COVID-19: Connecting small businesses to pandemic relief is a struggle, CDFIs say

The federal fiscal response to the COVID-19 pandemic relies on lenders to deliver critical public aid to small businesses. Community development financial institutions (CDFIs) are well-suited to act as intermediaries for aid to many of the small businesses that are most vulnerable to the economic fallout from social-distancing measures. However, the design of the major federal relief packages may be hindering CDFIs from fulfilling that role.

To learn how effectively CDFIs can access relief programs and serve their small business customers during this crisis, the Community Development team at the Federal Reserve Bank of Minneapolis interviewed leaders from ten CDFIs around the Ninth Federal Reserve District. Here, we summarize what they told us about their experiences in the earliest days of the pandemic. We conclude with a discussion of potential avenues and impediments for CDFIs’ engagement in the pandemic response effort from this point on.

What are CDFIs?

CDFIs are specialized entities that provide capital to otherwise underserved borrowers, often in rural or low-income areas of the nation. There are about 1,100 CDFIs in the U.S. They may be banks, credit unions, loan funds, or venture capital funds, and can operate on a for-profit or nonprofit basis. They are often federally certified, market-based, and mission-driven, and can be financed through a mix of public and private dollars. CDFIs may work in targeted geographies, such as Indian Country, and may also work within specific sectors, such as affordable housing or child care.

About 60 percent of CDFIs report making small business loans, with roughly a third reporting small business loans as their primary activity. Relative to most banks, many CDFIs are more likely to work with businesses owned by women, people of color, or Native entrepreneurs. CDFIs develop innovative underwriting standards to serve clients perceived as “risky” by traditional lenders—and many operate with a strong track record, achieving their goals safely and soundly.

Early responses to the pandemic

Like nearly all lenders in the country, the CDFI leaders we interviewed expected their customers to face difficulties making their loan payments as the scope of the pandemic-related economic fallout became apparent. Some CDFI leaders reported offering deferrals on loan payments for all of their borrowers. Others approached deferrals on a case-by-case basis, waiting to see if federal or state aid would enable their customers to pay. Regardless of their short-term stance, most CDFI leaders mentioned that their organizations will ultimately be limited in their ability to defer, renegotiate, or otherwise alter their customers’ debt obligations without approval from the CDFIs’ own financiers. CDFI leaders also reported an inability to fund new loans with their existing resources. Their ability to borrow against their assets was typically maxed out pre-pandemic because of the high demand for their services.

Most of the CDFI leaders we interviewed said they are unable to access federal COVID-19 aid on behalf of their small business customers. A lack of experience working with the U.S. Small Business Administration (SBA) was a major reason cited. The Coronavirus Aid, Relief, and Economic Security (CARES) Act’s primary small business relief program, the Paycheck Protection Program (PPP), funnels its dollars primarily through depository institutions or certain SBA-accredited lenders, and follow-up relief bills are likely to follow suit. During the first round of PPP funding, only about 200 CDFI credit unions, banks, or loan funds—representing less than a quarter of such CDFIs in the nation—had the requisite SBA certifications to potentially access the PPP. The number of CDFIs with potential PPP access increased when the SBA and the U.S. Department of the Treasury made some smaller lenders PPP-eligible in the program’s second round. Many of the smallest CDFIs designed to serve the underserved may still be unable to access CARES Act financing streams and thus unable to channel aid to some of the most vulnerable small businesses in the country; others may still need to develop relationships with traditional lenders to provide their clients with access to relief.

Another factor interviewees noted that limits CDFIs’ participation in federal relief efforts is a lack of technological resources. Generally, only relatively large CDFIs have digital platforms for processing their loans. For smaller CDFIs that lack such platforms, the volume of COVID-19 relief loans they could theoretically process under a given time constraint is limited. Some rural-focused CDFIs also lack access to high-speed internet service or the technology tools that enable staff members to work remotely while social-distancing measures are in place.

CDFI leaders reported that since the COVID-19 crisis began, they are serving businesses beyond their pre-existing customer base. According to CDFI leaders, many of the new CDFI clients are customers at traditional banks, but were turned away by those banks when inquiring about the PPP or the SBA’s longstanding Economic Injury Disaster Loan (EIDL) program. Their reports reflect anecdotes and data suggesting that traditional lenders prioritized larger clients, with larger loan sizes, in the first round of PPP commitments. Whether the CDFIs they manage are SBA-PPP lenders or not, CDFI leaders reported that their staff members are connecting customers to information about the EIDL program and the PPP and seeking out opportunities for them to apply. Interviewees described the application process as cumbersome and requiring significant assistance and time from staff members. Total demand for CDFI assistance has left CDFI leaders describing their organizations as stretched thin.

