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EDB: Big Plans For The ‘Little’ Bank

New Economic Development Bank President Maria Fuentes Pujols wants to double EDB’s loan portfolio to $300 million and expand services for small and medium-sized businesses.


April 19, 2001
Copyright © 2001 CARIBBEAN BUSINESS. All Rights Reserved.

Show me the money: The new EDB would accept commercial bank accounts, issue certificates of deposit, raise capital stateside, and provide more venture capital.

Maria M. Fuentes Pujols isn’t a car mechanic. But she knows that small and medium-sized businesses are the engines that move Puerto Rico’s economy. And she wants the Economic Development Bank (EDB) to be their preferred full-service station.

A former private-sector banker, new EDB President Fuentes wants the institution to become a real bank for small businesses. If she has her way, the small financial institution now primarily involved in extending loans to small businesses at preferential rates will soon be allowed to accept commercial bank accounts, issue certificates of deposits, and provide venture capital for small businesses.

Her goal: in four years double EDB’s loan portfolio to $300 million and to expand the venture capital fund to $40 million.

At present, the EDB has $50 million available for direct lending. The bank can make direct loans of up to $1.5 million, and up to $3 million when the Government Development Bank (GDB) agrees to finance the balance. The EDB can also guarantee up to 75% of any loan of $1.5 million or less obtained through commercial financial institutions.

The average EDB loan is $100,000 although $20,000 and $25,000 loans are common. The bank considers small and medium-sized businesses those with annual sales of $10 million or less. That’s about 90% of all businesses in Puerto Rico.

For example, the EDB has a $19 million agricultural loan portfolio, lent mostly to small plantain and banana farmers as well as to chicken farmers. The bank will now collaborate with the U.S. Small Business Administration (SBA) to offer businesspeople SBA guaranteed loans.

More products, more services

Although direct and guaranteed lending will continue to be EDB’s bread & butter business, Fuentes wants to expand the services it offers small and medium-sized business.

Appointed by Gov. Sila Calderon Jan. 10, Fuentes plans to go as soon as possible to the Legislature to seek an amendment to the bank’s charter so that the EDB will be permitted to accept commercial account deposits. At present, the bank can accept other financial institutions’ deposits but not those of individual’s or corporations.’ Some banks are occasionally making 30-day deposits at EDB, Fuentes said.

"Why shouldn’t our clients keep their regular business checking accounts and their certificates of deposits at EDB?" Fuentes queried, adding that she has discussed the idea with La Fortaleza Chief of Staff Cesar Miranda. She plans to iron out other details in future meetings with him. For one, she said, the EDB will not sell insurance as banks are now allowed to do.

Another top priority is to restructure EDB’s venture capital division so that it can take advantage of all government tax benefits and incentives just as the other non-government venture capital funds do. To take advantage of these incentives, Fuentes will create a venture capital subsidiary.

"Our mission should be to provide seed money to small entrepreneurs, those who need it most. That way we can reach more businesspeople. Large businesses have access to the large venture capital funds. We should concentrate on small and medium-size companies."

Fuentes’ vision is to invest no more than $1 million per company, instead of the former $3 million limit.

The EDB began its venture capital fund a decade ago. The bank currently has invested $29 million in some 20 important companies. The EDB’s largest venture capital investment is the $3 million given to Papri, the chicken processing plant, which has ceased operations temporarily due to financial problems.

To qualify for venture capital funds, the EDB requires that a business must create jobs and be sustainable, in other words, "that it makes business sense and that it has a future," according to Fuentes. Whereas the previous administration had a tendency to lend to technology companies, especially those involved in the Internet, such as e-commerce, Fuentes said she will promote all businesses, including manufacturing, tourism, service, and agriculture, "as long as they are feasible and create jobs."

EDB will offer venture capital for operations, expansion, management buyouts, or family successions where one of the heirs wants to purchase a family business.

To learn business basics, from writing a business plan to preparing a financial statement, those applying for EDB venture capital funds are being required to attend the Commerce Development Administration’s business school for entrepreneurs.

The conditions under which the EDB will offer venture capital are likely to change. Until now, the EDB had a subordinated debt, convertible to preferred stocks–what is known as mezzanine financing with rights to equity kickers or warrants.

"This was detrimental to the bank as most of the investments soured. This type of investment does not provide any rights to control the company or a more active participation in managing it," Fuentes said. She is not discarding this formula completely but is studying other alternatives to ensure loan repayment.

One alternative will be to require shares of the company and a seat on the board with voting rights, something that has never been done before. Fuentes is confident that the bank has the human resources necessary to determine what is the situation at each of the companies that has received venture capital funds.

"We want our venture capital investment to be active, not passive. We also want to have a staff of consultants in different fields who will go to each company that we consider is having problems, and advise them on what should be done," Fuentes said. "We also need a staff of auditors who will ensure EDB that everything is going as planned. We will be monitoring our investments much more than in the past."

The new EDB chief said companies should see their new policing role not as meddling, but rather as a added value in areas where they lack expertise. "After all, these are new companies and often the principals don’t know basic things which established businesspeople know well."

Show me the money

To pursue her ambitious agenda, Fuentes had determined she needed to raise $100 million to boost the EDB’s capitalization. She will have to do with less.

One option was to access the stateside capital markets through the GDB; another was to issue EDB capital notes. Both ideas have been nixed by GDB president Juan Agosto Alicea, who argues the government must first strengthen its finances before raising new capital.

Instead, Fuentes will have to do with the $50 million it now has, $15 million of which were transferred to EDB by the Commonwealth Agriculture Department and earmarked for agriculture loans. Another $10 million comes from loan deposits of a local financial institution and the rest was obtained from the bank’s limited resources, mainly from loan repayments.

