It happens all the time these days: One bank merges with another, wiping out hundreds of local branches across the U.S. -- and the loan officers who know small businesses in their neighborhoods. But does it mean that local entrepreneurs have to start at ground zero to shop for a loan when a megabank absorbs an older and smaller one?

Recently, the U.S. Federal Reserve Board's San Francisco division took a look at the problem in California and found a mixed picture. At a time when local banks are disappearing, national or regional lenders -- those that target markets by direct mail and do business remotely -- appear to be filling part of the gap, the San Francisco Fed found. But many of those lenders are really credit-card companies.

The study is one of the first the Fed has undertaken to try to assess the impact of mergers on small-business lending. And it's handicapped by a lack of historical comparisons. The study is based on information about loans of less than $1 million -- data that have been collected only since 1996 under the Community Reinvestment Act, which looks for discriminatory patterns in lending. Traditionally, the CRA measured concentration of market share by looking at deposits.

Despite the lack of comparative data, other San Francisco Fed figures show a steady consolidation of the California banking industry: As of Sept. 30, 1998, there were 337 banks (excluding thrifts or holding companies) headquartered in the region -- 247 of them considered small -- with assets of $300 million or less. Two years earlier, the state had 7.7% more banks overall and 18% more small banks.

What do the figures show? Strong influence of nonlocal lenders, especially in small towns. As of 1997, some 70% of the small-business lenders in California were out-of-market lenders -- those that have no local branches in a given banking market. The Fed divides the state into 34 banking markets. But the study finds that out-of-market lenders account for only 23% of the total loan volume, and much of that consists of lines of credit from credit cards.

"REASSURING." That's not entirely bad news for small business, says Fed economist John Krainer, the study's co-author. Clearly, plenty of outside lenders are providing some resources to small communities with almost no bank service. "So, in some ways, that's reassuring," says Krainer. For instance, the California City market (which borders the Mojave Desert), only has two banks -- if you count those with a local presence. The number expands to 20, however, once out-of-market lenders are considered. In California City, out-of-market lenders control 70% of the dollar volume of small-business lending.

Apparently, though, local lenders are still active competitors in Los Angeles, which has 115 locally based lenders and 161 out-of-market loan makers. There, the out-of-market lenders control only 12% of the small-business lending. In all, small markets (where total deposits are less than $500 million) get 27% of their loan dollars from outside their home areas, vs. 15% for large markets (those with deposits of more than $3 billion.)

How are banks able to penetrate a lending market without physically being there? Technology. Using databases and low-cost, automated credit-scoring techniques, banks can target and solicit (via telephone and direct mail) new business anywhere. That's in contrast to the traditional loan officer, who might personally visit a business before signing off on a deal. With credit scoring, says Krainer, "you don't have to go out and kick the tires."

Although the Fed study suggests that the new realm of megabanks might not totally squelch bank competition in local markets, it's hardly reassuring for Malcolm Bush, president of Woodstock Institute in Chicago, which promotes bank reinvestment in low-income areas.

"We find it's the smaller banks, both in absolute terms and market share, who do the bulk of small-business lending in low and moderate-income areas," Bush says. As small banks get pushed out, he contends, those most likely to suffer are local business owners. "It's the neighborhood bank on the street that does lending other than by credit scoring," Bush says. That activity wasn't tracked in the Fed study because banks with assets of less than $250 million are not required to report CRA data. Another Federal Reserve study supports his observations. Using 1996 CRA data, the analysis shows that local banks surveyed made 60% of their smaller loans (less than $1 million) to small companies, while out-of-market banks made only 47% of small loans to their smallest customers.

Credit scoring, argues Bush, is simply a way for large banks to target the "cream of the crop" in a given community. The result, he adds, is that local lenders lose their best prospects to national banks. That adds up to a double risk for small companies that have come to rely on a friendly local banker.

By Dennis Berman in New York
dennis_berman@businessweek.com

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