Black business lending: Harder hit, less rebound
When Donna Austin opened her funeral brokerage business in 2007, she invited everyone she knew to her new office in Greenbelt to celebrate.
“I was so excited,” she said. “I had it catered. I had Champagne. I opened the doors to let people know I’m here.”
Austin, a licensed mortician for more than 20 years, quit her job as a chemist at a pharmaceutical company, cashed in her 401(k) to invest it in the business and took the entrepreneurial plunge. She got a Small Business Administration loan to help start her company, Loss & Found Comfort Resources LLC, which guided families through the funeral process and connected them with funeral homes that met their budgets.
Austin was one of an unprecedented number of local African-American entrepreneurs who built their dreams on the back of an SBA loan from 2003 to 2008, when the SBA approved five times more loans to black-owned businesses in the region than it did during the previous six years. But for her and untold others, that dream soon collapsed.
Using SBA data obtained through a Freedom of Information Act request, the Washington Business Journal found that the black businesses community has suffered a reversal of fortune over the past few years. It faced a more severe downturn than other groups did, and its recovery has been more elusive.
Among the findings:
○ Nearly 44 percent of the 2,408 SBA loans disbursed to local black-owned businesses between 2003 and 2008 have defaulted, meaning they’ve either been written off as a loss or are in liquidation. The default rate for nonblack borrowers in that time was 25 percent.
○ The number of SBA loans made to black-owned businesses in fiscal 2011 was down 87 percent from 2007. The dollar amount lent to blacks plunged 71 percent, even as lending to other major ethnic groups was beginning to rebound. Blacks now get a smaller slice of local loans than Hispanics do, even though blacks outnumber them locally almost 2-to-1.
It’s disheartening news for some African-American business leaders encouraged by the surge from 2003 to 2008.
“It was getting better, then along comes the recession and knocks us back a peg or two,” said Maudine Cooper, president of the Greater Washington Urban League Inc., which advocates for African-Americans in the region.
In the delicate alchemy of turning a dream into a viable company, Austin seemed to be ahead of the curve with her funeral brokerage business.
She had relationships with funeral homes through a side business she ran for 10 years, transporting the dead from hospitals. She also had a side business as a licensed insurance agent and could sell families burial insurance to plan for their final expenses.
“I saw this as a niche, where I could broker a funeral,” said Austin, an Operation Desert Storm veteran who spent eight years in the Army’s mortuary unit.
Austin got her loan from Oakland, Calif.-based Innovative Bank, which made three-fourths of its local loans to blacks, disbursing more than 1,200 to the area’s African-American business community since 2002 — more than twice as many as any other institution.
The bank used contract loan brokers to sell its products in the Mid-Atlantic. Those brokers developed relationships with nonprofits like the Economic Development and Training Institute Inc. in Camp Springs, which promoted and hosted small business training seminars where its members could apply for loans of up to $50,000 through Innovative Bank.
With a detailed business plan showing how she would use the money, Austin applied for the full $50,000. But the bank approved her for just $5,000.
“I was deflated,” she said. “I knew $5,000 would be gone in a month.”
The 51-year-old had already been rejected by two other banks. Without enough working capital to manage her cash flow, she burned through her savings. Soon, the bills piled up, and the creditors were circling.
She tried shifting her business toward cremations, which appealed to the public’s new frugality amid the recession. But by then, her credit was shot and she couldn’t get the money to promote it widely or buy the merchandise she needed. By mid-2011, she folded the company, losing her car and her life savings.
Austin is not alone. More than 51 percent of the SBA loans Innovative Bank made to blacks in this area have gone into default, SBA data show.
“I didn’t know it was such a large amount,” said Joe Gaskins, CEO of the Economic Development and Training Institute, which facilitated 98 loans for a combined $1.4 million through its seminars, most of them through Innovative Bank. Had he known the magnitude of the defaults, Gaskins said, he wouldn’t have partnered with the bank.
Innovative made the bulk of its loans through the Community Express program, a pilot SBA initiative introduced in 1999 that focused on loans of less than $250,000 for underserved areas and women and minorities. It also required borrowers to receive business training as part of the loan.
Innovative was a small community bank founded in 1982 and acquired in 2001 by a group led by Tim Jochner, who ushered in the bank’s massive expansion in national SBA lending.
He sold the bank in 2005 and started Superior Financial Group LLC, which also dove into the Community Express program, becoming one of the most active lenders to black businesses in the Washington area. Superior is now among the top originators of small-dollar SBA loans in the country. Jochner could not be reached for comment.
