Community development micro loan funds - National ...

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TOOLK

COMMUNITY DEVELOPMENT MICRO LOAN FUNDS

Community Economic Development

Toolkit

Disclaimer

This fact sheet was produced by the California Community Economic Development Association, in partnership with the Community Action Partnership National Office, as part of the U.S. Department of Health and Human Services, Office of Community Services. The "Community Economic Development" publication series is designed to increase the knowledge of processes for community economic development projects nationwide. The contents of this manual are presented as a matter of information only. Nothing herein should be construed as providing legal, tax, or financial advice. The materials referenced and the opinions expressed in this product do not necessarily reflect the position of the U.S. Department of Health and Human Services, Office of Community Services, and no official endorsements by that agency should be inferred.

Support for the Community Economic Development project and this toolkit is provided by the Department of Health and Human Services Administration for Children and Families, Office of Community Services (OCS), grant award number: 90ET0426/01.

Entire contents copyright ? 2012 Community Action Partnership. All rights reserved.

COMMUNITYDEVELOPMENTMICROLOANFUNDS

UseofthisGuide TheCommunityDevelopmentMicroLoanFundGuideisintendedforusebycommunity developmentorganizationsforthefollowingpurposes:

1. OrganizationswantingtolearnaboutMicroLoanFunds 2. Organizationscreatingalternativelendingandinvestmentprograms 3. OrganizationsseekingservicesandcapitalfromMicroLoanFunds NOTE:Forpurposesofthisguide,focuswillbeonbusinesslending(tostart,expandorinvestin businessdevelopment)andtoalesserdegreeonpersonalloans(home,autooreducationalloans). Thisguideisoneoffiveguidesdiscussingthefollowingcategoriesoflendingandinvestmentactivities: 1. CommunityDevelopmentLoanFunds(CDLFs):Thisbroadcategoryincludesallloanfunds

thatarenotCreditUnionsorEquityInvestmentfunds.Theinformationinthissectionincludes thestepsandconsiderationsforstartingaloanfund. 2. MicroloanFunds:Thisisasubcategorytypeofloanthatfundfocusesonsmallerloans, primarilyforstartupfinancing. 3. CreditUnions:Thisisafederal/statedesignationforalendinginstitutionthatmeetscertain capitalrequirements,operatingguidelinesandmanagementsystems. 4. EquityInvestmentFunds:Fundsthatprovideequityinvestment(versusloans)intocommunity developmentactivities. 5. CommunityDevelopmentFinancialInstitutions(CDFIs):ThisisaFederalUSTreasury designationbasedonorganizationalandlendingstandardsthatallowsloanfundsaccessto USTreasurygrantsthroughtheCDFIFund(includesmostCDLFs,MicroloanfundsandCredit Unions).

Organizationsinterestedinexpandingaccesstocapitalforunderservedcommunitieshavefocused onvariousformsofloanandinvestmentfunds.Microloanfundsareaspecifictypeoffundwhich targetssmallloanstoentrepreneursandindividuals.Loanfundscanspecializeandfocuslending forvariousproductsandmarkets(homeorautoloans,businessstartupsorexpansion)inspecific neighborhoodsorregions.

AlloftheseformsofloanandinvestmentfundsareeligibletobecomecertifiedCommunity DevelopmentFinancialInstitutions.Thisfederalcertificationallowsloanandinvestmentaccessa widermenuofgrantsandprogramsdesignedtobringcapitaltolowincomeandunderserved communities.

CommunityDevelopmentFinancialInstitutions(CDFIs)isbecomingthestandardnomenclature categorizingallcommunitydevelopmentlendingandinvestmententities(albeitnotallsuch entitieshaveobtainedtheofficialUSTreasurydesignation,mosthaveandwillapplyfortheCDFI designationbecauseitrepresentsarecognizableindustrystandard).TheOpportunityFinance Networkistheassociationrepresentingalltypesoflendinginstitutionsandhasbroadly

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categorizedalllendinginstitutionsasCDFIsandsubcategorizedlendingandinvestment institutionsasfollows:1

