Hoping to consolidate 15 claims processing sites into a centralized
location, last year UnitedHealth Group of Minneapolis reportedly
looked at more than a dozen cities for a facility that was expected
to employ more than 300 workers.
In April 1999, the Fortune 100 company announced it would locate
its new customer service center in Eau Claire, Wis., thanks in part
to more than $1 million in low-interest loans from the state, Eau
Claire County and Gateway Industrial Park Corp. (a quasi-public
organization). The city of Eau Claire also offered two additional
low-interest loans, which UnitedHealth declined.
Such a scenario, while maybe not the rule, is far from the exception
as communities compete for new and expanding companies. Like Eau
Claire, many communities either administer or have access to multiple
public or quasi-public loan programs, using taxpayer-backed loans
to close incentive deals or provide gap financing for fledgling
businessestypically at subsidized interest rates to boot.
Yet despite their growing presence, use of public money, and involvement
in financial services (otherwise heavily regulated in the private
sector), public or quasi-public loan programs do not appear to receive
a significant amount of scrutiny.
Acknowledging a differing mission than the private loan sector,
there nonetheless appears to be fragmented and inconsistent measurement
of the impact and performance of public loan programsparticularly
local onesand few clear standards regarding what is or is
not an acceptable rate for bad loans given a program's mission.
Many examples were found where the rate of bad loans by a public
loan program was five, even 10 times higher than current private
Coming to a community near you
According to an informal survey by the Minneapolis Fed, low-interest
loans were the most used of any business incentive available to
local communities and distributed the most total resources (see
story). For some communities, they are
the go-to incentive. For example, East Grand Forks, Minn., used
loans in 16 of its 18 assistance agreements made between 1995 and
1998, according to a state report.
While the number of state and federal loan offerings to business
hasn't radically changed in the last decade, growth has been strong
among local revolving loan fund (RLF) programs during this time.
In Minnesota, the number of RLFs has gone from virtually zero in
1984 to well over 200 in 1996, according to the state's legislative
auditor. In South Dakota, the number of RLFs has nearly quintupled
since 1988 from 15 to more than 70, according to a recent state
In some ways measuring the performance of public and quasi-public
loan programs can get sticky because many have social or environmental
as well as economic development goals. Even when economic development
is the goal, the expectations of return on investment are usually
different from those of the private financial sector. To gain broader
insight on the financial performance of public loan programs to
business, data was requested for dozens of local programs, along
with 18 state-based programs in Minnesota, the Dakotas and Wisconsin
(Montana has no direct-loan programs).
According to information received, most loan programs make anywhere
from zero to about 50 loans in a given year. Only a handful of programs
lend more than $5 million annually, and most are at the state level.
But with literally hundreds of public loan programs in the Ninth
District alone, a significant amount of public money is at stake,
especially given high rates of payment delinquencies and loan losses
among these programs.
Financial yardstick: The good, the bad and the ugly of public
In the Ninth District, semi-annual reports from two dozen RLF programs
in Montana, South Dakota and North Dakota (funded through grants
from the federal Economic Development Administration) showed a collective
portfolio of almost 450 loans worth more than $32 million. Individual
portfolios ranged from a couple of loans worth little more than
$100,000 to more than 140 loans worth over $7 million.
Combined, these programs had a 30-day past-due rate of almost 11
percent, and a write-off rate of better than 7 percent. The value
of noncurrent loans and write-offs totaled $5.8 million, or 18 percent
of all loan funds. One Montana program had 98 percent of its $910,000
million loan portfolio past due more than 60 daysthe responsibility
of a single loan.
Local loan programs also receive grant money from the federal Community
Development Block Grant (CDBG) program. Montana communities have
used this money to make 102 loans to businesses since 1989, according
to data provided by the Montana Department of Commerce. Of that
total, 13 were in foreclosure. Another 15 loans were delinquent,
restructured or deferred.
If history is any pattern, the portfolio of CDBG-funded loans in
Montana could see still more trouble ahead because delinquency and
loss rates typically take several years to peak from when the loan
is made. From 1989 to 1995, 47 CDBG-funded loans were made, and
half experienced some difficulty; 12 loans have been foreclosed,
and another 12 were delinquent, restructured or deferred.
