On August 12, 2021, the Federal Reserve Bank of San Francisco held a Connecting Communities webinar covering the kinds of partnerships and innovative programs that were created to help fill the capital void for the small businesses that are struggling the most. Watch the video below.
The pandemic exposed deep structural inequities in America’s financial system. When COVID-19 hit the US, it became clear that millions of Americans and small businesses were disconnected from our banking system. As a result, the public and private sectors collaborated in a number of states to set up funds to provide responsible and affordable credit to these small businesses. The California Rebuilding Fund and the Southern Opportunity and Resilience (SOAR) Fund are key examples of these partnerships. Both programs saw community groups, community development financial institutions, and private and philanthropic capital (and in California’s case, the state government) come together to provide low-interest loans to businesses.
A number of new models have arisen that may continue to be used long-term to provide small-business owners—particularly those that are underserved by traditional financial institutions—with capital to survive and grow. This panel brings together thought leaders within these sectors to discuss these new partnerships and models, as well as methods of creating opportunities for a more equitable lending landscape. Speakers will also inform the ways federally-funded and state-led capital access efforts can help scale these innovative programs to help them thrive long-term.
Speakers:
- Beth Bafford, vice president of syndications and strategy, Calvert Impact Capital
- Tahreem Kampton, Treasurer, Microsoft
- Luz Urrutia, CEO, Accion Opportunity Fund
- Rocio Sanchez-Moyano, senior researcher, Federal Reserve Bank of San Francisco facilitator
- Matuschka Lindo Briggs, director of special projects and strategic support, Federal Reserve Bank of St. Louis moderator
Connecting Communities Innovative Models to Create a More Equitable Lending Landscape for Underserve Entrepreneurs (video, 1:02:30).
TRANSCRIPT
Matuschka Lindo Briggs
Good afternoon and welcome to Connecting Communities. Today’s webinar is Innovative Models to Create a More Equitable Lending Landscape for Underserved Entrepreneurs. On slide two I would now like to take the time to introduce our speakers for today. Beth Baffort, vice president of Syndications and Strategy, Calvert Impact Capital. Tahreem Kampton, treasurer at Microsoft. Luz Urrutia, CEO, Accion Opportunity Fund. Rocio Sanchez-Moyano, senior researcher at the Federal Reserve Bank of San Francisco. And I’m Matuschka Lindo Briggs, director of special projects and strategic support for the Community Development Department at the Federal Reserve Bank of St. Louis, and I will serve as your moderator for our session today.
Let’s move to slide three where we can take care of a few housekeeping items before we get started. For the best webinar experience, we recommend you use the Webstream to consume this live video event through your computer speakers. If you have technical issues, you are welcome to dial in to the phone number posted on the player page, but the video will not sync perfectly with the phone audio. This session will be recorded and the presentation will be available on our Connecting Communities website. Also, in connection with this session, you can find a variety of additional resources available www.fedcommunities.org. We will be taking audience questions during the event and we’d love to hear from you. To submit a question, use the Ask Question button located on the webinar player page, or you can email us communities@stls.frb.org.
As we move to slide four, I need to go over our legal notice and disclaimer, since this is a Fed webinar, which is that the opinions and statements expressed in this presentation are those of the speakers and are intended only for informational purposes. They do not reflect official positions of the Federal Reserve Bank of St. Louis, or the Board of Governors of the Federal Reserve System.
And finally, our mission on slide five. The mission of the Federal Reserve’s community development function is to promote economic growth and financial stability for low- to moderate-income individuals and communities. You can look at the map to see where your community development team is located. Our work is done through a range of activities, from conducting research and identifying emerging issues, to developing resources and sharing ideas, as well as fostering collaboration and building partnerships.
I would now like to turn the presentation over to Rocio Sanchez-Moyano, our facilitator for the afternoon, from the Federal Reserve Bank of San Francisco. Rocio, the floor is yours.
Rocio Sanchez-Moyano
Thanks, Matuschka. The pandemic exposed deep structural inequalities in America’s financial system. When COVID-19 hit the US, it became clear that millions of Americans in small businesses were disconnected from our banking system. Congress and the Small Business Administration launched the Paycheck Protection Program, which was intended to staunch the bleeding of America’s small businesses. But early research and reporting indicated that PPP wasn’t reaching many of the smallest small businesses, and those owned by women, low-income people and people of color often struggled to receive funding.
The public and private sectors collaborated in a number of states to set up funds to provide responsible and affordable credit to these small businesses through community development financial institutions or CDFIs. I have with me today three experts who have been working on these new models to provide small business owners, particularly those that are underserved by traditional financial institutions, with capital to survive and grow. I’d like to ask Luz, Beth and Tahreem to join me on screen. I’d also like to remind you that we are reserving time at the end for Q&A, so please submit questions as we go along.
Luz, I’d like to start with you. As the pandemic hit last year, what happened with small business lending?
Luz Urrutia
Thank you so much Rocio, and thank you very much for putting this great event together. To put just a little bit of context, before COVID-19, small businesses, especially those owned by people of color and women, were already facing significant challenges when they were trying to access responsible capital. At the time, most small businesses were already operating with an average of 15 days of cash reserves. When COVID hit and the world began to shut down, it was clear that, along with the health crisis, we were also facing an unprecedented economic crisis, and that small businesses in particular were going to be devastated. In response, as you mentioned, the federal government moved to create the Paycheck Protection Program with great intentions to help small businesses stay afloat and keep their employees on a paycheck.
