The going rate on loans for small companies continued to fall during the fourth quarter, and there's no sign that banks are following through on their promises to tighten credit.

In its fourth-quarter survey, the Federal Reserve reports that the average rate on loans of up to $100,000 was 9.13%, down from a revised 9.59% in the prior quarter and 9.66% a year ago. Intermediate-size loans of $100,000 to $1 million cost 8.12%, down almost a half point from 8.60% in the third quarter and 8.76% in the fourth quarter of 1997.

What's more, rates for small companies continued to improve when measured against larger rivals -- companies borrowing $10 million or more. Small businesses always pay more because they're considered a higher risk than large ones, but the premium they pay is now 2.97 percentage points over rates for blue-chip companies. Typically, the spread has been well over three points. The premium for intermediate loans narrowed to under two points in the last quarter.

These figures show several trends, explains Warren Heller, research director at Veribanc, the Wakefield (Mass.) bank analysis firm. First, the two Fed rate cuts are trickling through the system, reducing credit costs to everyone. Second, banks are in hot competition these days. Add to that the incentive that fees on small-business loans are higher than those for large companies. Finally, Heller points out: "Today's small-business loan is different from 10 years ago. They're documented up the kazoo. There's collateral. Unless the bottom falls out of the economy, they're not risky loans." Others aren't so sanguine. A top official at Wells Fargo recently expressed concern that banks are being too generous with small customers.

That, of course, is the bankers' problem, not yours. In fact, the Fed survey shows key loan terms became more attractive this quarter, with maturities rising to an average of 165 days, from 156 days, on the smallest loans and with fewer loans subject to prepayment penalties.

Among the most generous lenders were branches and agencies of foreign banks, where the rate on the smallest loans fell to 7.99% (7.35% for loans from $100,000 to $1 million). These banks were also less likely to demand collateral or a call provision.

Small domestic lenders offered the worst rates, averaging 9.40%. But they gave the longest maturities on average -- 250 days on small loans and 409 days for intermediate deals -- and they were the least likely to demand a call provision. Are small banks trying to capture a niche with longer terms to make up for higher costs of funds? Maybe, but they could just be applying old-fashioned yield-curve economics -- the further out you lend, the bigger the risk and the higher the rate, Heller points out.

In any case, what makes the report so striking is that the Fed has been prodding lenders to tighten credit terms. And when the Fed conducted a survey of lending officers in November, they told regulators that they had indeed cracked down -- raising fears of a credit crunch.

But the figures tell a different story. Banks are evidently more worried about competition and their bottom lines than regulators.

By Rick Green in New York
rick_green@businessweek.com

To: FINANCE