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IN THIS ISSUE:
Feature Story
2
The Growing Securitization of Small Business Loans
Recent developments in the capital markets aim to bring
improved liquidity and other benefits to lenders, mostly through
the sale of securities backed by small business and even
microenterprise loans.
P ro d u c t i v e Pa rt n e r s h i p s
9
The Venture Center: Venture Capital for Women-Owned
Businesses
Massachusetts-based Center for Women & Enterprise (CWE)
partners with Fleet Bank and BankBoston to improve the access
of female entrepreneurs to venture capital.
Informa tion Ex change
12
The Boston Fed announces the release of the video
To Their Credit: Women-Owned Businesses.
Enterprising
13
The Business Consortium Fund: Wo rking Capital fo r
MBEs
The New England Minority Purchasing Council offers minority
business enterprises (MBEs) help in obtaining short-term
working capital.
A ro u n d N e w E n g l a n d
16
Microenterprise in Maine: Training Curriculum Development
The new microenterprise curriculum aims to strengthen the
technical skills of microlending organizations in Maine and
throughout New England.
Consumer Focus
19
Regulation M: Improved Protection for Consumer Leasing
A review of the new Regulation M and its segregated
disclosures, intended to protect consumers during the leasing
process.
To o l s t o U s e
23
New CRA compliance software aims to make reporting and
analyzing data easier, and to help streamline the examination
process.
Summer 1998
F E D E R A L
R E S E R V E
B A N K
O F
B O S T O N
number twenty two
FEATURE
STORY
The Growing Securitization of Small Business
Loans
In 1993, Chairman of the
Federal Reserve Board Alan Greenspan
noted that "if we could find a way to
expedite a secondary market in small
business loans, it would be . . . a major
contribution to the financial vitality of
this country." Since then a growing
number of private and nonprofit organizations have been actively pursuing the
securitization of small business loans,
and in some cases microloans (see
pages 6-7.)
Legislative incentives, combined
with rapid developments in loan origination and underwriting technology, are
paving the way for the creation of marketable debt-like securities backed by
commercial loans. The driving force
behind the securitization wave is the
desire to give lenders access to capital
markets, improve their liquidity, and
spur more small business lending.
The Record on Securitization of
Small Business Loans
Securitization involves the creation of securities backed by a pool of
debt instruments, for example, loans or
receivables, which produce a stream of
payments and have a predictable default
rate. The securities are then sold to
investors, generating sale proceeds and
fees that can be recycled to provide
loans to other borrowers. Investors who
purchase these asset-backed securities
are purchasing a share of the future payments from the underlying debt, for
example, a group of auto loans. The
practice rose to prominence within
financial circles following the introduction of the mortgage-backed security in
the late 1970s, a move that led to the
2
creation of an extremely liquid secondary market for home loans in the
United States. Soon after, other forms of
debt were also being securitized.
Recently, a virtual explosion in
securitization has occurred; assetbacked securities grew from approximately $8 billion of investment instruments in 1987 to $140 billion in 1996.
The newer asset-backed securities are
increasingly risky, offering investors the
potential for higher returns while creating added liquidity for capital-constrained lenders. Once confined to mortgages, securitization has also turned
auto loans, credit card receivables, student loans, and even phone bills and
parking tickets into marketable securities.
Securitization of certain small
business loans has been ongoing since
the mid 1980s. Commercial real-estate
loans and small business loans collaterized with property are already widely
securitized by several banks and mortgage companies. In 1985, banks and
nonbank finance companies were
allowed to pool and sell the guaranteed
portion of loans originated under the
7(a) and 504 loan programs operated by
the U.S. Small Business Administration
(SBA). In 1992, nonbank finance companies were allowed to securitize the
unguaranteed portion of SBA loans,
after arguing that their lack of deposits
imposed liquidity constraints. Since
1985, qualified lenders (both banks and
nonbanks) have securitized over $20 billion of the guaranteed portion of SBA
loans; nonbank finance companies have
also securitized $1 billion of the unguaranteed portion of SBA debt.
The newer asset-backed securities are increasingly risky, offering
investors the potential for higher returns while creating added liquidity for
capital-constrained lenders. Once confined to mortgages, securitization has
also turned auto loans, credit card receivables, student loans, and even
phone bills and parking tickets into marketable securities
3
Small business lenders, including community banks, nonbank finance
companies, and economic development
agencies, are securitizing their illiquid
commercial loans for various reasons.
These include the potential to lower
loan servicing and capital costs, while
simultaneously reducing the riskiness of
their loan portfolios. In addition, lenders
wish to use sale proceeds to originate
more loans to small businesses. For borrowers, the key benefit is increased
availability of commercial loans, since
lenders will have wider access to the
capital markets.
cate commercial loan securitization
efforts are the lack of product standardization, difficulties in risk assessments,
and the transaction costs. These factors
combine to make small business loan
securitization more costly and less
attractive in comparison to other initiatives involving mortgages, auto loans,
and credit card debt.