The intention was good, but unfortunately the rollout fell short. The reason was because, to disperse PPP loans you had to go through the Small Business Administration that relied on traditional lenders. And on the first round of PPP, non-traditional lenders like CDFIs, MDIs and some FinTechs, we were not allowed to get a foot in the door. It was in the second part that this happened. Also, what happened is that the loan forgiveness rules were also very unclear, and the result was that larger banks focused mostly on their customers. Big businesses received over half of the PPP loans while many small businesses were left out entirely.
This problem was really pronounced, unfortunately, for entrepreneurs of color, women immigrants, and those of low to moderate income, because their businesses are largely unbanked and underbanked. And we know that they face lots of challenges trying to access PPP through banks and FinTechs. For instance, only 5% of businesses that received PPP loans were women owned. And a survey that was conducted by Color of Change found that only 12% of Black and LatinX owned businesses were successful in receiving the funding that they had asked for. Then there was a Secret Shopper study that was conducted by the National Community Re-Investment Coalition that found a bias in favor of white borrowers at banks. Meanwhile, without access to PPP on the first round, CDFIs and MDIs were challenged in being able to get the resources and the capital that we needed to support customers. But once we were approved, then we were able to offer PPP loans, and we saw how CDFIs, MDIs went to work and how much volume they generated when they got the resources.
The other thing that happened during this time is that local governments and states also launched a number of grant programs, which were very beneficial for the short term to help businesses stabilize and replace some of the revenue that they had lost. But these grant programs, like PPP, are all well intended and they brought stability and kept employees on the payroll, but it was for a period of time. They’re not there to be long term for sustainability, and they were not sufficient to allow for small businesses to rebuild. In some respects the flawed rollout of the PPP program put CDFIs and MDIs really in the spotlight and made people get more creative. And you’re going to hear Beth talk later about what that creativity did to bring resources to the market, to CDFIs and other organizations, to rebuild over the long term.
Rocio Sanchez-Moyano
Thanks, Luz. But before turning to Beth, I want to turn to you, Tahreem. How are you responding to the pandemic from a giving and investing perspective?
Tahreem Kampton
Hey. Thank you for having me here. Nice to have… Sorry. Let me go ahead and start. Our CEO, Satya Nadella, outlined in March 2020 that Microsoft adopt a first responder mindset across the company in response to the COVID-19 pandemic. As a result, we work with many individuals and organizations on the front lines to help soften the impact, and some of the examples include providing the necessary infrastructure using technology to support critical industries during the pandemic, including healthcare. As of December 2020, Microsoft provided more than $98 million of assistance to nonprofits in Washington state, including $67 million of cash and $31 million of technology.
More than 1,300 Microsoft employees help the city of Seattle run mass vaccination sites, and we mobilize resources to help COVID-19 response in India and became a founding member of the global task force on pandemic response. This is a public private partnership with the US Chamber of Commerce and the Business Roundtable to provide India with critical medical supplies, oxygen, and lifesaving assistance. The effort began in India and is designed to become a vehicle for support in other regions devastated by COVID-19. That’s what Microsoft has done on the giving side, and there’s a lot more examples there.
But on the investing side, some of the things that we have done is worked on programs such as the Entrepreneur Backed Association Fund, which focuses on CDFI micro lenders who make loans under $50,000 and are among the most effective lenders to diverse entrepreneurs, the smallest, and the least served businesses. 75% of these loans are made to entrepreneurs of color, and 75% of these loans are to low to moderate income census tracts.
What EBA does is that it buys the loans held by the CDFIs, which creates additional capacity on the CDFI balance sheets and allows the CDFI then to make more loans at an increasing velocity. The entire model is intended to increase the velocity of funds by three to five X with a potential of 10X increase in capital to these communities.
Then the other one I wanted to mention is that we also work to create the Clear Vision Fund in partnership with Seabert Williams Shank. This was created to mitigate the lack of capital that minority owned business often encounter with the hopes of creating successful businesses that can proactively affect these communities in which they operate. These are just a few examples. And as we go through the conversation, we could highlight some more things that we’ve been doing to support these communities.
Rocio Sanchez-Moyano
Thanks. Now I’ll turn to you, Beth. What solutions began emerging to deal with the need for lending at state and local levels? We started to hear from Tahreem, how his organization was responding, but I know there’s a lot more happening.
Beth Baffort
Yeah, absolutely. And thanks so much for having us today. It’s great to be on this panel with all of you. Just as a little bit of background, Calvert Impact Capital is a nonprofit investment firm that’s been around for about 30 years, supporting local intermediaries across the country and across the world so that they have the tools they need to be responsive to their communities. From our spot, we have been lending to CDFIs and small business lending CDFIs for our whole history. We know the amazing power of their role in their communities, their flexibility, their ability to work hand in hand with small business owners to provide not just access to the right financial resources, but access to assistance, support and networks that they otherwise lack.
When the pandemic hit, we knew right away that CDFIs were going to be what we call the economic first responders. We’ve seen them do that after Katrina, after 9/11, after Hurricane Harvey, after Sandy, the wildfires. We see CDFIs step up again and again to fight for their communities. And so, we knew that they were going to play a really proactive role, but we had never seen something at this scale and breadth and need to scale almost overnight to support the immense need that Luz mentioned. And so, we started calling our partners and saying, “What do you need? How can we help? How can you lean in? How do we structure something that is unique to your model and that will help you do what you need to do to be there for your existing clients and future clients who we know need your help?”
