Banking on the inner city: reverse redlining pays off for a network of alternative lenders - includes related article

On July 15 Joseph Holland stood on the South Lawn of the White House with the president, vice president, members of Congress and the press. With all eyes upon him, the 37-year-old lawyer recounted the opening of his Ben & Jerry's franchise - the first inner-city location for the chain - and the store's positive impact in his distressed Harlem neighborhood.

"I wanted them to understand that real progress could take place in an area like Harlem if the right approach was followed," says Holland, whose 100,000 business loan came from a small community development bank after several conventional lenders rejected his idea.

Holland then introduced President Bill Clinton, who announced a plan to provide $382 million over four years to strengthen the nation's community development financial institutions (CDFIs). The fledgling network, Clinton said, "has demonstrated that when there is a constant commitment to this kind of development, you can produce jobs and growth."

CDFIs, which include federally regulated banks and credit unions and unregulated loan funds and development corporations, operate specifically to rehabilitate housing and jump-start small business in neglected, credit-starved communities. The most talked-about CDFI is Chicago's South Shore Bank, a $250 million federally insured bank with checking and savings accounts like conventional banks, which has been successfully investing in low-income neighborhoods for 20 years.

CDFIs go where traditional bankers fear to lend, shunning the presumption that inner-city investments are sure losers. And after lending about $2 billion over the past 15 years for housing and small business that conventional banks would term risky, the network boasts a loss rate of just I percent.

Their secret is to provide more than money. CDFIs offer the kind of technical assistance critical to making a borrower "bankable."

"Joe [Holland]'s loan application was not in bankable shape when he walked in the door," concedes Lyndon Comstock, founder of the three-year-old Brooklyn-based Community Capital Bank, the CDFI that bankrolled Holland's Harlem scoop shop. "But that didn't mean it couldn't be." With some refinements to the business plan, the loan fell into place, says Comstock. His state-chartered, FDIC-insured institution has $23 million in assets, and $10 million in loans and commitments - and no defaults.

"We do a tremendous amount of technical assistance and hand-holding," explains Patty Grossman, executive director of the nonprofit Cascadia Revolving Loan Fund in Seattle. "At any one time as many as one-fourth of our borrowers are struggling."

Cascadia provides vital how-to information for the borrower, regarding everything from accounting procedures and employee benefit plans to marketing and expansion. In eight years, the fund has loaned nearly $2 million and lost less than 1 percent of it. "That's competitive with traditional banks on a portfolio they wouldn't touch," says Grossman, a former commercial loan officer for a Seattle bank. Like other revolving loan funds, Cascadia borrows money from socially conscious individuals, paying them market interest rates. The fund in turn loans money to credit-worthy projects.

One Cascadia customer, Western Cascade Truck Inc., was started by Pat Malara and four fellow truck mechanics in 1987 to repair fleets of trucks, trailers and tankers. Three years ago Malara got burned on $22,000 worth of service he advanced to a friend and the company was suddenly without cash.

After disappointing visits with Seattle banks, Malara turned to Cascadia, which set about researching the company and its market. "We believed in their ability to turn around," recalls Grossman. Since that first $32,000 loan, Western Truck has borrowed another $64,000 and paid it back. The company bought a new computer system, developed specialized inventory software and expanded into diesel emissions testing.

"That first loan gave us the boost we needed," says a thankful Malara. "It was apparent that banks only want to do business with cash-rich companies. Now with our sales of $1.5 million annually, the banks would want to do business with us but we're sticking with Cascadia."

A Market Opportunity

Community development in the early '70s was a vague idea in search of successful models. Riot damage and white flight to the suburbs left many inner-city neighborhoods blighted and labeled off-limits by conventional banks. For years, these urban communities have suffered crippling losses of banking services and investment capital.

In 1973 four idealistic bankers developed the concept of community development banking. Theirs was a radical idea: to establish a federally regulated bank that could turn a profit while transforming a declining community on the south side of Chicago. South Shore Bank has come a long way from its tiny initial investment of $800,000 from individuals and religious groups. Writing home mortgage loans in neighborhoods that other Chicago banks ignored and to borrowers those banks deemed risky, South Shore foiled the skeptics and became a model for sound banking in lower-income communities, posting more than $2 million in profits in 1992.

Under pressure from community activists, in 1977 Congress passed the Community Reinvestment Act (CRA), directing federally insured banks to make credit available to all communities in their service areas. Seen at the time to be a critical tool in getting capital to devastated communities, the law is more honored in the breach.

The Federal Reserve, which regulates federally chartered banks, estimates that banks have committed a mere $35 billion to lending in disadvantaged neighborhoods since CRA's passage. Community activists say the need has been for five times that amount.

"CRA just hasn't accomplished all that much," says Comstock, whose Capital Community Bank was modeled after South Shore. "Just look around at how much lending is going on. [CRA] has hardly been transformative."

