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If you haven't had luck landing a business loan or credit line from the big banks you've approached, don't expect your odds to improve any time soon. The Basel III guidelines, intended to prevent further financial crisis, will require lenders such as Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM), and Wells Fargo (WFC) to substantially increase the capital they hold against risk-bearing assets—up to five times what they are required to maintain today. In anticipation of the changes, which will start to go into effect in 2013, big banks are making changes to lending practices now. They're increasingly "terming out" small business lines of credit as they reach maturity, according to several lenders and intermediaries with whom I've spoken recently. To give you a quick sense of available alternatives, I've sketched your best bets:
1. Small Business Administration-Certified Nonbank Lenders. While only 14 exist, they have a grandfathered status from the SBA, which oversees them instead of state and federal bank regulators. This enables them to take on loans that competitors can't. These lenders focus on the SBA's 7(a) and 504 guaranteed loans, which top out at $5 million. Their employees target specific regions and industries, allowing them greater flexibility when performing underwriting. (While a generalist will rule out all businesses in a struggling industry as undesirable, a specialist who understands the sector knows how to spot sound businesses.)
"While the big guys still routinely reject applicants for their inability to show a positive year-on-year growth story over the past few years, we're nimble enough to look past that trend if the business remains profitable," says James Kim, Los Angeles-based nonbank lender Hana Financial's senior vice-president of small business lending. Kim notes that Hana's lending volume jumped 500 percent, from $9 million in 2009 to $54 million in 2010 (SBA fiscal year), making it the country's 33rd-largest SBA lender, according to the 2010 Small Business Administration National Lender Rankings.
2. Community Banks and Regional Lenders. The factors that give nonfinancial lenders an edge also apply to SBA-certified small and midsized lenders with less than $2 billion in deposits, which are also exempt from many of the capital requirements imposed by financial regulatory reform. A focus on local banking breeds industry- and geographic-specific expertise, which helps community banks avoid a cookie-cutter approach to analyzing creditworthiness. If your business is creditworthy, this is good for you.
SBA-guaranteed lending is also the focus of most community banking activity. Although the SBA sets specific guidelines for the type of applicants it deems creditworthy (including personal credit score, business profitability, and collateral requirements) and provides a 90 percent backstop, banks remain on the hook for the entire loan in the event that a default arises in the first 18 months. The downside of early default can be significant, so risk acceptance continues to vary from SBA lender to SBA lender.
Businesses in such hard-hit industries as restaurants or retail will have an easier time convincing a banker who has previously executed similar loans that they can pay back. The same applies for companies located in struggling regions with high unemployment or above-average foreclosure rates. Smaller lenders often specialize and can look past a national underwriting mandate to evaluate creditworthiness on a case-by-case basis, factoring in an owner's reputation within the local community.
3. Community Development Financial Institutions. There are over 1,000 registered CDFIs in the U.S., according to trade group Coalition of Community Development Financial Institutions. CDFIs can provide access to more substantive capital than the few-thousand-dollar microloans that most entrepreneurs associate with them. "The alternative-finance sector exists because there is a gap in the conventional market," says Edwin Hong, interim president of New York City-based CDFI Seedco Financial, who says Seedco's loans range from $50,000 to $750,000 for up to five years.
Most CDFIs require a business to have been operational for at least a year, with most successful applicants having been in business for three years to five years. You should know that all CDFIs require rigorous documentation and most have a regional focus. Unlike traditional banks, however, they are willing to work with you to gather and assemble clear financial statements as needed. Because of how they work, the process can be slower and capital can cost more. If you can get a loan elsewhere, you should. But CDFIs offer a good resource to those that traditional banks will not consider, including entrepreneurs with credit scores in the low 600s.
To find a CDFI near you, use Opportunity Finance Network's locator tool.