Easy Money: The Low-Rate Lending Bonanza
What's behind the glut of cheap money? Who's got it now? And how can you get some?
It used to be that entrepreneurs went to the bank to apply for a loan with hat in hand and maybe even a set of kneepads, in case the begging got really intense. Not anymore. This is the era of the low-grovel loan. A flood of new capital is heading for small companies, and it's not coming just from traditional banks. Any business owner who opens the mail is likely to find an offer for a credit card with a generous line of credit. Go on the Web and you can get almost-instant loans. You can also cruise through matchmaking sites with access to thousands of lenders and equity investors. Venture capitalists, backed by big institutions and pension funds, are handing out money at a record pace. "All the stars are aligned," says James D. Atwell, global managing partner for private equities at PricewaterhouseCoopers LLP (PWC). "There is a ton of money out there."
And it's cheap, too. Interest rates on commercial loans up to $100,000 fell to 8.82% during the second quarter, from 8.87% in the first quarter, according to the Federal Reserve, while rates on larger loans were rising. Even assuming the full brunt of June's rate hike by the Fed is passed along, you'd still have to go back to 1994 to find a better deal. Credit-card rates have fallen to single digits, too, as new issuers vie for your business by offering free airline miles, product discounts, and other goodies (page 24). Loan approvals have been cut from several weeks to less than a day.
It sounds like it's too good to last, and it probably is. Lenders are prone to boom-bust cycles in which they throw caution to the wind, only to pull back sharply when -- surprise -- many of the loans go bad. But for now, small borrowers have the upper hand, thanks to a combination of strong supply and weak demand. With the economy speeding ahead at a 4% growth rate, small businesses have less need for loans than in past years because they can finance much of their growth from profits. A PWC survey of America's fastest-growing small companies found that only 23% planned to get a loan as of late 1998. And the National Federation of Independent Business found in its May survey that only one-third of its members borrow regularly, a figure that has been dropping for 20 years. Few said that they thought it was particularly hard to get credit.
At the same time, there's a lot of new money available. Data released last month by the Small Business Administration show outstanding small-business loans reached $371 billion as of June, 1998, up 6.3% in 12 months. The actual number of loans rose 1.3 million, or 16.7%. Venture-capital investments hit $17 billion last year, according to PWC, up from $1 billion in 1991, which is part of the $175 billion in private equity chasing small companies. Startup financing from the federal Small Business Investment Co. program, which serves as seed capital for private loans, has tripled to $3.7 billion in four years. Then there's $37 billion in small-business credit-card debt outstanding, a 25% increase over 1997, says The Nilson Report of Oxnard, Calif., plus uncounted billions more charged on personal cards by owners of weak or new companies that cannot qualify for business credit.
One reason lenders are more willing to lend is that they no longer have to hold all the loans they make to maturity. Using tactics borrowed from mortgage markets, loans are being packaged by the hundreds and sold to institutional investors as AAA-rated securities -- which ostensibly means they have the same sterling credit rating as, say, IBM or General Electric Co. Sounds doubtful? Perhaps, but that's not the lender's problem: They pocket the fees you pay up front.
If it seems like lenders can't give money away fast enough, it's not for lack of trying. Take the new LoanWise E-commerce site, introduced late last month. It snaps through a small-business loan approval in just five minutes. A small-business owner can obtain an unsecured loan of up to $50,000 by electronically filling out a brief application. After it's submitted, credit history and possible lenders are almost instantaneously checked by computer. If the applicant qualifies, he gets the approval within a head-snapping matter of seconds. The money is available from American Express Co. or several participating banks in 24 to 48 hours. "It transforms the experience of getting a small-business loan," says Michael S. Grossman, chief executive officer of NetEarnings in Burlingame, Calif., the parent of LoanWise. "People don't think something like this is possible."
Other Internet financiers include Atlanta-based ebank.com Inc., launched in late June, which claims to be the first virtual bank targeting small business, and VentureShowcase.com, which plans to launch a new video matchmaking service for investors and entrepreneurs in July -- one step beyond the text-only Web pages (page 16). That's just the beginning. About 20 more banks will likely launch online operations aimed at entrepreneurs in the next 18 months, says Octavio Marenzi, research director at Meridien Research in Newton, Mass.
Traditional banks are responding with streamlined loan procedures, easier terms, and mass mailings. Technology helps them, too: Automated "credit scoring" and other computerized ways to assess risk have cut costs by reducing labor, research, and paperwork. Access to better small-business data also has made financing faster and easier. "Before credit scoring, there was no way a bank could make a $20,000 loan without losing money," says Amy A. Geogan, executive vice-president at Bank Boston Corp. Now, some banks can turn around a loan, using only a one-page application, in about 24 hours -- and for a fraction of the previous cost.
But there's a price to be paid. Bankers and venture capitalists say their rivals are driven by competition to make deals doomed to fail. Some lenders are pricing their product too low for the risk involved, and others are doing deals not backed by sufficient collateral. "It's a war for market share," says Craig Sheinker, president of Quantum Resources Funding, a New York City firm that buys accounts receivable. "Almost everybody is dropping rates, and almost everybody is doing airball deals."
Granted, that's good for borrowers in the short run. But over the long haul, it means lenders could lose big should the economy take a dive and drag many small companies under. Indeed, entrepreneurs could be overextended if they borrow too heavily based on revenues generated in boom times. "At the tail end of a strong economy, history tells us that people do deals they shouldn't do, and history tells us they will do it again," says Mike James, executive vice-president at Wells Fargo & Co., the No.1 small-business lender in the U.S.
The likely result: a swing of the pendulum back toward less favorable rates and stiffer terms as financiers, already holding bad loans, become reluctant to make new ones. The problems could be compounded this time because of the new lending techniques, such as business credit cards and credit scoring, that have never seen a real recession. "None of it has been stress-tested," notes William C. Dunkelberg, economist at the National Federation of Independent Business. The message for entrepreneurs is clear: Get it while you can -- and don't get used to it.
Which lenders have the best rates and terms for small companies? Click Online Extras at smallbiz.businessweek.com.
By Janin Friend
This article was originally published in the July 19, 1999 print edition of Business Week's Frontier. To subscribe, please see our subscription policy.
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