First, is the lack of standardization. Greater flexibility in maturity
schedules, interest rates, and other
underwriting terms have allowed lenders
to create loan packages to best suit the
particular needs of any small to mediInterest in securitizing commerum-sized enterprise. The downside of
cial loans grew rapidly after the passage
this degree of flexibility is that there are
of the Riegle Community Development
no consistent origination and underwritand Regulatory Improvement Act of
ing standards for most commercial
1994. The Riegle Act reduces capital
loans, making it very difficult to pool
requirements for banks
together similar
". . . if we could find a way to
that issue securities
loans and evaluate
backed by commercial expedite a secondary market in
the risk associated
small
business
loans,
it
would
and economic develwith them. The tenopment loans. It also be. . . a major contribution to the
dency of small busirelaxes investment
nesses to refinance
financial vitality of this country."
restrictions on securitheir debt more
---Alan Greenspan
tized loans. Under the
often, and the differChairman
of
the
Federal
Reserve
revised Community
ences in profitability
Reinvestment Act
among industries,
(CRA), a bank or a bank holding comalso muddle attempts to predict cash
pany may be entitled to CRA credit for
flows from these loans and to pool them
purchasing securities backed by small
together with other loans.
business loans. The underlying loans
must be determined to have primarily a
Second, are the difficulties in
community development purpose and
assessing the credit quality and risks of
benefit the institution’s assessment area
these loans. Jim Hammersley, Director
or a broader statewide or regional area.
of Secondary Market Activities for the
In addition, this March the SBA pubSmall Business Administration, states
lished a rule allowing all banks and
that while small business loans are not
other depository institutions to securinecessarily riskier than other types of
tize the unguaranteed portion of SBAdebt, "the quantifiability of risk is lower
backed debt. The proposed rules would
than for other debt." For example,
require that a lender retain a percentage
unlike mortgage loans, many small busiof the loans’ value equal to twice its hisness loans are not backed by property,
toric loan loss rate.
the value of which can be easily determined based on market forces. Apart
from personal guarantees, there is usualBarriers
ly little or no collateral standing behind
a small business loan.
Despite these legislative developments, securitization of small busiIn addition, the risk of default in
ness loans is still not a widespread praccommercial loans depends greatly on
tice. The three main factors that complithe individual borrower, his or her line
4
BENEFITS FROM SECURITIZING SMALL BUSINESS LOANS
LENDERS
Greater liquidity
Increased velocity of lending
Diversification of credit risk
Reduced regulatory capital and reserve requirements
Improved risk management
Drive towards more standard origination/underwriting criteria
BORROWERS
More loan capital for business start-up or expansion
INVESTORS
Enhanced diversification of portfolios
--adapted from Bridging the Capital Gap: The Securitization of Small
Business Loans, by Women’s World Banking, 1996.
of business, and other local factors.
While loan officers have access to this
type of information through personal
interaction with borrowers, such information is not readily accessible to
investment bankers, rating agencies, and
potential investors. Poor record-keeping
and documentation by lenders and small
business owners complicate matters. A
lack of long-term performance data on
small business loans further prevents
securitizers from determining the
expected performance of a pool of such
loans.
Finally, the transaction costs
associated with asset securitization tend
to be high, especially for low-volume
lenders. The minimum transaction cost
of securitizing a loan pool runs from
around $500,000 to $1 million, and
drops as the size of the loan pool grows.
Approximately $50 million to $100 million in loans is the minimum pool size
that must be reached before securitization becomes cost-effective. The vast
majority of community banks, with
assets under $5 billion, may not be able
to amass loan portfolios of that size.
Techniques
Lenders, investment bankers,
nonprofits, and others interested in secu-
ritizing small business loans employ a
variety of strategies to minimize the
costs and overcome some of these information and credit-related obstacles.
Most lenders that engage in
commercial loan securitization maintain
high levels of loss protection, either
through loan loss reserves or by retaining a portion of sold loans. This helps to
assure potential investors about repayment and facilitates the sale of commercial loan-backed securities. However, it
greatly increases the costs to the originating banks, thus diminishing most of
the cost savings associated with securitization. Apart from loss protection, securitizers also seek credit enhancements,
often from private foundations, economic development agencies, and public
sector initiatives. In particular, the loan
guarantees provided by the SBA’s various lending programs have been very
effective in enhancing the creditworthiness of securitized commercial loans.
In order to overcome the problems of inconsistent underwriting and
documentation standards, some secondary market agents specialize in
SBA-backed debt, since the agency prescribes certain criteria to its qualified
lenders. Others initiate advance commitments that stipulate a specified volume
5
What About Microloans?
When it comes to securitization, microenterprise loans present an even more difficult set of
circumstances than traditional small business loans.
First, microlending intermediaries offer a variety of
interest rate and maturity structures, third party
guarantees, and repayment options tailored to meet
the specific credit needs of the distressed communities in which they operate. Compounding this lack
of standardization are the small loan amounts: most
loans range anywhere from $500 to $15,000. Often
little or no collateral is behind these loans, since
microlenders usually rely on personal relationships
and monitoring to both ensure repayment and evaluate credit risk. Furthermore, the short history of
most microlending programs in the United States -some are only three or four years old -- also does
not allow for extensive long-term data collection to
aid in risk assessments. Finally, very few
microlending organizations have loan portfolios of
the size necessary to make securitization cost-effective. These factors make it very difficult to pool
similar loans, evaluate the risks involved, and turn
microloans into asset-backed securities that are
attractive to investors.
Frank Altman, CEO of the Community
Reinvestment Fund (CRF), explains that the requisite ongoing technical assistance and small loan
amounts make securitizing microenterprise loans
much more complicated. "If you underwrite loans
that small, you have to underwrite the lender. You
need a portfolio big enough to have critical mass,
and a high level of comfort with the lenders and
how they make and monitor their loans."
Policy debates concerning the expansion of
microlending services have often focused on the
need to securitize these loans. The purpose is to
allow the mostly nonprofit microlending intermediaries to obtain more loan capital and wean themselves from dependence on bank loans, private
donations, and dwindling federal grant money.
Strategies include the pooling of the often riskier
microloans with other conventional commercial
loans, thereby spreading risks and facilitating conversion into marketable debt instruments. Efforts
are also under way to develop more standardized
origination practices.
Larger microlending organizations are
beginning to pool and package their loans, usually
selling them in private placements. ACCION
6
of loans to be originated following specific
origination and documentation guidelines.
Minneapolis-based Community
Reinvestment Fund (CRF), which operates
a secondary market for community development loans, often uses advance commitment arrangements when purchasing loans.