"Aswithmainstreamlenders,avarietyofinstitutionshasemergedtoservethebroadrangeof needsinemergingdomesticmarkets.Althoughtheyshareacommonvisionofexpandingeconomic opportunityandimprovingthequalityoflifeforlowincomepeopleandcommunities,thefour CDFIsectors--banks,creditunions,loanfunds,andventurecapital(VC)funds--arecharacterized bydifferentbusinessmodelsandlegalstructures": 1. CommunityDevelopmentBanks:Communitydevelopmentbanksprovidecapitaltorebuild

economicallydistressedcommunitiesthroughtargetedlendingandinvesting.Theyarefor profitcorporationswithcommunityrepresentationontheirboardsofdirectors.Dependingon theirindividualcharter,suchbanksareregulatedbysomecombinationoftheFederalDeposit InsuranceCorporation(FDIC),theFederalReserve,theOfficeoftheComptrollerofthe Currency,theOfficeofThriftSupervision,andstatebankingagencies.Theirdepositsare insuredbyFDIC. 2. CommunityDevelopmentCreditUnions:Communitydevelopmentcreditunions(CDCUs) promoteownershipofassetsandsavingsandprovideaffordablecreditandretailfinancial servicestolowincomepeople,oftenwithspecialoutreachtominoritycommunities.Theyare nonprofitfinancialcooperativesownedbytheirmembers.Creditunionsareregulatedbythe NationalCreditUnionAdministration(NCUA),anindependentfederalagency,bystate agencies,orboth.Inmostinstitutions,depositsarealsoinsuredbyNCUA. 3. CommunityDevelopmentLoanFunds:Communitydevelopmentloanfunds(CDLFs)provide financinganddevelopmentservicestobusinesses,organizations,andindividualsinlow incomecommunities.Therearefourmaintypesofloanfunds:microenterprise,smallbusiness, housing,andcommunityserviceorganizations.Eachisdefinedbytheclientserved,though manyloanfundsservemorethanonetypeofclientinasingleinstitution.CDLFstendtobe nonprofitandgovernedbyboardsofdirectorswithcommunityrepresentation. 4. CommunityDevelopmentVentureCapitalFunds:Communitydevelopmentventurecapital (CDVC)fundsprovideequityanddebtwithequityfeaturesforsmallandmediumsized businessesindistressedcommunities.Theycanbeeitherforprofitornonprofitandinclude communityrepresentation. Thecompanion"CommunityDevelopmentFinancialInstitutions(CDFI)Guide"alsotoucheson manyaspectsofloanfundsandshouldalsobereviewed.TheCDFIGuidehoweverisusuallythe "nextstep"forestablishedloanfunds.Wewouldalsorecommendreviewingthe"Business TechnicalAssistanceGuide"sincethetwocommunitydevelopmentactivitiesworkhandinhand. Duetorecenteconomicandfinancialturmoil,commerciallendersandinvestorshavetightened lendingrequirements,resultingina"creditcrunch"wherecreditneedsaregreaterthanresources. Thiseconomiclandscapehasresultedincommercialfinancialinstitutionsrelyingmoreon communityloanfundsasthemechanismtobetterservenichemarketneeds.Financialinstitutions nowinvestandlendmoreaggressivelytofinanciallysoundandstableloanfunds.Loanfundshave builtastrongreputationbyunderstandinglocalcreditnuancesandneedsresultinginsound lendingandstrongloanportfolios

1 Opportunity Finance Network, website:

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Loanfundscomeinmanysizesandfocusonamyriadofcommunitydevelopmentcreditneeds. Communitybasedloanfundsareintegratedwithtrainingandbusinesstechnicalassistance programs.Togethertheseresourcesenhanceandsupportthesmallbusinessindustry,avery importantpartofcommunitydevelopmentandstabilization.Businessprograms,servicesandloan fundsareusuallymanagedbythesameorganizationthatprovidescomprehensivebusiness assistance.Loanfunds,howevercanstandaloneandbecomeacentralizedfundingmechanismin partnershipwithotherlocalandregionalbusinesssupportprogramsandorganizations. Forsuccessfulloanfunds,theCDFIdesignationisveryimportantandallowslendingprogramsto growdramatically.Mostfoundationandcorporategrantsandinvestmentsfromfinancial institutionslookfortheCDFIdesignationbeforegrantorinvestmentdiscussionsbegin.Overthe lastthreeyears,financialinstitutionshavebeenveryactivelyseekingsoundCDFIstoinvestin. CDFIshavebeenaverysuccessfulmechanismforfinancialinstitutionstomeetlendingand investmentmeasuresrequiredbytheCommunityReinvestmentAct(CRA)andenforcedbybanking regulators.AhighCRAratingisneededifthefinancialinstitutionhasplanstoexpandinthefuture. TheCDFIdesignationisdeterminedthroughacertificationprocessconferredbytheCDFIFundof theDepartmentofTreasury.Thedesignationisforfinancialinstitutions(andlendingprograms includingcommunityloanfunds)andallowsaccesstoTreasuryprogramsandinvestments.NOTE: BecausetheCDFIdesignationissoimportant,itwillbereferredtothroughoutthisguideandwillbe summarizedattheend.The"CommunityDevelopmentFinancialInstitutionsGuide"shouldbe referredtofordetailsontheCDFIFundanditsprograms. Loanandinvestmentfundsplayanintegralroleinacommunityeconomicdevelopmentstrategy. Loanfundsbringcapitaltounderservedmarketsthatincludebusinessfinance(startup,micro, non-profit,smallandbusinessexpansion),realestatedevelopmentfinance(affordablehousing, commercialandoffice,communityfacilitiesandindustrial)andpersonalfinance(auto,homeor personal).Capitalenhanceseconomicstabilitywhilecreatingjobsandopportunitiesfor communityresidents.Creationofpersonalandcommunityassetsisakeystoneinbuildingand strengtheningcommunities.Loanfundsalsobringcommunitiesahigherleveloftechnical expertiseinbusinessandfinance,increasingthepotentialforsustainedcommunitystabilityand growth. Financialinstitutionshavebecomemoreeffectiveinmeetingcustomerdemandsinlowincomeand disadvantagedcommunitiesthroughchannelscreatedbyloanfunds.Financiallysuccessfulfunds generateincometocoverorganizationaloperatingandoverheadexpensesandcanbringadditional incometosupportothercommunitycreditneeds,suchasbusinesstechnicalassistanceprograms andexpansionoflendingservices(suchasautoloans,microloans,homeorbusinessloans).A strongerandfinanciallyviablelendingbusinessenhancestheoverallsuccessandlongevityofyour communitydevelopmentorganizationwhilesupportingcommunitycreditneeds. Loanfundsplayaveryimportantroleincommunitydevelopment(revitalizationandstabilization). Theeffectsaresubstantialandinclude: FortheOrganization:

