Banks And The SMB Lending Desert

There is almost no one working with or in small businesses in the U.S. today who is unaware of how extremely difficult the mainstream lending landscape has gotten since the credit crisis and ensuing recession.

The most common piece of gallows humor circulating among small business owners nationwide is the one that always has: banks are those places people and businesses go when they don’t need to borrow money.

Taken on its own as a piece of hyperbole, it is admittedly not that funny of a joke. It transitions into tragic territory when taken in concert with recent Wall Street Journal analysis that indicates that the biggest banks in the nations are lending less to small businesses than they were a year ago.

A lot less.

In the last decade, mainstream lending to small business has taken an almost 40 percent hit. According to DePaul University Finance Professor Rebel A. Cole, who did The WSJ’s analysis, the plummeting figures only tell one story: Big Banks “have essentially abandoned the small business market.”

Sort of. But banks have done what they’ve always done and entrepreneurs have done what they’ve always done: max out their personal credit cards to run their businesses. That’s been how businesses have started and sustained themselves for as long as cards have existed.

How Bad Is The Bleeding?

Loans, on the other hand, have been as scarce as hen’s teeth — unless you’re a small community bank or an alt lender.

According to WSJ figures, the 10 biggest banks in the U.S. — Bank of America, JPMorgan Chase, Citigroup, Wells Fargo, U.S. Bancorp, PNC, Capital One, TD Bank, SunTrust and BB&T — collectively lent $44.7 billion dollars to SMB in 2014, according to an analysis of the banks’ regulatory filings. That is down from both a decade ago and the 2006 SMB lending peak of $72.5 billion.

According to data by PayNet, a small business credit tracking firm, as of August of 2015 banks were the underwriters of about 43 percent of business loans, down from 58 percent in 2009.

Also on the decline is the size of the loans themselves. Between 1998 and 2008, the number of dollars lent out to small business each year was increasing by a 7.3 percent rate on average, according to Cole. That growth since 2008, however, has stopped and has now started turning into a very noticeable contraction.

It’s hard to know whether banks are lending less or businesses are asking for less given the state of the economy.

As of Sept. 30 of this year, banks held $598 billion in small loans, according to the FDIC. That is a 16 percent decline from the 2008 peak of $711 billion.

And this great contraction in lending is not merely a holdover of a weak economy or a banking segment terrified of lending after the credit crunch. Consumer lending has largely recovered and is now growing at pre-recession levels. Large business lending has also increased, growing by 37 percent during the same seven-year period that SMB lending has been shrinking.

Why The Banks Quit The Field

In short, big banks gave up on small business lending because it is a lot of work from an underwriting point of view (due to the extremely conservative regulatory environment) without a lot of down-the-line profit associated with it.

Jay DesMarteau, head of small business banking at TD Bank, notes that underwriting a small business is basically as complicated as underwriting for a larger firm.

“We all struggle to make money on the lending side,” he noted. “It’s a lot of work to try and find these little companies, underwrite them and manage the book, when the units are high and the dollars low.”

A spokesperson for JPMC concurred.

“You have to figure out a way to make a $100,000 loan make economic sense,” a JPMC spokeswoman said.

But there were – and are – always cards.

JPMC, like many of the larger banking players, rely on their business card product (Ink small-business credit card accounts) to handle a large portion of their SMB lending, with cards handling 90 percent of loans to SMBs with less than $1 million in revenue.

Cards cost less for the bank to issue than loans, and they are a popular bridge between big banks and small business customers. Small business spending on credit and charge cards is estimated to clock in at $445 billion this year, up from about $230 billion in 2006, according to First Annapolis Consulting Inc. The average SMB APR is around 12 percent, according to CreditCards.com.

Notably, all 10 banks that were part of the analysis commented that they were committed to finding a way to make small business lending happen.

Wells Fargo and Cap One both noted they partner with nonprofit lenders to provide SMB credit for firms that do not meet that traditional underwriting standard. Wells further reports having extended $50.9 million in investments and grants to nonprofit organizations that support SMB business development over the course of 2014.

BoA has developed a streamlined lending process to offer SMBs a line of credit from $10K-$100K that includes a review of checking and merchant payments processor accounts, as opposed to the more tedious process of reviewing years of tax returns and other financial statements.

Bank of America Small Business Executive Robb Hilson noted that the program was developed to fit a need for consumers who need something other than a card, which was the best they had before.

“If you wanted $10,000, $15,000 or $20,000 in credit, the option we would give you would be a credit card,” he noted. “If someone wants to buy a forklift, it doesn’t make sense to put it on a credit card.”

The Emerging Competition

As banks have retreated from the space, nonbank lenders have proliferated to fill the hole. According to PayNet’s data, nonbank lenders have seen their market share grow to 26 percent from 10 percent in 2009.

“At least 60 percent of our borrowers would fall into classic bank lending criteria,” said Rob Frohwein, chief executive of online lender Kabbage Inc.,

A borrower like Jorge Rodriguez, who owns a Peruvian restaurant in Los Angeles, was unable to get a loan from Wells Fargo, despite being a longstanding customer, The Journal reports.

“They wouldn’t even look at me as a viable client,” Rodriguez said.

Rodriguez was instead able to secure a $311,000 SBA loan for this remodel from a local community bank in 2011, with a recent rate of 5.5 percent.

When Rodriguez applied to Wells again in 2014 for a $25,000 loan for supplies, he was once again rejected. This time he went to an online lender to secure the funds, but with an interest rate about 80 percent. He was later able to refinance through nonprofit lender Opportunity Fund, with an annual rate of 12.3 percent, the lender said.

And Rodriguez’s experience was actually easier than it is for most, as he had been in business for sometime.

“It’s the early stage companies that are getting hit hardest by the credit gap,” PayNet President William Phelan said.

And just how hard small firms, particularly early stage ones, have been hit by a decade in a lending desert is clear in recent BLS figures that show just how slowed SMB growth has been of late.

The number of jobs created by new businesses fell 7 percent in the first quarter from the fourth quarter of 2014 on a seasonally adjusted basis. That is an 18 percent decline from a decade ago. And a decline that is taking place, the experts agree, because, quite simply, new businesses aren’t founding fast enough to replace the ones that are closing.

“Look at the rate of new-business formation, that’s fallen for a couple decades in a row,” Jason Furman, Chairman of the Council of Economic Advisers, said Tuesday at The Wall Street Journal CEO Council annual meeting. “Fewer and slower-growing startups limit the ability of new businesses to invent new products and services that could serve as boon for future economic growth.”

“I think when the fluidity of the economy is down, that does make it harder to have productivity growth,” he said.

This is all a big deal, given how vital small businesses are to the economy. According to the most recent SBA data, 99.7 percent of American employer firms are small businesses (fewer than 500 employees). Almost half of all private-sector employment comes from SBAs and 46 percent of private sector output is derived from them. Moreover, 43 percent of high tech employees work for SMBs, 98 percent of firms exporting goods are small businesses and 49.2 percent of private sector payroll is generated by smaller entrepreneurial efforts.

Given the very large part small businesses play in the U.S. economy, simply letting lending to the sector wither and die on the vine is not an ideal outcome.