As CEO Frank Altman explains, "CRF
negotiates a lending protocol with them
[community development lenders] in
advance. If loans meet or exceed standards,
we buy them as they are made."
To deal with issues of scale and to
diminish risk, securitizing agents engage in
overcollaterization. Overcollaterization
involves the pooling of many loans, sometimes from different originating sources, to
increase the collateral value behind the
security. By raising the collateral value
above the face value of the debt, the issuer
reduces the overall risk of the newly created asset-backed security. Through pooling,
a lender can sell a larger number of commercial loans from its portfolio -- even
those that are potentially riskier.
Usually the securitizing agent issues
bonds or short-term commercial paper
backed by the pooled loans. The securities
are often sold as "A piece"/ "B piece"
structured debt instruments. This process
involves the division of the debt into senior
("A piece") and subordinate ("B piece")
tranches; the A piece is often attractive to
institutional investors, while the more risky
B piece, either retained by the lender or
purchased by less risk-averse investors,
absorbs most of the credit risk from the
commercial loans. In many cases, the
securities are sold through a private placement, which offers certain tax advantages
to potential investors.
Developments in the Field
To date, most of the small business
loans that have been securitized are either
real-estate-based or are originated under
the SBA’s lending programs. Currently,
there is significant interest in developing
mechanisms to further securitize non-realestate and non-SBA-backed commercial
loans. One potential solution is to create a
securitization intermediary. Although the
Riegle Act does not include provisions for
it, there has been some discussion about
creating a government-sponsored enterprise
(GSE) that would purchase small business
loans from banks and package them into
marketable securities, much as Fannie Mae
and Freddie Mac do with mortgages. The
creation of a GSE specifically for small
business debt might also aid in standardizing origination and underwriting criteria and
in the collection of long-term performance
data for use in risk assessments.
Despite the absence of such a public
intermediary, several promising developments are facilitating more widespread
securitization of small business loans. In
particular, technological advances are facilitating more securitization activity. The
prevalence of credit scoring in the commercial lending industry has accelerated the
application process, while also giving
lenders a standard benchmark against which
to measure an applicant’s credit risk. "Credit
scoring with known profiling capability can
[also] be used by investors," notes the SBA’s
Jim Hammersley. Credit scores might be
used to help aggregate commercial loans
and pool them based on broadly defined risk
categories.
Non-real-estate commercial and economic development loans are also being
securitized, often by individual banks and
nonprofit intermediaries. One of the most
well-established is the Community
Reinvestment Fund (CRF), which provides
liquidity to nonprofit and state-run economic development lenders. Since 1988, the
CRF has purchased 869 loans totaling more
than $57.1 million and issued over $45.7
million in bonds and certificates of participation to investors. The CRF has various
products to deal with the variety of underwriting criteria employed by its clients, and
it has recently begun to securitize microenterprise loans.
Investment banking firms are also
beginning to offer securitization services to
small business lenders. Van Kasper &
Company of San Francisco recently
launched its own Small Business Loan
Securitization Program, which will target
International, the Somerville, Massachusettsbased global microcredit organization, has
begun to securitize elements of its loan portfolio. In June of 1997, ACCION New York sold
64 microloans worth $272,500 in a private
placement with the CRF--the first time that
microenterprise loans were packaged and sold
in this manner. The CRF has also begun to
work with the Montana Department of
Commerce, entering an advanced commitment
agreement to purchase $500,000 of loans
made by five small microlending organizations
in that state.
The Senior Director of ACCION’s U.S.
Division, Livingston Parsons III, explained
that the organization used the sale proceeds to
retire several bank obligations, thereby
improving liquidity. Mr. Parsons also stated
that future securitization will depend on
ACCION’s ability to obtain grants and other
bank loans. "There’s only so much you can get
from foundations and banks," he said. In addition, Mr. Parsons predicts that increased securitization of microloans will become more
attractive to microlenders as banks seek more
investment opportunities. "Banks will get CRA
credit and find a true investment opportunity-not just having loans to ACCION on their
books."
The ACCION sale was a pilot program
for the CRF. The CRF’s Mr. Altman expects
that in the future his organization and others
will be able to create a secondary market security backed entirely by microenterprise loans.
While demand for securitizing services from
other microlenders has been high following
the ACCION deal, Mr. Altman explains that
regulatory prohibitions on the sale of loans
made under the SBA Microloan
Demonstration Program may keep other large
microlenders from accessing the secondary
market in the near future.
ACCION recently received a grant
from the Ford Foundation to help create a
vehicle for broader microloan securitization in
the United States, a project that is currently in
the development stage. ACCION’s Mr. Parsons
noted that such an intermediary would help
"bring a lot of standardization and familiarization to the industry."
7
community development agencies that
routinely lend to small businesses. Van
Kasper’s Senior Vice President, James
A. Laurie, states that "There’s a lot of
interest out there and [a sense that] the
private sector can play a role in assisting
communities with their lending programs and providing them with a source
of liquidity."
Certain developers of underwriting technology have also begun to pool
loans made using their own credit scoring and/or loan origination software.
Portland, Oregon-based CFI Enterprises,
in conjunction with TIS Financial
Services, Inc., recently launched LORI
MAE (Loan Origination Management
and Exchange), which will purchase and
securitize commercial loans originated
by community banks using CFI’s software. LORI MAE’s Chief Operating
Officer, Tom Sidley, explains that trends
in the banking industry, such as the
"commoditization" of small business
lending, are facilitating large-scale securitization of this type of debt. "The way
bankers do business enables the market
to securitize without a GSE [such as
Fannie Mae or Freddie Mac] behind it."
LORI MAE intends to create short-term
commercial paper backed by small business loans worth $75 million to $100
million by year end.
