A new study found credit unions with the Community Development Financial Institution designation tend to generate less profit than those without. However, according to the study's authors, a strong community development business model can produce not only robust profits, but also increased social returns.
Published by the Madison, Wis.-based Filene Research Institute, the study also highlighted what the authors, three executives from the Tacoma, Wash.-based consulting firm CU Strategic Planning, said was confusion inside and outside the credit union industry regarding the financial implications of community development efforts.
"These findings imply that a credit union seeking these designations should not do so with the designation as the end goal," the report read. "The process of obtaining the designation should be part of a larger plan to integrate community development products and practices into the credit union's business plan. Obtaining CDFI certification without adopting community development activities could lead to reduced profitability."
Using data from 2013, the study compared the overall profitability of credit unions with and without CDFI or low-income designations. It found CDFI credit unions had lower average ROAs than credit unions without the designation (0.63% versus 0.79%). They also had lower net worth ratios (9.91% versus 10.80%).
Low-income designated credit unions, on the other hand, appeared to have financial advantages over CDFIs, as well as credit unions without the low-income designation. In fact, the study said, the average ROA of all CDFIs was 15 basis points lower than the ROA of all U.S. credit unions, but low-income designated credit unions had higher-than-average profitability at 0.86% ROA and net worth ratios of 10.84%.
The 4,160 credit unions without the low-income designation had average ROAs of 0.77% and net worth ratios of 10.76%, the study said.
"The authors began the analysis expecting to see a higher return on assets for low-income designated and CDFI credit unions," it noted. "The evidence proved this theory correct for the low-income designation, but the CDFI certification alone did not correlate with increased credit union profitability."
"Low-income credit union"is an NCUA-issued designation for credit unions at which at least half the members meet specific income requirements. Among other things, the designation allows credit unions to include secondary capital in net worth computations and exempts them from the NCUA's 12.25% cap on member business lending. In 2013, just slightly more than 2,100 credit unions were designated low income.
Alternatively, a CDFI designation comes from the U.S. Treasury's CDFI Fund and makes a credit union eligible for a variety of grant and lending programs, among other things. From 2013 to 2014, the number of CDFI credit unions with this designation grew by 28% to 241, the report said.
The study was careful to point out that community development activities are still financially valuable to credit unions.
"The results of this study suggest that CDFI certification or low-income designation alone does not increase financial and social returns for the credit union," the report said. "However, community development as a business model, independent from designations, is associated with increased social and financial returns."
High-performing CDFIs with ROAs of more than 1% in 2013, for example, excelled because of their ability to deploy loans and generate noninterest income, the study said. They also offered financial counseling and education more often, helping generate bigger loan volumes and higher-quality loans, Filene noted.
However, misconceptions about the definition of "low-income consumer" and worries about additional regulatory scrutiny have proven off-putting to credit unions, the study noted. Other advocates of community development, including local and state government agencies and certain nonprofits, are largely unaware of credit union leadership in the field as well, it said.
Among its recommendations, the report said credit unions should offer services to help consumers qualify for loans they're unable to get from other mainstream financial institutions, partner with local nonprofits that provide a pipeline of loans and help turn unqualified consumers into qualified borrowers, and look beyond the labels and grant funds.
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