The Wall Street Journal
By: Emily Maltby
June 21, 2010
Forget the improving economy. Entrepreneurs still find it hard to get loans. Here's why we're in this mess--and how we may get out of it.
The economy is on the mend. The government has launched a boatload of programs to get small businesses financing. President Barack Obama has urged banks to give the companies a "third and fourth look" before rejecting them for loans.
Yet entrepreneurs are still struggling to land credit. Only half of small businesses that tried to borrow last year got all or most of what they needed, according to a survey by the National Federation of Independent Business. In the mid-2000s, 90% of businesses said they got the loans they needed.
What's going on here? Why is the credit crunch alive and well when it comes to small businesses?
Part of the problem is that most of the government programs created to address the problem have focused on Small Business Administration loans, which total less than 10% of overall lending to small companies. But there's a wider issue at work. Banks and the government are trying to avoid repeating the mistakes that led to the subprime meltdown. It's a perfectly understandable goal--but it's freezing up financing.
Federal regulators, for instance, say they want banks to make prudent loans, even as the pressure to give out credit grows. Some banks, meanwhile, think many more businesses are bad risks these days, and they don't want to damage their balance sheets by making questionable loans.
There's also lots of finger-pointing. Some bankers say loan volume is down because demand is down; small businesses, they argue, are wary of taking on debt in uncertain times. Other bankers accuse regulators of pressuring them to curb lending, while regulators say banks are just making them the fall guy.
Stuck in the middle are entrepreneurs. During the downturn, many of them lost their credit lines and couldn't get access to other sources of financing, such as home-equity loans. Now that things are looking up, they're frustrated that they can't get the financing they desperately need. So, many of them are curbing expansion and hiring plans--and that, in turn, may be slowing the nation's recovery and keeping unemployment high.
Julio Valencia is one of those frustrated owners. In the past eight months, he has tried working with four large banks to land a $500,000 credit line for his young business.
He has been turned down each time, he says, because JTI Landing Systems, which fixes landing gear for commercial aircraft, doesn't yet have three years of financial history to show the banks.
Mr. Valencia, along with his business partner, have exhausted personal cash and retirement savings for start-up purchases and payroll. If his Las Vegas company can't land funding, it can't expand--and may even have to close, he says.
"If we don't have the cash flow to support our employees, well, no one works for free," Mr. Valencia says.
How We Got Here
The lending freeze stretches back to 2007, when the nation plunged into recession. In the first quarter of that year, more banks were tightening standards for small-business loans than loosening them, according to the Federal Reserve's quarterly Senior Loan Officer Opinion survey of large lenders. By October 2008, the percentage was up to 84%--roughly where it is today.
Along the way, of course, the housing bubble burst. Banks suffering from heavily weighted real-estate portfolios compensated by reducing--and in some cases eliminating--credit lines, while raising interest penalties. What's more, the secondary markets, where many lenders bundled their SBA loans and sold them to investors, clamped shut, so banks couldn't get enough capital to make new loans.
Every potential borrower suffered, but small businesses were particularly hard hit. In 2009, small-business loan portfolios at big banks dropped by 9% from the previous year--more than double the 4.1% drop for their entire lending portfolios, according to a recent Congressional Oversight Panel report. At the smallest banks, small-business lending portfolios fell 2.7%, while overall portfolios fell 0.2%.
Heeding Mr. Obama's call to increase lending, a few big banks have made ambitious pledges. Bank of America Corp., for one, announced a goal of lending $5 billion more to small companies this year than last.
Some small banks are making efforts, too. Lani Hayward, executive vice president of communications at Umpqua Holdings Corp.'s Umpqua Bank, in Portland, Ore., says the bank has gone "a touch further in extending credit" through its MainStreet Lending program, which gives applicants who would otherwise be rejected another review.
Ms. Hayward says about 30% of the loans that move through that program get approved. Still, she says, "it's not like we are opening the coffers. For the regulators' sake and our own sake, there needs to be a gatekeeper."
Who's Clamping Down?
Some banks, particularly smaller lenders, say they want to lend more. But they say they're being pressured to be more selective by too-strict regulators, who have stepped up oversight to ensure banks are well capitalized and have balanced loan portfolios.
For instance, the Independent Community Bankers of America, a Washington-based advocacy group, announced as part of its 2010 policy priorities that it would urge a "more measured approach from overzealous bank examiners so that they do not further exacerbate the current economic downturn and community banks' ability to aid recovery efforts."
Regulators, though, say they haven't been urging banks to adopt overly rigorous standards--they simply want the banks to be prudent.
"Sometimes the regulators are a convenient excuse for banks who really don't want to tell borrowers they can't make the loan," says Timothy W. Long, senior deputy comptroller and chief national bank examiner at the Office of the Comptroller of the Currency in Washington. "Deciding which borrowers the banks should lend to is not part of our examination process. We tell them to lend in a safe and sound manner."
He says the effort has worked. Banks are underwriting more carefully, he says, and marginal borrowers aren't getting the overly favorable terms they often did before the recession.
