After Goldman Sachs (GS) and Morgan Stanley (MS) became bank holding companies in 2008, Lesia Bates Moss pounced. As president of New York-based nonprofit Seedco Financial, Moss looks for new sources of capital to expand Seedco's lending to small businesses in low-income neighborhoods. Often that capital comes from banks, which, under the Community Reinvestment Act, are rated on how well they serve disadvantaged areas. Investing in an institution such as Seedco, one of about 900 Community Development Financial Institutions (CDFIs), helps banks comply. As bank holding companies, Goldman and Morgan would be subject to Community Reinvestment Act requirements—and therefore, Moss thought, might be persuaded to invest in nonprofits like hers.
Policymakers and bankers expect CDFIs like Seedco soon to play a greater role in small business financing. "Several of the nation's largest banks are developing CDFI partnerships to provide small business credit," says Mark Pinsky, CEO of Opportunity Finance Network, a Philadelphia-based alliance of CDFIs. "I know of at least two significant deals that could launch in the coming weeks." American Express (AXP), CIT Group (CIT), and GMAC are also newly subject to CRA requirements. "What is occurring now is really a systemic shift in the whole financial markets," says Moss, as banks reduce their risk and their capacity to lend directly to small businesses. "It really supports the case for CDFIs and other alternative lending sources to play a much more critical role to fill that gap." On Feb. 3 the Obama Administration said it would use up to $1 billion from the Troubled Asset Relief Program to provide lower-cost capital to CDFIs.
CDFIs tap federal funding, foundation grants, and commercial banks to finance businesses, housing, and commercial development. JPMorgan Chase (JPM) has invested $1.2 billion in the last five years; Bank of America (BAC) has a $1 billion CDFI portfolio; and Wells Fargo (WFC) has $400 million in CDFI loans and investments. In November, Goldman announced a $500 million program to aid small businesses. Over five years, some $250 million of that will be lent to CDFIs, with an additional $50 million going to CDFIs as grants. Seedco received $20 million in January.
Critics treated Goldman's announcement as a PR move, but the allocation is real money: about 1% of CDFIs' combined assets. Goldman says its program goes well beyond CRA requirements. Regulators may consider a bank's CRA performance when approving mergers, acquisitions, or other expansions.
Lending to CDFIs gives banks a low-risk way to reach businesses that may become customers. Bankers say their CDFI portfolios have low loss rates, because community lenders take the first losses and because nonprofits provide technical assistance to entrepreneurs. That help "often makes a difference if small businesses are viable or not," says Megan Teare, vice-president for CDFI lending programs at Wells Fargo.
CDFIs have not been immune to the downturn—about 9.3% of loans were more than 30 days past due in the third quarter, compared with 6.25% in 2006, according to industry surveys. But, says Donna Gambrell, director of the U.S. Treasury fund that supports CDFIs, "We have not seen the deterioration that we were fearful we would see." To banks looking to expand their small business loan programs, that's good enough.