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Why Small-Biz Lending Is Still at a Crossroads

Traditional loans are still at a dribble for small businesses.

Wary risk managers, old-school underwriting standards, and banks still licking their wounds from the financial crisis are holding back significant movement in traditional small-business loans. 

“Traditional banks are in a bind when it comes to small business lending — they want to do more of it, but their legacy underwriting systems weren’t designed to accommodate it,” says Daniel DeMeo, CEO of Capital Access Network Inc., which specializes in small-business financing. 

One reason for the lack of change, DeMeo believes, is the weight banks continue to give business owners’ credit scores when evaluating eligibility for capital. “In general, they have an over-reliance on personal credit scores, which are not accurate predictors of business performance and a business’ ability to repay,” he says. 

It’s just one of many reasons small-business lending sits at a crossroads, even though various reports will have us believe there has been more activity between financial institutions and smaller companies. The reality is more complex.

Survey Says: Depends on Your Viewpoint
If you take into account all the financial surveys hitting the news, it seems like now is better than ever for a small business to secure a loan., a platform that helps small businesses find funding, reported in its December survey that approval rates from small banks increased almost 50 percent from a year ago and that larger banks have also been quicker to approve applications, accepting 14.9 percent at the end of 2012 compared to just 9.7 percent in 2011.

But how many small businesses are actually asking for loans? According to William Dunkelberg, chief economist for the National Federation of Independent Business, the answer is not many. And that’s OK with them: In an April report by NFIB, only 2 percent of small businesses said getting financing is their biggest problem.

In another recent report, the Federal Reserve’s latest survey of loan officers, 23 percent of banks eased lending standards in the first quarter of 2013, the highest increase since 2005 and up sharply from 7.7% at the end of 2012. 

Still, Dunkelberg says, that survey doesn’t poll the small community banks, which lack the access to cheap capital that larger lenders have. While he believes lending standards at community banks have eased since the financial crash, there’s been little change recently. “Small-business owners were slightly more optimistic during April but are generally still cautious,” he says. “More people believe that in six months, the economy will be worse than better. There’s a dim view of the future, and more firms are decreasing inventory. Almost 30 percent won’t expand because of political uncertainty.”

Money Up for Grabs
Before the financial crisis, in 2007, there was $13 billion ready to lend. Now, it’s a staggering $2 trillion, Dunkelberg says.

“This is lendable money. Everyone is cautious. No one is coming in and asking for money,” he says. “Only 4 percent of small businesses feel it’s time to expand — that’s a record low. More customers need to show up, and Congress needs to do something that makes people happy about what the future will look like.”

Ami Kassar, CEO and founder of MultiFunding, a contingency-based financing broker for smaller companies, agrees that demand isn’t as strong as people think, as small businesses are remaining very cautious. 

He offers that despite the fact that credit conditions have eased, banks are making fewer loans and that will probably remain true for the year ahead. In the meantime, Kassar suggests a solution would be for companies to get more organized with their books and be realistic about the money needed for shorter-term success rather than going after a mega loan.

Marc P. Palker, director of CFO Consulting Partners LLC and a member of the board of directors for the Institute of Management Accountants, believes a primary reason small businesses are struggling with credit access is they don’t have a relationship with their banker.

“Bank consolidation and the movement of personnel have shortened the period that bankers and small business owners spend together,” he says. “Small businesses have worked hard to survive. They lack the financial management skills to give the banker the information needed to properly structure the right credit facility for the future growth of the business and, at the same time, provide the risk tolerance sufficient for the bank to make the loan.”

When they do need a loan, CFOs should be prepared with answers to the following questions: What are the average days outstanding for your receivables if you are seeking an asset-based loan? What is the composition of your inventory? What percentage is finished goods versus raw material or work in process? 

“You do not need to be a savvy CFO to help your case for small-business lending, but you do need to be competent, with appropriate experience and continuing education to understand what the lender wants to know to approve your loan,” Palker says. “Bankers get financial reporting packages and tax returns for their files. What they need is a full understanding of how you do business, your customers, how fast customers pay, and the incidence of returns and/or disputes.”

According to Palker, small-business lending won’t see increased activity until small businesses adopt good accounting systems, timely reporting, and proven internal controls

“The use of interim statements, cash flow projections, and even budgets is a good indicator to a lender that the small business understands the needs of the lender and the information required to manage the finances of the small business,” he says. “Another thing that will lead to easier access to credit is the ability for a small business to comply with regulation.”

Barry Sloane, the CEO of Newtek, a non-bank lender to small businesses, says that the banking system is still undercapitalized and is in the process of shrinking balance sheets. So, despite the fact that credit conditions have eased, they are making fewer loans.

Many financial experts are quick to point out that more small-business owners are turning to small banks and nontraditional sources of capital to grow their operations

“During the tough times, alternative credit sources have become more sophisticated and creative to fill the credit needs of small business when a traditional bank has difficulty approving the credit,” Palker says. “These second tier lenders have become a good fallback position for traditional banks when lending to small business. In addition, government-backed programs have provided banks with products that assist small businesses with accessing credit; however, the process takes longer than most small business owners can tolerate.”

Keith Loria is a freelance writer who has written about everything from technology to corporate mergers to health care.

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