The Future
Recently investor acceptance of
securities backed by small business
8
loans has been growing. The CRF’s
Frank Altman remarked that because of
increasing demand from investors, "the
CRF can pick and choose among bidders." In addition, banks, eager to comply with the CRA, are finding that
investment in such securities allows
them to participate in community development activity without having to bear
increased loan servicing costs.
Of course more work needs to be
done. In particular, Mr. Altman believes
that "the challenge is to increase the
velocity of loan purchase activity." Mr.
Altman also believes that there has been
enough of a trend with these instruments to begin to obtain credit ratings
from national rating agencies on the
senior pieces-- a move that would allow
for more public issues of these securities by the CRF and other intermediaries. As of this writing, the SBA is
receiving comments on its proposal to
allow for securitization of unguaranteed
portions of SBA loans. No doubt, as
regulatory incentives and technological
developments increase, so too will the
securitization of small business loans
and, it is hoped, small business development itself.
--by Luxman Nathan
Federal Reserve Bank of Boston
PRODUCTIVE
PARTNERSHIPS
The Venture Center: Venture Capital for WomenOwned Businesses
The Center for Women &
Enterprise (CWE) saw an opportunity.
According to both the U.S. Small
Business Administration and the
National Foundation of Women
Business Owners, by the year 2000
more than 40 percent of all U.S. companies will be women-owned. While most
of these firms are small, there is a rising
number of women-owned and managed
firms with 100 or more
employees in various
industries. Despite the
rapid growth of womenowned business in the
United States, these
firms received about 1.5
percent of the $4 billion
invested by venture capital firms last year.
In the fall of
1998, CWE and Fleet
Bank will launch the
opening of the CWE
Venture Center. The
Venture Center is an innovative and
much needed resource in the state of
Massachusetts. One of the greatest
unmet needs for women entrepreneurs is
access to equity capital. The CWE
Venture Center will endeavor to fill this
gap.
The CWE
The Center for Women &
Enterprise (CWE) is a nonprofit educational organization established in
October 1995. Since that time, CWE
has served over 1,000 entrepreneurs
from more than 100 cities and towns in
Eastern Massachusetts. The organization’s mission is to empower women to
become economically self-sufficient and
prosperous through entrepreneurship. As
part of this mission, CWE is helping to
establish a more fair and efficient capital marketplace for women-owned businesses, by offering a continuum of programs and services for women at all
stages of business development. What
makes CWE’s
approach unique is
the belief that a fullservice, comprehensive, integrated educational program can
work for the many
women and the few
men they serve.
BankBoston is
CWE’s founding
corporate sponsor.
The bank has played
and will continue to
play a critical role at
CWE. It provided the initial seed money
and has a three-year commitment to
CWE. BankBoston’s commitment goes
beyond financial support, including the
continued hosting of networking and
business development events. These
events include Turbo Day -- a workshop
designed to help women "boost" their
businesses or start-up ventures. In addition, three members of the bank’s executive staff are involved at the board
level. Both Gail Long and Terry
Cavanaugh sit on CWE’s board of directors and Gail Snowden sits on the organization’s advisory board.
9
The Venture Center
The CWE Venture Center is
intended to assist women owners of
fast-growing businesses in accessing
growth capital. The Venture Center will
act as a one-stop capital shop where
women can explore their equity financing options. Specifically, it will provide
an on-line resource clearinghouse, as
well as workshops, mentoring, and networking opportunities.
Andrea Silbert, Executive
Director of CWE, explains that "oftentimes venture capitalists, angel investors
and women entrepreneurs operate in
parallel worlds." Venture capital firms
prefer large multi-million dollar deals
that provide fast turnaround with high
rates of return for their investors. Angel
investors, on the other hand, have more
independence and flexibility. They tend
to have longer time horizons than venture capitalists and represent a far larger source of equity capital. It is estimated that angels invest $20 billion in
30,000 businesses annually. The goal of
the Venture Center will be to connect
these worlds by identifying venture capitalists, establishing both relationships
and access to capital for women entrepreneurs. CWE will also work to directly expand the pool of capital available to
women-led firms by reaching out to successful women.
The Venture Center’s lead corporate sponsor is Fleet Bank. Fleet Bank’s
innovative initiative with CWE should
prove to be the beginning of a successful and long-lasting partnership. Pat
Hanratty, Fleet’s Executive Vice
President, will be joining the board of
directors at CWE. The bank will host
events such as panel discussions, networking workshops, one-on-one consulting and business plan reviews. In
their roles as board members, Fleet’s
representatives will provide advice to
CWE in designing the programs and
services for the Venture Center. They
will also provide CWE clients access to
financial and human resources from the
10
venture capital and private investor
arena.
Leveling the Playing Field
The Venture Center and other
initiatives like it across the country, are
responding to the increased demand for
venture capital, both from female entrepreneurs and the growing number of
female investors in the market. In fact,
there are now several women-owned
venture capital funds operating nationally. For example, the $25 million
Women’s Growth Capital Fund has
become one of the largest venture capital funds in the United States investing
exclusively in women-owned and managed businesses. The fund had 30 initial
investors acquiring units between
$50,000 and $500,000. Seventy percent
of the investors in the fund are women.
The SBA recently declared the Women’s
Growth Capital Fund the first womenowned, women-focused SBIC in the
country.
This fund and others are breaking new ground in the traditionally
male-focused world of venture capital.
According to Patty Abramson, cofounder and Managing Director of the
Women’s Growth Capital Fund,
"women have just in recent years begun
to look at venture capital as a way of
growing their businesses. Historically,
women-owned businesses have been
below the radar screen of venture capitalists due to the size of their companies. Typically, the types of businesses
owned by women were in the retail and
service industry and had a smaller need
for capital." Today, women are more
technologically astute and more likely to
either own or manage larger companies
in the software and health care industries with ever-increasing asset levels.
Michael Cronin, Managing
Partner of Weston Presidio Capital and
co-chair of CWE’s advisory committee,
believes that increasing women’s access
to venture capital is an evolutionary
process. He points out that the general
Did You Know?
