This is the final segment in a three-part series on the likely impacts of a recession on the CDFI industry. Part 1 focused on the negative impacts, Part 2 focused on potential opportunities, and this final installment offers guidance on how CDFIs can position themselves to thrive--even in a recession.
In the days since we published Part 2, more signs of recession have emerged—August inflation came in higher than anticipated, markets are forecasting as much as a 100-basis point rate increase, and stocks had their worst day since pandemic-driven volatility in 2020. The urgency to prepare for resiliency in a recession is clear. Read on for our recommendations for the impact lending industry.
Know your ALM. Asset-liability matching (“ALM”), or the process of ensuring capital inflows from your portfolio are sufficient to meet required outflows to your capital providers, is easy to underemphasize in a strong economy. During a recession, we no longer have the luxury of assuming that strong repayment and easy access to capital will prevent ALM challenges. Lenders need a dynamic model with scenario forecasting to understand how a changing economic landscape could impact their ability to perform on their liabilities. This should inform all aspects of an impact lender’s operations, from credit standards to portfolio management and fundraising.
Two specific liquidity pressures during a recession are increasing payment defaults and, especially for predevelopment and minipermanent lenders, maturity extensions. A dynamic ALM model, such as the customized model offered by High Impact, can allow CDFIs to stress-test their cash position under different delinquency and extension scenarios, giving staff and the board the insights necessary to proactively manage risk.
Having a strong understanding of your ALM position can also help you live out your mission. Providing payment deferrals to borrowers is a great support CDFIs can offer in a recession, but this can only be done responsibly if the CDFI can model how deferrals will impact its cash position. Once again, a dynamic ALM model can offer those insights on-demand. Lenders interested in improving their asset-liability matching practices can reach out to High Impact here to talk about our dynamic model, or get started with the free, simplified model offered in the resources section of the CDFI Connect platform maintained by the Opportunity Finance Network (“OFN”).
Prepare to onboard staff transitioning from traditional finance. Banks will shed staff as a recession worsens, particularly in originations. For the many CDFIs who have been struggling to hire, this is a meaningful opportunity to add talented staff. To capitalize on this, CDFIs first need to get these potential new hires in the door. Aligning job titles with traditional banking job titles, keeping a presence within your local chamber of commerce, and acting quickly if layoffs at a local lender occur are all helpful steps. Perhaps most importantly, communicating the mission of your institution and your cultural differentiators in job posts will help convey why your ‘Senior Credit Analyst’ opening should rise above the rest in an applicant’s search.
Once new hires are made, training must be the focus. For many CDFIs, this will require changes in how training is approached. Staff coming into the industry from traditional finance will likely be strong in lending and credit fundamentals but will need to change how they deploy those strengths. As an example, a bank underwriter may be accustomed to a rigorous market analysis as the cornerstone of a market-rate multifamily project underwriting, while in our field the market is emphasized much less given the massive demand for affordable housing in most communities. Similarly, key subsidy sources and certain loan types, like unsecured predevelopment loans, may be entirely new concepts. These differences can make even experienced bankers feel out of their depth initially, making good onboarding practices critical so that they can get comfortable quickly and maintain their confidence.
Creating a full-fledged training program for workers transitioning to impact finance is likely too large a task for any one CDFI. We would love to see OFN or a collective of industry players come together to work toward a training program to make this transition easier—this is an opportunity that is too great to be missed.
Increase risk tolerance—and show how resilient you are. This may be an unexpected perspective from a firm whose core practices include underwriting and risk mitigation. However, the CDFI industry is entering this recession in a very strong position and now has decades of extremely low loss rates to support its efficacy—as noted in Part 1, OFN found that the peak average delinquency and charge-off rates among unregulated CDFIs from 1994 to 2013 were 5.8% and 2.1%, respectively. Based on our work in portfolio analytics and portfolio management, we can anecdotally attest to the high performance of CDFI portfolios. This may be the time to strategically increase risk tolerance to double down on our core mission of filling capital gaps and providing financing to empower the most vulnerable borrowers.
For impact lenders willing to take more risk, the key is to do so strategically. First, identify the specific vulnerable population you want to support. Is it small businesses with high-cost debt? Minority-owned developers waiting to realize developer fees? Homeowners who lost their jobs? Making this group as specific as possible will increase the likelihood that you can target them successfully and tailor a higher risk product or approach to achieve the intended impact. Next, see 'Know Your ALM' above—make sure you can model how the downside scenario of this strategy could impact your liquidity. Finally, get investors on board by demonstrating to them how much you could lose without failing to repay them, explaining how your strategic approach mitigates risk to the extent possible, and by dedicating specific grant funds or other sources to credit enhance the strategy. Lenders who are bold and purposeful in a recession will strengthen their communities in their darkest hour while fearlessly pursuing the ultimate vision of our industry.
Thank you for reading this series. We invite you to leave your own thoughts in the comments, respond to our post on LinkedIn, or reach out to us at email@example.com if you’d like to discuss how we can help make sure your CDFI is resilient in a recession.