It is a perplexing problem for banks: How to fund riskier small businesses that may be good for community development but potentially bad for credit quality ?
In New York State, 131 banks say their solution is a partnership with the New York State Business Development Corp., which takes the riskiest part of loans that bankers worry would not pass regulatory scrutiny.
Partnerships such as the one in New York, believed to be the largest of its kind, are cited by regulators as a way to do good without creating bad loans. Bankers expect such programs to grow.
"We can accommodate our customers for a certain amount and the NYBDC can accommodate them for an additional amount," said Dan Hogarty, president and chief executive officer at Troy Savings Bank. "In this way, the amount available to the customer is expanded."
By using everything from guarantees from the U.S. Small Business Administration to participations from banks that refer deals, the corporation provided $65.3 million in new loans last year.
As a result, the corporation's loan portfolio has a higher degree of risk than regulators would allow at a federally insured bank.
For one, nearly 33% of its $70.4 million loan portfolio is invested in start-up companies. Women- and minority-owned businesses are also a target of agency loans. "There is a push in the CRA-related lending, not to do them exclusively, but to be an integral player in the community development area," said Robert Lazar, president and chief executive officer of the corporation.
This strategy has its problems, though. At any time, 3% to 4% of the loan portfolio is behind at least one payment. To compensate, Mr. Lazar said the corporation is diligent in the structuring of the loan and quick to start working with the borrower to resolve problems.
Despite concern over possible losses, the focus on community development lending keeps banks involved. In 1989, member banks bought $5.6 million of the corporation's stock to boost its lending power, even though it isn't traded, pays no dividend, and has virtually no value.
"It shows that the industry has recognized its commitment and is actively involved in community-based lending," said Michael Smith, executive vice president of the New York State Bankers Association.
It is also a sign to banking regulators that member banks are making an effort to comply with the Community Reinvestment Act. Mr. Lazar said the New York State Banking Department has issued an opinion saying an investment in the corporation is considered one component in a bank's overall CRA rating.
On the credit side, bankers like the corporation, because qualified loan applicants often lack collateral that regulators want or the project may be just too risky for the average bank. Mr. Lazar said the corporation then steps in and does an independent credit evaluation.
If the loan proceeds, the corporation focuses on the all-important issues of who takes the greatest share of risks. In a recent deal that Mr. Lazar says is typical, the corporation loaned a borrower 40% of its need and took a second mortgage on its real estate. The bank that referred the deal provided 50% of the loan, but got the first mortgage on the same collateral. The corporation then handles all servicing and, if necessary, collection. "Banks can reach out to the small businesses in their community without having to do all the work," Mr. Lazar said. "They'll just turn it over to us and we '11 do the rest of the work for them."
