Low-Cost Loans for Small Businesses Turned Down by Banks

It’s an old story: Bank lending to small businesses went away during the financial crisis and never came all the way back. Tighter lending standards created space for alternative lending models, most of which offer access to capital at sky-high interest rates. In other words, you can get a loan, and you can get it fast, but it’s going to cost an arm and a leg.

Roberto Barragan, chief executive officer of nonprofit lender Valley Economic Development Center, envisions a more affordable future for entrepreneurs seeking credit. On Dec. 9, VEDC launched a $20 million fund to lend to small businesses in New York, New Jersey, and Connecticut. The fund will make loans from $50,000 to $500,000, setting it apart from nonprofit microlenders that generally lend smaller amounts, says Barragan. Most borrowers will have previously been turned down by banks, and VEDC says it’s interest rates will probably average from 6 percent to 8 percent.

The Tri-State Business Opportunity Fund, as the new program is called, marks the latest expansion for VEDC, a Community Development Finance Institution (CDFI) that has lent more than $180 million to small businesses and nonprofits in the Los Angeles area since 1976. Last year, VEDC launched initiatives to lend to women- and minority-owned businesses in Nevada and in the Chicago area.

That’s still a drop in the bucket, relatively speaking. The U.S. Small Business Administration guaranteed about $30 billion in loans in the year ending in September 2013. Merchant cash advances probably account for a further $1 billion (PDF) in annual small business lending.

CDFIs have lent $1.5 billion to small businesses since 2008, according to Mark Pinsky, CEO of Opportunity Finance Network, an umbrella organization for CDFIs. Pinsky calls CDFIs “tugboat lenders” because they serve to bring larger financial institutions into lending markets. “It’s our job to show that it’s possible to lend to small businesses at reasonable rates and get repaid and repay our investors,” he says.

Barragan has two reasons for thinking nonprofit lenders can take a bigger piece of the pie. Banks are turning down lenders that VEDC sees as good credit risks, he says, allowing the nonprofit, which can lend to businesses that don’t fit into banks’ cookie-cutter credit standards, to keep its loss rate to about 2 percent. “One thing we’re seeing a lot of lately is borrowers who have had some challenge with the real estate market,” he says. “I have a [borrower] right now in Los Angeles—a garment company, 50 employees, great future, good cash flow, great collateral. But he walked away from a mortgage on a condo in Vegas, and that’s killing him with the banks.”

Because almost all of VEDC’s loans are repaid in full, the organization has had success courting deep-pocketed corporate partners. That includes UBS, which provided the $20 million for VEDC’s new lending program. That money doesn’t come free to VEDC, but the Community Reinvestment Act gives UBS and other banks reason to fund nonprofit lenders on friendly terms. Goldman Sachs, notably, has committed $300 million to fund small business loans by organizations such as VEDC through its 10,000 Small Businesses program.

Given VEDC’s track record at collecting from borrowers, Barragan would like to convince other behemoths with lots of small-business customers to support nonprofit lenders. “We hope that other institutions get involved in lending—not just banks,” he says.

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