What's Wrong With Small Business Lending?

Where will new jobs come from? Nobody knows, but most agree that small business lending is the key creating them. But lending to small businesses remains depressed. The New York Times covered the subject last summer in Small-Business Lending Is Down, but Reasons Still Elude the Experts—

Small businesses — those having fewer than 500 employees — employ half of all Americans and account for about 60 percent of gross job creation. Federal data indicate that lending to such companies fell to below $670 billion in the first quarter of this year from more than $710 billion in the second quarter of 2008...

How much of this reduction has been driven by

1. weaker demand for loans from small businesses?
2. a deterioration in the financial condition of small businesses during the economic downturn?
3. restricted credit availability?

Mr. Bernanke asked. “No doubt all three factors have played a role.”

We can not be surprised that the reasons for the decline in lending eluded the "experts" in 2010, including the geniuses at the Federal Reserve. In early 2011, the situation has not changed much, as reported by CNNMoney in Banks slashed small business lending by $43 billion—

NEW YORK (CNNMoney) -- The numbers back up what small business owners have been saying for two years: Main Street suffered a brutal credit crunch.

The total value of outstanding loans to small businesses plunged by $43 billion, or 6.2%, between June 2009 and June 2010, according to a report released this week by the Small Business Administration. That's a drop of $59 billion, or 8.3%, from June 2008.

Policymakers have made a big show of studying the small business credit crunch. The Federal Reserve hosted a series of more than 40 meetings across the country last year with small businesses, financial institutions, trade groups and regulators.

Its conclusion? The problem is "complex and multifaceted." That's what Julie Stackhouse, a senior vice president with the Federal Reserve Bank of St. Louis, wrote in the Fed report summarizing the input from the meetings.

The Fed's solution: America is going to have to brainstorm its way out of this one.

The total value of outstanding loans to small businesses plunged by $43 billion, or 6.2%, between June 2009 and June 2010, according to a report released this week by the Small Business Administration (SBA). That's a drop of $59 billion, or 8.3%, from June 2008. Both the SBA and FDIC assume that all commercial loans of $1 million or less went to a small business.

I hope your mental picture of "brainstorming" at the Fed is as entertaining as mine.

So, what is killing America's entepreneurial "can-do" spirit? Does the answer lie behind Doors #1 and #2 above? In other words, is demand for loans down because of a lack of customers? Or because struggling small businesses are not creditworthy?

Or does the real answer lie behind Door #3 — risk averse banks simply won't make the loans, as the SBA data seems to indicate. I have an anecdote to offer which may offer some insight into why the entrepreneurial spirit has been crushed in America. A correspondent sent me the true "real world" story below, but before you read it, you need to know about SBA-backed loans. From CNNMoney—

The SBA's own lending program, which doesn't make direct loans but insures qualifying bank loans against default, also dwindled during the recession.

The number of loans backed by the agency's flagship 7(a) program fell sharply from 2007 to 2008 and plunged again the following year. The total dollar value of the loans also plummeted, dropping 27% in 2009 to $9.3 billion.

A series of stimulus-funded SBA loan sweeteners that launched in early 2009 helped reverse the decline: SBA-backed lending rose in the 2010 fiscal year (which ended Sept. 30) to $12.6 billion, just shy of 2008's total. Those stimulus efforts were discontinued on December 31.

And now the story.

It is all for the greater good: free money for the banks, full payment for their worthless assets, direct bailouts, hollow reform legislation, 100 millin dollar bonuses. We are told that the important thing is that the banking system be protected from failure at any cost.  Our economy depends on the banking system.

But the following story is from the real world.  A small business owner—let's call him Frank— with a sound business plan and solid investors, was trying to create fifty jobs in a high-unemployment area. Frank wanted to start an industrial laundry in a region that badly needed one. He learned firsthand how the system really works. 

First, Frank put together an investment group of high net worth individuals with perfect credit records. These investors contributed over one million dollars to start this business in a depressed part of North Carolina. His business plan called for the immediate hiring of fifty full time employees with good hourly wages and benefits.

He obtained over one million dollars of local economic development money from the County for infrastructure. He got a great deal on a building and land for the plant   He obtained subsidies for his a solar energy array to help lower the plant's energy footprint. He got a great deal on used equipment. He obtained hiring grants from Recovery Act money. He got signed long term contracts from customers.

Frank went to the SBA, the script-perfect small business entrepreneur. The SBA approved the underwrting of the loan. At first the SBA was offering 50% guarantees to the banks, then Congress raised it to 90%. The SBA lender, a community bank, gave verbal approval to the loan. Why wouldn't they?  A perfect plan, plenty of collateral, and a loan guarantee from the U.S. of A. How could they lose?  The businessman began construction, purchasing and hiring. For seven months the bank asked for (and got) more and more documentation, including personal guarantees from the investors, appraisals of the equipment, and even more signed contracts from customers. The man dotted every I and crossed every T. He did everything he was asked to do.

Frank had resigned from his job and worked for a full year without salary to put this business together. He is not a wealthy man, and had dipped into his own savings to do so. It is often said that lenders and investors are hesitant to loan money to startups unless the founder has "skin in the game." The lender could not use that excuse to deny this business loan.

So far, so good. Then what happened?

Eventually, failing to find any reason to deny the loan, the bank simply told him they had changed their mind.

They were not comfortable with an industrial concern in a rural area, they said. In reality, it was clear that they had never intended to lend the money. The company of course cancelled its plans.

Fifty employees will not be hired.

The next time you think about small business lending, think about Frank's personal sacrifices, his futile attempts to do everything required to get a new business off the ground, and those 50 jobs in a rural North Carolina that were never created.

Is this a great country or what?

Comments

[sharonsj]

It isn't only that the banks are risk adverse. Thanks to funny accounting, these banks are probably not solvent and can't loan out money the don't have. I'm reading that if there was a run on any local bank, there just isn't the cash to cover the withdrawals.