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Capital vs. Confidence

Banks say they want to lend to smaller companies, but credit remains tight. Is relief in sight?
Alix Stuart, CFO Magazine
March 1, 2012

Last September, Centennial Bank announced that the U.S. Treasury Department had granted it $1.8 million through the Small Business Lending Fund (SBLF). Jim Basey, Centennial chairman and CEO, says the Greenwood, Colorado-based bank was glad to take the capital, for several reasons. It came with a low interest rate (1% at press time) and few restrictions, other than confining loans to businesses with fewer than 500 employees and capping loan amounts at $2 million.

The recently recapitalized bank has been growing, with $70 million in business loans outstanding and an acquisition underway. But has the federal booster-shot led to any loans Centennial wouldn't have made otherwise?

"No," says Basey, without missing a beat. "We do the same credit screen on everything; we have to make sure every loan is done prudently." In fact, the bank places a great emphasis on relationships, so "if someone walked through the door whom we didn't know, we'd be pretty skeptical."

Over the past three years, getting capital into the hands of smaller businesses — a universe that can encompass almost any company not traded on a major stock exchange — has become a cause du jour for politicians, researchers, celebrities, and even, well, big businesses. (Starbucks, for one, is collecting donations from customers to fund microloans to entrepreneurs.) The federal government has launched multiple efforts to stimulate the process, including the $30 billion SBLF aimed at banks and the $1.5 billion State Small Business Credit Initiative aimed at local development agencies, all of which is intended to be lent out in conjunction with private capital.

Credit conditions are improving for small businesses.

Yet nothing seems to be helping — so far. Experts caution that it's still early to assess the results of the federal boosters, many of which have only recently left government coffers. Yet the outflow into the marketplace seems to be weak, for reasons that have virtually nothing to do with the availability of capital. "Quite honestly, I don't think banks want to lend right now," says Lawrence Manson, CEO of Nexgen Capital Partners, which advises banks on their investments. "You can have all the programs in the world, but it's not the cost of capital that is constraining [banks]. It's the inability of people to get comfortable with where the economy is going."

Michael Eldredge, CFO of the $16 million telecom company AST Technologies, might agree that it's all about confidence. His company recently received $5 million from PNC Bank on very favorable terms, but it didn't come easy, despite the fact that AST has seen revenue increase by more than 30% and EBITDA grow by more than 80% in the past year. Eldredge spent a year working with bankers to secure a $2.5 million, five-year loan and a $2.5 million revolver. Thanks to a positive audit, the bank agreed not to tether the revolver to the state of payables and inventory, but the company will report on those monthly to the bank. And there are personal guarantees attached to the loans that will likely be removed in about a year pending favorable 2012 financials.

In the end, things worked out well for AST, but Eldredge doesn't believe the spate of new programs had anything to do with it. "While there is more money out there," he says, "we either don't fit [many] banks' profiles, or the rules remain problematic and archaic and ultimately prevent banks from lending their money. But if you can demonstrate a history of meeting or exceeding your goals, that gives bankers a comfort level that you'll do what you say you're going to do." Also key, he adds, is developing a personal comfort factor with your bankers. "You have to form business relationships," Eldredge says. "We've worked with some of the people at our bank for years."

Banks unquestionably have money, and some companies are getting it, but what does that mean for small businesses in the current credit market? Here we survey the banking landscape for smaller companies, including assessments of what banks are doing to help and where some of the recently launched programs designed to improve the climate stand.

Small Business Lending Fund
This ambitious, one-year program aimed at smaller banks (those with under $10 billion in assets) was dogged by both procedural problems and low demand from banks, in part because small-business loan volume must increase in order to keep interest rates low. Banks applied for only $11.8 billion of the $30 billion Congress initially earmarked; just $4 billion in requests was ultimately approved, and then only to the healthiest banks. About half of those banks were former recipients of the Troubled Asset Relief Program, and were required to use the funds first to pay off that debt. That cautious strategy may keep taxpayers whole, but it puts the government in the position of lending to banks that in many cases don't really need the money.

So far, it's unclear whether or not that money is spurring any lending that wouldn't have occurred otherwise. In January, the Treasury Department reported that banks had collectively increased their lending by $3.4 billion over the program baseline; the trouble is that the baseline was an average of (generally low) 2009–2010 levels. Many had made progress even before they got the Treasury funds in
mid-2011. The banks have some incentive to increase qualifying loans to maintain a low cost of capital, but many say that's not a driving factor for them.


