Brand-New Businesses Find Bankers Friendlier
The bad news: Banks may be stinting on loans to small companies in the crucial expansion phase
By most measures, entrepreneurs should be happy as clams about financing. Rates fell last year -- and last week's quarter-point rise in the Fed Funds target rate doesn't appear to herald a serious credit-tightening. The market for initial public offerings has recovered. Venture capitalists have been pouring money into fledgling high-tech companies.
So what's not to like? A new Small Business Administration analysis of 1998 loan data suggests the agency has found a snake in the grass: Banks may be more willing to take risks on brand-new businesses than in the past, but they still turn a cold shoulder when asked to fund that crucial expansion phase, when most young companies need a big slug of cash to grow.
The evidence? The SBA observed that the number of loans under $100,000 increased nearly 20% year-on-year, while the number of loans between $100,000 and $250,000; and those between $250,000 and $1 million, each grew less than 2%. The aggregate dollar value or volume of small-business loans, (those less than $1 million), grew only 6.3% in the year ended June, 1998 -- compared with a 13% increase for loans greater than $1 million. The study, released last month, was based on Federal Reserve Call report data from 8,966 commercial banks for the year ended June, 1998.
Bruce Philips, director of the office of economic research for the SBA in Washington, doesn't find the data definitive. "We don't know whether in fact it is getting harder to borrow that kind of money," he says. But he is troubled: By lending to more small businesses, banks may diversify their risk -- and reap far more in fees -- he says. But many small businesses may still be shut off from larger expansion loans they desperately need.
Warren Heller, research director for Veribanc Inc., the Wakefield (Mass.) bank research company, says the slower growth rate of small-business loan volume compared with that of larger companies is hard to fathom. "For whatever reason, not as much new money was being advanced into small-business loans between 1997 and 1998, vs. the previous year," he says. "We would not have expected that because the economy appears to be very robust." Yet, he's not convinced the SBA's findings are cause for concern given that at 6.3% small-business lending is still growing much faster than the economy. "You can't keep grabbing more of the pie," he says. "That's unsustainable."
Some bankers say they're a little surprised by the SBA findings. Peggy Bradshaw, executive vice-president for SBA loan origination at Comerica Bank in Detroit, says the bulk of the loans her department makes are for capital expansion. Comerica's average SBA-guaranteed loan for 1998 was $238,000, down 1.6% from the previous year, in line with a trend for banks and nonbanks to make more of the smaller loans, she says.
The SBA data correlates, though, with the picture at Wells Fargo, a prominent small-business lender. Mike James, executive vice-president in charge Wells Fargo's business banking group, says Well's $7 billion portfolio of loans under $100,000 grew 20% last year, and it's the bank's fastest-growing small-business portfolio. He adds that the increase in entrepreneurs seeking loans for less than $100,000 dates back to the early 1990s, when the number of companies with revenues under $1 million began to explode. And it's a trend that's likely to continue, he says. Technological developments, such as computerized credit scoring and new marketing techniques, which let banks target the borrowers they want to reach, have made small loans quite profitable.
James's experience is in turn confirmed by Charles Taylor, assistant director for the Community Development Commission of Los Angeles County, which operates a federal- and state-subsidized $20 million small-business loan fund. In the past two years, he says, he has had to fight banks for the best candidates for loans under $50,000. "Two years ago, if you were looking for a $50,000 loan, you would not have been able to find a bank that wanted to do it, even if you were a good credit risk," Taylor says. Now banks are snapping up the best credit risks for smaller loans.
Of course, the economy has been so good for so long that many entrepreneurs have been able to finance growth through cash flow. But where does all this leave small businesses that may be looking for larger capital expansion loans when times get tough? "My understanding is small business is a growing force, it is a big employer, and the need for small-business financing would go along with the growth of small business," says Comerica's Bradshaw. That's a notion growing businesses would second enthusiastically.
By Jeremy Quittner in New York