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"This is about us, as a region, getting smart about capital and capital development. This is something we need to be doing more proactively ..." - Sean Robbins, Thrive

Non-Traditional Sources Step Up to Fill a Gaping Hole in Regional Capital Access

May 17, 2010

The events that led to this capital crunch have been well chronicled. Lenders have pulled $700 billion in credit out of economy since the fall of 2008, when the bankruptcy of Lehman Brothers, an international financial services firm, revealed the depths of an unfolding financial crisis. In just one year, Wisconsin's non-performing commercial loans would more than double from $550 million to $1.3 billion, which mirrored the national trend.

The latest financial shoe to drop: $1.5 trillion in troubled commercial real estate loans that reach maturity before 2014, many of which could turn "toxic" in both large banks and smaller community banks. Commercial real estate loans make up 17% of portfolios at large banks and 42% at community banks, and the latter figure does not portend a robust economic period for small businesses.

Sean Robbins, executive vice president of Thrive, expects a tepid capital market for the next couple of years. "I think a big part of that goes back to the $1.5 trillion in commercial real estate loans that are still on the books in a lot of banking institutions around the country," said Robbins, who came to Thrive from the private sector. "Given that the number of non-performing loans has and will continue to increase over the next few years, there could be a lot of hold-back from the banking institutions."

This hold-back involves tighter underwriting criteria. Since the nation's financial crisis began, changes in underwriting characteristics such as loan-to-value and debt-coverage requirements have changed the lending game, according to Terri Preston, a principal with the accounting firm Baker Tilly.

For example, whereas banks once allowed people to secure loans at 85% loan-to-value, it's now restricted to about 75%. Where debt coverage requirements had been set at 1.10, they have steepened to 1.20, which means lenders are restricting the amount of funding a project can receive based on the amount of cash flow required for debt service.

"The banks are really trying to make sure they have a lot more collateral value in the properties when they are financing them," Preston explained.

In addition, borrowers are facing loan-loss reserves, the amount necessary to cover losses in the loan portfolio, in excess of four to six months. "That's a lot of operating capital to have tied up in the deal," Preston said. "It's happening on the federal side, too, because with the FHA loans, which are the insured loans from the government for real estate, they are modifying their reserve requirements as well."

With commercial development loans failing, Preston agreed that the credit crunch will be prolonged. She noted that banks are limited in how much they can have in each collateral type in their portfolio, and they are being told by their examiners that they need to shorten the amount in each stack — the real estate stack in particular.

"We're seeing a very uncomfortable trend where existing borrowers who have notes coming due, and normally would have just been revolved, are being asked to go elsewhere to refinance because the banks are being told that they have too much debt in that type of debt structure," Preston said. "We have very good borrowers with high credit standards that have to seek other lenders to take on their portfolios."

Filling the Gap
In the meantime, something has to fill the gap, which is where economic development financing tools come into play. Most of them occupy a very specific layer in the capital stack.

The Wisconsin Housing and Economic Development Authority, for example, had a record housing tax credit allocation last year to encourage housing and small business development, but the WHEDA allocations are expected to return to their pre-recession levels.

There also are $621 million in unused federal New Market Tax Credit allocations for Wisconsin, which promote economic development in distressed areas. At the moment, however, deal flow is weak and, thanks to the recession, the tax credits are less valuable.

Institutional investors purchase these credits, but they need to have a tax liability to take full advantage of them. "If they don't believe they will have the liability, those tax credits are less valuable," noted Brad Elmer, project director for Thrive.

Salli Martyniak, president of Forward Community Investments, a Madison-based community development financial institution, said CDFIs are becoming the "go-to" sources for micro-enterprise loans. The institutions, certified by the U.S. Department of the Treasury, lend close to home and have low default rates. There are 18 CDFIs in Wisconsin, and collectively they had $385 million in loans outstanding in 2008. "While some CDFIs may have been hit by the economy, it really has been through no fault of our own," Martyniak stated. "It's just because of what happened in the rest of the economy. It wasn't because we were making stupid loans."

Martyniak supports state legislation to incentivize investment in CDFIs. She noted that Pennsylvania is making $10 million available to CDFIs so the Quaker State can continue to lend to micro enterprises. "I think a lot of states are looking at the CDFI market to open up the flood gates, so to speak," she said.

Database Rescue
To help business executives and community leaders more efficiently navigate available gap funding, Thrive is developing a Capital Inventory Database for what Robbins calls "catalytic projects," those that add significant, long-term jobs and tax base to the region. Updated on an ongoing basis, Thrive's database will identify the various pools of capital that are available via all levels of government: federal, state, county, and local municipalities.

When the first phase of the inventory is rolled out in July, the data sets contained within will include program description and purpose, eligibility and geographic parameters, the amount of funds available, and contact information. Whether they are federal New Market Tax Credits, revolving loan funds at the county level, or municipal tax incremental financing programs, Thrive believes business people will be surprised at the sheer number of programs. "The local level will include TIF districts, so in Monona, for example, we'll show that the community has x-number of TIF districts, and it has invested a certain percentage of its total statutory limit, leaving x-amount of dollars available in these districts," Elmer explained.

Robbins said the available information is too voluminous and too scattered for business executives to quickly sift through, and the database will serve as a one-stop source. "We'll have all of this documented, and the value that Thrive will add is we will work diligently with community partners who administer these programs, and we'll understand how these programs work," he said. "As businesses come in, we can help them understand how the programs fit into their capital structure."