• Women-owned businesses contribute more that $2.38 trillion annually in revenues to the U.S. economy.
• The latest U.S. Census data indicate that women owned 6.4 million businesses in 1992. Current calculations indicate that women now own almost 8 million
firms, including C corps.
• Women entrepreneurs are taking their firms into the global marketplace at
the same rate as all U.S. business owners. As of 1992, 13 percent of womenowned firms were involved in international trade.
• From 1987 to 1992, employment in women-owned firms with 100 or more
workers increased by 158 percent -- more than double the rate for all U.S.
firms of similar size during that same period.
• Women-owned businesses are more likely to remain in business than the
average American enterprise. Nearly 3/4 of women-owned firms in business in
1991 were still in business 3 years later, compared to 2/3 of all U.S. firms.
• Women are increasingly starting businesses or managing enterprises in traditionally male-dominated fields such as construction, wholesale trade, transportation, communications, agriculture, and manufacturing. A recent study by
the National Foundation of Women Business Owners indicates that in particular, firms owned and operated by minority women are rapidly growing in these
non-traditional fields.
• The 10 states with the fastest growth in women-owned firms as measured by
number, employment, and sales are: California, Florida, Georgia, Illinois,
Michigan, New Jersey, New York, Ohio, Pennsylvania, and Texas.
--- adapted from information provided by the U.S. Small Business
Administration & The National Foundation of Women Business Owners
(NFWBO)
public, including venture capitalists,
must realize that women have just
entered the work force over the last few
decades and as a result women have
gained a tremendous amount of experience and knowledge of the business
world. Mr. Cronin also stated that at
Weston Presidio Capital, "if you have a
great idea or business plan, gender does
not matter." He adds that he sees a trend
in husband and wife teams, with more
and more husbands and wives becoming
business owners.
In response to these changing
circumstances, the overall demand for
venture capital targeted to womenowned businesses is rising. CWE,
11
INFORMATION EXCHANGE:
To Their Credit: Women-Owned Businesses, a production of the Boston,
Chicago, and San Francisco Federal Reserve Banks, is available on video. To
Their Credit highlights some of the difficulties that women business-owners
face in applying for and receiving credit. Studies show that one out of every
four workers is employed by a company that is either owned or managed by
women. Yet, many female entrepreneurs have a hard time obtaining credit for
start-up or even expansion of existing, profitable enterprises. To Their Credit
outlines techniques and strategies that women business-owners can use to
maximize their chances for loan approval. These tips include developing business plans, standardizing accounting procedures, shopping among banks for
better terms, and developing strong management teams. Above all, the video
stresses the need for women entrepreneurs to create and maintain relationships with their bankers, allowing the bankers to understand their firm’s short
and long-term credit needs in advance. For more information on how to obtain
a copy of this video, please contact the Federal Reserve Bank of Boston at
(617) 973-3459.
through its partnerships with BankBoston and
Fleet, is aiming to help women entrepreneurs
in New England gain access to much needed
equity capital. As women-owned businesses
grow and continue to expand both locally and
globally, they will become more and more
attractive to both traditional venture capitalists
and angel investors. Initiatives such as the
Venture Center should accelerate this trend.
-- by Arneese Brown
Federal Reserve Bank of Boston
12
ENTERPRISING
The Business Consortium Fund: Working Capital
for MBEs
For Minority Business
Enterprises (MBEs), quick access to reasonably priced short-term working capital can mean the difference between
growth and stagnation. MBEs, like
many small to medium-size businesses,
often struggle to meet their short-term
financial obligations. New business
activity, that arises in the form of contracts or large purchase orders can further exacerbate the strained
cash positions of MBEs.
Oftentimes MBEs cannot
fully realize opportunities
to increase market share
because they simply do not
have ready access to
affordable working capital.
The New England
Minority Purchasing
Council
The New England Minority
Purchasing Council (NEMPC) is a nonprofit organization established to
enhance the development, expansion,
and success of minority-owned businesses. The NEMPC certifies MBEs as
viable businesses, provides MBEs with
management training techniques, and
puts MBEs in contact with purchasing
agents at large regional and national
companies. The NEMPC makes this
interaction possible by informing its
Corporate Members (large regional and
national companies) of the availability of
minority-produced goods and services,
assisting them in establishing effective
MBE purchasing programs, and encouraging their commitment to utilize MBEs
as suppliers. Additionally, the NEMPC
can help MBEs realize business expansion opportunities by helping them gain
access to reasonably priced short-term
working capital through the Business
Consortium Fund.
The Business Consortium Fund
The Business Consortium Fund
Inc. (BCF) is a minority business development company of the National
Minority Supplier
Development Council
(NMSDC). The BCF provides short-term contract
financing to certified ethnic
minority businesses across
America through a network
of local participating banks
and Regional Minority
Purchasing councils like the
NEMPC. The BCF is funded through several sources
including corporations, state
governments, and foundations.
The BCF offers straight and
revolving lines of credit and direct loans,
with financing arrangements that fit the
payment terms of the MBE’s contract or
purchase order. To qualify for a BCF
loan, minority business enterprises have
to be certified by the regional minority
purchasing council and have a contract
or purchase order with a company that is
a Corporate Member of the National
Minority Supplier Development Council
or with an affiliate Regional Council.
The maximum loan amount is $500,000,
with a maximum guarantee of up to
$250,000.
BCF loans are administered by
13
Certified Bank Lenders (CBL). To
become a certified lender, banks must
submit a written request to the BCF and
provide a copy of their annual report,
proof of FDIC coverage, and specimen
signatures of bank officers responsible
for approving the loans. Once this
process is complete, the CBL’s role is to
perform the credit analysis and due diligence necessary to approve loans. The
CBL can then lend up to 25 percent of
the total value of the loan and charge as
much as 130 percent of prime on its participation. The BCF lends at prime rate
for the remaining 75 percent of the loan
value.
