. The program which was initially started as a grant project through Kansas University, has been primarily grant funded. Grant funds are waning and the interest and fees that KATCO charges have not been able to cover losses. As a result KATCO is considering revising underwriting criteria and potentially raising interest rates. In the future, KATCO would like to become a reporter, and is interested in becoming a CDFI, though capacity issues have been a constraining factor for beginning the process. Organization: Montana CDC Status: Considering SDL Program Summary: Montana CDC provides loans and TA to small businesses and would like to begin a consumer loan program to help fill the gap in the market that was created with 2010 payday loan legislation. 21

22 Through talking with consumer credit counseling organizations and looking at market trends, Montana CDC recognizes that there is a huge need for responsible consumer lending. Prior to 2010, the $40 million dollar payday loan industry served 35,000 households, many of whom are now turning to predatory online lending. Montana CDC is working closely with regulators (and with positive results) in order to secure payday lending and installment lending licenses. Montana CDC is looking to develop a Credit Builder loan, an installment loan, and a payday loan product, one of which they are considering piloting using an employer based model and an online platform. Using internal resources to seed initial SDL loan fund. Interested in exploring ways to create efficiencies but not willing to invest too much in the process at this stage. Primary contact out on maternity leave until September. Organization: People, Inc. Status: Current SDL Provider Summary: People, Inc. provides consumer loans as part of their community economic development program serving several counties in Virginia. People, Inc. s consumer loan program came into being because of the widespread use of payday and other high interest lending. People s loans, which go up to $20K and are all secured, cover a range of consumer purposes including auto repair, home improvement, household expenses and debt consolidation. Credit counseling workshops & FE strongly recommended but not required for loans. People markets their loans through traditional FIs, and closes approximately 6-7 loans per month. People, Inc. currently does not have a consumer lending license because their APR is below the state s usury rate of 12%. Organization: Community Development Finance Status: Current SDL Provider Summary: Community Development Finance (CDF) operates a nonprofit check cashing store that provides check cashing, financial coaching, small dollar loans and other services; it is based in Oakland, CA. Currently CDF has offered single repayment, alternative payday loans and credit repair loans for over 3 years. CDF also has used the pay day loan product for small businesses and would like to add a line of credit product. CDF has also offered installment loans but has not made many of them to date. CDF s rates are far lower than market rate payday lenders (including the Credit Repair Loan which has a 12% APR), and the products can be paired with financial coaching and referrals to traditional financial institutions. CDF is licensed as a payday lender and as an installment loan lender, but the process of working with regulators has been difficult. CDF recognizes the importance of location and is looking at options to expand their reach and access to target market by creating partnerships, opening new locations at nonprofit organizations such as affordable housing providers and developing the use of technology. CDF would like to credit report but constrained by type of loan product and lack of funds. CDF feels that its underwriting is very effective (loss rate is under 1% although delinquency rate is much higher) but could benefit from existing platform to scale. Organization: Ways to Work Status: Current SDL Provider Summary: Ways to Work (WtW) is a CDFI with over 50 loan offices across the country focused on providing primarily car purchase, repair and refinancing loans for low-income families. Ways to Work uses a centralized loan platform based in Milwaukie to process loans in 23 states. The loan platform uses systems and software provided by a number of different companies to create loan documents, underwrite loans, service active loans, manage programs and track client progress. 22

23 A major challenge for WtW is that lenders in different states must comply with their individual state lending regulations and license requirements. WtW would welcome CDFI or nonprofit specific regulations to get some sort of federal charter to exempt from individual state consumer licenses. WtW model is high cost (high-touch) in order for borrowers to be successful with loan products. This cost is only partially covered by fees and interest paid by borrowers. Organization: Office of Rural & Farmworker Housing Status: Considering SDL Program Summary: The Office of Rural and Farmworker Housing (ORFH) is a CDFI in Yakima, WA that currently provides comprehensive development services and lending to local non-profits, housing authorities, growers/employers and other organizations and individuals interested in developing new or preserving existing affordable housing for farmworkers and other low-income rural residents of Washington State. ORFH received a TA award from the CDFI fund to research a consumer loan program to serve as a payday loan alternative, and to help their clients build credit and assets. ORFH is still considering many factors of a consumer loan program including FE requirements, licensing requirements and whether to integrate the program into the current organization or to create a separate organization devoted specifically to this purpose. The main anticipated barriers for ORFH to starting a consumer loan program include concerns about staff capacity, loan pricing, delinquency rates and a steep learning curve for the board. ORFH is eager to partner with other organizations to provide financial education and share learnings, technological advice, and best practices. Organization: Capital Good Fund Status: Current SDL Provider Summary: Capital Good Fund (CGF) is a nonprofit microfinance organization that provides small dollar loans for the purposes of small business development, energy efficiency, technology acquisition, citizenship and credit building. Capital Good Fund designed its loan program as a way to address poverty with strategic loans that address key root causes of poverty. CGF provides financial coaching for borrowers and Coaching loans for loan applicants who do not qualify for loan products. Coaching loan participants build credit and receive financial education in order to prepare to be a borrower in the future. CGF has identified technological capacity as a significant barrier and is in the process of creating their own automated underwriting process to streamline their lending process. Organization: Innovative Changes Status: Current SDL Provider Summary: Innovative Changes (IC$) is a nonprofit CDFI devoted to providing consumer loans, financial education and asset building programs in Portland, OR. Innovative Changes was created with the purpose of providing a responsible alternative to high-cost payday loans and filling the gap for Oregonians who relied on this type of credit prior to 2008 legislation that restricted payday loans. IC$ is licensed as a consumer lender in the state of Oregon. IC$ identifies that access to loan capital, staff capacity, technological capacity and efficiency, and cost of lending are all significant barriers. Currently, IC$ uses Down Home loan manager to service loans, but is interested in exploring ways to automate underwriting, origination, and servicing further. IC$ is interested in connected with peer groups of other small dollar lenders to share best practices. In the future IC$ is interested in expanding their lending products to include lines of credit, immigration loans, and collateralized loans. 23