A 'Systemic Shift' in Small Business Lending

As banks cut back on lending directly to small businesses, CDFIs are expanding their role and tapping recently formed bank holding companies for capital

By John Tozzi

Lesia Bates Moss, president of community lender Seedco Financial, speaks at a forum on Opening the Small Business Capital Market in Washington, D.C., in March. Photo courtesy of Seedco Financial

Lesia Bates Moss knows opportunity when she sees it. Shortly after she became president of Seedco Financial, a New York-based nonprofit lender with balance-sheet assets of $55 million, in March 2009, she sought new sources of capital to expand Seedco's lending to small businesses in low-income neighborhoods. Among Moss's top prospects were mammoth financial institutions like Goldman Sachs (GS) that had converted to bank holding companies in late 2008 to access federal aid. These bailout recipients would now face federal ratings under the Community Reinvestment Act on how well they serve disadvantaged neighborhoods—and Moss thought Seedco Financial could help.

Community Development Financial Institutions like Seedco are generally nonprofits that finance small businesses, housing, and other development in poor areas. They have long tapped a mix of federal funding, philanthropic grants, and investments from commercial banks to fund their work. Although CDFIs typically lend to clients that banks consider too risky, their loans have held up well in the recession, in part because they come with lots of hand-holding for borrowers. With banks still reducing their direct lending to small businesses, policymakers and bankers alike expect CDFIs to play a growing role in financing small businesses in the recovery.

"As we speak, several of the nation's largest banks are developing CDFI partnerships to provide small business credit," says Mark Pinsky, CEO of Opportunity Finance Network, a Philadelphia-based alliance of CDFIs. "I know of at least two significant deals that could launch in the coming weeks if all goes well." Commercial banks have long been among the biggest funders of CDFIs: JPMorgan Chase (JPM) has invested $1.2 billion in the last five years; Bank of America (BAC) has a $1 billion CDFI portfolio; and Wells Fargo (WFC) has $400 million in CDFI loans and investments. Now add Goldman Sachs to that list.

Goldman's Small Biz Program

At a conference early last summer, Seedco's Moss met Alicia Glen, a managing director at Goldman's Urban Investment Group, a decade-old $1 billion division that invests in inner-city businesses and real estate. That started a conversation that led to Goldman making a $20 million loan to Seedco to fund small businesses in New York City's low-income neighborhoods. It's part of a $500 million national program to aid small businesses Goldman announced in November. The initiative includes $250 million in loans and $50 million in grants to CDFIs over five years, as well as $200 million for education and mentoring for business owners. "We're not a retail bank," Glen says, noting that Goldman has no plans to underwrite small business loans directly. "But there's a whole set of intermediaries that do exactly that."

Investments in CDFIs, along with direct community development lending, help banks comply with the Community Reinvestment Act, the 1977 law designed to encourage depository institutions to serve disadvantaged areas. A new cohort of financial institutions that converted to bank holding companies to access government bailouts during the financial crisis is now subject to the law, including Goldman, Morgan Stanley (MS), American Express (AXP), CIT Group (CIT), and GMAC.

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