Banks are caught between political rhetoric and fewer qualified borrowersJanuary 27, 2010 6:00 AM
by Heather B. Hayes
Illustration by Kerry Talbott
The small-business owners that Wayne E. Flippen sees every day are starving for capital. “What we’re hearing and experiencing is that it’s still a very, very tight lending market,” says the director of the Roanoke Regional Small Business Development Center. “I’m hoping that things will ease up in 2010, although so far we haven’t seen a lot of indication of that.”
President Obama probably had companies like these in mind when he recently told community banks they aren’t making enough loans to small businesses.
Virginia bankers say Obama’s lending push puts them in an awkward position. “One arm of the government is telling us lend, lend, lend, while the regulators are saying, ‘But don’t you make a bad loan,’” says David Pijor, chairman and CEO of First Virginia Community Bank in Fairfax. “It’s kind of schizophrenic, but we’re not going to make a loan just because someone asked us to.”
In fact, Virginia-based banks increased loans of less than $1 million for commercial and industrial purposes 4.1 percent in the first half of 2009 (the latest figures available), according to Charlottesville-based SNL Financial. On the other hand, real estate loans of less than $1 million were down 2.9 percent during the six-month period, a time when concerns about commercial real estate were rising. “The takeaway here is that there are banks that are still lending to small businesses,” says Chris Gill, director of SNL’s Banking and Professional Services Group. “However, they are being more conservative in their underwriting practices and going through more due diligence than they were before.”
Such prudent practices permitted 158-year-old Burke & Herbert Bank & Trust Co. in Alexandria to have its most successful year in 2009. Deposits rose 24 percent, and loans were up 15 percent.
“We’ve got capital to lend, and we need to lend it,” says Charles K. Collum Jr., the bank’s chairman. “That’s how we make our money. At the same time, we have opportunities to make deals today that we’re not making because we want to stay within certain limits that we have set for ourselves and other limits that the regulators have used as guidelines. Our capital is adequate. It’s good. We don’t want to deteriorate that.”
Facing two forces
Bruce Whitehurst, president of the Virginia Bankers Association, says banks are facing at least two countervailing forces as they’re being pushed to lend more.
For starters, there is more federal regulatory scrutiny of bank loan portfolios and their capital position. At the same time, fewer small businesses currently are qualified for bank loans, and many of the financing tools that small businesses once relied on, such as real-estate secured lines of credit, have been cut dramatically because of the real estate bust and the credit crisis.
“The universe of potential qualified borrowers has shrunk pretty dramatically, even as the universe of businesses that need some sort of a lifeline has gone up,” Whitehurst explains. “But banks are not typically in the lifeline business. That would have to come from venture capital, from interim financing, from loan guarantee programs, from some other source.”
In recent years, many businesses relied on those other sources for access to capital. In 2008, the non-bank financial sector provided two-thirds of total lending, Whitehurst says. These lenders included the CIT Group, which filed for bankruptcy last year, and the financing arms of the auto industry. Many of those sources, which charged higher interest rates and fees in exchange for taking on riskier loans, now have disappeared.
Pijor notes that the fallout from bad and risky loans made by both banks and non-banks has made regulators more critical than ever. For example, if a loan is secured by a depreciating asset, such as a commercial rental property that suddenly loses a couple of tenants, “there’s a lot of pressure from regulators to just take a loss on the loan,” he says. “Whereas in other times, you could wait for this loan to strengthen up again, to wait for new tenants to sign on.”
He says that the environment is frustrating because regulators are treating all banks alike, regardless of their past performance and lending history. “We don’t slice and dice loans and sell to Wall Street,” he says. “We make a loan to the guy whose business is across the street from us and we expect him to pay that loan back. And most of the time he does.”
Three factors for lending
The ability of a bank to increase its lending is contingent upon at least three factors, Gill says:
• Financial health: Banks that made bad loans during the economic boom still are rebuilding their liquidity and capital reserves. They have much less capacity to increase their small-business loan portfolio.
• Type of institution: Large banks typically have other sources of income, including securitized loans and banking fees, while the business models of small community banks largely rely on lending, predominantly to small businesses.
• Geographic region: Banks in areas with healthier economies and lower unemployment rates, such as Northern Virginia, are more likely to deal with healthy businesses, thus increasing the number of qualified borrowers.
Most banks are trying to adhere to the fundamentals of good lending practices, says John Neal, president and CEO of Bowling Green-based Union Bank & Trust. If a small business is turned down, the rejection has less to do with the credit and regulatory environment than it does with the financial position of the borrower.
“We not only want to be properly collateralized on a loan, but we also want to know how businesses are going to pay back the loan, and that’s where looking at cash flow and the business plan comes in,” Neal explains. “The reality is that people aren’t buying and spending as much as they did at one time, and we’re having to take that into consideration when we make any loan, but particularly a small-business loan.”
Hurdles and opportunities
None of this provides much solace for Flippen, whose Roanoke center is busier than ever trying to help small businesses. However, he sees a silver lining in the recent crisis. More owners recognize that they’ve got to return to fundamentals for their businesses to survive and thrive.
“Over the past 10 years, easy access to credit has been the way that most businesses operated rather than really concentrating on watching their cash flow,” he says. “Long-term, we’re hoping that small business owners will build up their reserves and be much more conservative in their estimates of the capital that they’ll need. That way, when the economy does start to really turn, business owners will be much more savvy about when and how to access capital.”