Are banks courting danger in the small-business market? Some observers are starting to think so.

Armed with mass-marketing techniques and automated loan-approval systems, major banks across the country have cranked up their small- business lending, in some cases venturing well beyond their home markets.

Though the effort is producing some handsome loan growth, some bankers and consultants worry that the industry is taking on more risk than it realizes. Credit losses, they say, could pile up quickly in an economic downturn - and possibly sooner.

"In the fourth quarter of 1996 or first quarter of 1997 we will start to see some credit-quality problems," said Michael Chagares, managing director for the Washington-based consultancy Furash & Co. "There's too much money chasing too few strong deals."

Right now, the average delinquency for small-business loans is between 0.75% and 0.80% - low compared to other loan types, according to Darren S. Parslow, an associate for New York-based Financial Institutions Consulting. But, he said, this ratio is rising as lending increases.

"I personally see a lot of risk" in mass-marketing to small businesses, said Jim Dougherty, executive vice president of BankUnited of Coral Gables, Fla. "I'm a firm believer in having a local loan officer who's familiar with the local economy, the reputation of the individual, and has his finger on the pulse."

Charles Wendel, president of Financial Institutions Consulting, said that the 100 largest banks in the country have maintained prudent small- business loan standards.

But he said bankers could hit problems in a weak economy, because the automated loan approval systems banks use to credit-score loans never have been tested in hard times.

"This is the first time that banks have been relying to the extent they are on credit-scoring, which is untested in an economic downturn," Mr. Wendel said.

Les Dinkin, managing principal of NBW Consulting Group, said he didn't foresee any imminent credit-quality problems. But as the small-business fray heats up, more banks will book riskier credits, he noted. "The risk profile of the portfolios will rise, so there's potential for things down the road."

Bankers acknowledge that they are taking on more risk - and will take on more in the future - but say they are able to price and reserve sufficiently for the risk.

Indeed, Filomena Soyster, director of business banking for Fleet Financial Group, Boston, believes that credit-scoring and electronic loan monitoring are making banks more competent at managing risk.

"I believe that our management of small-business lending is better than ever, and that allows us to be more responsive to customers," she said. "We have precision gauges and tools with which we can measure risk more accurately than we could years ago."

Ms. Soyster said that delinquency on Fleet's roughly $3 billion small- business portfolio has been falling over the past two years. She said the portfolio could grow as much as 10% in the next 12 months.

Steven D. Hickman, director of small-business banking for Barnett Banks, Jacksonville, Fla., also expressed confidence in his industry's ability to control small-business loan risk.

Delinquency on his bank's $2.2 billion small-business portfolio - which could grow as much as 15% by next year - is 0.86%. That's about the same as last year, he said.

Mr. Hickman said the portfolio's good showing could worsen as the loans become more seasoned, but for now he sees their performance as proof that the bank could lend more liberally.

"I see banks taking on more managed risk," he said. "Shareholders are looking at revenue growth and portfolio growth, so you're going to see a lot more aggressiveness on the part of banks to take on more risk."

Mr. Hickman practiced what he preached last month by unveiling, in a pilot program, a new product: An unsecured, $50,000 line of credit for small businesses. The lines will be available systemwide July 1 and will be marketed as a preapproved product.

"I fully anticipate seeing some higher risk patterns to appear in that product line," he said.

But some industry observers were skeptical that banks are going to be able to measure all their risks all the time.

"Banks are better at managing risk than in the past," Mr. Chagares said. "But it would be foolish to say everyone's prepared, everyone's managing their portfolios properly and no one's going to get hurt."

Following the lead of Wells Fargo & Co., San Francisco, banks other than Barnett are looking at offering preapproved credit lines inside and, in some cases, outside their traditional markets.

But Huntington Bancshares has found, at least for now, that selling preapproved products by direct mail might be too risky, according to Jerry Whittington, vice president of the business service center for the Columbus, Ohio, banking company.

Last year the bank started a pilot program to sell preapproved credit lines by direct mail, he said. But the bank found it would have to lower its credit standards to create a mailing base big enough to generate a sufficient return on its investment.

"We found that if we were going to do that we needed to back off on our criteria," Mr. Whittington said.

David Benjamin, commercial card manager for First Union Corp., Charlotte, N.C., said that accepting losses is the price of admission for any bank that wants to be a nationwide player for small-business credit.

Since March, the banking company has bombarded 1 million small businesses in 20 states - including some outside its East Coast base - with credit card solicitations.

The bank hopes to double its small-business credit card portfolio within a year, to $40 million in outstandings, and ultimately offer its product nationwide.

"We look at the business card side of things not as a traditional commercial loan but closer to a consumer credit card product," he said. "You accept the fact that you're going to have losses and not manage it to a zero-loss base."

Mr. Benjamin would not comment on the bank's chargeoff forecasts for the card, but said, "If you price it high enough you can have losses of up to 5%, 6%, and not worry about it. If you price it too low, half a percentage can hurt you."

Banks can run up their risks even without going outside their traditional markets or offering preapproved credits. For example, Michael Stoudt of BankAmerica Corp., San Francisco, said he is perplexed about when a small-business loan applicant should be treated as a consumer and when as a company.

Banks, including BankAmerica, have been cutting the reporting requirements for lower-end small-business loans and focusing on the owner's financial history.

This approach may make sense; bankers and industry observers said smaller-end businesses behave more like consumers than corporations. But bankers said it's a slippery task to decide the dollar threshold.

"The question is, Where do you draw the line," said Michael Stoudt, senior vice president and senior credit officer for BankAmerica Corp.'s business banking division. "We haven't done this long enough to find where that line should be."

"If you have a $10,000 loan to finance a business and the plans fall through, you can get gainfully employed and pay off the loan," he added. "But if you were to borrow $100,000, the chances are more likely that you'll file bankruptcy."

Based on lessons learned from its four-year focus on small-business lending, BankAmerica is comfortable using a streamlined application process for credit lines of up to $50,000. But the bank says it wants to increase that dollar limit to $100,000.

Mr. Hickman said Barnett's $50,000 limit on the streamlined credit line also is educated guesswork.

"Most banks don't have enough chargeoff data to determine that cutoff," he said.

Mr. Dinkin of NBW Consulting said this should be a cause for caution.

"Small-business loans perform like consumer loans, but at the same time you are dealing with a lot more zeroes than on the consumer side," he said.

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