We developed this program model that we have called the Community Recovery Vehicle that really has three legs of the stool. One is a capital solution, so it’s an off balance sheet loan purchase facility. We blend capital from public, private, and philanthropic investors and purchase 95% of every loan that the CDFIs originate so that they have access to low cost liquidity and can do a lot greater volume of lending. The second piece is the supportive technical assistance ecosystem, so trying to make sure that they have the partners and support that they need. We know CDFIs provide direct PA to almost every borrower they touch, but there’s also a need for the support businesses who… where they don’t have sufficient capacity to help. And so, wanting to make sure there was a supportive ecosystem around them. Then the third piece was technology, lead generation. How does small businesses actually find these CDFIs? They don’t typically have marketing budgets that allow them to be in bus stops and on billboards, so how do we make sure that small business owners can find the CDFIs who have these products available and can provide support?
We pulled those three pieces together. We’ve now done that program across 18 states, four different programs in very close partnership with Luz and her team, and I think 29 other CDFI small business lenders across the country.
Rocio Sanchez-Moyano
That’s great. Now I’d like to stay with you. Can you elaborate a little bit more on how these funds are solving for some of the problems that Luz laid out in her first answer?
Beth Baffort
Yeah, absolutely. I mean, the access piece is critical. Allowing these small businesses to find their local CDFIs is really critical. That’s where the CRF Connected Capital Platform has been really critical, in making sure that we have one centralized, very simple pre-application portal that matches a borrower with their local CDFI lender. The public sector has also been critical in that. We’ve been talking about these programs through the governor’s office, through mayor’s offices, through local leaders, through trusted partners to make sure that the business owners know that this is something that really was built to support them and not built to be predatory or to be pushing debt on people who don’t need it. Really, those partnerships have been critical.
Then on the CDFI capacity side, we’ve seen them do amazing things with access to this liquidity. In New York, the small business lenders… There’s four small business lenders who have been active in the New York Forward Loan Fund. They did 14 times the volume of lending in 2020 than they did in 2019. When we pull together programs like this, all the different puzzle pieces that need to come together to support CDFIs, we see that they stretch. And I think it was painful, but it was really effective.
Then we’re serving the businesses who we hope to serve. I think that’s a testament to both the CDFIs and their brands, their work, their support. But over 90% of the businesses we’ve provided loans to have been under a million revenue and less than 10 employees. Nearly 70% of the businesses have been owned by women and people of color, and that’s across programs.
Then the investor community really stepped up. We’ve gotten, I think, $335 million of commitments from everybody from our friends at Microsoft, to state and local governments, to philanthropies, family offices, banks. A lot of people figured out how to plug in the right part of the capital stack to really support small businesses and CDFIs at this time.
But I think most importantly, to address some of the structural challenges that Luz mentioned, we’re really trying to exercise a new muscle and adopt lessons from the broader markets on how to scale effectively without losing the integrity of what CDFIs do on the ground. That’s really been the big balance that we’ve tried to strike. How do we standardize everything that we can standardize to make sure that it works for the markets and it works for investors? But how do we make sure to maintain flexibility in the structure and really delegate as much to the CDFIs as we can so that they are really the ones driving the train, making the decisions, making the credit decisions, working with borrowers, making sure they have what they need? That’s really, I think, what I’m hoping we can take from this moment and really continue to build going forward.
Rocio Sanchez-Moyano
Thanks Beth. I’d like to expand actually on the ending of that answer, but turn here to Luz. How are these funds helping CDFIs reach those underserved small businesses, which has always been your bread and butter, but also how are they supporting the CDFIs in reaching these businesses in ways that we didn’t see in some of the earlier or other programs?
Luz Urrutia
Sure. Well first I want to say… I mean, Beth is incredibly humble about all this, but we are extremely pleased with the initial result of these programs. We’ve been participating in the California Rebuilding Fund and then the Southern Opportunity and Resilience Fund that’s launched in 15 states in the south and southeast. Very grateful for the incredible work that Calvert has done and Beth and CRF and Liz, who’s running SPVs for some of the funds, Kiva in California, and the rest of the CDFIs, all of which have come together with one common vision. It was to help small businesses access the resources that they needed so that they can rebuild over the long term. That is a very worthwhile cause.
The programs that Beth mentioned really leveraged the existing infrastructure of CDFIs. We have deep ties in our communities, and most in need, and we were then able to deploy that capital. They gave the CDFIs the structure, gave the CDFIs a customer acquisition platform, which Beth mentioned. We don’t have significant budgets as nonprofit CDFIs, so we can’t market directly to small businesses, direct mail, or billboards, or TV. That was incredibly effective and efficient for us to access customers in that holistic way.
The other piece was the low cost capital, the ability to access capital and to have this structure as a special purpose vehicle where we are originating the loans. And then in California we’re selling 90%, we’re selling 95%, so we’re transferring that loan and the risk to an SPV and we continue to service the loan. We continue to maintain the relationship with the customer.
And last but not least, the philanthropic resources that were available to support the work that the CDFIs do. To underwrite, disperse, service the loan. And also the fact that this fund created a secondary market for the CDFIs to transfer to that SPV, that was really helpful. Because that helps us free up our balance sheet, helps us continue to leverage so that we can continue to do more lending to small businesses.
