Volume 8; No. 4; Fall 1996
Community Development Lending: Profit or Cost Center?
by Karen Kollias, Senior Vice President, Shore Bank and Trust Company
It's not easy pondering the profitability of community development lending
while sitting on a beach under the hot sun of the Atlantic coast. But
in the aftermath of a rather spirited debate on the subject (one which
left its participants with more questions than answers!) I agreed to document
my opinions in an article for the Fed newsletter. It just so happened
that in the middle of all this, my previously scheduled vacation arrived.
No problem, I thought. When I get to the beach, I'll reflect on my ten
years of experience in community development lending and I'll conduct
a bit of impromptu research.
So that's just what I did... "Do you think community development
lending is profitable?" I asked my fellow beachgoers. The best response
I got was from a guy named Rick. "Hey," he said, sipping a cold
drink, "If you lend money and get it back, then everything should
be cool." While his answer wasn't exactly the analytical response
I was looking for, it was a good reminder that there are still serious
misconceptions about lending and its profitability. You see, our specific
issues as community development lenders may have a limited scope in the
context of broader banking issues, but within that scope, profitability
is an issue we must continually address.
In our business, profitability is most often measured by two things.
One is a loan's individual performance. The other has a much broader context--that
is, those activities a bank considers to be part of its overall community
development lending strategy. We could, therefore, be assessing the profitability
of an entire institution if it is a community development bank. Or, we
could be examining the performance of a specific department within a larger
bank structure. Or, we could be analyzing the performance of a single
loan portfolio handled by one or two people. This kind of disparity means
that we must be careful about how and what we measure when we attempt
to ascertain the profitability of community development lending.
We often hear from bankers that they are making money in community development
lending. What we do not often hear is how they arrived at that conclusion.
There are still lenders in our field who believe they will make money
on community development loans simply if the following happens:
- The loan is repaid in a timely fashion;
- The loan has market rate terms and conditions, and a loan fee was
- The bank uses one officer, not three, to underwrite one loan;
- There aren't any special events or groundbreaking ceremonies that
the bank has to sponsor.
While these points have some merit, they do not accurately reflect or
account for time--the time it takes to structure a deal on the
front-end; the time it takes to close a loan; the time of others involved
in the approval process; and the time needed to handle additional loan
servicing after the loan has closed. We do not have a consistent method
of accounting for the time spent on community development loans, and it
would be helpful for those of us in the business to review and agree upon
a set of evaluative conditions by which to measure time spent. By doing
so, perhaps we will be better able to make the case that our overall business
can be, and often is, profitable.
Why Community Development Lending May Not Be Profitable
Before I offer my suggestions for how to measure profitability, I'd like
to briefly summarize the issues surrounding the notion that community
development lending won't ever be profitable. There are still community
development lenders who believe that "this kind of lending"
is so labor intensive that the cost of loan production will never be justified
by the rate of return on the loans. Unfortunately, many of these lenders
may be jaded by CRA agreements wherein their bank committed to provide
a certain number of below-market rate loans for the purposes of community
development. By agreeing to a lower interest rate, it stands to reason
that associated costs will be more difficult to cover. And, because CRA
agreements tend to be widely publicized, other banks in the area may feel
pressure to offer the same kind of discounted financing. It's never fun
to receive a call from customers asking for "that cheap CRA money,"
and it's never fun to squeeze profit from a below-market rate loan.
In addition to below-market rate loans, there are other factors that
may work against profitability. Many banks host special activities or
ribbon-cutting ceremonies to highlight the good work they are doing in
a community. These activities are fine, but they take staff time and money.
Why not have the marketing department handle the arrangements and absorb
the associated costs of these events?
In the process of structuring a loan, a bank may agree to pay for specific
origination costs like legal, appraisal and other expenses typically passed
on to the borrower. To make matters worse, there are banks that waive
their loan fees entirely for community development loans! We work for
our money, so I make sure we get our loan fees. Since when does the "C"
in CRA stand for concessionary?
Although costly concessions like the ones indicated above will adversely
impact profit, lenders often equate a lack of profitability with specific
loans that are not performing well. Somewhere along the line, community
development loans were labeled "risky" and lenders assumed that
these loans would have a greater incidence of delinquency or default.
