Public-Sector Loans to Private-Sector Businesses

Public-Sector Loans to Private-Sector Businesses:

An Assessment of HUD-Supported Local Economic Development Lending Activities

Public-Sector Loans to Private-Sector Businesses: An Assessment of HUD-Supported Local Economic

Development Lending Activities

Final Report

December 2002

Prepared By:

Christopher Walker Martin D. Abravanel

Patrick Boxall Roger C. Kormendi

Kenneth Temkin Marsha Tonkovich

The Urban Institute Metropolitan Housing and Communities Policy Center

2100 M Street, NW Washington, DC 20037

Aspen Systems Corporation Rockville, MD

ICF Consulting Vienna, VA

Kormendi\Gardner Partners Washington, DC

KRA Corporation Silver Spring, MD

Submitted To:

U.S. Department of Housing and Urban Development 451 Seventh Street, SW Washington, DC 20410

Contract No. C-OPC-21583 UI No. 07019-000-00

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or it funders.

ACKNOWLEDGEMENTS

The data, analysis, and conclusions presented in this report are the product of a long and complex research effort whose participants include multiple research organizations, a very large design, data collection, and analysis team, and many cooperating state and local community and economic development practitioners and business owners from across the nation.

At the Urban Institute, Christopher Walker was the study's Principal Investigator and Martin D. Abravanel was the Project Director. The late Franklin James, an acknowledged national expert in the field of economic development research and policy analysis, was initially the study Co-Principal Investigator; he contributed substantially to its design and development until his death on July 4, 2001.

The principal authors of this report are: Christopher Walker and Martin Abravanel of the Urban Institute; Patrick Boxall of KRA Corporation; Roger Kormendi and Kenneth Temkin of Kormendi\Gardner Partners; and Marsha Tonkovich of ICF Consulting.

We appreciate the support and substantive contributions of Margery Turner at the Urban Institute, Anita Rechler at ICF Consulting, and Marie Pogozelski at Aspen Systems Corporation.

The following contributed substantially to the study's design, implementation, data analysis, or management: Christopher Snow, Kim Marschner, Jennifer Comey, Jeremy Gustafson, Elizabeth Cove, and Christopher Hayes--at the Urban Institute; Gregg Rich--at KRA Corporation; Andy Zehe--at ICF Consulting; and Cindy Maus at Aspen Systems Corporation.

We acknowledge the assistance of the following: Margaret Browne, Jessica Cigna, Aaron Graham, Jennifer Johnson, Seon Joo Lee, Sandra Padilla, Noah Sawyer, Diane Hendricks, and Tim Ware--at the Urban Institute; Sadie Bennett , Dan Cohn, and Wanda Hodge--at Aspen Systems Corporation; Scott Ledford, Shepherd Ayana, Tanara Bowie, Jill Canino, Elizabeth Drapa, Asli Gobuluk, Elizabeth Matusow, Lena McGinn, Benjamin Miller, Susanna Samet, and consultant Roger Frankoff--at ICF Consulting; John Douglass--at Kormendi\Gardiner Partners; and Dwight Jefferson, Janice Johnston, Joseph Kirchner, Barbara Mendez, Edward Mendez, and Robyn West--at KRA Corporation.

We appreciate the guidance, advice, and support provided by officials and staff of the U.S. Department of Housing and Urban Development, the study's sponsor. We especially acknowledge the assistance of Judson L. James (the Government Technical Representative for the study), Kevin Neary, and Priscila J. Prunella of the Office of Policy Development and Research, and Richard Kennedy, Paul Webster, and Robert Duncan of the Office of Community Planning and Development.

Despite the generous contributions of these individuals and organizations, any errors or omissions are those of the authors.

Foreword

This report assesses the performance of the third party loans under principal programs that the Office of Community Planning and Development (CPD) of the Department of Housing and Urban Development (HUD) directs toward economic development: the Community Development Block Grant (CDBG) Program; the Section 108 Program; and the Economic Development Initiative (EDI). The research describes the CDBG, Section 108, and EDI programs, how they work, and what types of economic development they fund; estimates the size and quality of the loan portfolio; and appraises the success of these programs in terms of job creation, business success, loan pay back, leveraging, and cost per job created. Additionally, the study examines the reasons why communities have used Section 108, their experiences using Section 108, the effect of EDI money on that use, and the results of Section 108 projects. The concluding chapter assesses the feasibility of developing a secondary market for the economic development loans originating under the CPD programs.

The findings of this report demonstrate the scope and variety in the CPD programs and the range of locallydetermined objectives served by third party loans. The more than $2.2 billion of HUD funds used for this purpose in the later half of the 1990s were examined. The nation's most populated and most distressed cities and urban counties account for the preponderance of this spending. Examination of nearly 1,000 loan files maintained by the 51 most active community users of CDBG and Section 108 funds for third-party lending indicates that local loan programs create jobs and leverage investment at costs that are comparable to those of other federal government programs.