All in all, we see tremendous potential for these structures. We think that it’s a way to scale lending for small businesses and basically to change the landscape of how small businesses can access effective and affordable capital.
Rocio Sanchez-Moyano
Thanks. And, I mean, an important component of this is the investor involvement in helping create these secondary purpose vehicles. And so, Tahreem, I want to turn back to you. What’s driving the interest in CDFIs and in small business lending from within corporate treasury teams? And how does these programs help you meet your commitments and goals?
Tahreem Kampton
Sure. Microsoft’s been investing and supporting CDFIs and small businesses for over 15 years. The majority of our activity historically was through deposits and transactional capital markets activity. In 2020, we increased the size and the scope of our programs to address racial equity and to help support small business in the face of COVID. This allowed us to have more tools, to have greater impact. As a result we were able to do different things that we weren’t able to do previously, such as invest in the Southern Opportunity and Resilience Fund, which is a program created by a diverse group of community lenders aimed to help small businesses and nonprofits to recover and rebuild from the COVID-19 pandemic, with a targeted geographic focus, as Luz mentioned earlier, of 15 Southern and southeastern states that represent greater than 50% of the US Black, African-American population. So far, as part of this fund, 57% of the loans funded through SOAR have gone to Black African-American owned businesses, and more than half of those have been to Black women and owned businesses.
For us, it’s a very powerful vehicle that really allows us to get capital where we want it to go and have greater impact that we want it to have, and really supports our overall broader corporate initiatives.
Rocio Sanchez-Moyano
Thanks. I want to start looking forward now. How do we think about sustaining these programs and using these programs into the future? I’ll start with you, Beth. Where are there opportunities to expand these partnerships to new locations?
Beth Baffort
Yeah, absolutely. I mean, I think what is really exciting is that the crisis really led to CDFIs stepping up, accessing new resources from private and philanthropic players, from the federal government, from the CDFI fund. And that has caused everybody to realize what they can do, what they themselves can do. We’ve seen that a lot of CDFI leadership is saying, “Okay, we did this enormous amount of lending and we served an enormous amount of businesses the last 18 months. We don’t want to go back. We don’t want 2022 to look like 2019. We want to continue this growth, we want to continue pushing forward.” And so, we know that to do that at a national scale requires a significant amount of subsidy, if we are simultaneously trying to scale the market and convince investors, the more institutional investors, that these are assets that are worth investing in. That these are really quality assets.
But to do that, we know we need a level of subsidy in these structures, and so we were really excited when the American Rescue Plan passed with the inclusion of the State Small Business Credit Initiative, which is a second iteration of a program that was administered under the Obama administration and now was reauthorized with significant more resources to really support creativity in small business lending, small business access to credit, venture programs across states. We are really looking both to that and to the leadership of state and local governments across the country to understand how we can plug their resources in with these models or models like them to continue pushing forward and making sure that CDFIs have the resources to continue doing this kind of lending.
We are currently in that process, trying to structure the right products, the right partnerships, the right opportunities for states to plug in to programs like this, for CDFIs to get the direct support that they need to increase capacity, increase investments in people and technology and systems and support, and making sure that all those puzzle pieces are coming together so that we can do this nationally, which really is our goal.
Rocio Sanchez-Moyano
Now I want to dig a little deeper on that. And Beth, this can go to you or it can go to any of the three of you. As we think about how to use the State Small Business Credit Initiative, how can states use it to support these kinds of efforts? Or what opportunities are there for states to work together or in collaboration with other partners to leverage these dollars for greater impact?
Beth Baffort
Yeah, I mean I can start, and then Luz and Tahreem, feel free to jump in. I think what we’re trying to balance is how do you… The State Small Business Credit Initiative included $10 billion that is going from treasury through the states for these programs. There is a target to leverage those dollars at least 10 to one over a nine year period. That’s an enormous amount of private capital coming into this ecosystem that was not there before. To do that, we know that it requires the really boring financial plumbing that it takes to get a dollar from a pension fund or someone’s retirement account into the hands of a small business owner in Washington, D.C. or Atlanta, Georgia.
We are trying to really work with our CDFI partners to figure out all of the pieces that need to come together to create that financial plumbing, to get those dollars moving quickly and at scale. But really leveraging their infrastructure, leveraging their strengths, and making sure that that liquidity piece is paired with those other pieces of the puzzle, the direct support to the CDFIs for capacity, the revenue streams and preferred revenue models that work for them for originations and servicing of loans.
And so, really trying to make sure that we are staying clear about the local mission of these funds while also trying to connect that work to the broader capital markets. That’s going to be our big challenge of the next six months or so, to make that happen.
Luz Urrutia
Yeah, I would just add very, very briefly to what Beth said. Obviously it’s an excellent source of funding, right? Because it really has the opportunity to enhance an inclusive national recovery, because it’s giving the states more flexibility and much more patient capital to help meet the unique needs of small entrepreneurs. I think that it’s going to be really important for the states to think about broadening, establishing wider scope of partnerships with network of lenders that include CDFIs and other organizations that help small businesses build capacity. That’s going to be important, because CDFI participation under the first iteration of SSBCI varied widely in how quickly the funds were deployed. Under this new reauthorized program, getting the money to small businesses effectively and efficiently is going to be really important to accelerate an inclusive recovery. Without a centralized effort to encourage CDFI participation you may find that some states may default solely to programs and partnerships from what we call SSBCI 1.0, which really to some degree ignore the realities of the changing small business landscape. We think that if this program now managed correctly, really has the potential to begin changing the biased nature of capital access in the United States.
