Bank lending to small businesses, moribund since the financial crisis, is finally starting to gather steam.
Demand for loans, which bankers say remained weak well after the recession ended in 2009, is picking up, and the industry is adjusting its business models to meet it.
"We are approving loans at the same rate as we did before the 2005-2007 bubble," said Marc L. Bernstein, head the small business segment and business direct lending at Wells Fargo. "I imagine business will pick up further. All indicators point to a very positive future."
But banks may want to act fast to take advantage of improving economic conditions. They have gained a reputation, justified or not, as being reluctant to lend to small businesses. And during banks' absence from the market, a number of nonbank, mostly online lenders have sprouted up.
According to those aspiring disruptors, a combination of factors including consolidation, overregulation and a failure to aggressively adopt emerging technology have severely limited banks' ability to meet small businesses' credit demands.
Regulation and a "hive of other issues" have left banks feeling "highly apathetic" about making smaller-size business loans, said Ryan Sullivan, a co-founder of CapFusion, one of the startups. "The financial crisis created this market."
Data compiled by Rebel Cole, professor of finance at DePaul University, indicates that the nation's top four banks, Citigroup, JPMorgan Chase, Wells Fargo and Bank of America, reduced small business lending by more than half in the wake of the crisis. And Federal Deposit Insurance Corp. figures show the aggregate dollar volume of banks' commercial and industrial loans of $250,000 or less remains 11% below its precrisis peak of $199 billion.
Statistics like those highlight a state of affairs that Karen Mills, the former administrator of the Small Business Administration, dubbed a "creditless recovery" in a working paper on small business credit she co-wrote with Brayden McCarthy in July.
"Every major survey of small business owners seems to point to credit access being a problem during this recovery," they wrote.
Community banks have always been more willing than their larger competitors to lend to small businesses, Cole said, but there are fewer and fewer of them around.
"Community banks are disappearing and that has profound implications for the economy," he said, linking ongoing softness in the employment market to a shortage of small business capital. "Small businesses have always done the most hiring but a lot of them can't get loans."
The amount of small business capital grew in 2014, but not nearly enough to jumpstart the economy, Cole said. "There was a slight uptick, ever so slight. But we'll need 10 times that amount just to get back to where we were in 2008."
The long-running perception that the industry simply refuses to lend to small businesses is a sore point for many bankers.
"There's this misconception that there is a lot of unmet demand out there, said Bernstein at Wells Fargo. "The percentage of businesses saying not all their needs have been met is at a historic low."
David G. Lucht, chief risk officer at the $565 million asset Live Oak Bank in Wilmington, N.C., acknowledged that some banks might have allowed their enthusiasm for small business lending to flag in recent years. But that phase has come and gone, he said.
"For a while, my belief was that commercial real estate was easier for banks than making a commercial-and-industrial loan to a small business," Lucht said. Now, banks are refocusing on small business lending in increasing numbers, he said. "I'm talking to a lot of bankers who are reentering the small business sector and trying to figure out how to do it profitably."
According to the American Bankers Association, the volume of small business loans outstanding which it defines as loans under $1 million has been increasing by an average annualized rate of 2% since the fourth quarter of 2012.
A monthly lending survey by online marketplace Biz2Credit indicated business loan approval rates at big banks hit a post-recession high in January. They approved 21.3% of loan applications, up from 17.8% in January 2014, Biz2Credit chief executive Rohit Arora said in an interview Friday.
This appears to be a propitious time for banks to turn their focus to small business. The National Federation of Independent Business' Optimism Index topped 100 in December, its highest level since October 2006. The index is drawn from participating members' responses to survey questions asking about their plans to hire and make capital outlays, as well as for information about inventories and earnings trends. For the January survey, NFIB said 1,663 businesses responded. According to Wells Fargo's most recent quarterly banking survey, optimism among small business owners is at a seven-year high. Just under half the business owners surveyed reported increased revenues in 2014 and about one in three plan increases in capital spending.
Lisa Stevens, the bank's head of small business banking, said increased optimism tracked by the survey is translating into more small business customers for her bank. The number of companies with their primary business checking account at Wells Fargo grew 5.4% between November 2013 and November 2014, Stevens said. The bank is entering the second year of an initiative to lend $100 billion to small businesses.
For a number of community banks, increased small business demand has translated into a sharper focus on making small-dollar loans.
Valley National Bancorp in Wayne, N.J., for instance, is reorganizing its lending operation to create a unit dedicated to making loans in the $5,000 to $100,000 range, according to Daniel Sorrell, a first vice president and community team leader at Valley, the $16.7 billion holding company for Valley National Bank.
Before the reorganization, Sorrell said, small loans were handled by a unit responsible for all credit under $500,000. Valley National bankers made a "remarkable number" of small business loans, Sorrell said, but smaller deals were sometimes sidelined while they worked on larger credits.