It's true that when you've been around long enough to originate a substantial
number of loans, you will encounter these problems. But how much delinquency
is there? From what lenders say to me, problems with soundly underwritten
community development loans occur less frequently than do problems with
other, more conventional loans. Taking lenders' conversations as sufficient
evidence for now, I think it's safe to say that once booked, the loans
themselves do not automatically have a negative impact on overall profitability--unless
of course, the loan carries a below-market interest rate. Rather, what
may most affect profitability is a bank's long-term servicing efforts
as well as the existence of other subsidies or credit enhancements in
a deal. Both of these factors are commonplace in community development
lending, but they require ongoing time and attention from a loan officer.
Regardless of where we think we are in the profitability spectrum, we'd
probably all like to be more profitable, both in terms of individual loan
performance and in terms of the community development lending department
and its programs. We need to talk about profitability more often. At conferences
and in other settings, we spend a lot of time on programmatic topics such
as subsidies and loan products. These are important, but so are actual
administration issues such as how to underwrite and structure loan risk,
how to deal with loan servicing and work-outs and, of course, how to assess
It would be interesting to review reports from banks that evaluate their
loans in terms of profitability. In addition to examining (and perhaps
standardizing) the evaluative conditions set forth in the reports, the
information would be helpful for lenders whose banking institutions still
hold negative perceptions of community development lending.
The more profitable we are and the more information we have to share,
the more leverage we have within our banks. That translates into doing
more in our communities.
Which reminds me... the "C" in CRA? It stands for Community.
Karen's Top 10 Ways to Make Money While Lending Money
- Use an internal profitability analysis chart to track each loan. Set
a profit goal for each one and attempt to stick to it. If you want to
make an exception for the social service agency that tugs at your heartstrings,
go for it... with the understanding that you'll make it up elsewhere.
- Develop an annual budget for all your community development lending
expenses and measure these against the loan returns. Be very clear as
to what is and is not included on both the income and expense sides
of the budget, and for what you are accountable.
- Develop a budget for indirectly related expenses such as loan marketing
and promotion. These expenses should be absorbed by the public affairs
or marketing departments, or in the case of small banks, as part of
the general overhead expense. Before the days of community development
lending, banks created and paid for all lines of business development
products. (I can still recall my days delivering golf balls and umbrellas
to potential customers). As much as possible, let's try to keep it that
- Make sure your customers pay for all their loan closing expenses,
and whenever possible, have them take you out. You may have to eat a
lot of pizza, but you'll save money. And, while fee waivers are nice,
they dig deep into your bottom line.
- Carefully analyze the number of loan officers vis-a-vis the size of
your portfolio and budget. If you're starting a lending group, you can
either staff-up on the front end without making any real money for a
while, or start very small and add staff and other expenses as the portfolio
grows. I recommend the latter.
- Make sure you price loans so that you make an acceptable return from
each one and do as much volume lending as possible. Some loan officers
complete forms highlighting the anticipated return on each loan. This
seems to be a good, basic tool to use. If you aren't sure how to do
it, check with any traditional commercial or real estate lender in your
- If you need or want to make a loan with some concessions, be sure
to offset it with other profit-driven loans. Limit concessionary or
very time-consuming loans to a certain number each year.
- Make sure you separate CRA compliance and other non-lending work from
the business of originating community development loans. Some banks
have one department doing both. Corporate contributions, regulatory
compliance, and those huge cardboard checks should not be expensed to
the community development lending department.
- Review your budget and profitability goals on a quarterly basis. If
you are doing well, go out and celebrate. If you are behind, do not
go out! Stay in the office, and bring in pizza. Eventually, you'll reach
your profitability goals and you'll need to establish new ones.
- Attend training sessions and conferences sponsored by the Federal
Reserve Banks. The information you bring back should offset the expense
of attending... and the Fed did not pay me to say this!
Karen Kollias is Senior Vice President and Director of Real Estate
Lending for Shore Bank & Trust Company in Cleveland, Ohio. The mission
of the bank and its real estate group is to extend credit to community
development projects located in the eastside neighborhoods of Cleveland.
Prior to joining Shore Bank and Trust in 1995, Ms. Kollias developed and
managed the community development lending group for the mid-atlantic region
of NationsBank. During her eight year tenure there, the group originated
nearly $300 million in community development loans serving the state of
Maryland, Washington, DC and Northern Virginia. Ms. Kollias is also a
public speaker, trainer and author on topics related to community development
lending and public/private partnerships.