But we also know that funding alone is not going to do it and it’s not sufficient. Whether it’s federal, at the state level, leaders, they need to develop new partnerships with organizations that provide capacity for small business owners to grow. We know that small businesses don’t want to stay small. Most of them would like to grow, but they need capital as well as the support and the capacity and the networks to get them there.
Rocio Sanchez-Moyano
Great. Thank you. And Luz, I want to stay with you, because I think that another part of thinking through the future is how do we scale and sustain these programs? How do we make sure that they’re sustainable for you as a lender as well and all the participating CDFIs?
Luz Urrutia
Sure. Obviously there’s a lot of critical participants in this ecosystem, in particular in these funds. And Beth, we’ve talked about those. But CDFIs are key in these programs. Ensuring that we have the resources that we need, as we’ve talked about, patient capital, equity, we call philanthropy to invest in building capacity, acquiring customers effectively and efficiently, and able to have a structure that we can mitigate risk are all critical elements to support entrepreneurs and scale lending and other products.
As CDFIs, we’re able to offer very flexible products and those products generally reflect the needs of the local markets. We know that not all businesses are created equal, and not all markets are created equal. But the lack of standardization, which Beth talked about, really limits our ability to scale by accessing more traditional market mechanisms like securitizations and active secondary market. Unlike traditional banks, CDFIs mostly use our balance sheet to fund our portfolio. And so, we need to access equity and net assets by raising philanthropy in order to be able to keep those loans on the books. Part of the reason is because, when we borrow from banks, CDFIs borrow from banks under the Community Reinvestment Act, loan covenants require us to maintain what’s called a 20% net asset ratio. That means that for every dollar that we borrow, we need to have 20 cents in equity or in net assets. The only way we can generate those net assets is either by raising philanthropy or generating earned surpluses.
This combination, and those limitations I say, makes it very difficult for CDFIs to build up their loan capital, particularly during times when lending is increasing and there’s a lot of demand. Designing these programs in collaboration with all of the members of the ecosystem, talking to the CDFIs, the investors, the philanthropists, the local state governments, is essential to ensure that they are sustainable for the long term. And when we engage with CDFIs and take time to understand their needs and those of their customers, then we can maintain a responsive, market-based, holistic approach, and then we can turn to communicate those needs to other participants to come into the fold. Everybody then has the opportunity to understand why certain things need to happen. Why does the CDFI need philanthropy? Why do we need cost of capital that is reliable and lower cost? What is the sustainability of the model?
I think generally these market structures need to allow to do CDFIs what we do best. CDFIs, we are experts providing hands-on support, access to affordable capital, and financial products and business advising. To scale this in a sustainable way, we need to preserve the good parts of our model and we need to continue to invest in things like technology and data analytics so that we can scale the business and do it more effectively and more efficiently. Now more than ever it’s really important that CDFIs have all of those resources that we need to support the rebuilding of Main Street in America.
Beth Baffort
Just to put a finer point on that, because Luz also is often modest. The subsidy that is required to support the CDFI business model is for the purpose of supporting the small business. The cost of making… Luz, I think Accion Opportunity Fund, the average loan size in the California Rebuilding Fund is probably somewhere around $30,000. 30 or $40,000, right?
Luz Urrutia
Yeah.
Beth Baffort
The cost of making that loan, including both the cost of underwriting it and making that loan and the additional support services that they provide, the time and energy that they spend with their small business owners, would require them to charge an interest rate on that loan that would be prohibitive for users. The subsidy is plugged in to allow them to do that high touch relationship-based lending model in a way that is still providing an affordable and flexible product to the small business owner, and that creates spillover effects that are good for all of us. They’re good for the public sector in terms of supporting the tax base. The small businesses create jobs and income, wealth building opportunities.
This is why I get so excited about the federal government really recognizing and stepping up in both supporting CDFIs and supporting small business programs right now. Because it really is a public good. The work they are doing is a public good and needs to be supported as such. And if we do that in a way that is sustained and really, really focused on longterm resiliency, I think we are going to see a much more robust, well-functioning, vibrant small business economy, which is going to address so many of the challenges that we’re seeing in our economy today.
Rocio Sanchez-Moyano
That’s great. Thank you. I just want to close out our pre-prepared questions with Tahreem and thinking about what is it about collaboratives of CDFIs like SOAR so that’s an important mechanism to encourage participation from corporations or other institutional investors? And [inaudible 00:36:20]
Tahreem Kampton
Sure. They provide the opportunity for corporates to direct their dollars to the communities that need it most in a single concerted effort. The aggregation of the resources that these funds and collaborates can gather make it much easier for corporates and other institutions to invest in communities that need it. These funds also provide simplification for investors and for corporates who are under-resourced. It’s a really easy way to get a bang for your buck effectively. Really the simplification, the collaboration helps drive the scale, which can really help attract more investors into this space.
Rocio Sanchez-Moyano
All right. Thanks. With that I want to thank my three experts here for joining me and for this thoughtful discussion, and I want to turn it back to Matuschka to lead our Q&A.
Matuschka Lindo Briggs
Thanks Rocio. As a reminder, we are taking questions from our participants today. You could do that by submitting them using the Ask A Question button on the left hand of your screen. Again, you can also email us communities@stls.frb.org. We have quite a few questions here. The first one is directed specifically to you, Luz. It’s a two part question. Why are many small businesses disconnected from the banking system, and why do they struggle to access the capital they need?