What’s the reason behind an EDB capital drive? Fuentes needs to compensate for the imminent flight of all its remaining Section 936 deposits by 2003. And that’s no less than $1.25 billion.

The EDB’s main source of funds, which reached 70% of the bank’s capitalization since its creation in 1985, came from deposits stemming from Section 936 of the U.S. Internal Revenue Code. Section 936, which gave significant tax exemption to U.S. companies with manufacturing operations in Puerto Rico, will be completely phased out by Dec. 31, 2005. The 936 companies had pledged the deposits to EDB in exchange for a low tollgate tax, which averaged 2% to 3%, when repatriating earnings back to the States.

Section 936 funds deposited at the EDB will run out by 2003. The 936 funds deposits at the EDB were structured so that an outflow of $500 million was to be withdrawn by 936 companies between October and November 2000. Another $150 million was withdrawn last month. In November 2002, close to $500 million will be withdrawn and in 2003, between January and February, the remaining $100 million will be taken out of the EDB.

This leaves the EDB with $170 million in public corporation deposits and $28 million in collateralized capital notes. The bank has a $700 million investment portfolio vs. $150 million in loans. The dearth of 936 funds also affects the investment portfolio, making attracting private sector funds a key strategy.

Again, show me the money, please

This financial scenario leaves Fuentes with an urgent need to straighten out EDB’s

weak areas so that it will be judged solid by everyone, including the small businesses whose commercial accounts it wants to attract.

To that end, Fuentes wants to revamp EDB’s operations so that the institution is stricter about granting loans and collecting payments on loans in arrears or in default, without losing sight of the bank’s mission to be a development bank.

"As a development bank, the EDB must take the risks that private sector financial institutions don’t take," Fuentes told CARIBBEAN BUSINESS. "Its reason for being is to promote the establishment of new, or strengthen existing, small and medium-sized businesses that will promote economic development and create jobs."

Still, one of Fuentes’ top priorities will be to improve collections. Contrary to the norm in commercial banks, which try to keep loans with 90 days or more in arrears at 5% or 6% of the total loan portfolio, EDB’s 90-days-or-more arrears figure runs 28% to 30%. Loans in arrears of 29 or more days, which include those with more than 90 days in default, account for 40% of the portfolio.

"I am aware that this is a development bank, which naturally involves taking more risks than regular banks. The acceptable norm is 25% of the portfolio in arrears of principal and interest," Fuentes said, adding that a large number of the delinquent loans are more than 300 days in arrears.

"Many of these loans are very old. The law firms that had them for collection or legal action were very slow in taking action. Perhaps the bank did not follow up enough on the collection, nor on the legal action that the law firms should have taken." This led the bank to declare between 4,000 to 5,000 cases as losses over an eight-year period since 1993, totaling $60 million.

The amount of loan payments in arrears has also affected the bank’s capital venture initiative. The money used for venture capital comes out of the bank’s funds. This means that the high percentage of clients in arrears affects the availability of EDB venture capital funds.

Fuentes wanted an additional $15 million in the next budget for the EDB’s venture capital fund. "The bank is not producing enough money to allow us to set aside a substantial sum for venture capital without sacrificing other areas," she said. Again, Fuentes will have to make do with less; her petition was not approved.

The need to improve the bank’s cash flow will also require a revision of some of the loan programs. For example, agriculture loans automatically have a one-year payment moratorium. "There are cases where a client can immediately start paying the loan. Others may need a three-month principal moratorium but they can start paying interest immediately. Moratoriums will not be automatic from now on," she said, noting that loans usually are granted with seven- to 10-year terms. "We need to maximize our money so if some clients want a shorter term, we should grant it."

According to Fuentes, in the past too much importance was placed on lending–which she admits is the bank’s mission–and too little on loan repayment. "The fact that there were 40 persons in the loan division and only three in the bank’s collection department shows where the emphasis was. We must change credit policies, there must be more analysis before granting loans."

Vilma Pellot, the new executive vice president in charge of financing and development, said the EDB now has five collection officers, which will be increased to 15. These officials will collect active loans in arrears as well as those classified as losses.

Loans in arrears for 180 days or more, which the loan officer cannot get the client to pay, will be passed to the collections division. If there are no positive results, the EDB’s revamped legal division will take over. Last year, the EDB paid private law firms $1.4 million for collecting a meager $300,000, Fuentes said.

"We also want our legal division to handle all loan closings under $100,000, and by December, when we have simplified all the closing formats, all loans under $500,000 will be done in-house," Fuentes said. Her plan calls for EDB to have five lawyers, including legal division head Ivette Lopez.

One of the lawyers will concentrate exclusively on loan closings under $100,000. "We have to make closing documents standard because until now, each law firm used their own style. As a result, it is quite difficult to read through the documents with some law firms protecting EDB better than others," Lopez said. Both she and Fuentes were surprised that some law firms prepared 20-page closing documents for a loan under $20,000, using words and terms that some clients could not understand.

Last year, the EDB closed $46 million in loans, which estimated at 1%, plus the legal stamps that accompany the document, could mean clients paid $500,000 in legal closing

charges. "EDB will have substantial earnings and clients will be much happier because they will pay less," Fuentes said. She is also convinced that once the EDB does its own loan closings "we will be bullet fast."

EDB will handle closings under $100,000 beginning in July. Currently, the bank takes two to three weeks, from the moment the client comes in with all the necessary documents required to process a loan. It usually takes private law firms another month to do the loan closing. When the legal work is done in-house, Fuentes hopes to shorten the closing period to a maximum of two weeks, for a total of four to five weeks for a loan to be processed and closed.

"I want a very solid bank with loans in arrears within the parameters of a development bank. I want an agile bank–which we are, but could be better–which responds quickly to customers’ needs."

This Caribbean Business article appears courtesy of Casiano Communications.
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