"This is about us, as a region, getting smart about connecting capital and capital deployment," Robbins added. "This is something that we need to be doing more proactively than we have in the past, and it's going to be something that through a recession, a recovery, or an expansion, will always be relevant."

Thrive Snapshot

The selected metrics provide insight into economic changes and the direction of the eight-county Madison region. When drawing conclusions about conditions in the overall region, it is important to note that economic trends may vary among individual counties. Furthermore, the size of Dane County's economy relative to other counties in the region often influences aggregate regional economic trends.

A large portion of sales and use taxes fall on tangible personal property and services, so changes in taxable sales provide one measure of spending activity. Above average per-capita sales suggest that a county captures more dollars from non-local consumers, local consumers are spending at greater rates, or the county has a large share of firms that sell high-cost products (automobiles). January & February per capita sales-tax collections were down in all eight counties in the Madison Region; the regional average fell by 11.2% and 14.5% in 2008 and '09, respectively.
According to the Wisconsin Realtors Association, annual home sales in Thrive's eight-county region increased between 2008 and 2009 in every county except of Rock, which experienced a decline of 3.6%. Annual figures for 2009 were influenced by fourth quarter sales that were 33% higher than the same quarter in 2008. The increase is attributed to several factors, including favorable interest rates and the first-time homebuyer's tax credit.

Capital at Work: The Highland Center

The Highland Center may not exist yet, but the idea behind it probably has occurred to anyone who enjoys local Farmer's Markets or finds something lacking in grocery produce that has been shipped across the nation or even the world.

The idea, which would start with a vegetable processing and freezing plant in Iowa County, has occupied a good deal of Rick Terrien's time of late. He's been imagining a place where the vegetables of local artisans can be prepared for consumption in a broader array of local venues, including hospitals and schools.

Terrien, executive director of the Iowa County Economic Development Corp., views it as an unfulfilled market opportunity. He's of the opinion that multiple plants could be built throughout Wisconsin and still not meet the demand. "I've been an entrepreneur for more than 35 years, and I've never seen the demand outstrip the supply of anything the way it does with the demand for local artisan food," he said. "There is no capacity to supply it."

To build that capacity, Southwest Cap, an anti-poverty agency, is seeking capital from a variety of sources to construct a 10,000-square-foot plant and acquire an IQF (individual, quick, frozen) freezer. The financing package might feature a gap piece that still is under negotiation, but it already includes a guarantee from the United States Department of Agriculture's Rural Development Program in Stevens Point. The program has placed an 80% federal guarantee on the loan, a move that helped the center buy down its rates.

The $3 million center project would be built on 2.5 acres in the Iowa County community of Highland, and current projections indicate that Southwest Cap would have to borrow roughly $1.8 million. "I wish everyone would guarantee my loans for 80%," Terrien said. "We could not do this without these alternative loan sources."

Thrive has played an invaluable role with the statewide contacts of Greg Lawless, its agriculture sector specialist. Among those contacts are people at the state Department of Agriculture, Trade, and Consumer Protection, including Secretary Rod Nilsestuen, and former Commerce Secretary Dick Leinenkugel.

In addition to exposing the concept to high-level state officials, Thrive offered Terrien a chance to speak at its 2009 annual meeting to explain his vision. "They have offered me a platform to talk about the project with regional and state players who can influence it," he noted.

A Plant for Plants
At the Highland Center plant, vegetables would be washed, sorted, and placed in a device that would freeze 2,000 pounds an hour (to start) and produce 1.5 million pounds of vegetables a year. The equipment would top out at about three million pounds per year.

While agriculture is a $59 billion industry in Wisconsin, the Highland Center's scale is nowhere near what Del Monte and Birdseye can offer. However, it's much larger than anything local farms have access to.

What about retaining flavor and freshness? "The vegetables actually are more flavorful than if they are trucked all the way across the country from California," Terrien stated. "You harvest them and you freeze them. The idea is like the old days with cheese plants because every five miles you had a cheese plant. I don't think we need one of these plants in every county, but maybe every other county."

The business model is a departure from the vertically integrated food system we've become accustomed to. It is a horizontal system that would include a number of hubs around the state, supplying local foods and being knitted together on a scale that begins to meet the demand.

In time, the plants will be spun off to local owners. While jobs would be family-supporting, they would generate significant job creation only if replicated as planned. The idea is to complete the "scary entrepreneurial stuff," Terrien said, and then get the plant up and running, prove the concept, and spin it off to someone or some group in the community. And then, do it again and again and again.

"We're looking at a co-op model," Terrien noted. "There is a very real possibility of an ESOP plan. The plants could remain in these communities for a few generations."

Terrien figures the same public schools that are jettisoning soda machines and fatty snacks would line up for higher-quality vegetables. "The Chicago school system serves over 400,000 meals every day," he noted. "That's a staggering amount of food and right now they know they could improve on it."

Terrien's partner in this food procurement revolution is Mark Olson of Renaissance Farm, an artisan producer of fresh herbs and vegetables in Spring Green. Olson, one of founders of, and an enthusiastic participant in the Dane County Farmer's Market, is part of the operator group that will lease the plant from Southwest Cap, establish it, and spin it off to local ownership.

"The entire community has been enlivened by this," Olson said. "We think there will be other economic spin-offs because of it."

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