Regulators hit Innovative with three enforcement actions beginning in 2007, citing the bank for shoddy underwriting practices, before seizing it in April 2010. Innovative had $267 million in assets and four branches, which were sold to Los Angeles-based Center Bank, which merged with yet another bank in late 2011 to become BBCN Bank. A BBCN spokeswoman said that it didn’t retain any of Innovative Bank’s lending staff and has no information about Innovative’s practices.
Set up to fail?
There is a common perception among black businesses that SBA loans provide them with just enough money to fail. A 2010 SBA inspector general’s report about Community Express found that the program’s most active lenders disregarded borrowers’ business plans, which include a financial analysis on how the company would use the loan.
“In lieu of analyzing the business plans, lenders assigned credit scores to loans based primarily on factors relating to the business principal’s personal creditworthiness. The higher the numeric score, the larger the loan amount the borrower could receive,” the report read.
The result: Lenders gave borrowers 20 to 80 percent less money than they requested in their business plans, which often made it impossible for the entrepreneurs to execute their plans without seeking additional capital, the report said. This often led the borrowers to default, which hurt their ability to obtain other credit.
Since 2000, 77 percent of all Community Express loans made locally have gone to African-American businesses, and 43 percent of all loans made to blacks locally were Community Express loans.
While the names of the lenders were redacted, the report mentioned that regulators hit one of the two most active Community Express lenders with three enforcement actions beginning in 2007 before seizing it in April 2010.
Lenders also had financial incentives to keep loan amounts low, the report said, including the ability to secure a larger 85 percent guarantee on loans of less than $150,000 and charge significantly higher interest rates for loans under $25,000, which make up the bulk of Community Express loans.
Banks, including Innovative, often sold the guaranteed portion of these loans on the secondary market for a premium of about 11 percent, according to current market rates, which are similar to what they were before the recession. This would effectively allow banks to profit off these loans even if a borrower defaults.
For example, if a bank makes a $10,000 Community Express loan, $8,500 of it is guaranteed by the SBA. That leaves the bank with $1,500 in potential losses. But after charging a loan packaging fee of $950 and selling the guaranteed portion of the loan for a $935 premium (which is 11 percent of $8,500), the bank has already brought in $1,885 on the loan — $385 more than its potential losses — before the borrower even makes the first payment. If an entrepreneur defaults almost right away, the bank still makes money.
Similar incentives hold true for most small-dollar working capital SBA loan programs, not just Community Express. However, most small-dollar loans are made through the SBA Express program, which only carries a 50 percent guarantee and is less susceptible to abuses, said Jeanne Hulit, associate administrator for capital access for the SBA.
She also argues that the decline in lending to blacks, which is playing out nationally, is not necessarily race based. Rather, it’s the small-dollar loans that have taken a major hit during the downturn as banks favor larger loans, which are more profitable, especially when factoring in the expense of the more extensive underwriting banks now do. Because blacks relied disproportionately on small-dollar loans, they were hit hardest by the decline.
Hulit said the SBA does not bear any responsibility for the abuses that happened under Community Express, which remained a pilot program for 12 years until it was scrapped in April 2011.
“We determined that the program wasn’t being utilized in the way that made the best impact on the community, and we ended the program,” she said.
At the same time that it announced the cancellation, the SBA unveiled two new initiatives aimed at filling the lending void in underserved communities: Small Loan Advantage, a small-dollar program open to the agency’s “preferred lenders,” and Community Loan Advantage, through which nonprofit community lenders are given authority to directly make SBA loans. The problem is, neither of these programs has had much impact.
Small Loan Advantage has received very little interest from lenders and is being revamped to make it easier for banks to use, Hulit said.
The Community Loan Advantage program is gathering interest from community organizations, but the process is slow. Since these initiatives were rolled out a year ago, just one loan for $200,000 had been made locally by Sept. 30, the end of fiscal 2011, SBA data show. The ethnicity of that borrower couldn’t be determined.
Prejudice in lending
Discrimination against blacks in lending is well-documented, particularly in mortgages.
Bank of America Corp., for example, agreed in December to pay $355 million to settle claims that Countrywide Financial Corp. engaged in widespread discrimination against well-qualified black and Latino borrowers, charging them higher fees and interest than similarly qualified white borrowers paid.