Luz Urrutia
That’s an excellent question. Historically, particularly when it comes to credit, a lot of the small businesses that we serve, the CDFI serves, they don’t have standard traditional documentation. Many of them are owned by immigrants. They don’t have credit scores or they have thin files. Their loan sizes, the requirement for loan sizes, are much smaller than what a traditional bank is used to working with. The credit boxes in general are much more restrictive than what a lot of these businesses require In order to underwrite credit. A lot of ways we underwrite credit is using alternative data. Yes, we look at credit scores, but we look at a lot of other things. We look a lot of moral collateral. The vast majority of our loans are unsecured.
Because of the profile of a lot of these small businesses that have not been part of the mainstream and don’t have all of what banks generally require, that’s why they’re not directly going to banks to borrow funds. In place of banks, they’re going to alternative lenders, some of what are very responsible and some of which are not. We all have heard about merchant cash advances and very high cost, predatory loans that have wreaked havoc in Main Street. Part of the challenge is that a lot of large banks and many banks just don’t have the capacity and the ability to underwrite because of the way they’ve set up their credit structure, and the profile of the businesses don’t meet that credit box.
What was the second part of your question?
Matuschka Lindo Briggs
It was, why do they struggle to access the capital they need?
Luz Urrutia
Yeah. They’re small in size. There’s a lot of startup businesses. Banks generally have a requirement that to get a loan you have to be in business for at least three years. You have a lot of businesses that are startups or have been in business less than three years. They don’t have traditional documentation, they don’t have credit. These are all limitations why small businesses do not generally access their credit from financial institutions and go to other organizations. CDFIs are really well positioned to serve them, as we’ve heard. Unfortunately, a lot of small businesses do not know about CDFIs. I think we saw that in the last 18 months when every webinar, every seminar, every time we reached out, it was like, “Where have you all been?”
The other piece is that credit is important, but I mentioned technical assistance, business advising and coaching is also very important. Generally a lot of banks don’t combine the two, and that’s part of another way to get to a business and get them through the journey to the point that they can borrow money.
Matuschka Lindo Briggs
The next question is to both Beth and Luz, and Beth, we can start with you on this one. Can you both provide some insight into whether the loss of investment income from selling loans in the secondary market has impacted their ability to generate a sustainable profit on the loan organization? Origination, I’m sorry. On the loan origination.
Beth Baffort
Great question and one we’ve talked to a lot of our CDFI partners about. It is a different revenue model for the CDFIs. It has shifted from interest income on the loans that they hold on their balance sheet to majority fee-based income from originations and servicing. That is a shift. It’s a mindset shift, system shift, it’s an accounting shift. But what we see is that it allows the CDFIs to use their capital more efficiently, and it allows them to earn revenue that is not encumbering their balance sheet and also doesn’t come with the loan loss expense that has to be held against every loan that they’re holding.
The way in which the fee revenue is structured for these programs is that the CDFI receives an origination fee on the full value of the loan that they originate, that they get at closing, and then they have a servicing fee that’s an annual fee, again, on the full value of the loan, the portion held on the balance sheet and the portion held in the fund, for servicing those assets on an ongoing basis to make sure that there is sufficient income coming in to support their operations.
The origination fee is higher. It’s been between 4 and 5% depending on the program. And so, it relies on certainty of originations in future years. It’s really why we’re trying to keep these programs to be stable in the market. It’s why we’re excited that SSBCI is a nine-year program. Because it really allows us to think about how do you keep these programs in the market? How do you create the certainty of that liquidity and that secondary market vehicle over a long period of time so the CDFIs can actually budget, understanding that they’re going to be able to do a certain amount of volume and be able to earn a certain amount of revenue from that origination fee over a longer period of time than just a blip during the COVID period?
Matuschka Lindo Briggs
Luz?
Luz Urrutia
Yeah. I agree. Everything that Beth said. Just to add, as admission driven organization, which all CDFIs are, we are about being able to put as much capital into communities of need as we possibly can. We have to be sustainable. That’s the only way that we can continue to access capital and have the kind of scale and impact that we need to have. But our focus is, are we covering the cost? Which is what Beth is talking about with the origination fee. And then getting those loans on the books and off the books and continuing to serve those customers and new ones coming along, that is our number one priority. How can we deliver much more capital with a structure like this than we could deliver if we had to hold those balance sheets on our books? Those loans on our books.
Matuschka Lindo Briggs
Right. I think we’ve been discussing this and covering this in this next question, but I think he’s being a little bit more direct. What are the biggest challenges in growing the network of lenders? And what needs to be done to streamline or increase the efficiency of making and administering these small loans? This is open to anyone.
Beth Baffort
I mean, I would turn it over to… No one has mastered this like Luz and her team have. She could teach a master class in how to balance integrity with technology and efficiency. I would turn it over to you, Luz, and talk a little bit about how you guys have thought about that over the last 18 years. I mean, 18 months and many years before that.
Luz Urrutia
Sure. It is a tough balance, right? Because we’ve been talking about how CDFI’s focus is on a high-touch customer relationship and one on one relationship approach. A lot of CDFI’s, a lot of their customer acquisition in most cases is coming from boots on the ground and local community partnerships. Those models are great, but they’re really hard to scale. What you have to think about is, where are there opportunities to leverage technology, invest in technology and data analytics? And then looking at core functions, things that are not core to your work.