The report merits the attention of all those concerned with the economic development of distressed urban areas and potential innovative developments in its funding, such as the establishment of secondary markets for third-party economic development loans.

Alberto F. Trevi?o Assistant Secretary for Policy Development and Research

Public-Sector Loans to Private-Sector Businesses: An Assessment of HUD-Supported Local Economic Development Lending Activities

TABLE OF CONTENTS

EXECUTIVE SUMMARY............................................................................................................. i

Study Goals ......................................................................................................................i Study Questions, Methods, and Data Sources................................................................ iii The Extent of Third-Party Lending ..................................................................................iv Results of Third-Party Lending.........................................................................................v Characteristics and Performance of Third-Party Loans ................................................. viii The Feasibility of a Secondary Market ............................................................................ix Selected Program Issues................................................................................................xi

CHAPTER 1: INTRODUCTION: RESEARCH QUESTIONS AND METHODOLOGY ............... 1

HUD's Local-Discretion Approach to Supporting Community Development .................... 1 Economic Development as a Local Community Development Option ............................. 3 Third-Party Lending as a Local Economic Development Option...................................... 4 HUD Programs that Support Third-Party Lending ........................................................... 5 Design Options for Local Third-Party Lending Programs .............................................. 15 An Overview of the Research Questions and Methods ................................................. 17 Organization of the Report............................................................................................ 25

CHAPTER 2: NATIONAL PATTERNS OF, AND TRENDS IN, ECONOMIC DEVELOPMENT AND THIRD-PARTY LENDING USE ....................................................................................... 29

Highlights...................................................................................................................... 29 Introduction................................................................................................................... 30 Sources and Uses of Information.................................................................................. 31 Economic Development Funding .................................................................................. 33 Economic Development Funding Patterns .................................................................... 39 "Explaining" Differences in Economic Development Funding ........................................ 50 Conclusion.................................................................................................................... 56

CHAPTER 3: PROGRAM ADMINISTRATORS' PERSPECTIVES ON CDBG AND SECTION 108 PROGRAM REQUIREMENTS .......................................................................................... 57

Highlights...................................................................................................................... 57 Introduction................................................................................................................... 58 Sources and Uses of Information ................................................................................. 59 CDBG Program Administration and Program Requirements......................................... 60 Special Section 108 Program Issues ............................................................................ 68 Use of EDI and BEDI .................................................................................................... 72 State Programs............................................................................................................. 74

Public-Sector Loans to Private-Sector Businesses: An Assessment of HUD-Supported Local Economic Development Lending Activities

CHAPTER 4: AN ANALYSIS OF THE BENEFITS THAT DERIVE FROM HUD-SUPPORTED, LOCALLY ORIGINATED THIRD-PARTY LOANS................................................................... 77

Highlights...................................................................................................................... 77 Introduction................................................................................................................... 79 Sources and Uses of Information.................................................................................. 79 National Objectives, Program Purposes, and Types of Borrowers ................................ 82 Program Benefits and Aspects of Program Performance .............................................. 91 The Relationship Between Project Benefits and Business Characteristics .................. 104

CHAPTER 5: THE FINANCIAL CHARACTERISTICS AND PERFORMANCE OF HUD-SUPPORTED THIRD-PARTY LOANS.......................................................................... 117

Highlights.................................................................................................................... 117 Introduction................................................................................................................. 118 Sources and Uses of Information................................................................................ 119 Description of the Portfolio of CDBG and Section 108 Economic Development Loans 124 The Relationship Between Loan Terms and Business Characteristics........................ 125 Characteristics of Uses of Funds, Loan Underwriting, Collateral, and Financing Structure..................................................................................................................... 127 The Performance of the National Portfolio of CDBG- and Section 108-Funded Loans.......................................................................................................................... 131 The Relationships Among Loan Performance and Underwriting, Collateral, Project Financing, and Business and Community Characteristics........................................... 136

CHAPTER 6: CONSIDERATION OF THE FEASIBILITY OF SECONDARY MARKET SALES OF THIRD-PARTY LOANS.................................................................................................... 152

Highlights.................................................................................................................... 152 Introduction................................................................................................................. 153 A Description of Secondary Market Securitization Transaction Structures .................. 154 Financial Economic Analysis of a Secondary Market for CDBG and Section 108 Third-Party Loans ....................................................................................................... 160 Noteworthy Issues in the Establishment of an Ongoing Secondary Market for CDBGand Section 108-Funded Loans .................................................................................. 166 Conclusion.................................................................................................................. 172

APPENDIX A: SAMPLING PROCEDURES AND WEIGHTS

APPENDIX B: THE ECONOMIC DEVELOPMENT FUNDING DATABASE

APPENDIX C: DATA COLLECTION METHODOLOGIES

APPENDIX D: REGRESSION MODEL RESULTS

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