Financial Innovations and Small Business GrowthPresentation Transcript
Financial Innovations and Small Business Growth Glenn Yago Milken Institute October 2009
Small Business are Vital to the U.S. Economy
99.7% of the 5.5 million firms in the United States have fewer than 500 employees.
Small businesses account for 50% of private-sector output, employ more than 50% of private-sector workers, and create about 75% of net new jobs per year.
2/3 of small businesses have less than 5 employees.
4/5 of small businesses are located in urban areas.
15% of small businesses are minority-owned; 24% are women-owned.
Low-Income Areas Suffer from a Lack of Capital
From 1996 to 1999, small business loans in upper-income areas grew 13 times the rate of growth in low-income tracks.
Of the 9.7% of individuals without bank accounts, 50.5% generate incomes below $10,000.
Fifty-three percent of individuals living in poverty are racial minorities.
Nearly forty percent of firms ranked in the InnerCity 100 were owned by minority entrepreneurs.
Roughly 13% of U.S. small businesses with employees are owned by minority entrepreneurs.
The U.S. Minority population today is larger than the population of 93% of the world’s countries.
The Minority population will account for nearly 90 percent of the total 131 million growth in the U.S. population from 1995 to 2050.
The Minority population will most likely pass the non-minority population after 2050.
Minorities today account for $1.3 trillion, or 20% of the U.S. total $6.5 trillion purchasing power.
Minorities Grow in Importance
Increasing Role of Minorities in the Labor Market
Labor Supply Constraint
Since the 1970s, the U. S. workforce growth rate as been declining--from 2.7% in the 1970s, to 1.6% in the 1980s, to between 1.0-1.5% today. Projections over the next decade predict continued low rates of increase.
Meanwhile, by 2020, 70% of the workforce growth will occur among minorities.
Unless this workforce can be tapped, the lack of labor will act as a brake on economic growth.
Small Business’ Sources of Financial Services by Sales Percent Fiscal Year Sales (Thousands) *thrift (savings institution, credit union); **finance company, brokerage, leasing company, other; ***family and individuals, other businesses, government
Small Business’ Sources of Financial Services by Ethnic Group Percent
Small Business’ Uses of Financial Service Products by Sales Fiscal Year Sales ($Thousands) Percent *checking, savings; **credit line, mortgage, vehicle, equipment, capital lease, other; ***transaction, cash management, credit-related, brokerage, trust and pension
Small Business’ Uses of Financial Service Products by Ethnic Group Fiscal Year Sales (Thousands) Percent *checking, savings; **credit line, mortgage, vehicle, equipment, capital lease, other;
Small Business’ Uses of Financial Service Products by Ethnic Group, cont. Percent *Transaction services, Cash management, Credit-related, Brokerage, Trust and pension. ** excludes proprietorships
Breakdown of CRA Lending By Category in 1999
CRA –Related Small Business Loans are Profitable
Center for Emerging Domestic Markets “CEDM”
Definitive source of information, innovation, and interaction for financing Emerging Domestic Markets
Joint venture of the Milken Institute and the Capital Access Group, with initial funding provided by MBDA.
Provides information-based services and products to help investors, lenders, entrepreneurs, guarantors, regulators, universities, and philanthropic and government organizations.
Virtual and real-time conferences and on-going dialogues between participants.
A “lab” to develop and pilot market-based public policies and innovations intended to increase access to and deployment of capital for EDM businesses.
Milken Institute Study: Purpose
Sponsored by the Ford Foundation.
Survey the small business capital access environment, focusing on pilot initiatives testing new financial innovations, and/or mechanisms that may bring existing programs to scale.
Analyze the situation surrounding capital access to small businesses in low income communities.
Make recommendations to address the disparity of access to capital.
Milken Institute Study: Methodology
In undertaking the study of capital access to small businesses in low-income communities, the Milken Institute conducted the following tasks:
Comprehensive literature review of current studies and research in finance, economics, and policy concerning the distribution of public and private equity/debt to low-income entrepreneurs.
Empirical review of data sources concerning barriers to capital access.
Industry focus groups with industry leaders from mainstream and community financial institutions (depository and non-depository), investors, regulators, and others.
Telephone interviews and surveys of industry practitioners.
Fundamentals of the Opportunity
Large concentration of consumers who are generally underserved
Significant supply of inexpensive, strategically located land
Large concentration of labor pool
Untapped market for investment
Empowerment zones, enterprise communities, and Brownfield initiatives
Obstacles to Financing
Lack of loan performance data
Leads to higher perceived risk
Lack of standardized products & sufficient deal size
Leads to higher cost
Lack of networks
Leads to disinformation regarding to capital sources
Lack of allocation of “value-chain” activities
Leads to inefficiency by small firms and non-participation by large firms
The “Value Chain”
Some Consistent Themes
Perceived risk is higher than actual risk
Better data is required
Small businesses need access to range of capital at all stages of growth
Key factor is access and repayment terms, not interest rate
Community development financing is often not cost-effective
Easier for smaller financial firms to innovate; Easier for larger firms to roll out
Financial technology must be deployed
Mergers limit lending – offer opportunities for innovation
CRA could benefit from broader applications
Characteristics of Successful Innovation
In studying the past and present innovations in economic history, we have identified several important components of successful innovation:
Ability to experiment
Replication and scale
Categories of Innovation
Innovations in sources of capital
Innovations in financing structures
Innovations in tools supporting financing
Innovations in means of ownership
Sources of Capital Examples
Shell Community Banking Initiative, Union Bank –Nix Check Cashing, Union Bank - WEDC
Community Bank of the Bay
CalPERS’ California Initiative
Financing Structures Examples
Credit enhancement – Capital Access Programs
Public/private funds for guarantees and leveraging
Chase Rural Development and Finance Corp
Revenue royalties - Sustainable Jobs Fund
Pooling and securitization
Pooling non-investment grade loans, turning them into S&P rated, investment grade securities
Southern Ute tribe gains tribal first independent AAA bond rating
Receivables guarantees - ACTrade
“ Debtquity” -CDVC Funds
Liquidation structures – Boston Community Capital Study
Tools Supporting Financing Examples
FleetBank Boston’s Community Link
Data collection – Merrill Lynch/CDTech
‘ Count-Me-In’ and Fair, Isaacs
Runners’ Club, SVCV
Financing professional services
Strong networks & intermediaries
CRA credit swaps
Forms of Ownership Examples
Pueblo Nuevo – Employee cooperative offers training, living wage, benefits, growth opportunities, and profit sharing for low-income workers
East-West Bank’s Chinese Language Web-Banking fills the demand of the Chinese immigrant community
FAME Renaissance – financing, mentoring, business assistance provided from a source familiar with the community.