Other loan programs in Montana are not faring much better. The
state's microloan program provides money to intermediary nonprofit
organizations, which in turn make loans to businesses, including
start-ups. This program reported a cumulative write-off rate of
almost 6 percent and a delinquency rate of 20 percent.
A now-defunct Montana Women's Capital Fund made 100 loans, 27 of
which were partially or wholly written off (although its cumulative
loss rate represented just 12 percent of funds loaned). Another
19 loans were restructured or refinanced, and at least four are
currently delinquent, according to a Montana Department of Commerce
There are programs, however, that even the private market would
envy. One of Minnesota's major loan programsthe Investment
Fundhas written off only one of 120 loans made in the last
five years, and just two others are delinquent.
In South Dakota's REDI Fund, only four of its 74 outstanding loans
were not current, which represented less than 1 percent of the program's
outstanding principal. The program's cumulative loan loss as of
last year was just over 1 percent. Three loan programs in Wisconsin
have made 185 loans in the last five years; there have been no write-offs
and only one is currently delinquent.
But there were also ample examples of poorer-performing loan programs,
at least in the financial sense. Two state loan programs in Minnesota
have combined write-off and delinquency loan rates of 17 percent
and 29 percent. The state's Small Business Development Loan program
has 11 loans worth $41 million in its portfolio. While it has seen
no write-offs to date, a $6 million loan recently became delinquent
when Excelsior-Hendersona start-up making high-end motorcyclesfiled
South Dakota's Agricultural Processing and Export Program made
30 loans from 1990 to 1999, seven of which went south. In two other
cases, loans were repaid but the business either moved out of the
state or went out of business after paying the loan.
Since its inception in 1991 through 1998, North Dakota's Development
Fund made 124 loans totaling a little over $23 million. During this
time, 39 loansone in threehave been at least partially
written off, totaling $5.4 million.
While not meant as a direct comparison, it's worth noting what the
private market typically achieves regarding bad loans. The strong economy
has done wonders for the loan portfolios of Ninth District Banks, as
both the number of noncurrent loans and loan losses have dropped significantly
since 1990. The volatility of the farm economy is also very noticeable
in the performance of banks in Montana, North Dakota and South Dakota.
Among local loan programs, many RLFs were found in the Ninth District
with no delinquent loans or loan losses for the year. But there
are indications that even programs with stellar rates are sometimes
playing by a different set of performance rules.
For example, a survey of 84 RLFs in South Dakota found a write-off
rate of less than 2 percent. But an RLF will often bend over backward
to ensure that a business succeeds. Sometimes that means restructuring
the loan five or six times, according to Beth Walz, president of
South Dakota Rural Enterprise, Inc., a statewide financial intermediary
that raises capital and provides other nonfinancial services to
public loan programs in the state.
"Here's the truth; RLFs are going to do everything they can to
work with these businesses to keep them from failing," Walz said.
Depending on how you view things, that can be either good or bad,
"In terms of pure fiscal management, it's probably not a good idea,"
Walz said. "But it's marvelous for business development" because
it builds a lasting, partnerlike relationshiprather than just
a financial onebetween the business and the lender.
"As long as there is the possibility of success and everybody is
working toward that, I don't think it's bad that RLFs have the ability
to be flexible" with individual borrowers, Walz said.
With six different loan programs, Bear Paw Development Corp. of
Northern Montana manages one of the largest nonprivate loan portfolios
in the Ninth District. It has a noncurrent loan rate of 14 percent.
"A bank would pale at that rate," said Dick King, who until recently
was the head of Bear Paw, having moved to a similar position at
the Missoula (Mont.) Area Economic Development Corp.
King pointed out that different lending strategies demand different performance
standards. Montana's microbusiness programwith its noncurrent rate
of about 25 percenttargeted start-up businesses that were "high
maintenance, high intensity," according to King. As a result, "you're
naturally going to have less overall performance. ... The legislature
authorized [the program] with precisely that in mind."
"There will always be pendulum swings" in the appropriate risk
levels of a program, according to Kevin Cramer, director of the
North Dakota Department of Economic Development and Finance. Individual
loan programs often have to find the location of that gray line
the hard way.
The Development Fund in North Dakota, for example, was very aggressive
in equity investments when it started in 1991, Cramer said. Losses
began piling up quickly for the fund. State lawmakers complained
and made the fund much more conservativeso conservative that
after several years, one lawmaker asked, "What good are you? You're
not taking on enough risk," Cramer said.
