Banks That Believe In Many Towns Called Hope

Four years ago, J. David Hair was getting nowhere in his attempts to persuade local bankers in Hot Springs, Ark., to take a flyer on his fledgling business, K-Tech Inc. The 50-year-old chemist's luck changed, however, when he visited Southern Development Bancorporation in nearby Arkadelphia.

Impressed by the entrepreneur's proprietary method of making wear-resistant ceramic coatings for machinery, Southern Development agreed to provide an initial $200,000, which enabled Hair to launch his business out of two Quonset huts. "Everybody else wanted to put in $10,000 and make a zillion dollars with no risk," recalls Hair. "Southern was willing to take the risk with us."

`MICROLOANS.' That may be because Southern is no ordinary commercial bank. It's one of a handful of community development banks nationwide whose mission is to stimulate the economy in areas where other bankers are loath to lend. It was founded in 1988 with $12 million in startup capital from private donors, such as the Winthrop Rockefeller Foundation, that were eager to bring jobs to rural Arkansas and were willing to limit their return to the inflation rate.

The idea has been working for Southern Development as well as for David Hair. In 1991, Southern's commercial bank unit, Elk Horn Bank & Trust Co., posted a return on equity of 10.68%, well above the industry average of 7.84%. Assets and net income have been growing steadily (chart).

Inspirational? Sure. But there's more to the story. Little Southern has powerful friends. President-elect Bill Clinton was instrumental in setting up the bank, and Hillary sits on the board. Her former law firm has done legal work for the bank. Clinton hopes to use Southern as a model for new-style financial institutions that will pump loans into depressed communities around the nation.

During the campaign, Clinton vowed to create 100 community development banks as well as 1,000 separate "microloan" programs that make small, short-term loans to the poor. Banks such as Southern "have helped show other lenders that community lending can be done profitably,"says Marc A. Weiss, a Columbia University professor and informal Clinton adviser.

Development banks are a typically Clintonian device to get maximum leverage for government spending through the creation of public-private partnerships. Under his proposal, the government would help launch a new institution by providing either matching funds or tax incentives for private investors. After that, the venture would be on its own.

Already, though, the mere idea of government-aided development banks is raising the hackles of commercial bankers. They argue the concept could turn into another Farm Credit System, the federal program that incurred huge defaults on agricultural loans in the early 1980s and needed a temporary infusion of $4 billion from the government. What's more, commercial lenders argue that they could do the job themselves were it not for the regulatory restrictions that they contend discourage lending to riskier borrowers. "Why not unleash the present banking system rather than creating a new and parallel system?" asks Kenneth A. Guenther, executive vice-president of the Independent Bankers Assn.

GOOD FAITH. Clinton advisers insist that the new banks would complement, not compete with, commercial banks. Indeed, some aides hope existing banks would form partnerships with the new community banks, perhaps buying stock in the new companies to meet their obligations under the Community Reinvestment Act of 1977.

Southern Development's role goes beyond mere bank lending. To help launch Hair's business, Southern's nonprofit venture-capital arm, Southern Ventures Inc., invested $375,000--in exchange for convertible preferred stock worth 33% of K-Tech--that allowed the chemist to begin purchasing equipment. Southern's Elk Horn Bank & Trust and an affiliate came in afterward with a loan of $225,000 for machines and working capital. With Hair's business having outgrown the Quonset huts, Southern's real estate development arm, Opportunity Lands Corp., has offered a $325,000 loan to build a new plant that will allow Hair to expand his production and hire five new employees.

Not all of Southern's programs have worked right off the bat. Southern's Good Faith Fund, which has made $170,000 in microloans to allow low-income individuals to start their own businesses, racked up high losses early on. "We were the new kids on the block," admits Good Faith's executive director, Julia Vindasius. "Every scam artist on the block took advantage of the fact that we would work with them."

To discourage fraud, Good Faith reduced initial loans from $5,000 to $1,200. And would-be borrowers must now sit through 21 hours of instruction in basic business skills. That has helped the program cut loan losses from 30% during that first year to just 3%.

The Good Faith program, modeled after the Grameen Bank of Bangladesh, relies more on peer pressure than credit evaluations or collateral to assure repayment. Good Faith groups participants into small "borrowing circles" that meet weekly to share experiences--and approve any loan requests by members. No group member can apply for a larger loan as long as any other member is behind on his or her payments.

CAUTION. Despite Southern's success, some community activists question whether it can be replicated on a large scale. Other development banks have had trouble coming up with a lending strategy that really helps their communities. South Shore Bank of Chicago, the pioneer in the field, has rejuvenated whole blocks of south Chicago with its housing-rehabilitation loans, but it spent years in a mostly futile effort to help small businesses take root in the neighborhood. "If people have the idea that they can come in a neighborhood and within a short period turn around a depressed situation that has taken years to develop, they're wrong," reflects South Shore Senior Vice-President Joan Shapiro.

With the savings and loan debacle fresh in the public's mind and many commercial banks facing foreclosure, Bill Clinton is likely to move cautiously in setting up a new and potentially risky program. But down the road, institutions such as Southern could be useful in providing financing to poor but worthy borrowers who have been ignored for years by conventional lenders.

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