RI State Government Banks Locally

RI General Treasurer Seth Magaziner well understands that what banks and credit unions do is accept money in from depositors and lend it out to borrowers, charging interest from borrowers and paying interest to depositors, and the amount of money they can lend is limited by the amount deposited with them. In a healthy economy, there will always be enough creditworthy borrowers to make use of available credit, so the choke-point of lending will be the limited amount of money to lend. The relationship between those who want to borrow and those who want to lend is a complicated matter of supply and demand, with interest rates rising and falling based upon the mix of potential borrowers.

One of the larger depositors in Rhode Island is the state government itself, and Magaziner said that he typically manages between a quarter of a billion and one billion dollars in cash in order to fund its operations, the amount varying because tax and revenue collections tend to happen during a relatively short few months while expenditures occur more evenly throughout the year. The state has to keep its cash safe in banks and credit unions, anyway, so Magaziner and his team realized that they could choose to allocate deposits strategically in order to encourage lending to small businesses with neither cost nor risk to the state. That realization led to the creation of the BankLocal program, where the state makes a deposit to replenish the supply of capital after a qualifying small business loan is made, allowing the bank to make another loan.

“When a bank is in the process of working with a small business owner to deliver a loan, they will also contact us, let us know that they have a loan in the pipeline that meets our qualifications, and then as soon as the loan is closed we transfer the cash. Our qualifications include: The loan has to be $250,000 or less, and it has to be to a business of 100 employees or less, that is located in the State of Rhode Island. We want to target this very specifically at small businesses in the state,” Magaziner told Motif.

“There hasn’t been any opposition, I think in part because we did our homework. We were very thoughtful about making sure that we did this in a way that was responsible where our risks would be managed. What we’re doing by moving state cash back home to local banks and credit unions is not a risky proposition because these are deposits that are federally insured – they’re insured by the FDIC, or by NCUA which is the credit union version of the FDIC. We require full collateralization of all these deposits. It’s also not the state who is picking and choosing which businesses get loans, we’re leaving that to… the experts at the banks and credit unions, to decide which businesses are worthy of lending to. Our role is just to make sure that the banks and credit unions have the capital to lend,” Magaziner said. “We have a minimum set of standards in our office for any bank or credit union that we would partner with, we won’t just work with any of them. They have to have a certain level of capital reserve, they have to have a history of profitability, they have to have positive return on assets. We have criteria of about six or eight different measures of soundness for a financial institution that we require for us to keep state cash with anybody, so not every local bank or credit union is one that we would partner with.”

Rhode Islanders are skeptical of state government, especially about employing assets to participate in the commercial market since the 38 Studios debacle – with which Magaziner had no involvement, beginning his service as General Treasurer in January 2015, nearly three years after the collapse of 38 Studios in May 2012 – and he emphasized that the BankLocal program was nothing like it. “The best mechanism and the biggest difference between 38 Studios is that, in this case, the banks are the ones at risk, not the state. If a bank makes a loan to a small business and that small business doesn’t succeed, the state’s deposits are insured and collateralized. The state doesn’t lose any money. It’s the bank that would take a loss, and so the bank has every reason to make sure that their underwriting standards are strong and that they’re not just giving out loans to anyone. That being said, every bank has a certain percentage of loans that don’t work out and that’s a normal part of the banking system.”

Small business borrowers face a much friendlier reception from local lenders, Magaziner said. “What we do know is that a small business is three times as likely to have its loan application approved at a small bank than at one of the big banks, and so what we want to do is help support these small lending institutions.” Why is there a factor of three? “Flexibility. If I’m a lending officer at one of the big banks, I’m working with a set of criteria that has been handed down to me from some central office somewhere a thousand miles away and I don’t have a lot of agency to be flexible outside of those parameters, whereas if I’m working at a smaller community bank or credit union, and a business comes that doesn’t fit into our normal parameters, it’s not a neat ‘cookie-cutter’ business, but for some reason I have faith in them and I think that they make a compelling case, I don’t have to try to call someone a thousand miles away to ask for an exception, I just need to go down the hall, probably, and talk to the head of commercial banking… I think a big part of it is it’s easier for smaller institutions to be more flexible when they are dealing with companies that don’t neatly fall into a pre-described box.”

BankLocal is a hands-on program for him personally, Magaziner said. “You talk to these small businesses – I’ve gone and I’ve met a lot of them – I was just visiting a couple of BankLocal businesses on Aquidneck Island last week. One of them is a kid who’s probably 28 years old who wanted to start a crane company, he rents out cranes to construction sites, and he was young… One of the big multinational banks that he went to first rejected him because he didn’t have enough of a track record, and they typically wouldn’t make a loan to an entrepreneur that didn’t have a track record running a business. But then he went to People’s Credit Union and the folks got to know him and learn a little more about his history, and were able to make an exception to their normal policy in order to give him a line of credit, and he has since gone on to grow the business and be successful. I think smaller institutions can just be more nimble sometimes.”