"We were treating $25,000 loans the same as $250,000 loans, and they're different animals," Sorrell said. "We want to give our smaller customers the same level of service as our biggest."
Royal Bancshares in Narberth, Pa., embarked on a similar initiative last year. The $733 million-asset company reported a record 68 commercial and industrial loans for less than $100,000. That averages $41,000 per credit, down from $44,000 per credit in 2013 and $61,000 in 2010.
While CEO Kevin Tylus said he doesn't expect small-dollar commercial loans to become a "driving force" in expanding Royal's loan portfolio, "there are plenty of good small companies" and offering them a streamlined application process is good business. "I'm pleased with the performance," Tylus said.
At Live Oak, Lucht said he is working full time on an effort to redesign the bank's loan processes with an aim toward making more loans in the $50,000 to $350,000 range. He called it his "number one priority."
Live Oak does little other than small business lending. Founded 2008, the company ranked as the second-largest SBA lender in the country last year, increasing originations by 72% over 2013 to $855 million, according to Lucht.
The No. 1 small business lender is Wells Fargo, and it, too, is pushing to make more loans. From October through December 2014 the first three months of the 2015 federal fiscal year Wells Fargo approved 1,145 SBA 7(a) loans totaling more than $413 million nationwide, a 13% increase in dollars and 31% increase in units from the same period a year earlier.
According to many observers, a good chunk of the firms borrowing from CapFusion and other online small-business lenders would not have qualified for bank credit. Indeed, Mike Schenk, senior economist for the Credit Union National Association a group with little love for banks said what alternative lenders have succeeded in doing is "broadening the market," reaching a different clientele rather than capturing business that would have otherwise gone to banks.
Sullivan, who started CapFusion in 2013 with partners Brett Elliot and BJ Adams, acknowledged the point, but he added that attitudes toward borrowing online are shifting. He predicted that a growing number of prime, bankable borrowers would begin to move "downstream" to alternative lenders to capitalize on the speed and convenience they offer. CapFusion receives the majority of its applications in the early morning hours or after 5 p.m., when most bank branches are closed, Sullivan noted. He expects the company's originations to surpass $25 million in 2015.
An increasing number of business executives are beginning to look online for funding, Biz2Credit's Arora said.
"Banking is one of the last industries that hasn't been affected by online discovery methods, but it is beginning to happen," Arora said. "For loans of $250,000 and less, the competition is going to get very interesting. Those who don't provide a good online experience are going to lose out. Banks have started moving in that direction, but banks are always slow."
Arora said many Biz2Credit clients opted to use his site even though they could have gone to a bank. He said more than two-thirds of his customers have been in business five years or more and their average credit score was north of 670.
Biz2Credit is more expensive than bank credit Arora said his rates range between 11% and 14% but he said customers get their money within three days of approval.
Sam Hodges describes himself as one of those prime borrowers to whom Sullivan and Arora refer.
As an investment banker, Hodges had raised millions of dollars for clients. But as part-owner in a chain of fitness centers, he struggled to get a $100,000 loan for new gym equipment. Hodges admitted the chain's accounting was complex, but said it was on solid financial footing with a clean credit history. Even so, no bank would approve a loan. The business was turned down over and over 96 times in all.
His difficulty financing the fitness chain resulted in an epiphany. Shortly afterward, he co-founded Funding Circle, the rapidly growing online marketplace small business lender that operates in the United Kingdom and United States.
In an interview last month, Hodges estimated that the five-year-old Funding Circle had made about $800 million of loans through 2014. For 2015, though, he forecasted a blowout year, estimating the company's originations would hit $1 billion for the 12 months.
Banks struggle with smaller loans that are not highly standardized, Hodges said. They excel at business credit cards, student loans and SBA lending, as well as large commercial loans, "but there is a big gap in the middle where fewer and fewer banks are playing," Hodges said.
Lucht at Live Oak agreed banks have difficulty matching online lenders' speed, but he said the added time banks take is largely a function of more rigorous underwriting. He added that he was skeptical of the data-driven underwriting processes employed by most alternative lenders.
"During a good economy, every loan works," Lucht said, adding he was not a believer in what he termed "score-and-go" models.
"I think it takes a little more than Big Data to make these decisions," Lucht said.
But Hodges said online lenders' credit metrics are approaching parity with banks. Funding Circle's credit losses are below 2% on an annualized basis, he said.
Credit unions have also made significant gains in small business lending the past few years, despite operating under a congressionally mandated cap that limits the size of their commercial portfolios to 12.25% of total assets.
Credit union member business loan portfolios have posted double-digit growth for four consecutive years, according to Schenk. The average loan size is $232,000. Small business lending "has been our bread and butter all along," Schenk said.