Room for improvement
Most sources did, however, generally agree that performance measurement
among programs often fell short, particularly among local programs.
A report on RLFs in Minnesota by the Corporation For Enterprise
Development (CFED) found that only about three of five could report
such basic items as cumulative lending activity.
"Despite the presence of RLFs in virtually every county in Minnesota,
information that documents their sources of capital, lending performance,
or impact is limited and incomplete," the report stated.
Walz said she's also seen resistance to performance measurement.
"Unless there is a compelling reason, a lot of them aren't keeping
track," Walz said. "My response is, 'So start.'"
Much of the problem of poor performance and poor reporting stems
from a lack of staffing. As many as half of all local loan programs
are inadequately staffed, according to Andrea Levere, CFED vice
president, who added that the current system "is devoid of incentives"
to help programs do better.
"You can't blame it on practitioners," Levere said. "They have
no money to do those things."
Where performance measurement is done, most fall back on job creation
or retention as the main goal. The problem is that programs usually
take credit for any and every job created or retained by a business
that has a loan through their organization. Often the success of
loan programs is "measured by ribbon cuttings" in many communities,
Cramer said. "Job creation is easy in economic development."
The CFED report argued that job creation remains the best proxy
for a loan fund's performance. But it also acknowledged that job
creation "is notoriously difficult to quantify, given the inherent
complexity of the job creation process, and the common wisdom that
it is impossible to credit a single factoreven if it is as
important as capitalfor the creation of a new job."
"If done right, it's one [good] indicator" of performance, Levere
said, and in some cases, it's the only indicator available. "If
you've got a hammer, everything becomes a nail," she said.
Levere pointed out that many loan programs were designed in the
1980s when joblessness was a pressing issue. While joblessness is
still an issue in most communities to some degree, larger issues
of job quality and business creation (rather than job creation)
were too often overlooked, she added.
The yin and yang of loan making
Greater sophistication is apparently coming to some loan programs,
particularly at the state level. North Dakota, for instance, has
begun to measure the wealth effect of loan programs, gauging not
just new jobs and salaries, but their impact on a community's standard
of living, Cramer said.
Minnesota currently tracks wage rates and the amount of private
financial leverage created by the public loan, and this year will
also track a loan's impact on the local property tax base, according
to an official with the state Department of Trade and Economic Development.
CFED is partnering with a number of organizations to build an industrywide
database to establish badly needed performance benchmarks for RLFs
to measure themselves against. "You have to be serious about [performance],"
Levere said. "Otherwise, how do you know what you're doing?"
As a matter of survival, performance measurement should lead RLFs
to rethink the notion of providing subsidized capital, Walz said.
If RLFs provide capital that the private market can't or won't supply,
"it should come at a premium, not a discount," Walz said. She added
that if loan programs want to grow, they will "have to find new
ways to grow capital, and it won't happen [when loans are made]
at zero or 1 percent."
Most of the push for better performance appears to be coming from
inside the industry, rather than from the public. Indeed, given
the social goals, a proactive disposition toward business and a
fairly low-scrutiny profile, loan programs appear to enjoy a fair
amount of support.
Even the banking community is somewhat ambivalent about public
loan programs. Some banks see programs "as a way to help their business"
because public loans often help leverage private loans which might
not otherwise be made, according to Daryll Lund, president and CEO
of Community Bankers of Wisconsin.
Bill Bond, executive vice president and CEO of the Minnesota Bankers
Association, said guaranteed-loan programs are well received and
frequently used by banks, and the public understands this particular
role of government in the market. "Where government programs get
into direct lending, that's where we start to get concerned." Individual
banks might not mind government subsidized loan programs, Bond said,
but the general direction of where it's going "deserves scrutiny."
"I think the key word is balance," Cramer said. "Economic development
isn't about throwing money at the wall and seeing what sticks."
That means wisely protecting public resources while taking on enough
risk to have a positive impact, Cramer said. Public loan programs
are more diligent today, he added, conducting research like any
bank would before funding a project. "But we're slightly more benevolent"
on loan approvals, Cramer said. "We do end up with higher risk,
and some people think that's appropriate."