1. Generatesadditionalincomefortheprogram 2. Supportsandallowsforthecreationofcomplementaryprograms,servicesandprojects 3. Expandsstaffcapacityandcapabilitiesbyattractingandretainingexperienced

professionalsinbusinessfinanceanddevelopment

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 Forthecommunity:

1. Increasesaccesstocapital 2. Increasedaccess-relatedresourcessuchastrainingandtechnicalassistanceintheareasof

financeandbusinessdevelopment 3. Createspersonalandcommunityassets 4. Enhancesthelocaleconomybysupportingimportantsegmentsoftheeconomic

infrastructureincludingbusiness,residentialandindustrialsectors 5. Effectivemeansofsupportingentrepreneurialdevelopmentinneighborhoodsandcreating

neededcommunitygoodsandservices. Successfullendingefforts(andancillaryfinancialprograms)resultsineconomicallystronger communities,strongerworkforces,moreinformedandcapablebusinessesandtenants,and ultimatelyastrongerandmoreinclusiveeconomy.

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COMMUNITYDEVELOPMENTMICROLOANFUNDS

Microloanfundsareaspecificcategoryofcommunitydevelopmentloanfunds.Accordingtothe OpportunityFinanceNetwork,"Communitydevelopmentloanfunds(CDLFs)providefinancingand developmentservicestobusinesses,organizations,andindividualsinlow-incomecommunities. [Loanandinvestmentfunds]aredefinedbytheclientserved,thoughmanyloanfundsservemore thanonetypeofclientinasingleinstitution.CDLFstendtobenonprofitandgovernedbyboardsof directorswithcommunityrepresentation."2

CDLFsarenotregulatedentitiesanddepositsorinvestmentsintofundsarenotguaranteed; howevermostadheretoastandardcreatedbytwomajorentities.Thefirstisafederalprogram throughtheCommunityDevelopmentFinancialInstitution(CDFI)Fund.TheFundhasestablished guidelinestobecomeaCDFI(andbeeligibleforprogramgrants).Thesecondhasbeenestablished bytheOpportunityFinanceNetwork(OFN).OFNisanon-profitassociationwhosemembership requiresthatprospectivemembersmeetperformancestandardsthatareappropriatefortheir particularoperatingcontext. OFNstandardsarebasedon:

1. MissionandImpact:Primarymissionto"striveandtohaveapositiveimpactonlow income.Low-wealthandotherdisadvantagedpeopleandcommunities"3

2. FinanceLedStrategy:Lendingactivityhistoryofovertwoyears,beanon-governmental entityandprovideaffordable,responsiblefinancialproductsandprovidefinancialservices.

3. CommitmenttoPerformance:Meetcertainloanandriskmanagementpoliciesand procedures,haveauditedstatementsandmeetcertaincapitalandportfolioratiosand requirements.