Black-owned businesses also get turned down more often than white companies with similar profiles, said Ken Cavalluzzo, who authored papers on the subject while a professor at Georgetown University until 2005. He now is a principal at Madison, Wis.-based SVA Plumb Financial LLC, a wealth management company.
“Even after controlling for many different factors, like the personal wealth of the business owner and the amount of equity in their home, there were large differences between white-owned businesses and those owned by African-Americans,” he said.
His research, published most recently in 2005 in the Journal of Business, also found that black-owned businesses faced rejection more often than Hispanic and Asian entrepreneurs.
While there aren’t any national studies examining how black-owned businesses have fared in the current downturn compared with whites, Cavalluzzo said the Business Journal’s finding that blacks have seen steeper declines in lending than other groups is consistent with what he would expect to see.
But don’t hold your breath for multimillion-dollar settlements resulting from racially biased commercial lending practices.
While consumers have state attorneys general, the Justice Department and the newly minted Consumer Financial Protection Bureau cracking down on lenders for discrimination, there is no watchdog for small commercial borrowers — even though many banks treat small business loans essentially as loans to the individual business owner.
“We don’t have any lawsuits. We don’t owe anybody tons of money. We have a good track record of clients. I don’t see why we can’t get the money.”
That’s what a frustrated Hanif Aljami, co-owner of District construction company New World Development Group LLC, told some 10 banks that turned his business down for a $500,000 line of credit in 2010.
New World, which has 12 employees, had a contract in hand for about $5 million in subcontracting work with a major construction company, but needed the funds to staff up so that it could fulfill the contract. Without the funds, it had to slash the scope of the contract to just $2 million.
“That was a shame,” Aljami said. “It was money in the pocket.”
Like a lot of businesses in search of funds, New World reluctantly turned to a factoring company — essentially a subprime commercial lender that funds businesses at steep interest rates. Although it has lined up the funding, New World so far hasn’t had to tap that money, instead borrowing about $50,000 from family and friends.
The company also went to the Washington Area Community Investment Fund, a nonprofit community development financial institution, or CDFI, that trains business owners and makes small loans aimed at boosting economic development. It funds loans with investments from more than 50 institutions and individuals.
New World got a $25,000 loan from WACIF in 2010, and after months of begging and pleading it got an additional $40,000 in 2011. The amount wasn’t enough to fund an expansion, but it helped.
At WACIF, more than 90 percent of the clients are African-American and the average loan size is $25,000. While it is much more flexible than banks on things like collateral (which it typically requires in some form), just 4 percent of WACIF’s loans have defaulted over its 24-year history, according to its financial statements.
The organization makes loans through several programs, including the SBA’s Microloan program and the Certified Business Enterprise Revolving Microloan Fund, a public-private partnership with the D.C. government. It saw a 120 percent jump in lending requests from 2010 to 2011, as more and more entrepreneurs struggled to land bank loans in the new world of tighter lending standards.
“That creates an overwhelming demand for financing from places like WACIF and other CDFIs that we just don’t have the supply to cover,” said Tim Flanagan, executive director of WACIF, which made just 14 small business loans in 2011. “It boils down to a basic supply and demand issue.”
While the black business community has seen a dramatic decline in lending, some argue that many of the loans made during the heyday were based on slapdash underwriting standards and went to would-be entrepreneurs who probably didn’t have the money or experience to run a successful business.
“No one deserves a loan,” said Eddie Tuvin, a longtime local lender now with San Francisco-based Wells Fargo Bank who was named Financial Service Champion by the SBA’s local office in 2011. “It’s not a right of citizenship. You have to work hard and perform well.”
Down, but not out
After Donna Austin, the licensed mortician, lost her business last year, she wasted little time feeling sorry for herself.
“I just file that one away and keep it going. Keep it moving,” she said.
To pay the bills, she ramped up her side business selling supplemental insurance benefits. She then hooked up with a partner who was starting a business in Capitol Hill called Urban Acres Project, a nonprofit wholesaler for green technology like solar panels and high-efficiency lighting.
Austin plans to use her veteran status and ethnicity to help Urban Acres get contracts with the District. She also plans to apply for SBA 8(a) status, which would help Urban Acres get federal contracts. She’s even hopeful the company will eventually be able to get a loan.
Despite the setbacks she faced, she’s determined to succeed in business.
“I’m not going to stop,” she said. “I’m not down and out. I’m back.”
This article appeared in the Washington Business Journal, March 23, 2012