So far, Magaziner said, program performance has been stellar. “We require after the loan is made every year the banks send us a report on whether the loans are still active. Since we launched the program just under a year and a half ago, we helped more than 200 small businesses get loans in 35 different cities and towns across the state. I am not aware of any of those 200 loans going into default, but we get regular reports, regular updates from the banks and the credit unions, so we’re monitoring it.”

One downside at present is that there is no way for the public to monitor the program in terms of job creation or other metrics because the loans are between private lenders and borrowers. Magaziner explained, in response to our question, that he sees this is an evolving trade-off. “When we first launched a year and a half ago, we were very sensitive to not wanting to burden the banks or the businesses with a lot of paperwork that was unnecessary, so in the first iteration we were very light on the type of reporting that we were asking for. We really just wanted to know: ‘Is it a small business? Are they in Rhode Island? Is the loan performing?’ That sort of thing. Now that the program is up and running we’re starting to ask for more information, so we’re starting to ask ‘Tell us about these businesses? Who are they? What are they doing with these loans?’ and starting to piece those stories together. So, to answer your question, in the first iteration, version 1.0, we weren’t doing that kind of measuring but now we’re working on implementing better reporting so that we’ll have a sense on what the larger impact on the economy is.” He promised more public access to information in the future. “When we started out some of the banks and credit unions weren’t so sure that they wanted to reveal who their customers were who were benefiting from the program. Now we are going back to them and saying, ‘Okay, now that the program’s up and running and we’ve done 200 loans, going forward we’re going to start to require some transparency on who the businesses are.’”

The inspiration for BankLocal was the result of careful research in other states, Magaziner said. “The whole reason that I got into this was because I had a sense that the treasurer’s office could be a good platform to promote economic growth and job growth in Rhode Island, and in particular I wanted to find a way to help small businesses, so we looked at a number of different options when I took office. We looked at and spent a lot of time researching what other states and large cities do, and one of the models that we really liked was something that a number of Midwestern states do for agricultural loans to help farmers get access to capital.” There was no reason the idea was in any way specific to agriculture, Magaziner realized. “The vast majority of businesses in Rhode Island are small businesses and, as part of our work, as part of our research, we also spent a lot of time talking to small business owners about what the challenges are that they face in growing and expanding their business in Rhode Island, and access to capital was one of the issues that kept coming up. There are a lot of entrepreneurs who have the energy and the talent and the desire to grow and expand their businesses, but they have a hard time getting the loans. When we saw that’s what these Midwestern states were doing for farmers to help them with access to capital was they would have different versions of programs where they would move state cash to local banks and credit unions for local banks and credit unions to lend to farmers. We figured, let’s do the same thing here in Rhode Island for small businesses and that’s where the idea was born.”

When asked whether re-homing state funds into smaller, local financial institutions is good practice on its own merits, Magziner answered, “I do think so, I think generally that is a good thing to do and, keep in mind, in many cases these credit unions and community banks are small businesses themselves, so we want to support them, but we’re trying to do it in a way that also incentivizes small business lending because we feel that’s especially important and we know there’s a gap there. We know there are a lot of small businesses where access to capital is a real challenge.” The nimbleness of local lenders can make them more profitable, he said. “One thing that’s interesting, and in my previous job when I worked in the investment world I used to analyze banks, the stock valuation for the biggest banks – Bank of America, Chase, Wells Fargo – is actually lower than the stock value of your typical small-to-medium size bank. In terms of return [on equity] to shareholders, the smaller- and medium-sized banks actually tend to do better.” Magaziner described the health of the local banking and credit union environment as “Generally good. Rhode Island, like most places, we have fewer small banks and credit unions than we did a generation ago. There’s been a lot of consolidation in the industry, and even some of what we’re calling local banks are now owned – BankRI, for example, was recently bought by Brookline Bancorp in Massachusetts – so you’re seeing some consolidation, but generally speaking we still have a relatively vibrant collection of local banks and credit unions in Rhode Island.”

For more information about the BankLocal program, see: treasury.ri.gov/banklocal where small businesses seeking loans can find links to participating financial institutions (currently BankRI, Bristol County Savings Bank, Centreville Bank, Customer’s Bank, Home Loan Investment Bank, Navigant Credit Union, People’s Credit Union, Washington Trust).