4. SupportOFN'sMission OFNalsoprovidesextensivetechnicalassistanceandaccesstoinformationanddatatoassistinthe start-up,operationandmanagementloanfunds. LendingandInvestmentProgramFeasibilityConcepts:Operatingaloanfundisabusiness. Loanfundscangenerateincomefororganizationsiftheyareoperatedproperlyandhavetheright levelofactivity.Keymanagementtermsandconceptsinclude:

1. CostofFunds:Yourloanpoolmayincludevarioussourcesofgrantsandinvestmentfunds. Somewillcomeinatdifferentinterestrates.Theblendedrateistheaveragerateforyour loanpool.Ifyoureceivedallgrantstheratewouldbe"0"butifyoureceivedaninvestment orloan,theratemightbe2-5%.

2. InterestRateSpread:Thespreadisthedifferentialbetweencostoffundsandwhattherate ofreturnisforyourfunds(averageinterestrateyouarecharging).

3. Breakeven:Thisistheminimumrate(abovethecostoffunds)youneedtochargetocover yourexpenses.

4. FundExpensesandOverhead:Expensesincludebusinessoperations(loanandportfolio management),businessmanagementandmarketing,officeandstaffcosts.Theseare expensesthatshouldbepaidfromtheincomederivedfromthe"interestratespread".If

2 Opportunity Finance Network, Website: 3 Ibid

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yourincomedoesnotcoverexpenses,youwillneedtosecureongoingfundingfor operations. 5. LoanLoss:Thisistheexpectedrateoflossesinbadloans.Allfundshaveprovisionsfor loanlossesandthemoreaggressivethefundis(willingtotakemorelendingrisks),the greaterthelossescouldbe.Successfulfundsestimateloanlosseswellbelow5%(whichat onetimewasastandardcommerciallendinglossexpectation). 6. LoanLossReserve:Loanlossreservesarefundssetasidethatmaybeneededtorepayany loansorinvestmentsmadetoyourfund.Ifyourfundconsistsofamixofloansinvestments andgrants,andaportion(ormajority)ofthebadloanneededtoberepaidtoalenderor investor,youwoulddrawthefundsfromaloanlossreserve.Ifoneloanwentbadandyour fundlost$25,000.,youwouldneedtotapintothereservetorepaythelenderorinvestor. Theriskieryourlendingisorifyouhavehadhistoricallyhighloanlosses,youwouldneeda higherloanlossreserve.Highloanlossreservesdonotbenefityourfundsincetheyare dollarsthataresetasideandarenot"working"asoutstandingloansorgeneratinginterest income.

Infinancialinstitutionsandinlargerfunds,loansinportfolioarerated.Thosewith greaterriskorinvariousstagesofdistress(latepayments)willhaveahigherpercentage setasideforpotentialloanlosses. 7. Feasibility:Incomeneedstoexceedexpenses.Thelargerthelendingpool(andlevelof fundingyouhaveouttoborrowers)thegreateryourpotentialreturnsare.Similarly, smallersizedfundshaveamoredifficulttimegeneratingincometocoverexpenses. Smallerloanshavegreaterrelativeoperatingcostsbecausehandlingandprocessingcosts foreachtransactionisaboutthesamewhethertheloanisfor$500or$5,000,000. StartuporExpansion/BecomingaMicroLoanFund Thefollowingsectionwilldiscussvariousstrategiesandstepsthatshouldbeconsideredifyouare astartuploanfundorifyouareexpandingtogainCDFIdesignation.Wewilllookatthefollowing: 1. Start-uploanfund:

A. Asanewfund B. Throughapartnership 2. Existing,slightlyexperiencedloanfund 3. Existing,experiencedloanfund StartupFund:Startingaloanfundisverydifficultduetocosts.Fundingisneededforbusiness operationsandfortheloanfund.Alendingtrackrecordisneededtoattractfinancingortobecome eligibleforatechnicalassistancegrantthroughtheCDFIFund. Thefollowingisasuggestedguidefororganizationsthathaveclearlyidentifiedneedsandstrong supporttocreateafund.Supportfromyourorganizationandboardiscritical.Thefundshouldbe targetedtoaspecificmarketsegment:microbusinesses,smallbusinesses,affordablehousingor consumerfinancing.TherearetwopotentialwaysofbecomingaCDLF,onestartingfromscratch andonethroughpartnerships. Strategy1:NewFund(Ifyourplanscallforthecreationofanewfundorstartup).Asignificant amountoffundingandpredevelopmentworkisneededfordevelopingthebusinessplan, marketingandmanagementplans.ConsiderapplyingforaCDFITechnicalAssistanceGrant.You willalsoneedfundingforoperationsandfortheloanfund.Ifthisisthecase,considerthefollowing steps:

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