For example, the 140-year-old Blue Hills Bank, based in Hyde Park, Massachusetts, just launched its commercial lending division in early 2011, about a year before the Treasury granted the bank $18.7 million in SBLF funds. Starting with only $1.7 million in loans, "we don't need [to make] much more than $17 million in loans for us to fill the plate, and our business plans go far beyond that," says Stephen McNulty, longtime CFO of the $950 million (in assets) bank. "If there had not been [an SBLF], or if we had applied for it and gotten rejected, we still would have proceeded — and succeeded — with our plan."

Bank executives also acknowledge that much of their loan growth often comes from taking market share from other local institutions, meaning that the total pool isn't necessarily growing. The best-case scenario is that the money somehow creates a rising tide, where banks' overall health sparks more lending. "The thinking was that the capital was available, and while we didn't need it short-term . . . it sets a base for more-aggressive loan expansion in 2013 and beyond," says McNulty. Even if the money helps fund more bank consolidation, it could be helpful, he adds, since "one larger bank has the ability to provide more capital than two or three smaller banks."

How to get it: Businesses with fewer than 500 employees can qualify for the loans, with no revenue limits. The Treasury Department maintains a list of participating banks on its website. Note that, unlike the Small Business Administration process (described below), banks are not generally creating a separate category of "SBLF loans."

State Small-Business Credit Initiative
The $1.5 billion program (which ultimately dispersed $1.4 billion) is much smaller than the SBLF but has great potential, since the government is asking lenders to leverage the capital 10 times over. According to a recent Government Accountability Office (GAO) survey, recipients expect to use the funds to create or support 153 lending programs, ultimately fostering up to $18.7 billion in new private financing and investment. All but two states applied for the funds, and all were approved.

Perhaps most helpfully, the SSBCI is designed specifically to help generate nontraditional loans. California, which in October 2010 received $168 million (one of the largest tranches) in SSBCI funds, is channeling them through two programs in the form of loan guarantees. One of the programs, the California Small Business Loan Guarantee Program, is available for nearly any company that is considered "near-bankable." Loans (which go to California-centric businesses) can range from $5,000 to $2.5 million, and include companies with up to 500 employees.

The state's loan-guarantee program existed before the SSBCI was launched, says program director Merrill Stevenson, but "had pretty much gone dormant" in 2009. With the fresh infusion of funds, the program (propelled by local financial development corporations, or FDCs, that advocate for the companies) had convinced banks to make 110 loans through the end of 2011, and is hoping to hit 200 in 2012. "A lot of banks are hesitant about getting back into lending, but FDCs are working with them and that's helping," says Stevenson.

Other states are using the money, in part, to set up venture funds. Missouri, for example, has used $16.9 million of its $27 million in funding toward a state-run VC fund that has already invested $7 million in 18 small businesses, according to Treasury Secretary Timothy Geithner's October testimony to Congress.

Since the government has not yet set up a reporting system for this program, and since much of the money was only recently disbursed, little is known about its progress. The ambitious multiplier effect is one likely future disappointment; the GAO report noted that some recipients "expressed concern that achieving a 10:1 leverage ratio of private financing and investment to program funds could ultimately prove challenging."

How to get it: The funds are mainly administered by state-sponsored economic development agencies, so start your research at the state level (and, in a handful of cases, at the municipal level). Some of the programs, like Missouri's venture fund, have standard application cycles with universal deadlines; others are more ad hoc.

Small Business Administration Loans
The longest-standing federal program to aid small-business lending has had several good years, in part due to the same Small Business Jobs Act of 2010 that created the SBLF and the SSBCI. At the moment, though, it seems to be taking a hit, with the number of SBA-backed loans down about 50% in the last quarter of 2011, compared with the same quarter of 2010.

It's not that the SBA is being cheap. Andrew McCune, an attorney with McDermott, Will & Emery who helps arrange SBA financings for clients, says he has never seen the SBA so proactive at trying to educate the marketplace on its offerings and, in some sense, sell them to banks. (The SBA generally guarantees the vast majority of a loan that a bank deems risky.) But, as Nexgen's Manson notes, many banks are averse to even the hint of risk these days, and the guarantees do not change their minds.