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Several CDFI leaders said they felt pressured to prioritize their own least-risky customers to maintain stability within their own portfolios. Though CDFI loans often perform as well as—or even better than—loans made by traditional lenders, many CDFIs hold unique portfolios containing businesses that are particularly vulnerable to a pandemic-related recession. For example, when CDFIs lend to very small businesses, the largest volume of their loans by sector goes to retail enterprises. Retail has been heavily affected by COVID-19 social-distancing measures. Additionally, because CDFIs often target very small businesses and are unable to access PPP dollars, when traditional lenders pass these smallest firms over, the businesses may miss out on critical relief dollars entirely. CDFI leaders reported that even among CDFIs that do access the PPP, the demands on their capital and staff resources, and the pressures on their balance sheets, may motivate them to turn to their less-complicated, larger clients.

Are relief programs reaching CDFI customers?

On the customer side, CDFI leaders report that the designs of PPP, EIDL, and other relief programs leave many of the small business owners they serve ineligible for aid or nervous about accepting it. For example, all start-ups and many newer businesses are unable to meet past-profitability requirements. Some relief programs require small businesses to predict future profitability and staffing decisions, but CDFI leaders report that their customers feel ill-equipped to do so as the economy remains in flux. CDFI leaders also reported that a lack of clarity on the rules and regulations around loan forgiveness may heighten any pre-existing distrust that historically underserved communities have about government assistance or traditional lenders. Reports on the first round of PPP funding indicate that some recipients are considering returning their PPP loans because they do not want to unintentionally take on debt due to unclear or misunderstood guidance about the loans’ forgivability.

CDFI leaders told us their customers report hearing misinformation about programs like the EIDL and PPP. In some cases, program administrators have made such rapid changes to rules and guidelines that CDFI leaders themselves reported hearing confusing or conflicting information on their own eligibility to process PPP loans. The lack of clarity delays applications—and thus relief—for small businesses, which often lack cash reserves to weather even a short-term downturn. If the application processes remain murky and small businesses continue to find themselves “on the bottom of the pile,” many more businesses than necessary will shutter as a result, CDFI leaders predict. Because many of these small businesses make up the heart and soul of their diverse neighborhoods, CDFI leaders are concerned about the overall impact on community conditions.

New avenues for PPP participation

Congress approved a second round of funding for the PPP, with $30 billion set aside for CDFIs, other community financial institutions, and banks with less than $10 billion in assets—a size limitation that will still allow 97 percent of banks around the nation to qualify for the set-aside. The SBA also recently announced that no lender will be allowed to originate loans worth more than 10 percent of the total PPP allocation. The new ceiling limits the amount of loans that will come from the nation’s largest lending institutions. The SBA also announced an 8-hour window of time during which PPP applications from lenders with less than $1 billion in assets would be prioritized. The SBA and Treasury also lowered the annual threshold of small business lending from $50 million to $10 million to allow for additional CDFIs to serve as eligible PPP lenders.

Initial data on the second round of PPP funding indicate that the funding is finding its way to relatively smaller businesses than in the first round. PPP funding has also remained available for a longer time during the second round; the initial PPP funding was entirely committed within two weeks of its passage. However, the PPP will still rely on the SBA as a distributor, meaning that the majority of CDFIs will still be unable to access the program directly on behalf of their clients.

Some CDFI leaders suggested that the SBA should fast-track the certification of CDFI lenders by accepting those that have undergone thorough soundness checks by other federal agencies. For example, the Treasury’s CDFI Fund awards funds to some CDFI lenders after assessing their stability. As the PPP or some version of a small business lending program may be renewed in the days ahead, CDFIs could also work to develop relationships with approved bank or non-bank SBA lenders to help their clients connect with PPP lenders. Creating more formal relationships between smaller businesses and lenders could have benefits that last beyond this crisis.

CDFIs that are able to access the PPP will have another tool at their disposal in the Federal Reserve’s PPP Liquidity Fund (PPPLF). The PPPLF will extend credit to CDFIs that originate PPP loans, taking the loans as collateral at face value. The additional liquidity from the PPPLF can increase the capacity of CDFIs to make additional PPP loans to new and existing customers. Interested CDFIs must designate a depository institution with an account at a Reserve Bank as their correspondent.

Some CDFI leaders we spoke with proposed new approaches for helping their small business customers through the pandemic. For example, one CDFI leader called for an aggregator that would allow CDFIs to package their loans and sell their debt on a secondary market. Still other interviewees referenced a proposal to buy the most vulnerable businesses’ debt from CDFIs, which would free up resources for CDFIs to focus on triage for more viable businesses.

Regardless of the form it takes, CDFI leaders agreed that additional help is necessary to aid their customers. The CDFI leaders we interviewed strongly believe that as currently structured, federal relief programs will result in a recovery that disproportionately passes over businesses owned by traditionally underserved entrepreneurs, including women, people of color, and Native people. On the other hand, CDFI leaders also believe they represent one of the sectors that holds the tools necessary to connect federal relief to often-overlooked communities that might otherwise be swept under the economic tide of this historic pandemic.