For example, in our case at Accion Opportunity Fund, what we looked at is what are the things that we and only we can do and do them well? And what are the things that others can do and do it better? That’s when we made the decision that our back office, our customer service, our intake for application, could be done by an outsourced call center. What that gave us was the opportunity to scale up and down with volume and to be open seven days a week, 15 hours a day. Customers are working during the day, so our folks, before we outsourced this part of our operations… And these are our policies, our procedures, our training, our quality control. It’s just that we are hiring resources from third party that we have worked with, several of us had worked with in the past, in order to help with that volume. Before that we had call centers that were open from eight to five. Well, that’s when businesses are working and don’t really have the time to deal with us.
Also understanding this idea that a lot of businesses cannot get through the process. When we went online when we started with CARF, the California Rebuilding Fund, I remember seeing that over a very short period of time, over 90% of the customers that came in got to a prequalification offer on their own. it is having that hybrid model that, when somebody is accessing you through online, they have the ability to talk to a real life person to answer their questions, to help them get through the process, or they can start on the phone and then they can move on to the digital channel. It is really understanding the markets that you’re serving, the customer that you’re serving, how they feel comfortable being served, and then designing the policies, the processes, and the technology to help them take the journey with you in however they feel comfortable.
Matuschka Lindo Briggs
Very helpful. Tahreem, we’re going to loop you in here. This is from a former CDFI practitioner asking, what about direct investments in under capitalized CDFIs that are deeply connected to vulnerable markets but lack the capital to expand their capacity? Is there an appetite for discretionary patient equity investments?
Tahreem Kampton
Yep. It’s a great point. It’s something that we’ve been thinking on and working through. There is an investment that we are working on where we would do some sort of equity allocation as a part of it. What I would say is that most corporate treasuries don’t allow equity investing as part of their policy, so it makes it very hard for corporations to be that equity investor. I think that’s where Beth or Luz mentioned earlier, that’s where you need some of that philanthropic capital to really help.
Then the other way to really get around it is it’s not necessarily… You really have to think about it from a portfolio approach. If you may do some equity that’s a little riskier, you need something to offset that so you have a barbelled sort of approach. But I think we all understand that that is what is probably needed the most, and that’s what we’re focused on in our next set of investments.
Matuschka Lindo Briggs
Does anybody want to add to that?
Beth Baffort
I would just say that one of the, I think, bright spots in the December stimulus bill was meant to be equity for CDFIs and MDIs. Both direct equity from treasury, $9 billion through the ECIP program, and then 3 billion in allocation for direct grants to CDFIs to support nonprofit loan funds. If that kind of investment from the federal government could be sustained, I think we would have a much different financial system in five or 10 years than we have today. I agree. It’s hard for folks like treasury teams and others who have just a very strict risk policy to make some of those investments, but it’s a really effective and high leverage way for public dollars to engage.
Luz Urrutia
Yeah. I mean-
Matuschka Lindo Briggs
And our next… Oh, go ahead.
Luz Urrutia
I was just going to add to that. One of the things is, I think we all saw over the last 18 months and when these funds launched, that when CDFIs are giving the capacity and the ability to invest, that scaling can start to happen. I think what Beth just said is really important. That provided that this kind of investment can continue to flow to CDFIs, the investments in technology and the tools and resources that CDFIs need in order to become more automated and more scalable, that could happen and it could really change the landscape of lending in the US.
Matuschka Lindo Briggs
In following up on that, the next question here is how do you make private investors, financial institutions comfortable to invest in this type of SVP entities?
Luz Urrutia
Beth?
Beth Baffort
I mean, I would say it’s an art more than a science, but I have found in talking… I think we’ve now raised money from over 50 institutional investors for these programs, and I have found that everyone is pleasantly surprised by the performance of the assets and the strength of these CDFIs. They may be small and they may have small balance sheets or limited volume previously, but as a sector we have decades of data on the performance of these assets and the approach that CDFIs take to lending. This high-touch relationship based lending leads to really impressive repayment rates. They are more flexible, they’re more patient.
But the loss rates of CDFIs, particularly CDFI small business lenders, are way lower than anybody really expects when they look at it from afar. We often say that the perceived risk of this sector is a lot higher than the actual risk, and it’s really our job in the next few years with these new programs, to build the case, build the data, build the track record to have a much more robust view of the asset quality. I think once we have that more holistically across the country, we will see much greater interest from investors coming into this space. But we know that it takes a lot to check their boxes, and so we’re doing our best to build the case to do that and attract more investment coming in.
Luz Urrutia
And wouldn’t you say, Beth, that that all-
Matuschka Lindo Briggs
Okay. Can you repeat that, Luz?
Luz Urrutia
No, I was just going to say to Beth, wouldn’t you say that that also applies to the expected returns that banks require on their capital? As they see that these are quality assets and that the performance is acceptable according to their guidelines, that then the returns that they’re expecting on the portfolio also start to be rethought.
Beth Baffort
Yeah, absolutely. I think once you understand actual risk of these assets and performance, you can bring the cost of capital or the expected cost of capital down significantly. I think we’re starting to see that on the CDFI real estate side with the CDFIs who have gotten rated and done bond issuances and really driven down their cost of capital. I think it’s just a matter of time until we start seeing that on the small business side.
