Tightening the Credit Screws

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The Wall Street Journal
By: Emily Maltby
May 17, 2010

Community banks are still offering loans. But businesses have to jump through a lot more hoops to get them.

In the depths of the credit crunch, community lenders became a popular financing source for Main Street. But small-business owners may need to work harder to get support from local banks these days.

Even though most community banks came through the financial collapse in good health, with lots of capital and liquidity to extend loans, some of them have gone under. So, the Federal Deposit Insurance Corp., Federal Reserve and other regulatory agencies are increasing their scrutiny of local lenders to spot troubled assets and keep the banks in solid financial shape. As part of the effort, the watchdogs are asking the banks to boost their capital and loan-loss reserves even further--which means raising more money, getting more selective about making new loans and canceling the risky loans on their books.


The upshot for business owners: Local bankers now demand a lot more information about the business and its operations before they sign off on a loan. Entrepreneurs who land a loan need to give frequent updates about the state of affairs--and not just routine financial information, such as sales figures.


Bankers need deeper "information about what's going on with the business...for instance, if one of the [borrower's] customers is in financial trouble," says Kevin Tenpas, chief executive of Heartland Business Bank in De Pere, Wis., a part of Heartland Financial USA Inc. in Dubuque, Iowa.


Small-business owners who don't work closely with their lenders will find it much tougher to get financing. "I think it's even more important to have that relationship now than before," says Mr. Tenpas. "I think the tendency is for owners to not communicate if it's not good news, which is when it's most important."


Crisis and Opportunity


In the depths of the crisis, business owners flocked to community banks when large lenders turned them away. The Independent Community Bankers of America, a Washington-based advocacy group that represents about 5,000 U.S. community banks, reported in March 2009 that its members were acquiring customers faster in the depths of the credit crunch than before the crisis. At that time, only 11% of institutions surveyed believed the weakening economy had significantly curtailed their ability to lend.


Most local banks stayed stable for simple reasons. "They hold capital levels that can weather downturns, and don't leverage themselves as much as larger banks," says Paul Merski, senior vice president and chief economist of the community bankers' group.


What's more, most of the banks steered clear of subprime mortgages--and were cautious about handing out loans to local businesses.


As part of that, many of the lenders established close ties to the businesses, getting to know the operations so well that they could act as advisers to the owners and get a much clearer picture of the company's chances of weathering hardships.


But a sizable chunk of local banks weren't so cautious--and that's where the problems started.


Prior to the recession, a number of these lenders were lured into the real-estate bubble, and others didn't look closely at small-business borrowers, issuing loans on the basis of strong economic indicators rather than a company's actual financials or a longstanding relationship with the owner.


When the downturn hit, those bad loans came back to haunt the banks. The FDIC reported in February that more than 700 banks were on its "problem list" of institutions in danger of failing, the highest number in 16 years, and FDIC examiners have closed more than 220 banks since 2008, a significant number of which are community lenders.


Facing increased federal scrutiny, small lenders are much more reluctant to make loans based on promises and not hard data. Mr. Merski of the community bankers' group says that a recent, informal survey of 141 of its members shows that 28% have held back small-business lending due to the regulatory environment.


Tougher and Timelier


For an idea of how much things have changed for small companies that work with local banks, consider Brad Glaberson, owner of Seattle-based specialty-foods company Cucina Fresca Inc. Last September, Mr. Glaberson left EvergreenBank, a seven-branch lender in the Seattle area that had served him for 10 years. "My company was fine, but Evergreen had started changing," explains Mr. Glaberson, who had a $70,000 revolving line of credit with the bank.


The bank said it was going to close the revolving line of credit, and the current balance of $38,000 would change into a term loan, with higher interest rates. Once Mr. Glaberson paid it off, he would no longer have any credit lines left with the bank.


Up to that point, Mr. Glaberson says, his relationship with Evergreen was "hands off." He communicated with the bank on an as-needed basis, such as to make deposits or increase his credit line. But even in those cases, he says, the relationship was strictly with the bank's 800 number, rather than a specified loan officer.


After the news about the credit line, the relationship between Mr. Glaberson and the bank went downhill rapidly, and he sought out another lender. Evergreen, meanwhile, was closed by the FDIC in January after posting "significant losses in its acquisition, development, and construction and commercial real-estate loan portfolios as a result of weak real-estate conditions," says an FDIC representative.


Umpqua Holdings Corp.'s Umpqua Bank, a 176-branch lender in Portland, Ore., that acquired Evergreen, declines to comment on particular customers. But, says Lani Hayward, executive vice president of Umpqua's corporate communications, "when this credit crunch happened, community lenders didn't stop lending unless they were in trouble. And we are seeing the fallout of those that got in too deep with commercial real estate."


When Mr. Glaberson walked into Foundation Bank, a single-branch, Bellevue, Wash., lender, officers made it clear that he would need to put in extra effort to land a loan by giving them tours of his facilities, opening all his books and building a personal relationship with the loan officers.


Mr. Glaberson received a $102,000 credit line with Foundation Bank, but the work wasn't over. Each month, he is required to submit financial reports to the loan officers. "They want certain reports in certain ways, and banking and financial sheets are so much work for me," he says. But Mr. Glaberson makes those reporting requirements a priority, so that the loan officers are better equipped to defend his line of credit if regulators question it.


"It's in the character of the bank to step up for the client, but the owner has to work harder, too," says Diane Dewbrey, CEO of Foundation Bank. "It's not just about being transparent anymore, but about being more timely. If the fiscal year ends on Jan. 31, I can't wait until April to get the yearly reports. I need them in February."


The greater emphasis on consistent and timely communication holds true for thriving businesses, as well, such as Cucina Fresca, which recently tapped its credit line to launch a new Lazy Lasagna product.


"If you have good news to tell, tell it now because the regulators can show up on any given day," says Ms. Dewbrey.

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