Recent research suggests that federally insured banks are failing to provide needed services and credit and, in the process, overlooking a potentially profitable market. Several newspapers found patterns of bias by banks in home mortgage lending. They drew from information collected under the Home Mortgage Disclosure Act (HMDA), which compels banks to report mortgage loan data in terms of race, income and location of borrower.

Using HMDA data for 1990, the Boston Federal Reserve found that minority applicants were more than twice as likely to be denied a mortgage as whites, even when they have equal incomes. The Federal Reserve's study of 1991 HMDA data revealed a continuing disparity in approval rates for loan applications from whites and minorities.

And Essential Information, a research group associated with consumer advocate Ralph Nader, found in a 1993 study what it called "prima facie evidence of unlawful discrimination in mortgage lending" by 49 major mortgage lenders in 16 metropolitan areas.

While many banks still seem reluctant to fulfill their CRA obligations, "the bankers who are active in this market will tell you [it] can be profitable," says Virginia Stafford, spokesperson for the American Bankers Association.

"There is market opportunity here," says Greg Ramm, executive director of the Institute for Community Economics (ICE), a nonprofit organization that promotes community investment and runs a $12 million revolving loan fund. But "banks cannot go in and say 'we have a CRA obligation, let's make loans.' They have to learn the market and treat it as a business opportunity. There are credit-worthy borrowers out there."

Among those to find home mortgage lending in lower-income neighborhoods profitable are Bank of America in California; Philadelphia's CoreStates Bank; and Meridian Bancorp in Reading, Pa. To increase their success, some banks have teamed up with community groups that offer borrowers technical assistance.

It Takes More Than CDFIs

Despite their commitment, CDFIS alone can't fill the inner-city credit gap, which the U.S. Treasury estimates at $15 billion. (While CDFIs have assets of nearly $1 billion, conventional banks and thrifts have $4.3 trillion.) "If banks give up the struggle to develop the expertise to make loans in low- and moderate-income neighborhoods, we will be much worse off," says Malcolm Bush, president of the Woodstock Institute, a Chicago-based think tank that works on CDFI issues.

Thus far, housing loans are more prevalent than small-business lending. Yet small business is the backbone of economic development, a key factor in turning around neglected neighborhoods. "If we got the support structure for business lending like we do on the housing side I think we would see similar breakthroughs," says Allen Fishbein of the Center for Community Change.

Clinton's plan calls on CDFIS to make more small-business loans and provides incentives for that purpose. The legislation cleared the Senate Banking Committee in September and is expected to pass the Senate this year. House action, however, is doubtful.

Meanwhile CDFIS aren't holding their collective breath."I'm not optimistic about the [bill]," says Mark Pinsky, coordinator of the CDFI Coalition, a trade group lobbying for the bill. "We could use the money, but we're going to keep doing what we do with or without it."

Leaving Welfare Behind

Most of its borrowers earn less than $15,000 a year, have no credit history and put up little collateral for their loan. This may sound risky, but the Chicago-based Women's Self-employment Project (WSEP) has found success lending to low-income and welfare-dependent women trying to make it as small-business owners.

It's a myth that women on welfare don't want to work, says WSEP Executive Director Connie Evans. "Our program recognizes women who are strong and talented and just need resources and support to succeed."

WSEP offers potential borrowers 12 weeks of business training (with fees based on ability to pay), monthly seminars and two loan programs, which. have default rates of 0 and 5 percent. An unforeseen benefit has been the creation of a new network of independent women. "Part of being in poverty is living an isolated life," says Evans, who says the women benefit from both the education and camaraderie. According to WSEP, since 1986 the staff has-counseled more than 4,000 women, helped launch more than 750 businesses and-loaned more than $577,000. The lending pool comes from foundations that offer WSEP long-term low-interest loans.

One of about 200 micro-enterprise programs nationwide, the lends first-time borrowers up to $1,500, far less than what a traditional bank would consider a normal business loan. But often that's enough to start someone on the road to self-sufficiency.

For Debra Davis, a $1,200 loan from WSEP meant having the cash to buy a second industrial sewing machine, fabric and notions to jump-start her clothing design business. "I was living month-to-month and never had any extra money to launch myself into business," says the 39-year-old Chicago native, who previously worked for an hourly wage at several department stores. "Most banks just wouldn't be bothered with me."

Through WSEP's training and counseling, Davis found the confidence to approach the Spiegel catalog about carrying her trademark 3-D caps. Since the first request for 30 caps, Spiegel has ordered 300 more. Today she employs three part-time workers.

"I am 180 degrees from where I was," she says. "I don't have to ask anyone for a raise and I am not set by others' limitations."

COPYRIGHT 1993 Common Cause Magazine
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