It’s clear that MBEs seeking
short-term working capital can benefit
by utilizing BCF funding, due to both
greater access to capital and lower borrowing costs. The favorable interest rate
extended through the BCF funding
source is of significant assistance to
MBEs. This is corroborated by a survey
(conducted by the O.N.E Corporation)
that suggests minority businesses often
have to seek higher interest rate, nontraditional forms of financing. The study,
Business In The Black Does Not Equal
Green, states that the average rate of
interest paid on a fixed rate loan from
an alternative funding source was 28
percent higher than interest paid on tra-
14
ditional fixed rate bank products.
The Results
Over the past ten years, $123
million has been lent nationally through
the BCF and participating CBLs. The
BCF has lent $92 million directly, with
participating banks lending the remaining $31 million. The default rate over
this same time period has hovered at 4.5
percent. In addition, some 534 minority
business enterprises have received loans
and 5,271 jobs have been created as a
result of BCF lending.
Mrs. Carrie Jones, President of
Sparkle Cleaning Associates, a commercial janitorial cleaning service company
in Framingham, Massachusetts, received
BCF financing in 1993 for operations
capital. At the time, Mrs. Jones was
unable to obtain debt or equity financing
from either traditional or nontraditional
sources. She looked to the BCF as her
lender of last resort and received assistance. The BCF loan she obtained
helped her complete her contract. Now
Ms. Jones has a revolving line of credit
with a local bank, but she vividly
remembers the days when her access to
capital was not so good. Mrs. Jones
thinks that MBEs should understand
that "BCF financing is not free money,"
and that the loan approval is still based
on the creditworthiness of the applicant.
Mr. Mark Cutting, President of
C&D Electronics, a military and commercial electronics component distributor in Springfield, Massachusetts, also
recalls difficult experiences during his
attempts to obtain traditional sources of
debt and equity financing. Much like
Mrs. Jones, Mr. Cutting has recently
been able to access traditional sources
of financing, and he currently has a line
of credit with a local bank. However,
things weren’t always so easy. " The
Business Consortium financing worked
out great; [it] was very timely, and it
was critical to my ability to expand and
fulfill my contract obligations."
has gone through a strategic planning
exercise to revamp and enhance the program. One of the main challenges identified was the need to improve communications with regional councils, minority vendors, and banks in general. John
Tear, vice president of operations, at the
BCF, stated that he and others from the
organization will begin visiting regional
councils and banks around the nation to
better communicate the mission of the
BCF. This is a simple but worthwhile
mission that will lead to more business,
more jobs, and economic growth and
development in communities that need it
the most. In short, this will be a mission
to "support minority businesses with the
needed capital to perform on corporate
contracts or purchase orders."
The Challenge Ahead
As part of celebrating the BCF’s
tenth-year anniversary, the organization
--By Marques Benton
Federal Reserve Bank of Boston
15
AROUND NEW
ENGLAND
Microenterprise in Maine: Training
Curriculum Development
This past Spring, the Federal
Reserve Bank of Boston co-sponsored a
microenterprise lending seminar with
Maine’s microenterprise lending association, MicroNet. The program was held
in Bangor, Maine, and was the culmination of a year-long partnership between
the two organizations to develop a comprehensive and affordable training seminar for microlending practitioners.
The project began over a year
ago, when the Federal Reserve realized
that a significant number of community
organizations were beginning to shift
their traditional focus from the creation
of affordable housing units to economic
development issues. In part the change
was due to a shift in the community
development industry’s view that sustainable communities need jobs as well
as housing. But it was also a response to
changes in the economy. The growth of
the service sector and low-wage, parttime employment has compelled some
of the working poor to try to make ends
16
meet by starting small home-based businesses. Defense cutbacks, along with
corporate downsizing, and mergers,
have led many skilled workers also to
consider the new challenge of starting
their own companies.
Many municipalities and community development organizations, hoping to meet the credit and technical
assistance needs of these new entrepreneurs, in turn started community development loan funds and took on a new
challenge, with little or no training.
While these loan funds lend relatively
small sums, they have taken on a job
that even experienced bankers consider
to be an impractical, if not impossible
task -- lending to start-up companies -which includes small business loan
underwriting, the applications and due
diligence process, and loan monitoring
and collection. On the nonfinancial side,
microentrepreneurs often need basic
education in businesses management,
writing business plans, and developing
and marketing products.
TYPES & SIZES OF MICROENTERPRISE VENTURES
Employees
(5 or less)
Typical
Capital
Needs
Sole propri- Supplemental Owner parttime and
etor, rarely a
perhaps
corporation
Micropart-time
or
partnerenterprise
seasonal
ship
(often
family)
$3,000 or
less
Type
Ownership
Owner
Income
A
Small
business
D
Growth
business
Size/Growth
in Business
Equity
Little or no
Inventory
growth. Usually
Marketing
Fixed assets limited to startup, fixed
assets and
some inventory,
seldom
retained earnings (often
cash-based
businesses)
Living wage
Owner
$1,000 to
full-time and $10,000
usually other
part-time
(often
family)
Inventory
Marketing
Fixed assets
Operating
capital
Some growth
in fixed assets
and inventory,
sometimes
retained
earnings
Sole proprietor, sometimes a corporation or
partnership
Living
wage,some
profits distributed to owner
Owner
$5,000 to
full-time and $25,000
other
full-time
Inventory
Marketing
Fixed assets
Operating
capital
Some growth
in fixed assets
and inventory,
usually
retained
earnings
Usually a
corporation
or partnership
Living wage
for owners
plus profits for
distribution to
partners or
investors
Owner
full-time and
other
full-time
Product dev.