One frustrated former CFO who has been pursuing an SBA-backed loan in the hopes that it will allow his company to acquire a small, profitable business in the Houston area says the program's inflexible criteria are obstructing his progress. "While money is available, the terms are so severe that it is next to impossible to qualify," he says. (He asked that his name not be used, as he hopes to work with the banks in the future.) One example: the bank will consider only tax returns from the selling business, and not the interim results, which show 40% growth this year. It also won't allow for adjustments to back out the current owners' personal expenses and reflect its higher real cash flow.


Collateral is another problem; the banks require it, "but will not utilize the existing $700,000 in inventory or receivables as collateral," since they deem it unsellable, says the former finance executive. Instead, they want a lien on his house. (The SBA website notes that it "will generally not decline a loan when inadequacy of collateral is the only unfavorable factor," but for all SBA loans, "personal guarantees are required from every owner of 20% or more of the business, as well as from other individuals who hold key management positions.")

One potential ray of hope emanating from the SBA is the increase in other types of funding the agency is promoting, beyond standard bank loans. The agency's budget indicates it is aiming to make more microloans available to "unbankable" entrepreneurs, while it is also crafting a new venture-like program. Parallel to all of that is the increasingly successful SBIC program, which lends money to private-equity firms at low rates for middle-market financing.

How to get it: The list of SBA lenders is on the agency's website (www.sba.gov). It's also worth poking around the byzantine site for some of the lesser-known alternatives.

Large Banks: Ready and Willing?
Government efforts aside, how easy is it for smaller companies to get a conventional bank loan or line of credit these days? The answer largely depends on whom you ask. Multiple sources indicate that credit is still tight for smaller companies. Between Q3 2010 and Q3 2011, the majority of finance executives polled in our Duke University/CFO Magazine Business Outlook Survey said they found borrowing to be about the same or slightly more difficult. Few said it was much more difficult, although those who did were concentrated in the under–$100 million revenue range.

Executives at the biggest banks counter that they are, in fact, aggressively seeking to lend to smaller companies. "We are all extremely motivated to extend more credit [to smaller businesses], and our people are very focused on it," says Robert Hilson, head of Bank of America's small-business segment, targeted at companies with up to $5 million in annual revenues. The dollar volume of new originations (including
credit-card-based debt) to such companies increased 21% last year, he points out, with loan-approval rates doubling in the past 18 months.

That growth has been bolstered by an internal reorganization and the presence of 700 newly hired small-business bankers in branches across the country. "We've always had people in our branches available to talk small business, but to be fair, we did not have the level of expertise in those banking centers that we have today," Hilson acknowledges. Such bankers still don't make the final decisions on loans, but "at the end of the day, they get paid for making good loans."

As far as credit standards, "I don't want to say our credit standards have loosened," Hilson says, but the improving economy is allowing loan officers to be "more accommodating" and look at variables like future orders and interim reports along with historical financials when assessing a client's ability to repay.

The same trend holds true at Wells Fargo, which saw new lending to companies with under $20 million in revenue rise 8% last year, to almost $14 billion, including a 40% spike in SBA-backed 7(a) loans for federal fiscal-year 2011. What drove the increase? "The quality of applicants has improved," says Marc Bernstein, head of Wells Fargo's small-business segment.

He sees the decline in lending over the past several years as a function of several factors. When the recession began, many businesses were carrying high levels of debt and faced declines in sales that made it harder to obtain additional credit. During the recession, "it's not as if we required something dramatically different, it was that the businesses coming in looked weak," says Bernstein. Now, loan approval rates are "the same as they were before the recession."

Those claims are supported by data from the Thomson Reuters/PayNet Small Business Lending Index, which measures the volume of new commercial loans and leases to small businesses. It was up 18% in 2011, hitting a four-year high in November (when the annual statistics were compiled).

The situation is frustrating, to be sure: piles of money (including hard-earned taxpayer dollars) are parked at banks, while many businesses starve for lack of funding. In the end, despite the positive statistics at the macro level, many individual companies are left feeling that they still can't get the money they need. In the not-too-distant future, the federal programs may live up to their lofty potential and create enough competition to spur banks to lend more readily. That certainly hinges far more on what's happening beyond the banks' vaults and approval systems. Says McCune: "Once there is more confidence in the economy, there is extraordinary liquidity available."

If things go well, that could be the understatement of the decade.

Alix Stuart is a contributing editor at CFO.




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