Packaging the Undervalued Assets of Low-Income Areas
Low-income communities’ assets can be packaged and developed properly to create great value and opportunity for residents and investors:
Strategically developed land trusts
Pooling small business loans
Leveraging government incentives, funds, regulations effectively
Creating new financial structures, tools, and products
Innovations Small Business Finance Model Loan Sellers Non-Profit Development Org Banks SBA Loans Credit Unions Municipalities Non-Depository Financial Inst Market Rate Investors Banks Insurance Companies Pension Funds Corporations Concessionary Investors Foundations Religious Institutions Charitable Contributors Foundations Loan Pool Credit Reserve Fund DOA (IRP), DOC-MBDA, EDA, DOE, EPA, DOT, SBA (7A, 8A) Existing Government Guarantors
Innovations Securitizing Community Development
Securitizing community development loans is a potentially lucrative market:
Variety of loan or receivable pools that can be securitized.
Firms are constantly exploring possible products for securitization.
Institutional investors may find securitization attractive.
Identified pools of capital for a California pilot include:
Contract receivables securitization.
Senate Bill 661 - allows for securitization of community development funds backed by funds from CIDFAC.
Private funds active in securitization - Impact Capital, CNL Commercial, Women's Equity Mutual Fund
Innovations California Capital Access Program “CalCAP”
Loans up to 2.5 million dollars are insured by premiums paid by borrower and lender, which are matched by government and placed into loan loss reserves; total premium of 8%.
Verifiable 12-year history of defaults averaging 3.9%, 3.5%
Over time, as more and more loans are enrolled, a lender's loss reserve account grows substantially.
Securitization of these loans are pending
CNL Commercial Finance of Yorba Linda, California will securitize $100 million of CalCAP loans in the first year and $150 million each year thereafter.
Loans will be real estate related, with an 80% recovery history, 25-year maturity, five years non-refund, 7.75 years average life and float at prime+1.
Loans will be 85%-90% LTV and have coverage of 1.2 times.
Expectations for 90% of loans to be rated AAA and the remaining 10% to be rated A
Innovations National Capital Access Programs
Support for a National Capital Access Program:
Currently, state Capital Access Programs (CAP) are small business-lending programs available in 22 states and two cities.
Over $1.2 billion loans have been issued, with losses running at 3.1% of all loan volume.
Off-balance sheet, risk-less 20% profit return to CAP lender on each deal after all expenses.
U.S. Congress authorized, but not appropriated $200 million to for a national CAP reserve, intended to replenish state portion of CAP programs.
BridgeNotes are subordinate-lien, “companion” loans developed by the Capital Access Group and designed to “bridge” the gap between the amount a bank is willing to lend and the small business borrower’s total financing need.
Bridge Notes will:
Increase bank lending to low-income communities.
Increase community-lending capacity.
Increase availability of data on loans to under-valued businesses.
Transaction Diagram ($1,000 loan) BridgeLine Company Trust Bank 1. Advances $1,000 2. Signs $750 senior note and $250 junior note; pays 2% insurance fee. 4. Gives $788 for senior note 3. Sells $750 senior note Retains $250 junior 5. Transfers $250 note and $58 fee 6. Sells bonds; gives $250 cash
Innovations Breaking up the Value Chain: Micro-enterprise Training and Financing Program
USC Business Expansion Network, Liberty Hill, California Community Foundation and CalFed Bank team up to tap the untapped market.
MTFP will provide loans to small-scale businesses which require less than $10,000 of investment capital.
USC BEN has a 14-year history of cultivating entrepreneurship and will provide mentoring to the borrowers.
California Community Foundation covers the cost of full time staff at USC BEN.
Liberty Hill has a stake in promoting social and economic development in low-income communities and will share the risk with CalFed.
CalFed Bank is able to provide the mechanics of loan processing, securitization, funding, and monitoring.
Innovations CRA Credit Swaps
CRA credits can be traded among banks much like carbon swaps in environmental trading
Banks specializing in CRA –related lending can “swap” with banks who are short of adequate CRA credits.
CRA credit swaps encourage specialization and niche lending – familiarity with the people, business, culture and economy of their CRA assessment community.
Banks unfamiliar with the low-income market will not make poor quality loans based on poor understanding of the market.
Broadened Application of Legislation and Regulation