Marketing
Inventory
Fixed assets
Significant
growth in cash,
inventory, fixed
assets and
retained
earnings.
Sole proprietor. someVery small times a corbusiness poration or
partnership
B
C
Capital
Uses
Start-up
capital to
$25,000,
plus capital
growth
--adapted from Northeast Enterprise Fund, Inc.’s Minnesota Microenterprise Study,
December 1994.
17
It became clear that meeting
these challenges required a significant
lending and training capacity that many
community loan funds lacked. In an
attempt to build this capacity among
microloan funds around New England,
the Fed partnered with MicroNet to
develop a training curriculum and twoday seminar for microlending practitioners.
Content
The curriculum and seminar
cover many facets of microlending. The
program defines for practitioners the
various types and sizes of microenterprise ventures. The differences between
more traditional enterprises and the nontraditional enterprises serviced by
microloan funds, including differences
in ownership structures, numbers of
employees, and capital needs and uses,
are also discussed.
The curriculum covers issues of
adult learning and approaches to providing technical assistance to small business entrepreneurs. The program discusses key points such as the importance of guiding clients to solving their
own problems and making their own
decisions.
Among the more perplexing
issues for community loan funds is the
use of due diligence procedures by traditional lenders, and how such procedures can be adequately tailored for
assessing microenterprise borrowers.
The curriculum’s due diligence checklist
18
helps microlenders define the appropriate level of information needed to assess
each borrower, and it also helps entrepreneurs better understand their businesses by including them in the information-gathering process. Other issues
covered by the course include loan
packaging, loan monitoring, and postloan technical assistance.
The May seminar represented an
important step in the Federal Reserve's
effort to increase the technical capacity
of public and nonprofit microloan funds
to finance and advise their entrepreneur
clients. But much of the expertise that
made the program and curriculum possible was the work of MicroNet members
such as Ellen Golden of Coastal
Enterprises, Inc., Al Maroney of
Sanford Institution for Savings, and
Eloise Vitelli of Maine Centers for
Women, Work and Community. They
and their organizations’ experience in
working with microentrepreneurs helped
to develop the program's focus on good
lending practices as well as on the specific needs of microenterprises -- particularly start-ups.
The Federal Reserve Bank of
Boston and MicroNet plan to hold similar training seminars in the Fall in other
New England states. Copies of the curriculum will be provided to all program
participants. For more information about
the microenterprise lending seminars,
contact Paul Williams at (617)973-3227.
-- by Paul Williams
Federal Reserve Bank of Boston
CONSUMER
FOCUS
Regulation M: Improved Protections for
Consumer Leasing
As of January 1, 1998, auto leasing companies (lessors) are required by
law to provide their customers with
more meaningful information about
lease transactions. This is the result of
the Federal Reserve Board’s (Board)
recent amendments to Regulation M.
Regulation M implements the Consumer
Leasing Act, which is a disclosure law
requiring lessors to provide particular
information to consumers prior to the
consummation of a leasing contract.
The changes to the law are
largely in response to the exploding
popularity of auto leasing. Auto leasing increased fivefold over the past ten
years and doubled over the past five
years. Approximately one third of all
new cars delivered in 1997 were leased.
Some consumers have found leasing
attractive because down payments and
monthly payments may be lower than
payments in a purchase transaction. In
a lease transaction, the consumer pays
only for use of the vehicle for a certain
period of time rather than paying for the
vehicle itself. Others have traded the
benefits of purchasing (for example,
equity in the car, unlimited mileage, no
early termination or excess wear and use
charges) for the luxury of driving a
more expensive car that might otherwise
be unaffordable.
Whatever the reason, the increasing popularity of leasing has been
accompanied by increasing consumer
complaints and problems. The Board’s
amendments to Regulation M are intended to respond to these consumer
issues. The most significant feature of
the amended Regulation M is the segre-
gation of all critical disclosure information in a uniform format. Under the old
version of the regulation, lessors were
required to provide certain disclosures
to consumers, but these terms were scattered throughout the lease documents.
Leasing contracts can be lengthy and
complex, and key information is often
overlooked. To rectify this problem,
Regulation M now requires that lessors
provide the most important information
separately from all other leasing information. The segregated disclosures
must be given to consumers before consummation of the lease on a form substantially similar to the model provided
in Regulation M (see page 21).
The segregated disclosure form
is meant to help the consumer focus on
and understand key terms in the lease
and improve the consumer’s ability to
comparison shop for financing alternatives and negotiate terms. It provides a
clear picture of payments required at the
beginning, during, and at the end of the
lease.
Payments at Beginning of the
Lease
The new amendments now
require lessors to itemize the amount
due at lease signing and how that
amount will be paid. In the past, it was
often unclear to consumers whether and
how down payments and trade-in were
credited to a lease. Now, consumers
need only review the segregated disclosure form to be sure that proper credit is
given for down payments, trade-in, and
rebates.
19
Payments During the Lease
The segregated disclosures also
make it easier for consumers to understand how monthly payments are determined. The amended regulation now
requires lessors not only to provide the
dollar amount of the monthly payments
in the segregated disclosures, but also to
provide a mathematical progression
demonstrating just how the lessor calculated the dollar amount. A consumer can
check the progression to ensure that the
lessor based the monthly payments on
the negotiated price of the car and not
the sticker price. The progression
begins with the agreed-upon value of
the vehicle, which is part of the gross
capitalized cost, and shows deductions
for trade-in, rebates, cash paid, and the
residual value of the car and additions
for rent charges and applicable taxes.
Payments at End of the Lease
The new segregated disclosure
form must include strong narrative
warnings about the possibility of incurring early termination charges and
excess automobile wear and use
charges. The regulation also requires
lessors to inform consumers of any
mileage limits and excess mileage
charges. In the past, when consumers
returned their cars, they were often surprised by these charges that ranged from
hundreds to thousands of dollars. The
new warnings for early termination and
excess wear and use are notices only:
the actual guidelines or standards are
20
listed elsewhere in the lease documents.
