Domestic Microfinance Steps into the Credit Breach

During the credit crunch, small business owners rejected by traditional lenders found growth funding through domestic microfinance organizations geared to helping the poor and disenfranchised. Loan applications have increased in the past two years at 66 percent of microfinance groups surveyed by the Aspen Institute, a policy and research organization. While only a few microlenders were able to accommodate a majority of new applicants, those more likely to get funding were "people who were very strong small business owners who in the past would have received financing, but because the banks pretty much shut down, they did not," says Elaine Edgcomb, the director of Aspen's microenterprise FIELD project, which tracks domestic microfinance and conducted the survey.

Domestic microfinance will never replace traditional business lending, nor should the industry drop its primary goals of social improvement and poverty alleviation, says Sean Foote, a venture capitalist and professor of microfinance at the University of California, Berkeley. The industry, which reported lending an aggregate $68.6 million in FIELD's survey from financial year 2008, represents only a drop in the bucket of the U.S. credit market. But it is growing fast and has taken on new importance during the recession.

"There's a class of potential loan recipients for which microfinance really works," says Foote, who measures interest in the industry partly by the fact that his Berkeley classes are simulcast to 50 universities nationwide. The ideal microfinance borrower is "trying to get a loan from a traditional bank and is unsuccessful because they have no credit history or they've had some hiccups," he says.

Microlenders Helping Small Business

Although U.S. microenterprise development has been around since the 1980s, there are only a handful of organizations that make more than 100 loans a year, including ACCION USA, Kiva, and Opportunity Fund.The industry got a publicity boost two years ago, when Grameen America, an offshoot of Bangladesh-based Grameen Bank founded by Nobel Peace Prize winner Muhammad Yunus, began operations in Harlem and Brooklyn. In mid-May, Grameen opened a Manhattan branch.

But most of the 700 institutions identified in FIELD's survey are tiny nonprofit and quasi-governmental organizations that operate on a local or regional level, working one-on-one with disenfranchised populations. Most provide business training and technical assistance; about 400 also do small business loans, Edgcomb says. A typical maximum loan is around $35,000.

An even smaller amount can be a vital lifeline for a small company struggling to move to the next level. Simonida Cvejic, executive director of Bay Area Medical Academy, a medical technician school in San Francisco, says the $10,000 initial loan she got from San Jose-based nonprofit microlender Opportunity Fund was crucial. Cvejic survived war in her native Yugoslavia, won grants to study abroad, and worked in Goldman Sachs' (GS) Silicon Valley venture capital distribution office before starting her own business in 2005. Her school, which brings in $1 million in yearly revenue, now trains 400 students annually, many of them recently laid off or former welfare recipients.

Qualitative Evaluation

But in 2007, when she applied for a traditional bank loan to lease and furnish more classrooms, neither her scrappy background nor her successful business was enough to get her foot in the door. "They denied me based on the fact that I'd been in business for slightly less than two years. And they looked at my personal credit record—I'm a single mom with two kids! It's all about checking a bunch of boxes, and if you check one wrong, they deny you. It's very impersonal," Cvejic says.

Opportunity Fund looked at her credit history, but they also talked to her for more than two hours, asking about her background and evaluating her company's potential. After she got the $10,000, Cvejic was able to attract $20,000 from a private investor. "Once somebody gives you money, it's a vote of confidence that means so much. When others see it, they feel more comfortable," she says.

William Ortiz-Cartagena has a similar story. His San Francisco-based company, Gentle Parking, pulls in $250,000 annually managing six lots and a city parking contract. "To have a small business get a city parking contract is unusual. The industry is dominated by huge corporations because smaller companies can't carry the cost of insurance," he says.

After growing up in the city's high-crime Mission District and having some brushes with the law as a teenager, Ortiz-Cartagena was proud of his business accomplishments. But when he applied for a line of credit this year so he could bid on another city contract, a large bank turned him down because a modification on his adjustable-rate mortgage had affected his personal credit.

Loan Rates Rising

He, too, got a green light from Opportunity Fund. The microfinance group's loan rate increased 30 percent this year over last year, when CEO Eric Weaver says he began seeing a "huge increase" in loan inquiries. The same trend was reported by the industry's top players when they gathered last month at the first national microfinance conference, Weaver says. The event, which has been held on the state level in the past, drew 700 attendees, including California First Lady Maria Shriver.

"The very sudden and dramatic pullback in small business lending by U.S. banks has caused people to realize they need alternative lending," Weaver says. "We didn't stop lending when the recession came because we don't do anything else but lend."

Federal government support, including funding from the 2009 recovery act, and an increase in private donations have also helped. "People are getting it that we have to rebuild the economy in a sustainable way that strengthens our neighborhoods and gets back to basics. Microlending fits right into that," he says.

Ortiz-Cartagena, who is now bidding against the big players for that new city contract, is a believer. "It's like David and Goliath, and Opportunity Fund is my slingshot," he says.