Study Proposes Means to Boost Minority Loans

Selling blocks of minority business loans to investors could bring needed capital--and crucial equity--to the nation’s fast-multiplying but long-underserved minority entrepreneurs, according to a report to be released Tuesday by the Commerce Department.

The report by the Milken Institute in Santa Monica tackles a topic buzzing through government and economic development circles: how to link the engine of the capital markets to the unmet needs of minority entrepreneurs, who are forming businesses at twice the rate of the total population but lag their white counterparts significantly in wealth.

It comes at a time when a growing number of influential leaders--including President Clinton, Federal Reserve Chairman Alan Greenspan and the Rev. Jesse Jackson--are speaking publicly on the issue, calling for more equity investment in traditionally underserved communities and pondering ways to link those communities with flush investors.

The report will be among the topics discussed at a meeting today of the White House National Economic Council to explore whether federally backed community development loans could also be bundled and sold as securities.

Commissioned last year, the Milken Institute study aims to ensure minority business a place “at the center” of that policy debate, said Courtland Cox, director of the Commerce Department’s Minority Business Development Agency.

“In the next 50 years, 90% of all the net growth in the country in terms of population will be in the minority communities,” Cox said. “If the country is to be a dynamic business and economic leader, it needs to figure out . . . mechanisms that will allow minority businesses to grow and take advantage” of capital markets.

The report’s key proposal calls for the securitization of minority business loans--which would be pooled, rated, insured or otherwise enhanced to protect investors, and sold as securities, freeing up more capital that lenders could pump back into minority markets.

The practice of securitization of small-business loans is just beginning to take hold, facilitated by credit scoring and other technologies that have standardized the loans and made risk more predictable, said Mary Beth Sullivan, managing director at Furash & Co., a Washington-based banking consultant firm.

The process also requires a steady volume of loans, low default rates by participating lenders and some type of credit enhancement to protect investors. All of those issues are likely hurdles for any efforts to securitize minority business loans as a distinct class, analysts said, but they could eventually be overcome as the volume of loans increases and they become more standardized.

In general, a secondary market for such loans could expand access to capital for struggling minority entrepreneurs, much as the secondary market Fannie Mae helped create expanded access to home mortgages.

“Now even if your own mother won’t lend you money to buy a house, if you have a job and a little bit of money, you can probably qualify for a mortgage loan at a [low] rate. . . . That’s because we created a very effective secondary market in the last 50 years,” said Glenn Yago, one of the report’s lead authors. “Build the market and they will come. That’s part of the logic.”

Small-business loans are the latest in a string of assets to be securitized--from student and auto loans to earthquake insurance and the anticipated flow of record industry royalties.

But so far, the growing number of stable minority businesses has fallen “below the radar screen” of the capital markets, Yago said. Those undervalued businesses--particularly the growing number with annual revenues of $1 million or more--could present an opportunity for investors, particularly institutional investors such as pension funds, he said.

The report also calls for a shift in the type of financing offered to minority businesses, which tend to get fewer and smaller loans than their white counterparts. While they could benefit from better access to loans, the report stresses an even greater need for equity and mezzanine financing--a combination of borrowing and equity--rather than simply debt, which has been the focus of most government-supported lending programs until now.

Although minority-owned enterprises make up nearly 12% of the nation’s business population, the report said, they receive only an estimated 1% to 2% of the total equity capital invested in the U.S.

The need for equity financing was championed last year by Greenspan, who will speak next week at a Federal Reserve conference that addresses both access to capital for minorities and the securitization of small-business loans.

“This is an essential part of the financial foundation for the dynamic young enterprises that are so central to our wealth-creating process,” he said in a speech to Jesse Jackson’s Wall Street Project, a New York round-table where this year Clinton announced new equity financing proposals for poor and minority communities. “Unless minorities can have access to all forms of capital from which to create wealth, they will be denied the full benefits of our vibrant economy,” Greenspan said.

However, others in the field of community lending warn that focusing the debate only on access to capital is misguided.

“I would question the blatant argument that equity financing will solve all the problems of the world,” said Nitin Bhatt, interim director of USC’s Business Expansion Network.

“When I ask business owners, ‘What are your two problems?’ one is, ‘We lack customers and markets,’ and the second is, ‘We lack the road plan to take our business to the next level.’

“To me, these things are much more fundamental than the assumption that it’s [a lack of] capital that’s keeping businesses from succeeding.”