The segregated disclosure form must,
however, include the actual mileage
limit and the cost per mile in excess of
the limit.
The segregated disclosure form
must also inform the consumer of the
option to purchase the vehicle at the end
of the lease. The lessor is required to
disclose the purchase price and any purchase option fee.
Other Disclosures
Other important segregated disclosures include total payments (total
dollar amount the consumer will have
paid by the end of the lease) and other
charges. The total payment amount
does not include the purchase price, the
purchase option fee, or refundable
amounts. "Other charges" may include
a disposition fee, which covers the
lessor’s cost of selling the vehicle if the
consumer chooses not to exercise a purchase option.
Note that Regulation M requires
lessors to provide consumers with other
disclosures which do not appear on the
segregated disclosure form. For this
reason, there is a required statement on
the segregated disclosure form encouraging consumers to review their lease
documents for other important disclosures. It is important that consumers
review all documents before signing the
lease contract.
21
Educational Efforts
In addition to these and other amendments to Regulation M, the Board has taken
further steps to help consumers better understand the intricacies of leasing. Given the
complex nature of auto leases, the Board determined that it was necessary to educate
consumers about the existing protections. Together with state and federal consumer
education and protection agencies, not-for-profit consumer groups, and industry trade
associations, the Board organized a national educational program. One of the results of
this campaign was a brochure entitled, Keys to Vehicle Leasing- A Consumer Guide. To
help consumers better understand the vocabulary used in auto leasing, the coalition also
compiled a leasing language glossary. These and other educational materials pertaining
to auto leasing may be obtained from the Federal Reserve Bank of Boston, Public &
Community Affairs at (617) 973-3097. They are also available on the following website: http://www.bos.frb.fed.us/pubs/leasing
--by Carol Lewis
Federal Reserve Bank of Boston
The Community Affairs Staff, Federal Reserve Bank of Boston
Left to right: Ricardo Borgos (College Intern), Paul Williams (Supervisor), Cindy Reardon (Manager),
Richard Walker (A.V.P. & Community Affairs Officer), Luxman Nathan (Editor & Community Affairs
Specialist), Arneese Brown (Community Affairs Specialist), Lesly Jean-Paul (Community Affairs
Specialist).
Pictured above is the Community Affairs
Staff which works to promote the understanding and use of public and private
community and economic development
resources through this and other publications.
22
Communities and Banking seeks to further the practice of community and economic development by exploring effective
ways for lenders to work with public, private, and nonprofit sector organizations
toward proactive compliance with the
Community Reinvestment Act.
For free subscriptions, contact:
Mark Lloret
Public and Community Affairs,
Federal Reserve Bank of Boston
PO Box 2076,
Boston MA 02106-2076
phone:(617) 973-3097
e-mail: Mark.A.Lloret@bos.frb.org
Views expressed are not necessarily those of the
Federal Reserve Bank of Boston or the Federal
Reserve System. Information about upcoming
events and other organizations should be considered strictly informational, not as an endorsement of their activities.
Articles may be reprinted or abstracted if
Communities and Banking is credited.
Please send copies of the reprinted materials to the editor. Readers interested in having community development programs or
projects described in Communities and
Banking should contact:
Luxman Nathan
Editor,Communities and Banking
Public and Community Affairs
Federal Reserve Bank of Boston
PO Box 2076
Boston, MA 02106-2076
(617) 973-3997
e-mail: Luxman.Nathan@bos.frb.org
TOOLS
TO USE
CRA Compliance Software
The key to CRA compliance is
managing and maintaining information
about loans and borrowers. Two computer software products are available
that can assist you in meeting your CRA
requirements by providing you with
tools for better analysis and presentation
of lending data.
The CRA Data Entry Software
System
The most up-to-date version of
the CRA Data Entry Software System
by the Federal Reserve System has been
available since November 1997. A new
version will be released later this year.
It was designed to help bankers automate the filing of CRA data on a per
loan basis. This user-friendly software
not only should assist bankers in preparing for CRA examinations, but should
also help streamline the entire examination and monitoring process.
The software allows you to
record information on small business,
small farm, community development,
third-party, and consumer loans at the
time of origination. The software also
allows for more standardization of
CRA-related data and allows users to
print out several different types of
reports for improved product and market
analysis.
Finally, the software also
includes editing and reporting features
to help lenders verify, complete, and
analyze data.
The CRA 1996 Aggregate &
Disclosure Software System
This CD-ROM, offered by the
Federal Financial Institutions
Examination Council (FFIEC) and the
Board of Governors of the Federal
Reserve System, contains comprehensive information on small business,
small farm, consumer, and community
development lending throughout the
United States as of 1996 (the most
recent year available). The software
allows the user to obtain information on
bank originations and purchases, aggregated by MSA (Metropolitan Statistical
Area).
The software can be used to prepare reports about lending in certain
MSAs as well as about the lending
activity within specific neighborhoods.
It can also be used to determine if an
institution’s lending activity demonstrates that it serves the credit needs of
the communities where it does business.
This information is highly useful
for community development groups that
seek to better understand the bank lending activity in their areas. It is also
important for banks, which can gauge
their lending performance against those
of other lenders and thereby improve
CRA compliance activities.
The CRA Data Entry Software
System is available free of charge, and
the CRA Aggregate & Disclosure
Software System is available for a fee of
$10. Both software packages can be
obtained from the Board of Governors
of the Federal Reserve System, 20th &
C Streets, N.W., Mail Stop 502,
Washington, D.C. 20551. Assistance
with these software programs can be
obtained by calling the CRA Assistance
Line at (202) 872-7584 or by sending
e-mail to crahelp@frb.org
23
@FedFRASER