Matuschka Lindo Briggs
All right. On several topics here we have similar questions, so I’m trying to group them together. We’ve had a couple of questions about technical assistance. Can you talk about types of technical assistance available? Are any CDFIs or philanthropies funding subsidized or free access to accounting platforms for small BIPOC businesses that are not yet bankable?
Luz Urrutia
I’ll start. I’ll talk in general. I mean, technical assistance, business advising, coaching that’s provided by CDFIs really runs the gamut. It’s anything from how do you incorporate your business, how do you set up a business plan, how do you put together a budget, how do you start your financial statements, how do you fire taxes? How do you negotiate legal contracts? How do you pivot? How do you retain customers? It’s the gamut and it really is on a case by case basis.
I think CDFIs approach it in different ways. In our case, we have a pretty robust financial health programming. One, through our free online resource library where there’s hundreds of articles and ways that businesses can get engaged to learn based on the need that they have. The other is through webinars where we go and conduct webinars that… A group of small business owners signs up depending on what their needs are. And then one-on-one coaching and mentoring. And again, it runs the gamut. Obviously that is one of the areas… Because we do all this for free. We do not charge the small business owner. That is an area where we do raise philanthropy to support that.
Now to the question, are there any financial or technical assistance providers that are offering accounting systems pro bono? Was that your question?
Matuschka Lindo Briggs
It was, are any of the CDFIs or philanthropies funding subsidized or free access to accounting platforms?
Luz Urrutia
I don’t know the question to that, Matuschka. We could definitely follow up. Beth, are you aware of any that are doing that?
Beth Baffort
I know there’s some interest from some of these technology platforms to provide access and free support either on the CDFI side for their systems, or for the small businesses directly. But I haven’t seen any broad coordinated approaches implemented yet. I know there’s a lot of interest in the tech side, but people are trying to figure out the best way to engage.
Matuschka Lindo Briggs
No, that’s helpful. We can always follow up to that question too if we get some more information. We have time for about one more question here. And again, there’s several questions about serving rural markets, so we’re trying to just combine it into one so that maybe we can cover a lot of them in one with our last question here. How are these programs reaching rural markets which have been historically underserved? Is there something government or philanthropic partners can do?
Beth Baffort
Absolutely. I mean, I would say we have tried a few things. One is really trying to work with CDFIs that have a strong history lending in rural markets and lending to rural businesses. In all of our programs we have CDFIs that specialize that or are located in those markets and lend locally. And really trying to use these programs to increase their capacity and potentially broaden their geographic reach so that they can serve a greater region.
The other thing I will say is that, for all of these programs we try to do what I call an access audit and try to understand where there’s barriers to access. I mentioned we run all this through an online platform. There are obviously a lot of people in rural areas who don’t have access to broadband, don’t have access to internet. And so, always trying to work with our technical assistance partners and that ecosystem we talked about to see, can we put a phone number on our materials? Do we have a place where people can go to call a local organization, or walk into a local small business development center or office and find out about this program and get support and be able to apply. I think we probably have a lot more work to do there, but it’s something that we are very focused on, in addition to language access and other access barriers to these programs.
But I think what COVID taught us is that local presence is important, but not always necessary to serve businesses. I think a lot of the CDFIs were doing virtual site visits with their borrowers on Zoom and walking around their business and getting to know them and their customers and their employees. CDFIs have been able to stretch into geographic areas that I think they weren’t really thinking about pre COVID. I think that is a large opportunity for new access in rural areas where it might not be feasible to have an office, but there can be partnerships or marketing specific to those areas to make sure that they’re plugged in with the products and services available from these networks.
Matuschka Lindo Briggs
Great. I’m actually going to sneak in one last question, and if one of you could just provide a brief answer. Just because the question just came in here towards the end from two different states. Concisely, can you provide more information about SOAR?
Beth Baffort
Yeah. Luz, I don’t know if you wanted to jump in. Absolutely. Happy to follow up with anybody. Hopefully we can circulate our email addresses and follow up directly, but SOAR is the Southern Opportunity and Resilience Fund. It’s a program operating across 15 states in the south and southeast, with 12 originating CDFI partners and a lot of fantastic investor partners who have allowed us to do this work. It’s the one program that’s not anchored by a state government, so we’ve relied on philanthropy for the first loss money and then raised philanthropic support in subordinate debt and senior capital from folks like Microsoft and other institutional investors.
Like Tahreem mentioned, it’s an area of the country where there’s chronic lack of access to credit, chronic structural barriers for small business owners, particularly small business owners owned by people of color, and the highest population of Black and African American business owners in the country. So, we’re really excited by the results we’ve seen thus far and excited to grow it going forward.
Matuschka Lindo Briggs
Great. I’d like to thank Rocio and the panelists for sharing their time and expertise with us, as well as all the participants that joined today for our discussion on innovative models to create a more equitable lending landscape for underserved entrepreneurs. A few reminders as we close out here. Keep an eye out for the Small Business Credit Survey starting September 8th. We will have a recording available with an audio file on the Connecting Communities website. You can also find a variety of additional resources available on the Fed Communities website. We also welcome ideas for future recordings. We just shared a survey link if you joined us in the webinar, and this same link will be distributed via email in a few minutes. We really appreciate your feedback about today’s session.
Finally, join us next month, September 2nd, for our next Connecting Communities titled Envisioning a US Economy That Works for Everyone. Thank you for joining us. This concludes today’s Connecting Communities webinar. Enjoy the rest of your day.
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