A big breakthrough in tiny loans
The Alameda Swap Meet in South Los Angeles is about the last place you’d expect to find a breakthrough in small-business lending.
Filled with Spanish-speaking mom-and-pop vendors selling cowboy boots, videos, quinceañera dresses and fresh fish, the indoor bazaar tends to be long on cash sales and short on formal bookkeeping.
But vendor David Manzo is building his business one swipe at a time. Every time a customer pays with a credit or debit card, a portion of that sale automatically goes to pay down a $5,775 loan to the Mexican immigrant, whose Mirna’s Market offers herbal remedies and religious items.
The loan’s 12% interest rate is a fraction of what Manzo paid in the past for expansion and inventory loans. And he never worries about repayment. If business slows down, his installments drop automatically; when things pick back up, the higher sales mean the loan balance goes down faster.
Keeping up with his payments “is just not a problem,” Manzo said, surrounded in his cramped stall by kidney pills, amulets, bath salts and devotional candles. “I really don’t have to think about it.”
In a season of political clashes over Uncle Sam’s role in the private sector, Manzo’s loan — an innovative product dubbed EasyPay — was made possible by a little-known partnership involving the government, financial institutions and charities.
His lender is Opportunity Fund, a San Jose nonprofit that is among roughly 700 federally certified Community Development Financial Institutions. The CDFIs, as they are known, include some small banks and credit unions, but most are community loan funds along with a scattering of venture capital funds.
The institutions provide subsidized loans to low-income and hard-to-serve customers using funds from banks, foundations, religious groups and individuals, along with awards from the U.S. Treasury. In Los Angeles, the nation’s capital for immigrant-run businesses, there are plenty of potential customers.
Such microlending has boomed in the developing world, involving “lending circles” of individuals who pool their savings. There are also loans from institutions such as Grameen Bank of Bangladesh, whose founder, Muhammad Yunus, is a Nobel laureate.
Mainstream U.S. banks have found tiny loans expensive to administer and fear being criticized for charging rates high enough to cover their costs. So they have largely yielded the field to nontraditional private-sector lenders, including the CDFIs.
“Microlending can be the answer to job creation and upward mobility in the U.S. The problem is that financing a hair salon is a different ball of wax from financing a goat” in a developing country, said Mitch Jacobs, founder of On Deck Capital Inc., a for-profit microlender that makes short-term loans at 18% to 36%.
Jacobs said the biggest problem for banks is overhead costs, since determining a start-up’s creditworthiness is far more difficult than pulling a consumer’s credit score.
“Small commercial loans don’t make money for banks,” he said, “because rather than use the cheap personal FICO score, they have to gather business data, which is very hard to do with micro businesses.”
By contrast, working intensely with tiny businesses is a primary focus of CDFIs, which have their roots in decades-old government efforts to reduce poverty. The CDFIs expanded their funding in the 1970s by reaching out to religious institutions, individuals and other private sources, but the biggest boost came from two early initiatives by the Clinton administration.
The Community Development Financial Institution Fund, a Treasury Department agency that certifies CDFIs and makes awards to them, was created in 1994. A year later, the federal Community Reinvestment Act was revised so that banks could automatically receive credit toward their obligation to lend in lower-income areas by providing funding to CDFIs. The banks typically lend money at 2% to 3% interest to the CDFIs, which use the cheap funds to make loans of their own.
Over the years, CDFIs have extended about $40 billion to tiny U.S. businesses, almost all of it coming from banks and private investors.
“We’re like tugboats — we can sort of prod capital into our communities,” said Mark Pinsky, chief executive of Opportunity Finance Network, an industry association and standard setter.
Traditionally affordable housing and small-business lenders, the CDFIs have proved much more adept than banks at serving certain niches.
Examples include loans to grocery stores in poor neighborhoods and the financing of building purchases for charter schools, said Megan Teare, a Wells Fargo & Co. senior vice president who manages the bank’s $400 million in CDFI lending.
Locally, Orange County’s Clearinghouse CDFI has made $925 million in loans over the last 15 years to such borrowers as the Monarch School for homeless children in San Diego, the Samoan Congregational Community Church in Carson, and Native American Natural Foods, which produces buffalo meat and berry snacks on the Pine Ridge Indian Reservation in South Dakota.
Because CDFIs are closer to their customers and often less constrained by regulations than banks are, they’re often better positioned to stretch out repayment periods and to provide lower rates.
