A Risk Worth Taking

These lenders put into practice the types of bromides that financial-services companies like to use in their advertising. "We're in business to improve people's lives and do asset building," says Linda Levy, CEO of the Lower East Side Credit Union. The 7,500-member nonprofit, based on still-scruffy Avenue B, doesn't serve the gentrified part of Manhattan's Lower East Side, with its precious boutiques and million-dollar lofts. The average balance in its savings accounts is $1,400. The typical member? "A Hispanic woman from either Puerto Rico or the Dominican Republic in her late 40s or early 50s, on government assistance, with a bunch of kids," Levy says. Sure sounds like subprime. But the delinquency rate on its portfolio of mortgage and consumer loans is 2.3 percent, and it's never had a foreclosure.

Ethical subprime lenders have to look beyond credit scores and algorithms when making lending judgments. Homewise, based in Santa Fe, N.M., which lends to first-time, working-class home buyers, makes credit decisions based in part on whether borrowers have scraped together a 2 percent down payment. "If customers build a savings habit to save that money on a modest income, it says a lot about them and their financial discipline," says executive director Mike Loftin. Of the 500 loans on Homewise's books in September, only 0.6 percent were 90 days late. That compares with 2.35 percent of all prime mortgages nationwide.

Since ethical subprime lenders know they're going to live with the loans they make—rather than simply sell them—they invest in initiatives that will make it more likely the loans will be paid back. Faith Community United Credit Union, which got started in the basement of a Baptist church in Cleveland in 1952 with members saving quarters on Sundays, now has $10 million in assets. In addition to making loans, "we teach people how to manage their finances and accounts," says CEO Rita Haynes. ShoreBank, as part of its energy-conservation loan program, offers free energy audits and a free Energy Star refrigerator when upgrades are completed. The theory: reducing energy bills makes it more likely people will stay current with their mortgages. Today, only $4.83 million of ShoreBank's $1.5 billion loans are in foreclosure, or just 0.32 percent.

Ethical subprime lenders are now expanding beyond mortgages. Ed Jacob, manager and CEO of Chicago's North Side Community Federal Credit Union, was alarmed to learn that many of his 2,700 members, most of whom have less than $100 in their accounts, were relying on the "second-tier financial-service marketplace": check-cashing outlets and payday lenders, which charge exorbitant fees. So he rolled out a Payday Alternative Loan (PAL), $500 for six months at 16.5 percent. The delinquency rate on the more than 5,000 PALs extended thus far is 2.5 percent. "For payday lenders, it's a success if customers keep taking out loans. To me, it's a success if they don't have to anymore," Jacob says. He believes such loans can build a credit history and help "move people to better products for them and us—auto loans and, eventually, mortgage loans."

Lending small amounts of money, carefully and responsibly, to working-class people isn't a recipe for riches or grand executive living. At the headquarters of ShoreBank, which occupies a former movie theater built in 1923, the window in one founder's office looks out onto a brick wall. Bystry, the CEO of Clearinghouse CDFI, earns a salary of $190,000, a pittance compared with the compensation of larger lenders. (Angelo Mozilo, former CEO of Countrywide Financial, was paid $22.1 million in 2007.) For all the growth, this remains very much a niche industry.

Still, the mortgage crisis has provided an opportunity for ethical subprime lenders to expand. ShoreBank has added staffers and in August 2007 rolled out a Rescue Loan program, which aims to move borrowers out of expensive adjustable-rate mortgages into fixed-rate loans. "We really believe we can help people caught in these bad mortgages," says Jean Pogge, executive vice president of consumer and community banking at ShoreBank. And with plenty of lenders having failed or pulled back from markets, new customers are flocking to their doors. "We're getting demand for regular co-op loans for the first time," says Levy of the Lower East Side Credit Union. In California, the news on housing may be unrelentingly grim, but through the third quarter, Clearinghouse CDFI made 161 loans for $48.4 million, up about 50 percent from the total in the first three quarters of 2007. Doug Bystry says, "This may be a record year for us."

With Andrew Murr in Los Angeles and Hilary Shenfeld in Chicago

© 2008