Some bankers, mostly at large institutions, argue that their standards--and federal oversight--haven't gotten stricter. "What has changed is the financial condition of most small businesses," says Kathie Sowa, a commercial-banking executive at Bank of America. "Few small businesses have not been impacted" by the downturn.
The bankers say few creditworthy candidates are walking through their doors despite signs of economic recovery. The requests banks are getting these days are "disproportionately from businesses that we would have a difficult time lending to with confidence we'd get the money back," says Marc Bernstein, who heads small-business lending at Wells Fargo & Co.
Some bankers also argue that loan volume is down because many businesses are choosing to go without funding. They say many owners don't want to take on additional debt during uncertain economic times and are opting to rein in spending and shave overhead. "Demand has been down," says Maria Coyne, executive vice president of business banking at KeyBank, a national lender operated by Cleveland-based KeyCorp.
Ms. Coyne believes that lending won't bounce back to the levels of years past because borrowers realized the dangers of assuming too much debt. "We saw America deleverage by hundreds of millions of dollars, and businesses did the same thing," she says. "They hunkered down. They got refocused."
Under the Microscope
Are small companies actually seeking fewer loans? It depends on whom you ask. Through the recession, the National Federation of Independent Business consistently reported in monthly surveys that the credit crunch was not the biggest issue for its constituency, because so many owners weren't seeking loans. Other small-business advocacy groups such as the National Small Business Association offer a different view. Although lower demand "may be a small part of the equation, the decrease in loans is more likely related to the terms and availability of such loans," said the association's 2009 end-of-year report.
As for the quality of borrowers these days, many businesses have undeniably become less creditworthy because of reduced sales, tighter cash flow, and lower credit scores from debts and slashed credit lines. But most business owners, like Mr. Valencia, don't view themselves as risky investments.
His company pulled in $2 million in sales last year, he says, and has received interest from some large international airlines. With credit access, he adds, JTI could hire 100 employees in the next four years. Without it, the company has had to shave its staff of 12 down to four.
"We spent quite a bit of money to procure machines and equipment," says Mr. Valencia. "I have the experience. I know what we're capable of doing."
Mr. Valencia says he is having trouble with cash flow, often a red flag for bankers. But he adds that the problems are stemming not from his financial mismanagement but instead from his customers who have been slower to pay--a point he thinks banks fail to take into consideration.
What Happens Next?
So far, efforts from the administration to spur small-business lending have fallen flat.
As part of last year's stimulus package, for instance, the SBA enhanced its loan-guarantee program, which gives banks more confidence to lend by reimbursing them in the case of default. The program eliminated loan fees for borrowers while increasing the maximum guarantee amount to 90% from 75%.
But such programs haven't proved as popular as hoped, in part because many banks are disenchanted with SBA lending programs. Particularly for community lenders, programs are too paperwork intensive and require personnel that banks can't afford. Streamlining the programs was one of the banks' top requests at a roundtable meeting with Mr. Obama in December.
Last week, the House passed a $30 billion initiative for community banks to borrow from the government at low rates. President Obama, who announced the idea last October, is encouraging the Senate to quickly pass the program into law. The president has also asked legislators to pass a regulatory overhaul and raise the limits on SBA loans.
There are other proposals on the table. Among other Democrats, New York Congresswoman Nydia Velázquez, who heads the House Small Business Committee, has proposed expanding the SBA's disaster-loan program, which issues loans directly to businesses in areas that have been hit by catastrophes. The agency, she says, could underwrite loans to small businesses that have not been able to get funding from banks.
The SBA has vehemently opposed this idea, arguing that it lacks the infrastructure to take on such a task and would not want to compete with the lenders that use their loan products.
Other proposals center on nontraditional lenders that don't work like banks and have more flexibility in lending guidelines.
Some politicians, such as Yvette Clarke, another House Democrat from New York, want to expand a Treasury Department fund that supports Community Development Financial Institutions. These groups, usually nonprofit microlenders, often have a mission to target people who don't qualify for traditional loans, provided the borrowers can ameliorate the risk. For instance, some CDFIs will lend to less-creditworthy people if they enroll in financial-education courses.
Similarly, the Small Business Intermediary Lending Pilot Program Act of 2009, sponsored last year by Sen. Carl Levin, a Michigan Democrat, would authorize the SBA to make direct, low-interest loans to 20 nonprofit intermediary lenders, which would then use the money to make loans of up to $200,000 to eligible small businesses.
Another proposal targets credit unions, which have boosted their lending through the recession. Legislation in both the House and Senate would let these nonprofits lend 25% of their assets, up from 12.25% under current law.
Meanwhile, Mr. Valencia and other hopeful borrowers continue to pound the pavement in search of financing. Until they can procure it, the promise of full recovery may continue to be out of reach.
"There are millions of us that are trying to get this economy back to where we were," says Mr. Valencia. "The government is not creating programs to support start-up businesses. It's irritating."
Ms. Maltby is a staff reporter in The Wall Street Journal's New York bureau. She can be reached at email@example.com.