“It’s relationship banking on a very small scale,” said Bill Luecht, a spokesman for Treasury’s CDFI Fund, noting that the hand-holding often includes helping customers develop business strategies and improve their creditworthiness. “They may work with a business for a year or more before they even make a loan.”
That “tailored assistance” is largely responsible for a relatively low default rate on CDFI loans, Luecht said, despite the modest resources of their customers.
About 2% of all CDFI loans over the years have been written off as uncollectable, according to Opportunity Finance Network, an industry association and standard setter.
At Opportunity Fund, the San Jose-based nonprofit that helped L.A. small businessman Manzo, overall defaults have totaled less than 1%, according to Chief Executive Eric Weaver.
Performing especially well have been the fund’s roughly $200 million in real estate loans — money for affordable apartments, health clinics, community centers and other development, mostly in low-income neighborhoods in the Bay Area.
The loss rate has been higher on about $25 million of small-dollar business loans averaging $7,800 each. The success rate on those microloans has been 92%, Weaver said, with 85% of the small businesses helped by Opportunity Fund still in operation.
Founded in 1995 by a consortium of banks as a way of meeting their community lending obligations, Opportunity Fund also has a “micro savings” program that matches every dollar saved by individuals with $2 in funds supplied by government and philanthropic sources.
Entrepreneur Paul Cruce turned to Opportunity Fund after his Albany, Calif., pastry and coffee shop failed.
He wanted to reinvent himself as a seller of gourmet coffees and teas at farmers markets. Credit dings ruled out a bank loan. The CDFI reviewed Cruce’s business plan and agreed to help his Holy Cow Coffee Co.
“The standards Opportunity Fund uses are a little different,” Cruce said. “They kind of look at the person rather than the credit rating.”
To participate in the two-for-one micro-savings plan, Cruce socked away $2,000 into a savings account. Opportunity Fund then matched it with a $4,000 grant after a year, enabling him to buy an old postal delivery van.
The fund then lent him $4,000 last spring so he could outfit the van as the Holy Cow Espresso Express.
When it turned out that his onboard generator was inadequate, Opportunity Fund “rode to the rescue again,” Cruce said, refinancing him into a three-year, $7,000 loan at 7.5% interest.
“Just last Friday I picked up the truck fitted out with the new generator and now it works as intended,” he said. “They are amazing people to work with.”
While Cruce was helped by a standard microloan, the EasyPay loan that Manzo received has provoked the most interest in community lending circles. Opportunity Fund last month received a $100,000 grant to expand the new loan program, provided by the Opportunity Finance Network with funding from Wells Fargo and the MacArthur and Kresge foundations.
The aim is to spread the EasyPay loans — “a potential breakthrough product,” according to Wells Fargo community lending chief Lesley Eckstein — from a test market in Southern California to Opportunity Fund’s home in the San Francisco Bay region and beyond.
Rather than rely on credit histories, the program analyzes credit card and debit card sales records to determine whether the loans can be repaid at a pace the business can support.
EasyPay greatly simplifies bill collecting, since a portion of the debt is repaid every time a card is swiped. Borrowers sign up with one of two transaction processing companies that have agreed to send a predetermined percentage of card sales directly to Opportunity Fund.
Repayment of loans to buy inventory is typically targeted at 12 to 18 months; the projected payoff for equipment purchase loans is three or four years.
Still, because payments fluctuate, “we can only guess how long it will take,” Opportunity Fund CEO Weaver said.
“If they’re having a great sales month they’ll pay down the loan quickly at a time they can afford it. When it’s slow they pay less,” he said. “So repayment matches cash flow.”
The EasyPay program was devised at a for-profit predecessor, Financiera Confianza, which Opportunity Fund took over this month.
During six years in business, Confianza proved unable to turn a profit while making what are known as merchant cash advances. These are short-term business loans with annual interest rates that typically work out to 70% or more, although Confianza’s rates were in the 40% to 50% range.
After testing EasyPay loans on 30 borrowers at 12% interest, Opportunity Fund was impressed by the efficiencies of the system and decided to take over the operation. Confianza’s 12 employees, including founder Marco Lucioni, are staying on to run the business.
The high rates for merchant advance loans make them suitable only in times of crisis for businesses, Lucioni said, while the 12% Opportunity Fund loans are appropriate for everyday financing needs. “We think there could be a very high demand for these loans,” Lucioni said.
For Manzo, it’s another step toward realizing his American dream.
“My fourth son is starting college,” he said. “This is a real help.”
